B.

Com-Commercial &Company law

B.Com.

Second Year
Paper No. IX
COMMERCIAL LAW AND COMPANY LAW

BHARATHIAR UNIVERSITY
SCHOOL OF DISTANCE EDUCATION
COIMBATORE – 641 046
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CONTENTS

Lesson Page
No.
1. Nature and Kinds of Contracts 5
2. Discharge of Contract 19
3. Remedies for Breach of Contract 35
4. Offer 47
5. Acceptance 59
6. Bailment 67
7. Pledge 81
8. Contract of Sale of Goods Act 1930 87
9. Rights and Duties of a Buyer and Seller 101
10. Company form of Business – On Over View 108
11. Formation of a Company 121
12. Memorandum of Association 133
13. Doctrine of Ultravires 149
14. Articles of Association 156
15. Prospectus of a Company 169
16. Shares 185
17. Debenture 196
18. Directors 205
19. Company Secretary 224
20. Meeting 234
21. Winding up - Compulsory Winding up by the Court 248
22. Winding up - Voluntary Winding up 262

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SYLLABUS
PAPER IX COMMERCIAL LAW AND COMPANY LAW

Objective : To enlighten the Students Knowledge on Commercial and

Company Laws.

UNIT - I
Law – Meaning – Law of Contract – Definition – Classification of Contracts –
Essential Elements of Valid Contract – Discharge of Contract – Remedies of
Breach of Contract – Offer – and Acceptance – Legal Rules relating to Offer and
Acceptance – Revocation of Offer and Acceptance.

UNIT - II
Bailment and Pledge – Essentials of Bailment – Rights and Duties of Bailor and
Bailee-Pledge-Essentials-Rights and Duties of Pawnee. Contract of Sale of Goods
Act 1930 –Rules regarding Delivery of Goods – Rights and Duties of a Buyer and
Seller.

UNIT - III
Company – Definition-Characteristics – Kinds – Privileges of Private Company –
Formation of a Company – Memorandum of Association – Meaning – Purpose –
Alteration of Memorandum – Doctrine of Ultravires – Articles of Association -
Meaning Forms – Contents – Alteration of Articles – Doctrine of Indoor
management.

UNIT - IV
Prospectus – Definition – Contents – Deemed Prospectus – Misstatement in
Prospectus - Shares and Debentures – Meaning – Types – Director and Secretary
– Qualification and Disqualification – Appointment – Removal – Remuneration –
Powers, Duties and Liabilities.

UNIT - V
Meeting – Requisites of Valid Meeting – Types of Meeting – Winding up – Meaning
– Modes of Winding Up.

Books for Reference

1. N.D.Kapoor, “Business Law”, Sultan Chand & Sons, New Delhi 2005.
2. R.S.N.Pillai & Bagavath, “Business Law” S.Chand, New Delhi 2005
3. Bagrial A.K, “Company Law”, Vikas Publishing House, New Delhi
4. Gower L.C.B, “Principles of Modern Company Law”, Steven & Sons, London.
5. Ramaiya A, “Guide to the Companies Act”, Wadhwa & Co., Nagpur
6. Singh Avtar, “Company Law”, Eastern Book Co., Lucknow.

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LESSON-1
NATURE AND KINDS OF CONTRACTS

CONTENTS
1.0 Aims and Objectives
1.1 Introduction
1.1.1 Definition of law
1.1.2 Object of law
1.1.3 Classification of law
1.2 Contract
1.2.1 Meaning
1.2.2 Definition
1.3 Law of contract
1.3.1 Purpose of the law of contract
1.3.2 Definition
1.3.3 Nature of the law of contract
1.3.4 Components of a contract
1.4 Classification of contract
1.4.1 Classification according to Validity
1.4.1 (a) Essential elements of a valid contract
1.4.2 Classification according to formation
1.4.3 Classification according to performance
1.5 Let us Sum Up
1.6 Questions for discussion
1.7 Model answer to check your progress
1.8 References

1.0 AIMS AND OBJECTIVES

In this lesson, we discuss the meaning, objectives, classification of law,

definition of contract, classification of contract and essential elements of valid
contract. After going through this lesson you will able to

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1) know the meaning of Law

2) understand the definition and classification of Law
3) understand the definition of contract and classification of contract
4) study the essential elements of valid contract

1.1 INTRODUCTION

The word law is a general term and has different connotations for different
people It is not possible to give a single, accurate definition. In general law
includes all the rules and principles which regulate our relations with other
individuals and with the state. Here, we discuss the definition of Law, objects
and classification of Law.

1.1.1 Definition of Law

Professor Holland defines law as the external rule of human action enforced by
sovereign political authority. In case of inanimate objects, they are governed by
law of nature. In the words of Salmond, “Law is the body of principles
recognised and applied by the State in the administration of justice.” Law is not
static, as circumstances and conditions in a society changes, Laws are changed
to fit the requirements of the society.

1.1.2 Object of Law

1. The object of law is to establish socio-economic justice and remove the
existing imbalance in the socio-economic structure.
2. Law has to serve as a vehicle of social change and as a harbinger of social
justice.

1.1.3 Classification of Law

Law can be divided in to substantive law and Procedural law. Substantive law
speaks about substantial rights and duties of parsons to enter into transactions.
Procedural law speaks about procedure to be followed. Further, Law may be
broadly classified as private law, public law and personal law.
Private law deals with laws that are applicable to and among individuals in
society. Personal laws are laws that are applicable to various communities
pertaining to marriage, divorce, adoption, succession and inheritance, etc.
Public law deals with matters pertaining to rights of the individuals versus the
state, rights of the state versus centre, rights inter se amongst states.
Mercantile law is that branch of law which is applicable to mercantile
transactions. Commercial law is quite essential for anyone who desires to have a
basic knowledge in respect of commercial transactions like sale of goods,
guarantee, bailment, agency, partnership, insurance and negotiable instruments

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1.2 CONTRACT

A contract is an agreement made between two or more parties which the law will
enforce. In this section, we discuss the meaning and definition of contract
1.2.1 Meaning
Contract is an agreement between two or more parties mentally agrees upon
doing or not doing a particular work.
1.2.2 Definition

William : “ a legally binding agreement between to or

Anson more persons by which rights are acquired
by one or more to acts or forbearance on
the part of the other or others”
Savigny : “the union of several persons in an
accordant expression of will with the
object of creating an obligation between
them”
Salmond a contract is “an agreement creating and
defining obligations between the parties.”
Commercial transactions are made by parties who do not expect contingencies of
failure with regard to fulfilment of the obligations. It is only when parties to the
transactions refuse, omitted or unable to fulfil their obligations; the question of
forming a contract with legal terms becomes essential. In this connection, the
ingredients of commercial obligations cannot be converted by parties into legal
obligations, according to their own convenience. Hence, it is very important that
the basic ingredients of a contract must be known to everyone.

1.3 LAW OF CONTRACT

Its rules define the remedies that are available in a court of law against a person
who fails to perform his contract, and the conditions under which the remedies
are available. The law of contract is the most important branch of commercial
law .It introduces definiteness in business transactions and determines the
circumstances in which promises made by the parties to a contract shall be
legally binding on them. In this section we discuss definition of law, purpose of
law and nature of law.
1.3.1. Purpose of the law of Contract
The purpose of the law of contract is to ensure the realisation of reasonable
expectation of the parties who enter into a contract. Agreement enforceable by
law becomes contract. All contracts are agreements and obligations but not vice
versa.

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1.3.2 Definition
John Salmond “the law of contracts is not the whole law of agreements, nor is
it the whole law of obligations, but it deals with those
agreements which create obligations and those obligations is
which have their source in agreements”
1.3.3 Nature of the law of Contract
The law of contract differs from other branches of law in an important respect. It
does not lay down a number of rights and duties which the Law will enforce; it
consists rather of a number of limiting principles, subject to which the parties
may create rights and duties for themselves which the law will uphold. The
parties to a contract, in a sense, make the law for themselves. So long as they do
riot infringe some legal prohibition, they can make what rules they like in
respect of the subject-matter of their agreement, and the law will give effect to
their decisions
1.3.4 Components of a Contract
Contract essentially consists of two elements viz., a) agreement and b)
obligations.
1.3.4.(a )Agreement:
When the person to whom the proposal is made signifies his assent thereto, the
proposal is said to be accepted. A proposal, when accepted, becomes a promise.
Every promise forming consideration for each other is called as an agreement.
An agreement is an accepted proposal there must be a proposal or offer by one
party and its acceptance by the other. The Law of Contract does not exhaustively
deal with all types of agreements
i) it does not deal with agreements which destroy rights.
Example:
Surrender deed. When rights are surrendered there is nothing to be enforced.
(ii) it does not deal with agreements which transfer rights. Example:
Assignment deed. When rights are assigned in favour of another, here also
there can be no contract for enforcement,
(iii) Therefore, the law of contract deals with such type of agreements which
create, define, protect and preserve rights and obligations. An agreement
may be a social agreement or a legal agreement. A social agreement does
not give rise to contractual obligations and is not enforceable in a court of
law.

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Examples:
1. Nithilan invites his friend Saminathan to come and stay with him for a
week. B accepts the invitation but when he comes to Nithilan, Nithilan
cannot accommodate him as his wife had died the day before. Saminathan
cannot claim any compensation from Nithilan as the agreement is a social
one.
2. A father promises to pay his son Rs. 200 every month as pocket allowance.
Later he refuses to pay. The son cannot recover as it is a domestic
agreement and there is no intention on the part of (he parties to create
legal relations.

1.3.4 (b) Obligations

Obligation is a legal tie which imposes upon determinate person or persons the
necessity of doing or abstaining from doing a definite act or acts. Obligations are
also said to be varied, such as social obligations, obligations arising out of torts
(civil wrong or breach of duty), obligations arising out of compromise decree,
obligations arising out of quasi contract and obligations arising out of
agreements.
1) The Law of Contract does not deal with social obligations.
2) Obligations may also arise out of torts. Tort means civil wrong which
amounts to breach of duty.
3) The Law of Contract does not take notice of obligations arising out of a
compromise decree in a suit between two litigants.
4) The Law of Contract again does not deal with obligations arising out of
quasi contracts.
5) It is needless to say that the Contract Act deals with such obligations
arising out of agreement which again creates, defines, protects and
preserves rights and obligations.
Check your progress 1
Write short notes on need for the “knowledge of law”
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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1.4 CLASSIFICATION OF CONTRACT

In this section we discuss the classification of Contract under three headings

i) Classification according to Validity
ii) Classification according to formation
iii) Classification according to performance

1.4 1 CLASSIFICATION ACCORDING TO VALIDITY

From the point of view of validity a contract is classified as follows
i) Valid contract
ii) Void contract
iii) Voidable contract
iv) Unenforceable contract
v) Void agreement
vi) Illegal agreement

1.4.1.(i) Valid Contract (section 2 (h) )

According section 2(h) contract is an agreement enforceable by law. All contracts
are agreements but not vice versa. The formation of the contract requires certain
important ingredient without which the contract cannot be constituted. An
agreement becomes a valid contract when all the following essential elements are
present. If any one of these elements is missing, the contract is voidable, void,
illegal or unenforceable.

1.4.1.(i) ( a) ESSENTIAL ELEMENTS OF A VALID CONTRACT

The term ‘agreements’ it is much wider than the term ‘contract’. An agreement
becomes enforceable by law when it fulfils certain conditions. According to sec,
10 of the Act lay down the essentials of a valid contract. In this section, we
discuss the essential elements of a valid contract.List of essential Elements:
1. Offer and Acceptance
2. Intention to create legal
3. Lawful Consideration
4. Capacity of parties
5. Free and genuine consent
6. Lawful object
7. Agreement not declared void
8. Certainty and possibility of performance
9. Legal formalities.

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1. Offer and Acceptance:

An agreement is the result of an offer and its acceptance. So, there must be
‘lawful offer’ and a ‘lawful acceptance’ of the offer. In an agreement there must
be atleast two parties, one of them making the offer and the other accepting it.
The offer and acceptance must satisfy the requirements of the contract Act in
relation thereto.

2. Intention to Create Legal Relations

There must be an intention among the parties that the agreement should be
attached by legal consequences and create legal obligations. If the parties do not
intend to create legal obligations, there is no contract between them. An
agreement which gives rise to a moral or social obligation is not contract.

Example:

Ram invited Raja for a dinner. Raja accepted the invitation. It is a social
agreement. If Ram fails to serve to Raja, Raja cannot go to Courts of Law for
enforcing the agreement. Similarly, if Raja fails to attend the dinner, Ram cannot
go to Courts of Law for enforcing the agreement.

3. Lawful Consideration

One of the essential elements a valid contract is the presence of ‘consideration’.

The agreement must be supported by lawful consideration on both sides. Each
party to the agreement must give or promise something and receive something or
a promise in return. Consideration is the price for which the promise of the
other is sought. The consideration is lawful, unless it is forbidden by law or is
fraudulent.

Example:

If A offers to sell his scooter to B for Rs. 10,000 and B accepts the offer, then for
A Rs. 10,000 is the consideration and for B the scooter is the consideration

4. Capacity of Parties

The parties to an agreement must be competent to a contract; otherwise it

cannot be enforced by a Court of Law. If any of the parties to the agreement
suffer from Minority, Lunacy, Drunkenness, idiocy, etc., the agreement is not
enforceable at law, except in some special cases. Under section 11 of the act,
“Every person is competent to contract who is of the age of majority according to
the law to which he is subject, and who is of sound mind, and is not disqualified
from contracting by any law to which he is subject”

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5.Free and Genuine Consent

“Consent” means that the parties must have agreed upon the same thing in the
same sense. The consent of the parties to the agreement must be free and
genuine. The consent of the parties should not be obtained by
misrepresentation, fraud, undue influence, coercion or mistake. If the consent is
obtained by any of these flaws, then the contract is not valid.
6. Lawful Object
For the formation of a valid contract it is also necessary that the parties to an
agreement must agree for a lawful object. The object for which the agreement
has been entered must not be illegal or immoral or opposed to public policy. If
the object is unlawful, the agreement is void.
Example:
‘A’ lets his house to a prostitute to carry on prostitution; he cannot recover the
rent through a court of law.
7. Agreement not declared Void
The agreements must not have been expressly declared to be void by any law in
force in the country. If certain agreements are expressly declared to be void by
the law of the country, f then such agreements if entered into shall not be
enforceable by Courts of Law.
8. Certainty and Possibility of Performance
Agreements to form valid contracts must be certain. If it is vague and it is not
possible to ascertain its meaning, it cannot be enforced. The performance of an
agreement must be possible. An agreement to do an impossible act is not valid.
Example:
X agrees to sell Y hundred tons of oil. There is nothing whatever to show what
kind of oil was intended. The agreement is void for uncertainty.

9. Legal Formalities
A contract may be oral or in writing. If, however, a particular type of contract is
required by law to be in writing, it must comply with the necessary formalities as
to writing, registration and attestation, if necessary. If these legal formalities are
not carried out, then the contract is not enforceable at law.

1.4.1. (ii) Void contract

The word ‘void’ means ‘not binding in law’. Accordingly the term ‘void contract’
implies, contract which has no legal effect at all. A void contract is that which is
not enforceable by law. Sec. 2 (j) defines: “A contract which ceases to be
enforceable by law becomes void when it ceases to be enforceable”. A contract
which is enforceable by law at the time it was made. But later on if it becomes
legally unenforceable due to some reasons, it is called void contract.

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Example:

Prasath promised to marry uma. Later on uma died. In this case, the contract
becomes void on the death of uma.

A void contract is not void from its inception and that it is valid and binding on
the parties when originally entered but subsequent to its formation it becomes
invalid and destitute of legal effect of certain reasons. The reasons which
transform a valid contract into a void contract, as the Contract Act, are as
follows:

i) Supervening impossibility (Sec. 56)

A contract becomes void by impossibility of performance after the formation of

the contract.

Example:

“Narayanan” and “Suba” contract to marry each other. Before the time fixed for
the marriage Narayanan goes mad. The contract to marry becomes void.

ii) Subsequent illegality (Sec. 56)

A contract also becomes void by subsequent illegality. Example, A agrees

to sell B 100 bags of wheat at per bag. Before delivery, the Government bans
private trading in tie contract becomes void.

iii) Repudiation of a voidable contract

A voidable contract becomes void, when the party, whose consent is not free,
repudiates the contract.

Example:

Kannan by threatening to murder satha’s son, makes satha agree to sell his car
3, 00,000 for a sum of Rs 1, 00,000 only. The contract, being the result of
coercion is voidable at the option of satha. satha may either affirm or reject the
contract. In case satha decides to rescind the contract, it becomes void.

iv) In the case of a contract contingent on the happening of an uncertain future

event, if that event becomes impossible.

A contingent contract to door not to do something on the happening of an

uncertain future event, becomes void, when the event becomes impossible.

Example:

Selvi to give Rs 15,000 as loan to seethe, if seetha marries loganathan..

Loganathan dies without being married to seethe. The contract becomes void.

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1.4.1.(iii) Voidable Contract

According to section2 (i)“An agreement which is enforceable by law at the option

of one or more of the parties thereon, but not at the option of the other or
others, is a voidable contract”. A voidable contract is one which is enforceable by
law at the option of one of the parties, until it is avoided or rescinded by the
party entitled to do so by exercising his option in that behalf, it is a valid
contract.

The consent of one of the parties to the contract is obtained by coercion, undue
influence, misrepresentation or fraud such a contract is voidable at the option of
the aggrieved party i.e., the party whose consent was so caused (Secs. 19 and
19 A). In such cases where the consent is not free, the party whose consent is so
caused becomes the aggrieved party who can either affirm the contract or set
aside or rescind it. This right of recession should, however, be exercised within
reasonable time and before the third party acquires rights under the contract

Example:

A agreed to sell his car to B for Rs. 50,000. The consent was obtained by use
of force. The contract is voidable at the option of A. A can put an end to this
contract, if he so decides.

1.4.1. (iv) Unenforceable contract

The unenforceable contracts are those which cannot be enforced in a Court of

Law because of some technical defects such as absence of writing, registration,
requisite stamp etc., If such formalities are not properly observed, the contract
cannot be enforced is court of law. Such contracts can be enforced if the
technical defect is removed.

Example:

An oral arbitration agreement is unenforceable because the law requires an

arbitration agreement to be in writing. Similarly, a bill of exchange or promissory
note, though valid in itself, becomes unenforceable after three years from the
date of bill or note falls due, being time barred under the Limitation Act.

1.4.1. (v) Void Agreement

According to section 2 (g), “An agreement not enforceable by law is said to be

void”. There is absence of one or more elements of a valid contract, except that
of ‘free consent’ in the case of a void agreement. A void agreement has no legal
effect. It confers no rights on any person and creates no obligations.

Example:

An agreement with a minor is void ab-initio as against him, because a minor

lacks the capacity to contract. Similarly, an agreement without consideration is
void ab-initio,

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1.4.1. (vi) Illegal Agreement

An agreement is illegal and void if its object or consideration:

(a) is forbidden by law; or (b) is of such a nature that, if permitted, it would
defeat the provisions of any law ;or ( c) is fraudulent; or (d) involves or implies
injury to the person or property of another; or (e) the court regards it as
immoral, or opposed to public policy (Sec. 23).Thus an agreement to commit
murder, robbery etc.

1.4.2 CLASSIFICATION ACCORDING TO FORMATION

From the point of view of mode of creation a contract can be classified into the
following three types
i) Express contract
ii) Implied contract
iii) Quasi contract

1.Express contract
According to section 9 “In so far as the proposal or acceptance any promise is
made in words the promise is said to be express”. An express promise results in
an express contract. When such contract is formed, there is no difficulty in
under standing the rights and obligations of the parties. In other worlds, where
both the offer and acceptance constituting an agreement enforceable at law are
made in words spoken or written, it is an express contract.

Example:
A tells B on telephone that he offers to sell his car for Rs 20, 000 and B in reply
informs A that he accepts the offer, there is an express contract.

2. Implied contract
According to section 9 “In so far as such proposal or acceptance is made
otherwise than in words, the promise is said to be implied”. The both offer and
acceptance constituting in an agreement enforceable at law are made otherwise
than in words such contract comes into existence on account of act or conduct
of the parties.
Example:
Mr. X went to a restaurant and took a cup of coffee. In this, there is an implied
contract that he will pay for the cup of coffee, even though he makes no express
promise to do so.
3. Constructive or quasi contract
Quasi contract is a misnomer. If a contract does not arise by virtue of any
agreement, express or implied between the parties but the law infers a contract
under certain special circumstances is called as quasi contract. There are
certain dealings which are not contracts strictly, the parties act as if there is a

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contract. In fact, it is an obligation which the law creates in the absence of any
agreement. It rests on the ground of equity that "a person shall not be allowed to
enrich himself unjustly at the expense of another. Thus, a finder of lost goods is
under an obligation to find out the true owner and return the goods
Example:
Mr. X supplied Y, a lunatic, with necessaries suitable to his conditions in life,
this case, X is entitled to be reimbursed from Y’s estate.

1.4.3 CLASSIFICATION ACCORDING TO PERFORMANCE:

From the point of view of the extent of execution a contract may be executed or
executory

1. Executed contract:
When both the parties have completely performed their obligations, under the
contract, the contract is said to be executed. That is, it is a contract under the
terms of a contract nothing remains to be done by either the party.
Example:
Cash sales, the contract is executed at once.
Where only one of the parties to a contract has performed his share of obligation
and the other party is still to perform his share of obligation, then the contract
is called ‘executed’.

Example:
M advertises a reward 1,000 to anyone who finds his missing son. B knowing
the offer finds missing boy and brings him. As soon as B traces the boy, there
comes existence an executed contract because B has performed his share of ion
and it remains for M to pay the amount of reward to B.

2. Executory Contract
In this contract the obligations of the parties are to be performed at a later time.
When both the parties have not performed their respective obligations under the
contract, the contract is said to be executory.
Example:
Mr. A agrees to sell his bus to B for a certain amount. Delivery and payment are
to be made in the month following. The contract is said to be executory.
Suppose, a delivered the bus- to B, but fi has not paid the amount, the contract
is still executory because B is still under obligation to pay the price. As such,
the contract as a whole is executory one, though it is partly executed and partly
executory.

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Check your progress - 2

Distinguish between Express and implied Contract
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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1.5 LET US SUM UP

In this lesson, we have briefly touched upon the following points. A contract is
an agreement made between two or more parties which the law will enforce. An
agreement may be a social agreement or a legal agreement. Essentials of
contract: 1.There must be an agreement. 2. The parties must intent to create
legal relationship. 3. The parties must be capable of entering into an agreement
.4.The agreement must be supported by consideration on both side.5.The
consent of the parties must be free and genuine 6. The object of the agreement
must be lawful.7.The terms of the agreement must be certain and capable of
performance.8.The agreement must not have been expressly declared as void.
Contract can be classified according to Validity, according to formation and
according to performance.

1.6 QUESTIONS FOR DISCUSSION

1. What are the object and nature of law of contract?

2. Discuss the essential elements of a valid contract
3. Distinguish between void and voidable contract.
4. Write short notes on i) Quasi contract and ii) Bilateral contract

1.7 MODEL ANSWER TO CHECK YOUR PROGRESS

Check- 1 Write short notes on need for the “knowledge of law”

It is not possible for a layman to learn every branch of law, yet it is to the advantage of
each member of the community to know something of rules and regulations by which he
is governed and as such he must acquaint himself with the general principles of the law of

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the country. The law now –a-days is a matter of great intricacy. As such no sound
businessman would attempt to solve important legal questions affecting his business
interest without legal advice. A general knowledge of some of the more important legal
principles and how they apply to certain problems will certainly help a business man in
avoiding conflict with the persons with whom he comes into business contacts.

Check- 2 Distinguish between Express and implied Contract

Where both the offer and acceptance constituting an agreement enforceable at law are
made in words spoken or written, it is an express contract. In executory contract the
obligations of the parties are to be performed at a later time. When both the parties have
not performed their respective obligations under the contract, the contract is said to be
executory.

1.8 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-2
DISCHARGE OF CONTRACT

CONTENTS
2.0 Aims and objectives
2.1 Introduction
2.2 Various modes of discharge of contract
2.2.1 by Performance
2.2.2 by Agreement
2.2.3 by Impossibility of Performance
2.2.4 by Lapse of Time
2.2.5 by Operation of Law
2.2.6 by Breach of Contract
2.3 Let us sum up
2.4 Questions for discussion
2.5 Model answer to check your progress
2.6 References

2.0 AIMS AND OBJECTIVES

In the first lesson, we discussed the meaning and law of contract, definition and
various kinds of contracts. Here we discuss the meaning of discharge of contract
and different ways of discharge of contract. After going through this lesson, you
will able to
1. know the meaning of discharge of contract
2. understand various modes of discharge of contract

2.1 INTRODUCTION

Discharge of Contract means termination of the contractual relationship

between the parties. When the rights and obligations arising out of a contract
are extinguished, the contract is said to be discharged or terminated.

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2.2 VARIOUS MODES OF DISCHARGE OF CONTRACT

A contract may be discharged by various modes which are discussed one by one
in this section
By Performance
By Agreement
By Impossibility of Performance
By Lapse of Time
By Operation of Law
By Breach of Contract

2.2.1. Discharge by Performance of contract

Performance means the doing of that which is required by a Contract.
Performance of a contract is the most usual mode of discharge of Contract. It
may be Actual or Attempted.

(i) Actual Performance

Actual performance mean when each party to a Contract fulfils his obligation
arising under the Contract within the time and in the manner Prescribed, most
of the contracts are discharged by performance in this manner.
(ii) Attempted Performance (or) Tender
Tender is not actual performance but is only an offer to perform the obligation
under the Contract. When the Promisor offers to perform his obligation, but the
promise refuses to accept the performance, it is called attempted performance or
tender.

2.2.2 Discharge by Agreement:

A contract is created by an agreement, is the same way it can be discharged by
an agreement. It means the rights and obligations created by an agreement can
be discharged without their performance by another agreement which provides
for the extinguishment of the earlier rights and obligations. A contract can be
discharged by the following two types of agreements.
(1) Express consent
(2) Implied consent
1) Express consent
Express consent can be classified in the following two types
(1) Express consent at the time of formation of contract
(2) Express consent subsequent to formation of contract

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Express consent at the time of formation of contract:

The consent of one party to a contract is given to other parties at the time of the
formation of the contract.
Example:
“R” sells a computer to “M” on approval with the condition that if the computer
does not work efficiently M may return it. Consent to return the computer is
given to M at the time of the formation of the contract.
Express consent subsequent to formation of contract:
According to see 62 if the parties to a contract agree to substitute a new contract
for it, or rescind or alter it, the original contract need not be performed.
According to see 63 “Every promisee may dispense with or remit, wholly or in
part, the performance of the promise made to him, or may extend the time for
such performance, or may accept instead of it any satisfaction which he thinks
fit”.
Implied consent
Since contract is created by means of an agreement, it may also be discharged
by another agreement between the same parties. Implied consent means the
parties to contract enter into a fresh contract in place of original contract. The
following are the important methods for the discharge of a contract by a new
contract.
(1) Novation
(2) Rescission
(3) Alteration
(4) Remission
(5) Waiver
(6) Accord and satisfaction
(7) Merger

1.Novation:
Novation means substitution of a new contract for the existing one. There are
two types of novation. a) New contract is substituted for old one with change of
parties. b) New contract is substituted for an existing one without change of
parties.

a) Novation with change of parties:

In this type, the nature of the obligation remains the same but the parties are
changed with the consent of one party of the contract.

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Example:
“X” borrowed Rs.1000 from “Y” now x is a debtors and y is a creditor. “Y”
borrowed Rs.1000 from “Z” Here, “Y” is a debtor and “Z” is a creditor. By mutual
agreement Y’s debt to “Z” and Y’s loan to “X” are cancelled and “Z” accepts “X” as
his debtor. There is novation involving change of parties.

b) Novation without change of parties:

The concerned parties to a contract agree to substitute the existing contract with
out change of parties. Here parties are not changed but the nature of the
obligation must be altered substantially in the new substituted contract. The
original contract is discharged with out performed.

Example:
Sheela owes Bala Rs.5000. sheela enters into an agreement with Bala and gives
Bala a mortgage of her estate for Rs.2500 in place of the debt of Rs.5000. This
is new contract and extinguishes the old contract.
The following points are also worth noting in connection with Novation:
(1) The new contract must be valid and enforceable.
(2) An agreement to substitute a contract in future will not be Novation.
(3) Novation cannot be compulsory it can only be with the mutual consent of
all the parties.

Example:
A owes B Rs.5,000 under a contract. B owes C Rs.5,000. B orders A to credit C
with Rs.5,000 in his books, but C does not assent to the agreement. B still owes
C Rs.5,000 and no new contract has been entered into.

2. Rescission
Novation means a new contract in place of the old one. Rescission means
cancellation of the contract. A contract may be discharged, before the date of
performance, by agreement between the parties to the effect that it shall no
longer bind them. Such an agreement amounts to rescission or cancellation of
the contract, the consideration for mutual promises being the abandonment by
the respective parties of their rights under the contract. Rescission of a contract
takes place by mutual consent of the parties or where one party fails in the
performances of his obligation. In such a case, the other parties may rescind
the contract without prejudice to his right to claim compensation for the breach
of contract.

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Example:
1) ‘A’ promises to deliver certain goods to ‘B’ on a certain date. Before the
date of performance, A and B mutually agree that the contract will not be
performed. The contract stands discharged by rescission.
2) “Anbu” promises to supply certain good to “Babu” six months after date.
By that time, the goods go out of fashion. Anbu and Balu may rescind the
contract.
3.Alteration
Alteration of a contract means change in one or more of the material terms of a
contract. It a material alteration in a written contract is done by mutual
consent, the original contract is discharges by alteration and the new contract in
its altered form takes its place. The alteration is valid when it is made with the
consent of all the parties. An alternation may cither be material or immaterial.
i) Material alteration
A material alteration is one which alters the legal effect of the contract.
Example:
A charge in the amount of money to be paid, the rate of interest or the names of
the parties.
ii) Immaterial alteration
Immaterial alteration has no effect on the validity of the contract and does not
amount to alteration in the technical senses.
Example:
Correcting a clerical error in figure or the spelling of a name. If the parties
mutually agree to change certain terms of the contract, it has the effect to
terminating the original contract.
It is relevant to state that a material alteration make in a written contract by one
party without the consent of the other, will, make the whole contract void and no
person can maintain an action upon it.
The difference between “novation” and “alteration” may be noted. In case of
novation. There may be a change of parties also while in case of alteration
parties remain the same, only the ferns of a contract are altered.
Example:
“Arasu” enters into a contract with “Bala” for the supply of a material at his
warehouse on 1st February. Later both Arasu and Bala agree to post pone the
date of delivery to 1st march. This change amounts to alteration of the contract.
4.Remission:
A contract may be discharge by remission of performances. Remission means
acceptance of a lesser fulfillment of the promise made. Remission may be

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defined “as the acceptance of a lesser sum than what was contracted for or a
lesser fulfillment of the promise made”.
According to section 63, “Every promise may dispense with or remit, wholly or in
part, the performance of the promise make to him, or may extend the time for
such performance, or may accept instead of it any satisfaction which he thinks
fit”. It is not necessary that there must be some consideration for the remissions
of the part of the debt.
It is a unilaterial act of the promises discharging the obligation of the other
party, either partly or wholly.
Example:
A owes B Rs.10, 000. A pays to B who accepts in satisfaction of the whole debt
Rs.7, 000 paid at the time and place at which the Rs.10, 000 were payable. The
whole debt is discharged.

5. Waiver
Waiver is nothing but foregoing one’s own right, authorized under law,
whereupon the other party to the contract is released form his obligation. There
is no need of an agreement for a waiver and consideration is not necessary for it.
Example:
A promises to tailor a shirt for B if he will sing a song at his birthday party and
accordingly B sang the sons but offer wards B forbids A to tailor the shirt to
which A consents, the contract is terminated by waiver.

6. Accord and satisfaction

The term “accord” may be defined as the promise to accept lesser amount than
what is due under the contract. Satisfaction means the payment or fulfillment of
the lesser obligation. An accord accompanied by satisfaction is valid and there
by discharges the obligation under the old contract. The old contract is
discharged only when the lesser sum is actually paid and accepted by the
promisee, i.e., there must be actual performance of the new promise and its
acceptance by the other party.

7. Meger
Where an inferior right Contract merges into a Superior right Contract, the
former Stands discharged automatically. Merger the inferior rights vanish and
one not required to be enforced.
Example:
‘A’ Purchase a house, which he was having on lease. His right as a lessee will
merge into his right as on owner, as right of a lessee is Inferior to the right of an
owner.

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Check your progress 1

List out essentials of a valid tender
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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2.2.3 Discharge by impossibility of performance
A contract is discharged if its performance becomes impossible. In other words,
there is no question of discharged of a contract which is entered into to perform
something that is obviously impossible, e.g. an agreement to discover treasure
by magic, because, in such a case there is no contract to terminate, it being an
agreement void ab-initio by virtue.
According to sec.56, Impossibility of performance may fall into either of the
following categories:
1. Initial impossibility
2. Subsequent impossibility
1. Initial impossibility
This is known as pre-contractual or impossibility existing at the time of
agreement. If an agreement contemplates doing something which is absolutely
impossible, the same becomes void ab -initio. The rule is based on the following
two maxims:
a) Lex- non -cogit ad impossiblia est i.e., the law does not recognize what is
impossible; and
b) Impossibilium nulla obligatio est, i.e., what is impossible does not create an
obligation.
Section 56, pare 1 which provides: “an agreement to do an act impossible in
itself is void”. It is notice that something which is impossible inherently or by its
very nature and which may or may not be known to both the parties at the time,
when the contract is made.
The impossibility may be;
(a) Known to the parties
(b) Unknown to the parties.

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(a) Known to the parties

This is known as absolute impossibility. In case of absolute impossibility the
agreement is void ab- inito.

For example:
When A agrees with B to discover treasure by magic, or undertakes to put life
into the wife of B, the agreement is void.

(b) Unknown to the parties

Where at the time of making the contract both the parties are ignorant of the
impossibility, as in the case of destruction of subject-matter to the ignorance of
both the parties, the contract is void on the ground of mutual mistake. It,
however, the promisor alone knows of the impossibility of performance at the
time of making the contract, he shall have to compensate the promise for any
loss which such promise sustains through the non-performance of the promise.
Examples:
(a) X sold to Y certain goods supposed to be on a voyage. The goods had
ceased to exist due to the periles of the sea held, the contract was void.
(b) ‘A’ contracts to marr ‘B’, being already married to ‘C’, and being forbidden
by the law to which he is subject to practise polygamy. ‘A’ must make
compensation to ‘B’ for the can caused to her by the non performance of
his promise.

2. Subsequent impossibility
Impossibility which arises subsequent to the formation of a contract is called
post-contractual or supervening impossibility. In such a case, the contract
becomes void when the act becomes impossible or unlawful.
Section 56 para 2 declares, “A contract to do an act which, after the contract is
made, becomes impossible, or by reason of some event which the promisor could
not prevent, unlawful, becomes void when the act becomes impossible or
unlawful”.
In order that the section would apply the following conditions must be fulfilled.
1. that the act should have become impossible.
2. that impossibility should be by reason of some event which the promisor
could not prevent.
3. that the impossibility should not be self-induced by the promisor or due to
his negligence.

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The word “impossible” should be construed here in its practical sense and not
only in a physical or literal sense. Impossibility of performance of a contract, as
a general rule, is no excuse for the non performance of the contract; but where
this impossibility is caused by the circumstances beyond the control of the
parties, the parties are discharged from further performance of the obligation
under the contract.

Example:

A contract to take in cargo for B at a foreign port, A’s Government afterwards

war against the country in which the port is situated. The contract becomes void
when war is declared.

Supervening impossibility may occur in ways, some of which are explained

below:

1. Destruction of subject-matter of contract: when the subject matter of a

contract, subsequent to its formation, is destroyed without any fault of the
parties to the contract, the contract is discharged.

Taylor V.S. Caldwell (1863) Back burn observed as follows: “In contracts in
which the performance depends on the continued existence of a given person of
thing, a condition is implied that the impossibility of performance arising from
the perishing of the person or thing shall excuse the performance”.

Example:

A music hall was let for a series of concerts of certain days. The hall was burnt
down before the date of the first concert. The contact becomes void.

2.Death or personal incapacity:

A promise may become physically incapable or performance by reason of the

death or incapacity or some person whose continues life and health are
necessary for the performance of the contract. Such impossibility discharges the
promisor from liability.

Example:

A and B contract to marry each other, before the time fused for the marriage, a
goes mad. The contract becomes void.

3. Failure of ultimate purpose:

Where the ultimate purpose for which the contract was entered into fails, the
contract is discharged, although there is no destruction of any property affected
by the contract and the performance of the contract remains possible in literal
sense.

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4. Change of law

A contract is discharged by impossibility of performance by the subsequent

change in the law. He law may actually forbid the doing of some act undertaken
in the contract, or it may take from the control of the promisor something in
respect of which he has contracted to act or not to act in a certain way.
Impossibility created by law is a valid excuse for non-performance.
Example:
A sold to B 100 bags of wheat as Rs.700 per bad. But before delivery the
Government rendered the sale and purchase of wheat by private traders illegal
under the defence of India rules. The contract was discharged by impossibility
created by subsequent change in law.
5.Declaration of war
Contracts entered into before the outbreak of war are suspended during the war
and may be revived after the war is over provided they have not already become
time-barred. It may be noted that if war is declared between the countries of the
contracting parties than only the contract is suspended during war. If war is
declared between the country of one of third country, contract remains binding,
and if the party of the country now at war could not perform the contract
because of dislocation of transport etc., It will be treated as “difficulty in
performance” only and does not discharge the contract.
Example:
A contract to take in cargo for B at a foreign port. A’s Government after wards
declares war against the country in which the port is situated. The contract
becomes void when he war is declared.
6. Failure of pre-condition:
When certain things necessary for performance cease to exist the contract
becomes void on the ground of impossibility. If a contract depends on the
occurrence of an event, which does not in fact happen, the contract is
discharged.
Example:
“A” person “B” got a lease of land from “P” on a rental basis, then a German
prince seized the land and it was not possible for B to use it. The landlord “P”
sued for rent. The court held that B must carry out all the terms on the contract
including the payment of rent.
Cases not covered by supervening impossibility:
Impossibility of performance is, as a rule, not an excuse for non performance,
“He that agree to do an act must do it or pay damages for not doing it” is the
general rule of the law of contract. When a person undertakes to do something,
he must do it unless its performance becomes absolutely impossible, a person is

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bound to perform cannot claim to be excused by the mere fact that performance
has subsequently become unexpectedly burden some, more difficult or
expensive.
In the following cause, a contract is not discharged on the ground of
supervening impossibility:
1. Difficultly of performance:
A contract is not discharged by the more fact that it has become more difficult of
performance due some uncontemplated events or delays.
Example:
“X” contracted with “Y” to send certain goods from Bombay to Delhi in
September. In August transport companies went on strike and transport was
available at very high rates. Held, the increase in freight rate did not excuse
performance.
2.Commercial impossibility:
When in a transaction profits dwindle to a very low level or actual low becomes
certain, it is said that the performance or the contract has become commercially
impossible. Such a situation may arise on account of higher price of the raw
material or increase in the wage bill etc. commercial impossibility also does not
discharge a contract.
Example:
‘A’ promised to send certain goods from Bombay to Antwerp in September.
Before the goods were sent, war broke out and there was sharp increase in
shipping rates. Held, the contract was not discharged.
3. Impossibility due to failure of a third person
Where a contract could not be performance because of the default by a third
person on whose work the promisor relied, it is not discharged.
Example:
“K” a wholesaler, enters into a contract with “B” for the sale of certain goods ‘to
be produced by “Z” a manufacturer of those goods. “Z” does not manufacturer
those goods. “K” is liable to ” B” for damages.
4. Strikes and lock-outs:
A strike by the workmen or a lock-out by the employer also does not excuse
performance because the former is manageable and the letter is self induced.
Events such as these do not discharge a contract unless the partics have
specifically agreed in this regard at the time of formation of the contract.

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Example:
The unloading of a ship was delayed beyond the date agreed with the ship
owners owing to a strike of dock workers. Held, the ship owners were entitled to
damages, the impossibility of performance being no excuse.
5. Failure of one of the objects
When a contract is entered into for several objects, the failure of one of them
does not discharge the contract.
Example:
A company agreed to let out a boat to H, (a) for viewing a naval review on the
occasion of the coronation of king Edward VII, and (b) to sail round the fleet.
Due to illness of the king, the naval review was later cancelled but the fleet was
assembled. Held, the contract was not discharged because the holding of the
review was not the sole basis of the contract. To sail round the fleet, which
formed an equally basic object of the contract was still capable of attainment.
Check your progress 2
What do you mean by Doctrine of frustration?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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2.2.4 Discharge by lapse of time:

A contact is discharged by lapse of time. A contract should be performed with a
specified period, called period of limitation. The period of limitation for simple
contract is three years. If the three years expire and creditors fails to file a suit
to recover his amount, the debtor, is discharged from his liability.
Example:
The price of goods sold without any stipulation as to credit should be paid within
three years of the delivery of the goods. Where goods are sold on credit to be paid
for after the expiry of a fixed period of credit, the price should be paid with in
three years of the expiry of period of credit. If the price is not paid and creditors
does not file a suit against the buyer for the recovery of price within three year
the debt becomes time barred and hence irrecoverable.

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2.2.5 Discharge by operation of law

A contract terminates by operation of law in the following cases:
(a) Death
In contracts involving personal skill or ability. Death of the promisor results in
termination of the contract. The rights and liabilities of the deceased person
pass on to the legal represent actives.

(b) Merger
Where an inferior right contract mergers into a superior right contract, the
former stands discharged automatically.
(c) Insolvency
A contract is discharged by insolvency of one of the parties to it an insolvency
court passes an “order of discharge” exonerating the insolvent from liabilities on
debts incurred prior to his adjudication.
(d) Unauthorized material alteration:
A material alteration made in a writer document or contact by one party without
the consent of the other, will, make the whole contract void. A material
alteration is one which changes, in a significant manner, the legal identify or
character of the contract or the right and liability of the parties to the contract.
The effect of making such an alteration is exactly the same as that of concelling
the contract. Both parties will be discharged from their respective obligations.

2.2.6 Discharge by breach of contract:

The “breach of contract” means the failure of a party to perform his obligations.
The party, who fails to perform his obligations, is said to have committed a
breach of contract. A breach of a contract discharged the aggrieved party from
performing his obligations of course the aggrieved party i.e., the party not a fault
can sue for damages for breach of contract as par law; but the contract as such
stands terminated.
Breach of contract may be of two kinds
1. Anticipatory breach
2. Actual breach
1. Anticipatory breach
An anticipatory breach of contract is a breach of contract. It occurs when a party
to executory contract declarers his intention of not performing the contract
before the performance is due. In other words, a refusal by the promisor to
perform his part of the contract, before the due date of performance is known as
the anticipatory breach of contract.

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Anticipatory breach may take place in two ways:

(a) Expressly by words spoken or written:
Here a party to the contract communicates to the other parity, before the due
date of performance his intention not to perform it.

Example:
A contracts with B to supply 5000 bags of wheat for is Rs.6,00,000 on 1st June
on 15 March A inform B that he will not be able to supply the wheat. There is
express rejection of the contract.

(b) Impliedly by the conduct of one of the parties:

Here a party by his own voluntary act disables himself from performing the
contract.

Example:
Ramu contracts to sell a particular horse to somu on 1st of July and before that
date he sells the horse to somebody else. Section 39 of India contract act lags
down “when a party to the contract
(i) has refused to perform or
(ii) disables him self from performing the contract,
(iii) in its entirety, the promise may put and end to the contract
(iv) unless he had signified by words or conduct, his acquiescence in its
continuance”.
Effect of an anticipatory breach:
When anticipatory breach occurs, the aggrieved party can take the following
steps:
(1) He can treat the contract as discharged, so that the is no longer bound by
any obligations under the contract and
(2) He can immediately adopt the legal remedies available to him for breach of
contract viz., tile a suit fro damages or specific performance or injunction.

2. Actual breach
Actual breach may also discharge a contract. It occurs when a party fails to
perform his obligation upon the date fixed for performance by the contract.
Actual breach entitles the part not in default to elect to treat the contracts s
discharged and to she the part at fault for damages for breach of contract.

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Example:
On the appointed day the seller does not deliver the goods or the buyer refuses
to accept the delivery actual breach of contract may take place. (i) at the time
when the performance is due and (ii) during the performance of the contract.

2.3 LET US SUM UP

In this lesson, we have briefly touched upon the following points. A contract is
said to be discharged when the obligations created by it comes to an end. The
various modes of discharge of a contract are as follows 1.Discharge by
performance: The parties to the contract fulfil their obligations arising under the
contract with in the time and the manner prescribed.2 Discharge by agreement:
A contract rests on the agreement of the parties. As it is agreement which binds
them, so by their agreement or consent they may be discharged. 3. Contract may
be discharged by impossibility of performance.4. Discharged by lapse of time; if a
contract is not performed within the period of limitation and if no action is taken
by the promise in a law court, the contract is discharged. 5. Discharged by law;
It includes discharge by death, merger, insolvency and unauthorized alteration
of the terms of the written agreement. 6. Discharge by breach of contract; If a
party breaks his obligation which the contract imposes, there takes place breach
of contract.

2.4 QUESTIONS FOR DISCUSSION

1. Write a note on ‘discharge of contract by consent’

2. Discuss fully the “doctrine of supervening impossibility”
3. State briefly the various modes in which a contract may be discharged.
4. What do you understand by anticipatory breach of contract?
5. Discuss fully the law relating to Novation of contract

2.5 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 List out essentials of a valid tender

1. It must be unconditional
2. It must be made at proper time and place
3. It must be of the whole obligation contracted for and not only of the part
4. It must be made a proper person

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Check – 2 what do you mean by Doctrine of frustration?

It is the parallel concept of ‘supervening impossibility’. It come into play when
‘the common object of a contract can no longer be achieved or when the contract
, after it is made , becomes impossible of performance due to circumstances
beyond the control or contemplation of the parties.

2.6 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. 3.N.D. Kapoor - Elements of Company Law

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LESSON-3
REMEDIES FOR BREACH OF CONTRACT

CONTENTS
3.0 Aims and objectives
3.1 Introduction
3.2 Various remedies for breach of contract
3.2.1 Suit for rescission
3.2.2 Suit for damages
3.2.3 Suit upon quantum meruit
3.2.4 Suit for specific performance
3.2.5 Suit for an injunction
3.3 Let us sum up
3.4 Questions for discussion
3.5 Model answer to check your progress
3.6 References

3.0 AIMS AND OBJECTIVES

In the second lesson, we discussed the meaning of discharge of contract and

different ways of discharge of contract. In this lesson we discuss the meaning of
remedies and different types of remedies against the guilty party. After going
through this lesson, you will able to
1. know the meaning of remedy
2. understand various remedies against the guilty party
3. know rules regarding damages

3.1 INTRODUCTION

Where there is a right, there must be a remedy. A contract gives rise to

correlative rights and obligations. In this section we discuss the meaning and
definition of remedy for breach of contract.

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3.1.1 Meaning
Remedies means the rights of the aggrieved parties of seed redress by way or
restoration or claim compensation from the parties who was responsible for
causing the cuss, occasioned to them. Parties to a contract are expected to
perform their respective promises. If a party fails, neglects, or omits to perform
his promise, the other, must be entitled to enforce his right. In breach of
contract the injured or the aggrieved part is entitled to bring an action for
damages.

3.1.2 Definition
Remedies can be define as “A remedy is the means given by law for the
enforcement of a right”.

3.2 VARIOUS REMEDIES FOR BREACH OF CONTRACT

Whenever there is breach of contract, the injured or aggrieved party is entitled to

bring an action for damage. In this section, we discuss the various remedy for
breach of contract. The aggrieved or injured part becomes entitled to any one or
more of the following remedies against the guilty party:
1. Suit for rescission
2. Suit for damages
3. Suit upon quantum meruit
4. Suit for specific performance
5. Suit for an injunction.
As regards the last two remedies stated above, the law is regulated by the
specific relief Act, 1963.

3.2.1 Suit for rescission:

Rescission means cancellation. Ever for canceling a contract, it must be done
according to the norms laid down under law. When a contract is broken by one
party, the other party may sue to treat the contract as rescinded and retuse to
perform his part of performance on the rescission of he contract, the aggrieved
or injured part is discharged from all the obligations under the contract.
Example:

Bharathi promises Narayanasamy to sell her building for Rs.7,00,000 on certain

date. Narayanasamy agreed to pay the price on receipt of the building. Bharathi
refuses to sell her building to Narayanasamy. Narayanasamy may cancel the
contract and there is no liability on his part to pay price to the Bharathi.
Narayanasamy may also file a “Suit for rescission” and claim damages.

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Rescission and the consequent payment of damages depend upon facts and
circum stances under which contracts are cancelled.

Under section 39, When a party to a contract has refused to perform or disabled
himself from performing his promise in its entirely the promise may put an end
to contract, unless he has signified, by words or conduct, his acquiescence in its
continuance.

Under section 65, Obligation of the person who has received advantage under
void agreement or contract that becomes void. “When an agreement is
discovered to be void, or when a contract becomes void, any person who has
received any advantage under such agreements or contracts is bound to restore
it, or to make compensation for its, to the person from whom he received it”.

Under section 75“A person who rightfully rescinds a contract is entitled to

compensation for any damage which he has sustained through the non-
fulfillment of the contract”.

Power of the

Court has power to grant or refuse to rescission.

The court may grant rescission of the contract.

(1) Where the contract is avoidable by the plaintiff.

(2) Where the contract is unlawful for causes not apparent on its face and the
defendant is more to blame than the plaintiff.

The court may refuse to grant rescission of the contract:

(1) Where the plaintiff has expressly or impliedly ratified the contract; or

(2) Where owing to the change of circumstances, the parties cannot be restore
to their original positions; or

(3) Where third parties have, during the subsistence of the contract acquired
rights in good faith and for value; or

(4) Where only a part of the contract is sought to be rescinded and such part
is not severable from the rest of the contract.

Applying to the count for “rescission of the contract” is necessary for claiming
damages for breach or for availing any other remedy. In practice a “suit for
rescission” is accompanied by a suit for damages, etc., in the same plant.

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Check your progress - 1

What do you mean by cost of decree?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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3.2.2 Suit for damages

Damage means injury. Damages signify the method of making good the loss.
Such as indemnification. Damages are a monetary compensation allowed to the
injured party for the loss or injury suffered by him as a result or the breach of
contract. The fundamental principle underlying damages is not punishment but
compensation. In the event of a breach of contract, the other party have certain
rights including the right to claim damages of loss arising three from. Damages
are to be awarded for comes which naturally arose from the breach.
The law of contract does not seek to punish the quality. The defaulter party is
liable to pay damages to the aggrieved party. As a general rule, “compensation
must be commensurate with the injury or loss sustained, arising naturally from
the breach”. “It actual loss is not proved, no damages will be awarded”.
According to section 73 insured party is entitled to received from the defaulter
party are:
a) Such damages which naturally arose in the usual course of things from
such breach no compensation is to be given generally for any remote or
indirect loss sustained b reason of the breach.
b) Such damages which the parties knew, when they entered into the
contract, as likely to result from the breach.
c) In estimating the loss or damage caused to a party by breach, the means
which existed of remedying the inconvenience caused by the breach must
also be taken into account.
With a view to making the study of the quantum of damages easily
comprehensible, the above rules, as enunciated in section 73 may now be
considered in some more details under appropriate heads.

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3.2.2. (a) Kinds of damage

Damages may be of four kinds.
1. Ordinary damage
2. Special damage
3. Exemplary damage
4. Nominal damage
We shall now see these kinds one by one.

Ordinary damages
Damages that could be claimed under ordinary circumstances in the regular
course of business on account of the default committed by another party to a
contract is known as ordinary damages. In other wards damages as may fairly
and reasonably be considered as arising naturally and directly in the usual
course of things from the breach of contract. It is other wise called as general or
compensatory damages. General damages are usually assessed on the basic of
actual loss. The measure of ordinary damage is the difference between the
contract price and market price at the date of breach.
Example:
Abishnavi contracts to sell and deliver 500 quintals of wheat to Nitailan at
Rs.600 par quintal, the price to be paid at the time of delivery. The price of
wheat rises to Rs.700 per quintal and Abishnavi refuses to sell the wheat.
Nithilan can claim damages at the rate of Rs.100 per quintal.
According to section 73, Compensation is not to be given fro any remote or
indirect loss or damage.
Example:
Abishnavi contracts to sell and deliver 1000 backs of cotton to Nithilan on a
fixed day. Abishnavi knows nothing of Nithilan’s mode of conducting his
business. Anishnavi breaks his promise and Nithilan, having no cotton, is
obliged to close his mill. Abishnavi is no responsible to Nithilan for the loss
caused to Nithilan by the closing of the mill.

2. Special damages:
Special damages are those which arise on account of the special or unusual
circumstances affecting the plaintiff. In other words, they one such remote
comes which one not the natural and probable consequence of the breach of
contract.
Special damages cannot be claimed as matter or right these can be claimed only
it the special circumstances which would result in a special loss in case of
breach of contract are brought to the notice for the other party. It is important to

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note that notice to this special effect must have been given to the other party. It
he had no knowledge, he is not answerable. Subsequent knowledge of special
circumstances will not create any special liability of guilty party.
Example:
A builder, contracts to erect and finish a house by the first of January, in order
that B may give possession of it at that time to C, to whom B has contracted to
let it. A is informed of the contract between B and C. A builds the house so badly
that, before the first of January, it falls down, and has to be rebuilt by B, who, in
consequence loses the rent which he way to have received from C, and is obliged
to make compensation for breach of that contract. A must pay to B, by way of
compensation, (i) for the cost of rebuilding the house (ii) for the rent lost, and
(iii) for the compensation made to C.
3. Exemplary or vindictive damages:
Exemplary damages signify the claims with a view to punishing the guilty party
for the breach and not by way of compensation for the loss suffered by the
aggrieved party. As observed earlier, the cardinal principle of the law of damages
for a breach of contract is to compensate the injured party for the loss suffered
and not to punish the guilty party. Hence, obviously, exemplary damages have
no place in the law of contract and are not recoverable for a breach of contract.
There are two exceptions to this rule.
Breach of a contract to marry:
In this case the amount of the damages will depend upon the extent of injury to
the party’s feelings, one may be ruined, other may not mind so much. Dishonor
of a cheque by a banker when there are sufficient funds to the credit of the
customer
In this case the rule of ascertaining damages is “the smaller cheque, the greater
the damage”, of course, the actual amount of damages will differ according to
status of the party.
Nominal damages:
Nominal damages are those which are awarded only for the name sake. In latin,
it is known as injury without damage. In this case there may be a breach of
contract but no material loss would have been caused. Nominal damages are
either awarded by way of compensation to the aggrieved party not by way of
punishment to the quality party. These are awarded to establish the right to
decree for breach of contract when the injured party has not actually suffered
any real damage.

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3.2.2.(b)Rules regarding damages

Explanation to Section 73 provides that, “In estimating the loss or damage

arising from a breach of contract, the means which existed of remedying the
inconvenience caused by non-performance of the contract must be taken into
account” The principles regarding the measure of damages is based on the
decision given in Hadley Vs. Baxendale. The rules may now be summarized as
follows:

1. General Damages

A party who suffers by breach of a contract is entitled to only such damages

which arise naturally in the usual course of things as a result of such breach.
Rest of the damages will be deemed to be a remote consequence and are not
recoverable

2. Special Damages

Special damages are recoverable only if the special circumstances were brought
to the notice of the defaulting party. That is, where a party claims special
damage for any loss sustained he must prove that the other party knew at the
time of the making of the contract that special loss was likely to result from the
breach of the contract.Example: Pinnock Bros. Vs. Lewis & Peat Ltd. (1923)

3. Remote Damages

The second para of Section 73 states that “Such compensation is not to be given
for any remote and indirect loss or damage sustained by reason of the breach”.
The remote or indirect damages are not due to natural and probable
consequences of the breach of the contract. In other words, these are the
damages which arise indirectly from the breach. The injured party is not entitled
to any remote or indirect loss. Example: Hobbs Vs. London A S.W. Railway Co.
(1873)

4.Restitution and Compensation

Damages are paid as restitution and compensation and not as punishment. In

fact through damages, efforts are made to put the party back into the same
position as if the contract had been performed. In other words, “If a contract is
broken, law will endeavour, so far as money can do it, to place the injured party
in the same position as if the contract had been performed”.

5. Mitigation of Loss

The injured party has to take all reasonable steps to minimise the loss caused
by the breach. Explanation to Section 73 of the Indian Contract Act reads as
under:

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“In estimating the loss or damage arising from a breach of contract, the means
which existed of remedying the inconvenience caused by the non-performance of
the contract must be taken into account”. The loss caused by the breach must
be kept to the minimum. The damages which results due to the negligence of
the aggrieved party, are not recoverable. Example: Neki Vs. Prabhu

6. Nominal Damages

Nominal damages area small amount awarded by the court when the aggrieved
party cannot prove any substantial loss suffered by him. These are neither
awarded by way of compensation to the aggrieved party nor by way of
punishment to the guilty party. For instance if the contract price is Rs. 10 and
after a breach the party obtained the goods from the market also for Rs. 10, he
may get only nominal damages for his worries and inconvenience.

7. Actual Loss (Actual Damages)

Ordinarily, the aggrieved party is entitled to recovery by way of compensation,

only the actual loss suffered by him. In a breach of contract for the sale of
goods, the damages payable would be the difference between the contract price
and the market price at the date the breach takes place.

8. Vindictive or Exemplary Damages

Vindictive or exemplary damages are not usually awarded for breach of contract
except in case of breach of contract of marriage or wrongful refusal by the bank
to honour the customer's cheque. Such damages are awarded by way of lesson
to the wrongdoer.

9. Liquidated Damage

When the parties to a contract mutually agree that in the event of a breach the
one shall pay to the other a specified sum of money, called liquidated damage.
When such an amount has been mentioned in the contract, under Sec. 74 of the
Indian Contract Act, the injured party is entitled to get reasonable compensation
not exceeding the amount mentioned.

10. Damages in Quasi Contracts

According to Section 73, para 3, “When an obligation resembling those created

by contract has been incurred and has not been discharged, any person injured
by the failure to discharge it is entitled to receive the same compensation from
the party in default, as if such person had contracted to discharge it and had
broken his contract.”

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Explanation:

“In estimating the loss or damage arising from a breach of contract, the means
which existed of remedying the inconvenience caused by the non-performance of
the contract must be taken into account”.

11. Difficulty of Assessment

Difficulty in calculating damages is no ground for refusing damages. The court

must make an assessment of loss and pass a decree for it. Example: Chaplin Vs.
Hicks (1911)

Check your progress 2

Explain English law on Penalty and Liquidated damages?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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3.2.3 Suit upon quantum merit

The next remedy for a breach of contract available to an injured party against
the guilt party is to file a suit upon quantum merit. Quantum of work that is
done by a person must be rewarded according to the merit of his work. The
quantum merit means “as mush as is earned” or “in proportion to the work
done”. A right to sue on a quantum merit arises where a contract, partly
performed by one partly has become discharged by breach of the contract by the
other party. This remedy may be availed of either without claiming damages or
in addition to claiming damages for breach.

The aggrieved party may file a suit upon quantum merit any may claim payment
in proportion to work done or goods supplied in the following cases:

1. Where work has been done in pursuance of a contract, which has been
discharged by the default of the defendant.

2. Where work has been done in pursuance of a contract which is “discovered

void” or “become void”, provide the contract is divisible.

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3. When a person enjoys benefit of non-gratuitous act although there exists

no express agreement between the parties. One of such cases is provided
in section 70 lays down that when services are rendered or goods are
supplied by a person (i) without any intention of doing so gratuitously and
(ii) the benefit of the same is enjoyed by the other party, the latter must
compensate the former or restore the thing so delivered.

4. A party who is guilty of breach of contract may also sue on a quantum

merit provided both the following conditions are fulfilled.

a. the contract must be divisible and

b. the other party must have enjoyed the benefit of the part which has been
performed, although he had an option of declining it.

3.2.4 Suit for Specific performance

Specific performance means the actual carrying out of the contract as agreed.
Under certain circumstances an aggrieved party may tile a suit for specific
performance, i.e., for a degree by the court directing the defendant to actually
perform the promise that he has made. Specific performance of the contract
cannot be claimed as a matter or right rules regarding the granting of this relief
are contained in the specific relief and specific performance is usually granted in
contracts connected with land, buildings, rare articles and unique goods having
some special value to the party suing because of family association. Notice that
in all these contracts monetary compensation is not an adequate relief because
the injured party will not be able to get an exact substitute in the market.

Some of the cases in which specific performance of a contract may, in the

discretion of the court, be enforced are as follows

(a) When the act agreed to be done is such that compensation in money for its
non-performance is not an adequate relief.

(b) When there exists no standard for ascertaining the actual damage caused
by the non-performance of the act agreed to be done.

(c) When it is probable that the compensation is money cannot be got for the
non-performance of the act agreed to be done.

Specific performance is not granted in the following case, when:

(a) Damages are adequate remedy;
(b) The contract is not certain;
(c) The contract is inequitable to either party;
(d) The contract is of revocable nature;

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(e) The contract is made by the trustee in breach of trust

(f) The contract is of personal nature
(g) The contract made by a company ultra vires of its memorandum of
association; and
(h) The court cannot supervise its carrying act.

3.2.5 Suit for an injunction

“Injunction” is an order of a court restraining a person from doing a particular

act. It is a mode of securing the specific performance of the negative terms of the
contract. That is, it is order of the court restraining a person from doing
something which he promised no to do. This type of order is generally issued in
case where the compensation in terms of money is not an adequate relief. Thus
injunction is a preventive relief. It is particularly appropriate in cases of
“anticipatory breach of contract”.

Example:

“Nithilan” agreed to sing at “Abishnavi” theatre for three months from its April
and to sing for on one else during that period. Subsequently he contracted to
sing at Bharathi’s theatre and refused to sing at Abishnavi’s theatre. On a suit
by Abishnati, the court refused to order specific performance of his positive
engagement to sing at the plaintifit’s theatre, but granted an injunction
restraining Nithilan from singing, else where and awarded damages to B to
compensate him for the loss caused by Nithilan’s refusal.

3.3 LET US SUM UP

In this lesson, we have briefly touched upon the following points. In case of
breach of a contract, the injured party has one or more of the following remedies

1. Rescission: When there is breach of a contract by a party, the injured party

may sue to treat the contract as rescinded. He is also absolved of all
obligations under the contract

2. Damages: Damages are monetary compensation awarded to the injured

party by Court for the loss or injury suffered by him.

3. Quantum meruit: A right to sue on a quantum meruit (as much as

earned) arises where a contract, partly performed by one party, has
become discharged by the breach of the breach of contract by the other
party. This right is founded on an implied promise by the other party
arising from the acceptance of a benefit by that/party.

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4. Specific performance: In certain cases the Court may direct the party in
breach of a contract to actually carry out the promise, exactly according to
the terms of the contract. This is called specific performance of the
contract

5. Injunction. It is a mode of securing the specific performance of the negative

terms of a contract.

3.4 QUESTIONS FOR DISCUSSION

1. What are liquidated damages?

2. What is meant by injunction?
3. When do claims on quantum meruit arise?
4. What are remedies available to an aggrieved party in case of breach of
contract?
5. State briefly the principles on which damages are awarded on the breach
of a contract

3.5 MODEL ANSWER TO CHECK YOUR PROGRESS

Check - 1 what do you mean by cost of decree?

The aggrieved party is entitled in addition to the damages, to get the cost of
getting the decree for damages. However, the cost of suit for damages is at the
discretion of the court.
Check – 2 Explain English law on Penalty and Liquidated damages?
In the case of liquidated damages the amount is fixed by the parties at the time
of formation of the contract on the basis of reasonable and fair calculation after
making a genuine pre-estimation of loss. The amount fixed is considered to be a
penalty if it is not based a reasonable calculation of actual loss but is fixed by
way of punishment and as a threat.

3.6 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-4
OFFER

CONTENTS
4.0 Aims and objectives
4.1 Introduction
4.1.1 Definition of offer
4.1.2 Parties to the offer
4. 1.3 Essentials of an offer
4.1.4 How an offer is made
4.2 Types of offer
4.2.1 Specific offer
4.2.2 General offer
4.2.3 Counter offer
4.2.4 Cross offer
4.2.5 Continuing offer
4.3 Rules relating to offer
4.4 Revocation of an offer
4.5 Let us sum up
4.6 Questions for discussion
4.7 Model answer to check your progress
4.8 References

4.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the remedies of breach of contract. Here we

discuss the meaning, definition, legal rules relating to offer and Revocation of
offer. After going through this lesson, you will able to
1. know the meaning and definition of offer
2. understand various rules relating to offer
3. know the different types of offer
4. study the revocation of offer

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4.1 INTRODUCTION

While discussing the essential elements of a valid contract in the preceding

chapter we observed that as a first step in the making of a contract there must
be a ‘lawful offer’ by one party and a ‘lawful acceptance’ of the offer by the other
party. Offer or Proposal is nothing but conveyance of an idea by one person to
another for obtaining the consent of the latter in respect of doing or not doing an
act or acts. The words ‘proposal’ and ‘offer’ are synonymous and are used
interchangeably. In this section we presented here the definition, essentials of
offer and parties involved in offer.

4.1.1 Definition of ‘offer’

Section 2(a) of the Indian Contract Act defines an ‘offer’ as, “when one person
signifies to another his willingness to another in respect of doing or to abstaining
from doing anything, with a view to obtaining the assent of the other, he is said
to make a proposal”.

4.1.2 Parties
There are two persons involve in offer, the person making the ‘proposal’ is called
the ‘promisor’ or ‘offeror’. The person to whom the offer is made is called the
‘propose’ or ‘offeree,’ and person accepting the offer is called the ‘promisee’ or
‘acceptor’

4.1.3 Essentials of an offer

The above definition reveals the following three essentials of an offer:

(i) It must be an expression of the willingness to do or to abstain from doing

something.

(ii) The expression of willingness to do or to abstain from doing something

must be to another person. There can be no 'proposal' by a person to
himself.

(iii) The expression of willingness to do or to abstain from doing something must

be made with a view to obtaining the assent of the other person to such act
or abstinence

4.1.4 How an offer is made

An offer may be made by express words, spoken or written. This is known as an

express offer.

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Example:

A advertises in a newspaper offering Rs 500 to anyone who returns his lost dog.
There is an express offer.

An offer may also be implied from the conduct of the parties or the
circumstances of the case. This is known as an implied offer.

Example:

A transport company runs a bus on a particular route; there is an implied offer

by the transport company to carry passengers for a certain fare.

4.2 TYPES OF ‘OFFER’

An offer that is made by a party to an agreement reveals the intention of such

party. Hence, to understand the offeror’s intention, offer has to be studied under
different headings. In this section we attempt to make a brief explanation about
different types of offers.

4.2.1 Specific offer

An offer or proposal that is made by one person exclusively to a specific and
identifiable person is known as specific offer.
4.2.2 General offer
When an offer is made not to any specific person but made to the general
public, it is known as general offer. Such offer can be accepted by any person
from the public.
Example:
Announcement of reward through newspapers for restoration of lost goods to
the owner.
4.2.3 Counter offer
When the person to whom the offer is made, instead of accepting the offer
modifies the same and sends it to the offeror in a different manner, then such
modified offer made by the offeree is known as counter offer.
Example:
Rukmani wants 100% cotton shirt from Sundarm Readymade. But, Sundaram
Readymade offers in return 85% cotton mixed with polyester, then the offer in
return made by the Suadaram Readymade is known as counter offer.

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4.2.4 Cross offer

When two persons make offers against each-other simultaneously with regard to
the same subject matter without knowing the intention of the other, then such
offers are known as cross offers.
Example:
Rani makes an offer to sell garments to Shyamala. Simultaneously, without
knowing the intention of Rani and the offer made by her, Shyamala makes an
offer to buy garments from Rani. Both these offers made against each other
cross simultaneously. This is known as cross offer which can never be accepted
and ripen into a promise.
4.2.5 Continuing offer
A continuing offer is one that holds good for a span of period (for a specific
duration). In other words, it is a series of offer, which is made from time to time
for duration of time.
Example:
Tender is a continuing offer. Ram agrees to supply 100 litres of oil every month
commencing from January to December which has been accepted by Krishna
Hotels. The offer made by Ram is a continuing offer.
Check your progress 1
What constitutes an offer?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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4.3 RULES RELATING TO OFFER

There are certain rules under contract Act for making a valid offer. In this
section we pointed out some of the rules that are to be observed, adhered to, and
acted upon in order to form a valid contract.

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1. The offer must be communicated to the other party

2. The terms of the offer must be definite and clear
3. The offer must be capable of creating legal relationship
4. The offer must be made with a view to obtain acceptance
5. An offer may be positive or negative
6. The offer should not contain any term the non-compliance of which
amounts to acceptance
7. Special terms and conditions of the offer be communicated
8. Two identical cross-offers do not result in a contract

4. 3. 1. The offer must be communicated to the other party

According to Sec. 4 of the Act, “The communication of a proposal is complete

when it comes to the knowledge of the person to whom it is made”.An offer is
effective only when it is communicated to the offeree. A person cannot accept an
offer unless he knows of the existence of the offer. Until the offer is made known
to the offeree, there can be no acceptance and no contract. An offer is completed
only when it has been communicated to the offeree. An offer accepted without
its knowledge, does not confer any legal rights on the acceptor.

Example:

Lalman Shukla Vs. Gauri Dutt (1913).

The defendant sent the plaintiff who was in his service in search of his missing
nephew. Later on the defendant announced that anybody, who discovered the
missing boy would be given a reward of Rs. 501. The plaintiff discovered the boy
without knowing the reward. When the plaintiff came to know about the reward,
he brought an action against the defendant to recover the same. His suit was
dismissed on the ground that he could not accept the offer, unless he had
knowledge of it.

4.3.2. The Terms of the Offer must be definite and clear

The terms of an offer should be definite and certain and not vague or
ambiguous. Anson says “The law requires the parties to make their own
contract: it will not make a contract for them out of terms which are indefinite or
illusory”. Further Sec. 29 of the Act lays down “Agreements, the meaning of
which is not certain, or capable of being made certain, are void” The offer must
be reasonably definite and requires nothing to complete it except acceptance.

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Examples:

(1) Montreal Gas Co. Vs. Vasey (1900).

The plaintiff relied on a clause that if the company were satisfied with him as a
customer the company would “favorably consider an application for renewal of
the contract”. The court held that there was nothing in these words to create
legal obligation

2) Taylor Vs. Portington (1855)

‘X’ purchased a horse from ‘Y’ and promised to buy another, if the first one
proves lucky. ‘X’ refused to buy the second horse. ‘Y’ could not enforce the
agreement it being loose and vague.

(3) “A” offered to sell his car to “B” for Rs. 40,000 or Rs. 45,000. There is nothing
to show which of the two prices was to be given. This offer cannot be accepted
as it is not clear. Thus, no contract will result from this offer.

4.3.3. The Offer must be Capable of Creating Legal Relationship

If the offer does not intend to give rise to legal consequences, it is not a valid
offer in the eye of law. An offer must be such that when accepted it will result in
a valid contract. The offer must be one which is capable of creating a legal
relationship. A social party or an invitation to play cards is not a legal
relationship. Generally speaking, in the case of agreements regulating social
relations, it is natural inference that the parties do not intend to create legal
relations, while in the case of agreements, regulating business relations, the
inference is that the parties intend to create legal relations.

Examples:

(1) Balfour Vs. Balfour (1919) (See Chapter II)

The agreement was only an arrangement between husband and wife, and the
parties never intended to make a bargain.

(2) Rose and Frank Co. Vs. Crompton & Bros Ltd. (1925)

Sometimes the parties to a business transaction may deliberately state that they
do not intend to enter into any legal relationship. The plaintiffs, an American
firm, were the constituted selling agents in North America for the defendent,
English Company under a written agreement. It contained the following clause
“This arrangement is not entered into nor is this memorandum written, as a
formal or legal agreement, and shall not be subject to legal jurisdiction in the
Law Courts”, it was held that the agreement was not legally binding contract.
The intention of the parties as expressed in the written document was respected
by the court.

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4.3.4. The Offer must be made with a View to Obtain Acceptance

When a person is making an offer it means that he is making it with a view to

obtain the consent of the offeree. Sec. 2 (a) of the Act lays down “When one
person signifies to another his willingness to do or to abstain from doing
anything, with a view to obtaining the assent of that other to such act or
abstinence, he is said to make a proposal.” The terms of an offer should be clear
so that there is no confusion whether it is a valid offer or a mere statement of
intention. A declaration by a person that he intends to do something gives no
right of action to another.

An offer must be distinguished from an ‘invitation to receive offer’ or as it is

sometimes expressed in judicial language an ‘invitation to treat.’ In the case of
an ‘invitation to receive offer’ the person sending out the invitation does not
make an offer but only invites the other party to make an offer. His object is
merely to circulate information that he is willing to deal with anybody who, on
such information, is willing to open negotiations with him. Such invitations for
offers are therefore not offers in the eye of law and do not become agreements by
their acceptance. We may give some examples of them here:

An advertisement for sale of goods by auction does not amount to

an offer to hold such sale. It merely invites offers. Actual bids made at the
auction are ‘offers’, each higher bid superseding the previous one, and when
the hammer falls on the highest bid, there is an acceptance and the contract
becomes complete. Newspaper advertisements inviting applications for a job or
inviting tenders for some work is not an offer. It is only an invitation to make
offers. Applicants who reply to the advertisement are the offerors.

Following are other example of invitation to make an offer:

(1) Goods exhibited with price on a label stuck to them in showcase.

(2) Menu card in a restaurant.

(3) Prospectus of a company inviting public to subscribe for shares or

debentures.

(4) An advertisement inviting applications for situation or a post.

(5) An advertisement for sale of goods by auction.

An advertisement for an auction sale does not even bindthe auctioneer to hold
the auction and the prospective bidders have no legal right to complaint if they
have wasted their time and money in coming to the advertised place of the
auction sale (Harris vs Nickersorf )Quotations, catalogues of prices or display of
goods with prices marked thereon do not constitute an offer. They are instead an
invitation for offer and hence if a customer asks for goods or makes an offer, the
shop keeper is free to accept the offer or not. While explaining the logic behind
the aforesaid rule, Lord Herschell has made an interesting observation in
Grainger & Son vs Gough”

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The transmission of such a price-list does not amount to an offer to supply an

unlimited quantity of the wine described at the price named, so that as soon as
an order is given there is a binding contract to supply that quantity. If it were
so, the merchant might find himself involved in any number of contractual
obligations to supply wine of a particular description which he would be quite
unable to carry out, his stock of wine of that description being necessarily
limited.”

Example:

There is a 'self service system' in a shop. A customer selects the goods and
takes them to the cashier for payment of the price. The cashier totals the price
and accepts the amount. The contract, in this case is made, not when the
customer selects the goods, but when the cashier accepts the offer by accepting
the payment. The selection of goods by the customer constitutes an implied
offer' to buy goods and the acceptance of payment by the cashier constitutes.

4.3.5. An Offer may be Positive or Negative

Sec. 2 (a) reads as under:” When one person signifies his willingness to do or
abstain from doing something...” Thus, an offer may be to do something or not to
do something. An offer to do something is a positive offer. And an offer not to do
something is negative offer.

4.3.6. The offer should not contain any term the Non-compliance of which
Amounts to Acceptance

Thus an offeror cannot say that if acceptance is not communicated upto a

certain date, the offer would be presumed to have been accepted. If the offeree
does not reply, there is no contract, because no obligation to reply can be
imposed on him, on the grounds of justice.

4.3.7. Special terms and conditions of the offer be communicated

Regarding the communication of the special terms of the contract as contained

in a ticket, receipt, or ‘standard form documents’, the more important rules
adopted by the courts are as follows:

(i) If the acceptor or the promisee had no knowledge of special terms, before or
at the time of the contract, they are not binding upon the acceptor. Example In
Handerson vs Stevenson

The plaintiff bought a steamer ticket which bore on its face the words ‘Dublin to
Whitehaven.’ On the back of the ticket certain special terms were printed one of
which excluded the liability of the company for loss, injury or delay to the
passenger or his luggage. The plaintiff never looked at the back of the ticket and
no one told him to do so, and the front of the ticket bore no reference to the
back. The plaintiffs luggage was lost in the shipwreck caused by the fault of the
company's servants. He claimed damages for its loss. It was held that the
plaintiff was entitled to recover his loss from the company as there was not

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sufficient communication of the terms and conditions contained on the back of

the ticket.
(ii) If the acceptor or the promisee had the knowledge or may be presumed to
have the knowledge; because a reasonably sufficient notice has been given to
him by suitable words on the document; of special terms, before or at the time
of the contract, the terms are binding upon the acceptor whether he has read
them or not is immaterial. The leading case on the point is Parker vs South
Eastern Railway Co.

Example:
In the above case “.deposited his bag at the cloak-room at a railway station and
received a ticket containing on its face the words, ‘see bac’. On the back of the
ticket there was a condition that, ‘the company will not be responsible for any
package exceeding the value of £ 10 unless extra charge was paid’. A notice to
the same effect was hung up in the cloak-room. P's bag was lost and the claimed
the actual value of the lost bag, £ 24 Sh. 10. P, admitted knowledge of the
printed matter on the ticket, but denied having read it. It was held that, even
though he had not read the exemption clause, he was bound by it, as the
defendants had done what was reasonably sufficient to give him notice of its
existence, and therefore P was entitled to recover only £ 10.

Again, where the terms are printed in a language which the acceptor does not
understand, he cannot set up this fact as a reason for not being bound by the
terms, provided his attention is drawn to them by suitable words on the
document. It is the acceptor's duty to ask for a translation of the terms before
he actually accepts the offer and if he did not ask, he must suffer for his
ignorance (MacKillican vs The Compagnie Marikcmas de France).

Similarly, the acceptor cannot plead that he was illiterate or blind, provided the
notice is reasonably sufficient for the class of persons to which he belongs
(Thompson vs L.M. & S. Railway Co.) .It is important to note that the special
terms and conditions become binding as part of the contract only if they are
brought to the notice of the acceptor before or at the time of contract. A
subsequent communication will not bind the contracting party unless he has
assented thereto.

4.3.8. Two Identical Cross-Offers do not Result in a Contract

When the parties make identical offers to each other, in ignorance of each
other's offer, the offers are cross-offers. Cross-offers do not constitute
acceptance of one's offer by the other and as such there is no completed
agreement. Example : Tim Vs. Hoffmann (1873).

The defendant wrote to the plaintiff offering to sell a certain quantity of iron at a
particular price. The same day the plaintiff wrote to the defendant offering to
buy the same quantity of iron at the same price. Unknown to each other the
letters crossed in post, the plaintiff claimed that there was a contract. It was
held that mere cross-offers made in ignorance of each other would not create a
contract.

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4.4 REVOCATION OF AN OFFER

An offer may come to an end by revocation or lapse, or rejection. Section 6 has

described the modes in which an offer lapses. In this section we pointed out
some circumstances for an offer comes to an end.

1.By Notice

An offer may be revoked any time before acceptance but not afterwards. An offer
lapses when a notice of revocation has been given any time before its acceptance
is complete as against the offeror.

2. By lapse of time

An offer lapses if acceptance is not communicated within the time prescribed in

the offer, or if no time is prescribed, within a reasonable time For example, an
offer made by telegram suggests that a reply is required urgently and if the
offeree delays the communication of his acceptance even by a day or two, the
offer will be considered to have lapsed.

3. After expiry of reasonable time

If there is no time has been prescribed, the proposal lapses after the expiry of a
reasonable time. What is reasonable time will depend on the circumstances of
the case.

4. By Death or Insanity

The offer lapses by death or insanity of the offeror provided that the offeree
comes to know about it before acceptance.

5.By non-fulfilment of condition

If the offeree fails to fulfill a condition precedent to acceptance, the offer lapses.

6..By Counter-offer

An offer lapses if it has been rejected by the offeree. The rejection may be
express i.e., by words spoken or written or implied. Implied rejection is one: (a)
where either the offeree makes a counter offer, or (b) where the offeree gives a
conditional acceptance.

7.If the law is changed

An offer comes to an end if the law is changed so as to make the contract

contemplated by the offer illegal or incapable of performance

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Check your progress 2

Explain different types of rejection of offer?
Note:

a) Write your answer in the space given below

b) Check your answer with the ones given at end of this lesson ( pp)

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4.5 LET US SUM UP

In this lesson, we have briefly touched upon the following points. An offer is an
undertaking by the offeror to be contractually bound in the event of a proper
acceptance of the offer by the offeree. It may be made by express or implied.
Offer may be specific offer, general offer, counter offer, cross offer and
continuing offer. The communication of a proposal is complete when it comes to
the knowledge of the person to whom it is made. An offer lapses or comes to an
end by different reasons.

4.6 QUESTIONS FOR DISCUSSION

1. What is an offer ?
2. Discuss briefly the law relating to offer.
3. How can an offer be accepted?
4. Discuss the circumstances under which an offer lapses.
5. “An invitation to offer is not an offer”. Elucidate the statement.

4.7 MODEL ANSWER TO CHECK YOUR PROGRESS

Chcek- 1 What constitutes an offer?

Not every proposal made by an offerer is legally regarded as an offer.The tests to

determine whether or not an offer has actually been made are as follows: The
offer must show an obvious intention on the part of the offerer to be bound by
it.The offerer must make the offer with a view to obtaining the assent of the
offerer to such act. The offer must be definite and it must be communicated to
the offerer.

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Chcek – 2 Explain different types of rejection of offer?

An offeree may reject the offer. Rejection of the offer may be express or implied.
The offeree may reject the offer expressly by words, written or spoken. Rejection
of the offer is implied by law. Where the offeree makes a counter offer or gives a
conditional acceptance.

4.8 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-5
ACCEPTANCE

CONTENTS
5.0 Aims and objectives
5.1 Introduction
5.1.1 Definition of acceptance
5.1.2 Acceptance may be express or implied
5. 1.3 Who can accept the an offer
5.2 Types of acceptance
5.2.1 Absolute acceptance
5.2.2 Tentative acceptance
5.2.3 Grumbling acceptance
5.2.4 Express acceptance
5.2.5 Implied acceptance
5.2.6 Conditional Acceptance
5.3 Rules relating to Acceptance
5.4 Revocation of an Acceptance
5.5 Let us sum up
5.6 Questions for discussion
5.7 Model answer to check your progress
5.8 References

5.0 AIMS AND OBJECTIVES

In the previous lesson we discussed the meaning, definition, legal rules relating
to offer and revocation of offer. Here we discuss meaning, definition, legal rules
relating to acceptance and revocation of acceptance. After going through this
lesson, you will able to

1. know the meaning and definition of acceptance

2. know the different types of acceptance
3. understand various rules relating to acceptance
4. study the revocation of acceptance

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5.1 INTRODUCTION

A contract, as already observed, emerges from the acceptance of an offer.

Acceptance is the act of assenting by the offeree to an offer. An offer without
acceptance will not give room for formation of a contract. In other words, an
acceptance is the concurrence by the offeree to act according to the terms of
the offer. Unless acceptance is communicated, there is no valid acceptance. In
this section, we attempt to make a brief explain of the definition and mode of
communication of acceptance.

5.1.1 Definition
2(b) defines ‘acceptance’ as “when the person to whom the proposal is made
signifies his assent thereto, the proposal is said to be accepted.” And states that
“A proposal when accepted becomes a promise”

5.1.2 Acceptance may be express or implied

When acceptance is communicated by words, spoken or written or by doing
some required act is known as express acceptance. If acceptance is to be
gathered from the surrounding circumstances or the conduct of the parties is
known as implied acceptance.

5.1.3 Who can accept the an offer

An offer can be accepted only by the person or persons for whom the offer is
intended. An offer made to a particular person can only be accepted by him
because he is the only person intended to accept. But, an offer made to the
world at large can be accepted by any person whatsoever. To constitute a valid
acceptance the assent must be communicated to the offeror.

Check your progress 1

Explain the effect of silence on acceptance
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)

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5.2 TYPES OF ACCEPTANCE

When an offer is made to the offeree or acceptor the acceptor sometimes, instead
of accepting the offer as such, may impose certain conditions while conveying
his acceptance. He may also accept the offer on some other occasion subject to
the happening of an event which may be certain or uncertain. In all .lie above
cases, the acceptance is not said to have been made absolutely, but subject to
fulfilment of certain conditions. Such types of acceptance are discussed below

5.2.1 Absolute acceptance

When an acceptance is made by the acceptor as per terms contained in the offer
without making any change absolutely, such acceptance is said to be absolute
acceptance.

5.2.2 Tentative acceptance

A tentative acceptance is not an acceptance at all, for the reason such

acceptance is made for the time being subject to final approval or decision. In
other words, such acceptance is subject to another acceptance. There cannot be
an agreement for entering into another agreement (Section 29).

5.2.3 Grumbling acceptance

An acceptance made by the offeree with a grumble is still held to be a valid

acceptance, unless it is challenged in a court of law on the ground of coercion,
etc. Acceptance under protest is not a valid acceptance but a qualified one.

5.2.4 Express acceptance:

An acceptance is said to be expressed when (a) it is conveyed by words spoken

(orally) (b) or by writing.

5.2.5 Implied acceptance

An acceptance is said to be implied when it is inferred from the conduct of the

parties.

Example:

The conductor issuing the ticket to the passenger who has boarded the bus
signifies the implied acceptance of the conductor by his conduct.

5.2.6 Conditional Acceptance

When an offer is accepted by the offeree, subject to fulfillment of conditions,

then it is said to be a conditional or qualified acceptance. Such conditional
acceptance may be classified as condition precedent and condition subsequent.

Condition precedent: Condition precedent imposes fulfilment of certain

obligations of the offerer by the acceptor before acceptance of the offer.

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Examples:

Condition precedent - X the daughter of Y offers to marry Z chosen by Y

provided, Z learns cooking within a month before marriage. This is condition
precedent, which is enforceable under law.

Condition subsequent: Condition subsequent imposes fulfilment of certain

obligations of the offerer by the acceptor after acceptance of the offer.

Example 1:

X the daughter of Y offers to marry Z chosen by Y provided Z learns cooking

within a month after marriage.

Example 2:

A having offered to marry B's daughter imposes a condition that within 2 years
subsequent to his marriage with B's daughter, he should become a father of a
child. These two examples signify condition subsequent, which cannot be
enforced by law.

5.3 RULES RELATING TO ACCEPTANCE

The law of contract prescribes certain fixed rules that are to be followed for
effective and valid communication of acceptance by party who has agreed to act
upon the proposals conveyed by the offeror .In this section we attempt make a
brief explain about rules relating to acceptance. A valid acceptance must be in
conformity with the following rules

5.3.1. Acceptance must be given only by the person to whom the offer is
made.

An offer can be accepted only by the person or persons to whom it is made and
with whom it imports an intention to contract; it cannot be accepted by another
person without the consent of the offeror. The rule of law is clear that “if you
propose to make a contract with A, then B can’t substitute himself for A without
your consent.” An offer made to a particular Person can be validly accepted by
him alone. Similarly an offer made to a class of persons (i.e., teachers) can be
accepted by any member of that class. An offer made to the world at large can be
accepted by any person who has knowledge of the existence of the offer.

Example:

A sold his business to his manager B without disclosing the fact to his
customers. C a customer, who had a running account with A. sent an order for
the supply of goods to A by name. B received the order and executed the same C
refused to pay the price. It was held that there was no contract between B and C
because C never made any offer to B and as such C was not liable to pay the
Price to B ( Boulton vs Jones ).

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5.3.2. Acceptance must be absolute and unqualified [Sec. 7 (1)].

In order to be legally effective it must be an absolute and unqualified acceptance

of all the terms of the offer. Even the slightest deviation from the terms of the
offer makes the acceptance invalid. In effect a deviated acceptance is regarded as
a counter offer in law.

Example:

L offered to M his scooter for Rs 4.000. M accepted the offer and tendered Rs
3.900 cash down, promising to pay the balance of Rs 100 by the evening. There
is no contract, as the acceptance was not absolute and unqualified.

5.3.3. Acceptance must be expressed in some usual and reasonable

manner, unless the proposal prescribes the manner in which it is to
be accepted [Sec. 7 (2)].

If the offeror prescribes no mode of acceptance, the acceptance must be

communicated according to some usual and reasonable mode. The usual modes
of communication are by word of mouth, by post and by conduct. When
acceptance is given by words spoken or written or by post or telegram, it is
called an express acceptance. When acceptance is given by conduct, it is called
an implied acceptance. Implied acceptance may be given either by doing some
required act, for example, tracing the lost goods for the announced reward, or by
accepting some benefit or service, for example, stepping in a public bus by a
passenger. Acceptance must be communicated to the offeror, otherwise it has no
effect.

If the offeror prescribes a mode of acceptance, the acceptance given accordingly

will no doubt be a valid acceptance, even if the prescribed mode is funny. Thus,
if an offeror prescribes lighting a match as a mode of acceptance and the offeree
accordingly lights the match, the acceptance is effective and complete. But what
happens if the offeree deviates from the prescribed mode? The answer to this
query is given in Section 7(2) itself which states that in cases of deviated
acceptances "the proposer may, within a reasonable time after the acceptance is
communicated to him, insist that his proposal shall be accepted in the
prescribed manner, and not otherwise; but, if he fails to do so, he accepts the
(deviated) acceptance.”

Example:

If the offeror prescribes “acceptance by telegram” and the offeree sends

acceptance through a messenger, there is no acceptance of the offer, if the
offeror informs the offeree that the acceptance is not according to the mode
prescribed. But if the offeror fails to do so. it will be presumed that he has
accepted the acceptance and a valid contract will arise.

It should be noted that law does not allow an offeror to prescribe ‘silence’ as the
mode of acceptance. Thus, a person cannot say that if within a certain time

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acceptance is not communicated the offer would be considered as accepted.

Similarly, a trader who, of his own without receiving any order, sends goods to
some person with a letter saying. If I do not hear from you by the next Monday, I
shall presume that you have bought the goods," cannot impose a contract on the
unwilling recipient. It is so because in the absence of such a rule the offerees
will be at the mercy of offerers, unless they reply all such offers in negative
which will certainly be causing a lot of inconvenience and financial burden to
them.

5.3.4. Acceptance must be given within a reasonable time and before

the offer lapses and or is revoked.

To be legally effective acceptance must be given within the specified time limit, if
any, and if no time is stipulated, acceptance must be given within a reasonable
time because an offer cannot be kept open indefinitely (Shree Jaya Mahal
Cooperative Housing Society vs Zenith Chemical Works Pvt. Ltd.). Where M
applied for certain shares in a company in June but the allotment was made in
November and he refused to accept the allotted shares, it was held that the
offeror M could refuse to take shares as the offer stood withdrawn and could
not be accepted because the reasonable period during which the offer could be
accepted had elapsed (Ramsgate Victoria Hotel Co. vs Montefiore). Again, the
acceptance must be given before the offer is revoked or lapses by reason of
offeree's knowledge of the death or insanity of the offeror.

5.3.5 Acceptance must succeed the offer.

Acceptance must be given after receiving the offer. It should not precede the
offer. In a company shares were allotted to a person who had not applied for
them. Subsequently he applied for shares being unaware of the previous
allotment. It was held that the allotment of shares previous to the application
was invalid.

5.3.6. Rejected offers can be accepted only, if renewed.

Offer once rejected cannot be accepted again unless a fresh offer is made.
Check your progress 2

Write short note on “Acceptance through telex”

Note:

a) Write your answer in the space given below

b) Check your answer with the ones given at end of this lesson ( pp)
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5.4 REVOCATION OF AN ACCEPTANCE

An acceptance may be revoked at any time before the communication of its

acceptance is complete as against the accepter, but not afterwards. According to
section 5 “An acceptance may be revoked at any time before the communication
of the acceptance is complete as against the acceptor but not afterwards”. In
fact, revocation of acceptance amounts to withdrawal of the acceptance to a
proposal by the offeree himself.
Example:
A proposes, by a letter sent by post, to sell his house to B. B accepts the
proposal by a letter sent by post. B may revoke his acceptance any time before
the letter communicating it reaches A but not afterwards.
According to English law, an acceptance once complete, cannot be revoked.
Acceptance is necessarily irrevocable for it is acceptance that binds both the
parties. Anson has said, "Acceptance is to offer what a lighted match is to a
train of gunpower. It produces something which cannot be recalled or undone".
Therefore, when the acceptance is effected properly the offer ceases to be an
offer and it becomes an enforceable contract.

5.5 LET US SUM UP

In this lesson, we have briefly touched upon the following points.Acceptance is

an assent or approval which may be either expressed or implied to carry out an
act. Acceptance must be absolute and unqualified. It must be communicated to
the offeror. An acceptance may be revoked at any time before the
communication of the acceptance is complete as against the acceptor but not
afterwards.

5.6 QUESTIONS FOR DISCUSSION

1. What is meant by waiver of acceptance?

2. Acceptance must be before the offer lapses – Discuss.
3. State rules regarding valid acceptance.
4. State rules regarding revocation of acceptance.
5. An acceptance to an offer like a lighted match to a train of gun powder-
Discuss

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5.7 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 Explain the effect of silence on acceptance

The acceptance of an offer cannot be implied from the silence of the offeree
unless the offeree has by his previous conduct indicated that his silence means
that he accepts.
Check – 2 Write short note on “Acceptance through telex”
In the case of contracts over the telephone, each contracting party is able to
hear the voice of the other. There is instantaneous communication of offer and
acceptance, rejection and counter offer. And therefore, the rule which applies to
contracts negotiated orally by the parties in the physical presence of each other
i.e., the contract is complete only when the acceptance is received by the offeror
also applies to contracts made over the telephone. If the acceptance is not in fact
communicated to the offeror because the telephone suddenly goes”dead,” there
will be no contract. The offeree, therefore, must make sure that his acceptance
is received (heard and understood) by the offeror, otherwise there is no binding
contract.

5.8 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-6
BAILMENT

CONTENTS
6.0 Aims and objectives
6.1 Introduction
6.1.1 Meaning
6.1.2 Definition
6.1.3 Persons involved in Bailment
6.1.4 Examples for Bailment
6.2 Essential of Bailment
6.2.1 . Contract
6.2.2. Delivery of possession
6.2.3 Specific Purpose
6.2.4 Return of specific goods
6.2.5 Movable goods
6.3 Kinds of Bailment
6.3.1 Kinds on the Basis of Reward
(i) Gratuitous Bailment
(ii) Non-gratuitous Bailment
6.3.2 Kinds on the Basis of Benefit
(i) Bailment for the Exclusive Benefit of Bailor
(ii) Bailment for the Exclusive Benefit of Bailee
(iii) Bailment for mutual benefit
6.4 Difference between Sale and Bailment.
6.5 Difference between ‘Bailment’ and ‘License’
6.6 Rights of Bailor
6.7 Duties of Bailor
6.8 Rights of Bailee
6.9 Duties of Bailee

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6.10 Termination of Bailment

6.11 Let us sum up
6.12 Questions for discussion
6.13 Model answer to check your progress
6.14 References

6.0 AIMS AND OBJECTIVES

In the fifth lesson, we discussed the meaning of acceptance, legal rules relating
to acceptance and revocation of acceptance. In this lesson we discuss the
meaning of Bailment, essentials of bailment and Rights and Duties of Bailor and
Bailee. After going through this lesson, you will able to
1. know the meaning of Bailment
2. understand various essentials of bailment
3. study the Rights and Duties of Bailor
4. study the Rights and Duties of Bailee

6.1 INTRODUCTION

Transfer of goods from one person to another for some purpose is quite nature in
the business. In this section we discuss the meaning and definition of Bailment,
and Persons involved in Bailment.

6.1.1 Meaning

Bailment plays a popular role in day-to-day life. Bailment means any kind of
‘handing over’. In legal sense, it involves change of possession of goods from one
person to another for some specific purpose. The word ‘bailment’ is derived from
the French word ‘ballier’ with means ‘to deliver’.

6.1.2 Definition

According to Section 148 of the Contract Act — “A Bailment is the delivery of

goods by one person to another for some purpose, upon a contract that they
shall, when the purpose is accomplished, by returned or otherwise disposed of
according to the directions of the person delivering them.”

6.1.3 Persons involved in Bailment

The person delivering the goods is called the ‘bailor.’ The person to whom they
are delivered is called the ‘bailee.’ and the transaction is called the ‘bailment.’

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Examples:

(a) A delivers a piece of cloth to B, a tailor, to be stitched into a suit. There is

a contract of bailment between A and B.

(b) A lends a book to B to be returned after the examination. There is a

contract of bailment between A and B.

(c) A sells certain goods to B who leaves them in the possession of A. The
relationship between B and A is that of bailor and bailee.

6.1.4 Examples for Bailment

Delivering garments for dry cleaning, hiring a cycle, handing over old jewels for
remaking them as new jewels to the goldsmith, depositing luggage in the cloak
room, borrowing books from library are examples for bailment. Sometimes there
may be bailment even without a contract. For example, when a person finds
goods belonging to another, a relationship of bailee and bailor is automatically
created between the finder and the owner. Example. E’s ornaments having been
stolen and recovered by the police disappeared from police custody. Held, the
State was liable, the contract of bailment having been implied.

6.2 ESSENTIAL OF BAILMENT

Section 148 of the contract Act explains the characteristics of bailment. In this
section, we shall see the law relating to bailment from Sections 148.
6.2.1. Contract
A bailment is usually created by agreement between the bailor and the bailee.
The agreement is that the goods are to be returned when the purpose is fulfilled.
The condition is that the goods should be returned either in their original form
or in altered form. The agreement may be express or implied. In certain
exceptional cases, bailment is implied by law as between a finder of goods and
the owner.
6.2.2. Delivery of possession.
A bailment necessarily involves delivery of possession of goods by bailor to
bailee. The basic features of possession are control and an intention to exclude
other. As such, mere custody of goods does not create relationship of bailor and
bailee. A servant who receives certain goods from his master to take to a third
party has mere custody of the goods; possession remains with the master and
the servant does not become a bailee.
Example:
A lay employed a goldsmith for melting her old jewellery and making new one
out of it. Every evening she received the unfinished jewellery and put it into a
box kept at the goldsmith’s premises. She kept the key of that box with herself.

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One night the jewellery was stolen from the box. Held, there was no bailment as
the goldsmith had re-delivered to the lady (the bailor) the jewellery bailed with
him by her
Section 149 explains the mode of delivery to the bailee and states that the
delivery of goods may be either ‘actual’ or ‘constructive’. When the bailor hands
over to the bailee physical possession of the goods, that is called ‘actual delivery.’
‘Constructive delivery,’ on the other hand, does not involve handing over the
physical possession, but something is done which has the effect of putting the
goods in the possession of the bailee. For some purpose. The delivery of goods
from bailor to bailee must be for some purpose. If goods are delivered by
mistake to a person, there is no bailment.
6.2.3 Specific Purpose
When goods are delivered by mistake without any purpose, there is no bailment
within the meaning of Section 148. Delivery of goods must be for some specific
purpose.
6.2.4 Return of specific goods
The goods are delivered subject to the condition that when the purpose is
accomplished the goods are to be returned in specie or disposed of according to
the directions of the bailor, either in their original form or in an altered form.
6.2.5 Movable goods
Bailment is concerned only with goods. Goods, as defined in Sec. 2 (7) of the
Sale Goods Act, 1930, mean every kind of movable property other than money
and actionable claims. The bailment can be only of movable goods. Money is not
included in movable goods. Moreover, in a contract of bailment it is only
possession that passes from the bailor to the bailee and not ownership. Thus if
the property in goods is transferred for money consideration, it is a sale and not
a bailment. Thus a deposit of money with a banker is not a bailment because
there is no obligation to return the identical money. But if notes and coins are
deposited in a box for safe custody, it is a bailment as they are to be returned in
specie.

6.3 KINDS OF BAILMENT

In this section, we discuss the different basis of classified of Bailment

(i) Reward and
(ii) Benefit
6.3.1 Kinds on the Basis of Reward
On the basis of reward, bailment is classified into two types

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(i) Gratuitous Bailment.

It is one in which neither the bailor nor the bailee is entitled to any
remuneration, for example, A gives his book to B for reading.
Consideration in Relation to Gratuitous Bailments
There arises a necessity of discovering a consideration to support a contract of
bailment where it is ‘for the exclusive benefit of the bailor’ or ‘for the exclusive
benefit of the bailee,’ that is, where it is a gratuitous bailment. Perhaps viewing
such a transaction as a whole very carefully shall enable us to see how the
doctrine of consideration is satisfied. “The detriment suffered by the bailor in
parting with the possession of the goods is sufficient consideration to support
the promise on the part of the bailee to return the goods.”

(ii) Non-gratuitous Bailment

It is a bailment for some charges. Either the bailor or the bailee is entitled to
remuneration, for example, cycle let out for hire, or cycle given for repairing etc.

6.3.2 Kinds on the Basis of Benefit

On the basis of benefits, bailment may be classified into three types:
(i) Bailment for the Exclusive Benefit of Bailor
It may be in the case of safe custody, where goods are delivered to a neighbour
or someone else for safe custody without any charge, while the bailor (owner)
goes away.

(ii) Bailment for the Exclusive Benefit of Bailee

It may be in the case of a delivery of a thing to someone else for his use with any
charge, for example, delivery of scooter to a friend to go somewhere.

(iii) Bailment for mutual benefit

In this type of bailment delivery of goods is done with some consideration, for
example, delivering a scooter to a mechanic for repairs.
Check your progress – 1
How is Delivery Made?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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6.4 DIFFERENCE BETWEEN SALE AND BAILMENT

In this section , we discuss the difference between sale and dailment.

(1) In a sale, the ownership in goods is transferred from seller to buyer , while
in bailment, there is transfer of possession only and no ownership is
transferred to bailee.
(2) In a sale, there is no return of goods from buyer to seller. But in bailment,
the bailee returns the goods to the bailor.
(3) The buyer can use the goods in any way he likes : but in bailment, the
bailee can use the goods only according to the directions of the bailor.
(4) In a sale, the consideration for a sale is the price in terms of money. In
bailment, the consideration is an understanding to return the goods after
the purpose is accomplished.

6.5 DIFFERENCE BETWEEN ‘BAILMENT’ AND ‘LICENSE’

In this section , we discuss the difference between license and bailment.

A contract of ‘license’ is that under which one party is permitted to place his
goods in the premises belonging to the other party.
It is to be noted that in a contract of license, there is no delivery of goods to the
licenser. The licenser merely permits the licensee to use the license’s place for
keeping the licensee’s goods. Thus, in a contract of license the goods are not
delivered to the license, while in bailment the goods are delivered to the bailee
and the bailee is responsible for their safety.

6.6 RIGHTS OF BAILOR

Rights of a bailor are almost the same as the duties of a bailee. In this section,
we summarized the rights of bailor

6.6.1. Right to sue

The bailor has a right to sue the bailee for the enforcement of the bailee’s duties
and liabilities.

6.6.2. Rights to Terminate the Bailment (Sec. 153)

Section 153 states that “A contract of bailment is voidable at the option of the
bailor, if the bailee does any act with regard to the goods bailed, inconsistent
with the conditions of the bailment.”

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Example:

A lets to B for hire a horse for his own riding. B drives the horse in his carriage.
A can terminate the bailment.

6.6.3. Unauthorised use by the Bailee (Sec. 154)

Section 154 states, “If the bailee makes any use of the goods bailed, which is not
according to the conditions of the bailment, he is liable to make compensation to
the bailor for any damage arising to the goods from or during such use of them.”

Example:

A lends a horse to B for his own riding only. B allows C, a member of his family
to ride the horse. C rides with care, but the horse accidentally falls and is
injured. B is liable to make compensation to A for the injury does to the horse.

6.6.4. Right against Mixture of Goods Bailed (Section 155, 156 and 157)

If the bailee, with the consent of the barilor, mixes the goods of the bailor with
his won goods, the bailor and the bailee shall have an interest, in proportion to
their respective shares, in the mixture thus produced

6.6.5. Right to Demand Return of Goods (Sec. 159)

In case of gratuitous bailment the bailor can, at any time, exercise his option to
terminate the contract and take back the goods bailed.

6.6.6. He is Entitled to Claim Damages

Bailor can claim damages for loss, destruction or deterioration of the goods
bailed, owing to bailee’s negligence.

6.6.7. Right to Claim Increase in Value or Profits (Sec. 163)

The bailor is entitled to get any increase or profit from the goods baile.

6.6.8. Suit against Wrongdoer (Sec. 180)

The bailor can sue a third person who wrongfully deprives the bailee of the use
of the goods, or does them any injury.

6.6.9. Share in the Compensation Received (Sec. 181)

Under sec. 180, Compensations in any suit, received shall be apportioned
between bailor and bailee, in accordance with their respective interest.

6.7 DUTIES OF BAILOR

A bailor is the person who delivers the goods. In this section, we discuss the
bailor’s duties one by one

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6.7.1. Duty to disclose faults in goods bailed.

Section 150 lays down this duty. The Section makes a distinction between a
gratuitous bailor and a bailor for reward and provides as follows:

(a) A gratuitous bailor is bound to disclose to the bailee all those faults in the
goods bailed, of which he is aware and which materially interfere with the use of
them, or expose the bailee to extraordinary risks, and if he fails to do so, he wil
be liable to pay such damages to the bailee as may have resulted directly from
the faults. A gratuitous bailor will not be liable for damages arising to the bailee
from defects of which he was ignorant.
Example: (to Sec. 150).
A lends a horse, which he knows to be vicious, to B. He does not disclose the
fact that the horse is vicious. The horse runs away. B is thrown and injured. A
is responsible to B for damage sustained
(b) A bailor for reward is responsible for all defects in the goods bailed whether
he is aware of the defects or not, if he does not disclose them to the bailee.
Unlike a gratuitous bailor, ignorance of the defects is no defence for him.
Example (to Sec. 150)
A hires a carriage of B. The carriage is unsafe though B is not aware of it, and
A is injured. B is responsible to A for the injury. (If the carriage were lent
gratuitously, B would not be liable under the circumstances. Similarly, had B
told the fault to A, and then also he would not be liable.)
It may be mentioned that where the goods bailed are of dangerous nature, it is
the duty of the bailor to disclose the fact to the bailee otherwise he will be liable
for all the resulting damage (Great Northern Rly. Vs L.E.P. transport Ltd3.).
For example:
A delivers to B, a carrier, some explosives in a case but does not warn B. The
case is handled without extra care necessary for such articles and there is an
explosion. The carrier is injured and some other goods are damaged. A, the
bailor, is liable for all the resulting damage.

6.7. 2. Repay Necessary Expenses (Sec. 158)

According to Section 158, ‘Where, by the conditions of the bailment, the goods
are to be kept or to be carried, or to have work done upon them by the bailee for
the bailor, and the bailee is to receive no remuneration, the bailor shall repay to
the bailee the necessary expenses incurred by him for the purpose of bailment.”
Thus, in the case of gratuitous bailment, the bailor has to repay to the beilee all
the necessary expenses incurred by him for the purpose of bailment. In the
repay to the bailee, all the necessary expenses incurred by him for the purpose
of bailment. In the case of non-gratuitous bailment, the bailor is held
responsible to bear only extra-ordinary expenses.

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Example:
If a horse is lent for journey, the expenses of feeding the horse would be borne
by the bailee (ordinary expense). But if the horse becomes sick and expenses
have been incurred for its recovery, the bailor should have to pay it
(extraordinary expenses).
6.7. 3. To Indemnify the Bailee (Sec. 159)
If the borrower is compelled to return goods, in the case of gratuitous bailment,
before the specified time and suffers loss which exceeds the benefit derived by
him, the bailor’s duty is to indemnify the borrower for such loss.
6.7 .4. Responsibility for any Loss due to Defect in Title (Sec. 164)
“The bailor is responsible to the bailee for any loss which the bailee may sustain
by reason that the bailor was not entitled to make the bailment, or to receive
back the good, or to give directions, respecting them”.
6.7.5. Duty to receive back the goods.
It is the duty of the bailor to receive back the goods when the bailee returns
them after the time of bailment has expired or the purpose of bailment has been
accomplished. If the bailor refuses to take delivery of goods when it is offered at
the proper time, the bailee can claim compensation for all necessary expenses of,
and incidental to, the safe custody.
Check your progress – 2
What is consideration?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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6.8 RIGHTS OF BAILEE

The duties of the bailor are the rights of the bailee. However, to recapitulate, the
bailee has the following rights against bailor:
1. A bailee is entitled to claim damages for any loss caused to him from the
undisclosed faults in the goods bailed. (Sec. 150)
2. In case of gratuitous bailment, bailee is entitled to recover from bailor all
necessary expenses incurred by him for bailment (Sec. 158): and of the
extraordinary expenses in case of non-gratuitous bailment.

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3. Right to indemnify, in case of gratuitous bailment, against premature

termination of the contract by the bailor for any loss sustained. (Sec. 159)
4. A bailee is entitled to claim any loss sustained by him because of non-
entitlement or defective entitlement of the bailor on goods bailor on goods
bailed.
5. If a third person claims the ownership of the goods bailed, the bailee can
ask the court to decide the ownership and can withhold the delivery to the
bailor.
6. If a third person wrongfully deprives the bailee of the use or possession of
the goods bailed to him, he has the right to bring an action against such
third party (Sec. 180).
7. According to Section 165, in case of several joint bailors, the bailee can
deliver the goods back to one of them without the consent of all.
8. Bailee enjoys the right of lien (Sec. 170 and 171) Bailee’s lien, discussed
separately, in this chapter.

6.9 DUTIES OF BAILEE

A bailee is the person who receives the goods. In this section, we discuss the
bailee’s duties one by one

6.9.1. To Take Reasonable Care of the Goods Bailed (Sec. 151)

According to Section 151, “In all cases of bailment the bailee is bound to take as
much care of the goods bailed to him as a man of ordinary proudence would,
under similar circumstances, take of his own goods of the same bulk, quality
and value as the goods bailed.”

Further Section 152 States, “The bailee, in the absence of any special contract,
is not responsible for the loss, destruction or deterioration of the thing bailed, if
be has taken the amount of care of it described in Section 151”.

6.9. 2. Not to Make Unauthorised Use of Goods Bailed (Sec.154)

“If the bailee makes any use of the goods bailed, which is not according to the
conditions of the bailment, he us liable to make compensation to the bailor for
any damage arising to the goods from or during such use of them”.

Example:

(1) A lends a horse to B for his own riding only, B allows C, member of his
family, to ride the horse. C rides with care, but the horse accidently falls
and is injured. B is liable to make compensation to A for the injury done
to the horse.

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(2) A hires a hors in Calcutta from B expressly to march to Banaras. A rides

with due care, but marches to cuttack instead. The horse accidently falls
and is injured. A is liable to make compensation to B for the injury to the
horse.

6.9 .3. Not to Mix the Goods Bailed with his Own Goods (Secs. 155, 156
and 157)

The bailee should not mix the goods bailed with his own goods. If he mixes, the
following rules apply:

(a) “If the bailee, with the consent of the barilor, mixes the goods of the bailor
with his won goods, the bailor and the bailee shall have an interest, in
proportion to their respective shares, in the mixture thus produced” (Sec.
155).

Example:

A bails one bag of sugar to B. B with the consent of A, mixes A’s sugar with
three bags of his own. Here A and B have interest in the mixture in proportion
of 1:3.

(b) “If the bailee, without the consent of the bailor mixes the goods of the
bailor with his own goods, and the goods can be separated or divided, the
property in the goods remains in the parties respectively but the bailee is
bound to bear the expenses of separation or dividion, and any damage
arising from the mixture” (Sec. 156).

Example:

A bails 100 bales of cotton marked with a particular mark to B. B without A’s
consent mixes the 100 bales with other bales of his own bearing a different
mark. A is entitled to have his 100 bales returned and B is bound to bear all the
expenses incurred in the separation of the bales and any other incidental
damages.

(c) “If the bailee, without the consent of the bailor, mixes the goods of the bailor
with his won goods, in such a manner that it is impossible to separate the
goods bailed from the other goods and deliver them back, the bailor is
entitled to be compensated by the bailee for the loss of the goods” (Sec. 157).

Example:

A bails a barrel of cape flour worth Rs.45 to B. B without A’s consent mixes the
flour with country flour of his own, worth only Rs.25 a barrel. B must
compensate A for the loss of his flour.

6.9. 4. To Return the Goods Bailed (Sec.160)

According to Section 160, “It is the duty of the bailee to return, or deliver,
according to the bailor’s direction, the goods bailed, without demand, as soon as

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the time for which they were bailed has expired, or the purpose for which they
were bailed has been accomplished”. Again according to Section 165, “Where
there are several joint bailee may return the goods to any one of the joint
owners.

According to Section 161, “If, by the default of the bailee, the goods are not
returned, delivered or tendered at the proper time, he is responsible to the bailor
for any loss, destruction or deterioration of the goods from that time”.

Example: Shaw & Co. Vs. Symmons & Sons (1917)

A delivered certain books to B to be bound and return and return within

reasonable time. B could not complete the job within reasonable time. The
books were subsequently burnt in an accidental fire in B’s was held liable in
damages for the loss of the books and the plea that the fire was accidental or an
act of God was of no avail.

6.9.5. To Return Increase or Profit Accrued

According to Section 163, “In the absence of any contract to contrary, the bailee
is bound to deliver to the bailor, or according to his direction, any increase or
profit which may have accrued from the goods bailed”.

Example:

A leaves a cow in the custody of B to be taken care of. The cow has a caif. B is
bound to deliver the calf as well as the cow to A.

6.9.6. Not to set up an Adverse Title

Under section 117 of the Indian Evidence Act, the bailee holds the goods on
behalf of and for the bailor, he cannot deny the title of the bailor. It is the duty
of the bailee to return the goods only to the bailor even though any third person
is claiming title over them.

6.10 TERMINATION OF BAILMENT

In this section, we discuss various circumstances for a contract of bailment

terminates
1. If the bailment is for a ‘specified period’, the bailment terminates as soon
as the stipulated period expires.
2. If the bailment is for a ‘specified period’, the bailment terminates as soon
as the purpose is fulfilled.
3. If the bailee does any act with regard to the goods bailed, which is
inconsistent with the terms of bailment, the bailment may be terminated
by the bailor even though the term of bailment has not expired or the
purpose of bailment has not been accomplished (Sec. 153).

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4. A gratuitous bailment can be terminated by the bailor at any time, even

before the specified time or before the purpose is achieved, subject to the
limitation that where such termination causes loss in excess of benefit
actually derived by the bailee, the bailor must indemnify the bailee for the
amount in which the loss occasioned exceeds the benefit derived (Sec.
159).
5. A gratuitous bailment is terminated by the death either of the bailor or of
the bailee (Sec. 162)

6.10 LET US SUM UP

In this lesson, we have briefly touched upon the following points.A ‘bailment’ is
the delivery of goods by one person to another for some purpose, upon a
contract, that they shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering them.
The person delivering the goods is called the ‘bailor’ and the person to whom
they are delivered is called the ‘bailee’ (Sec. 148).
Requisites of Bailment
1. Contract. 2. Delivery of possession of goods for some purpose. 3. Return of
goods when the purpose is accomplished.
Classification of Bailment
Bailment may be for the (1) exclusive benefit of the bailor, or (2) exclusive benefit
of the bailee, or (3) mutual benefit of the bailor and the bailee. Bailment may
also be classified into (1) gratuitous bailment, and (2) non-gratuitous bailment or
bailment-for reward.
Duties of bailee
1. To take care of the goods bailed. 2. Not to make any unauthorised use of the
goods. 3. Not to mix the goods balled with his own goods. 4. Not to set up an
adverse title. 5. To return any accretion to the goods. 6. To return the goods.
Duties of bailor
1. To disclose known faults. 2. To bear extraordinary expenses of bailment.
3. To receive back the goods. 4. To indemnify bailee.

6.4 QUESTIONS FOR DISCUSSION

1. Define a contract of bailment. What are its essentials?

2. What are the duties of a bailor ?
3. What are the duties of a bailee ?
4. What are the rights of a bailor and bailee ?

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6.5 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 How is Delivery Made?

The delivery to the bailee may be made by doing anything which has the effect of
putting the goods in the possession of the intended bailee or of any person
authorized to hold them on his behalf.
Check – 2 What is consideration?
There arises a necessity of discovering a consideration to support a contract of
bailment where it is ‘for the exclusive benefit of the bailor’ or ‘for the exclusive
benefit of the bailee,’ that is, where it is a gratuitous bailment. Perhaps viewing
such a transaction as a whole very carefully shall enable us to see how the
doctrine of consideration is satisfied. “The detriment suffered by the bailor in
parting with the possession of the goods is sufficient consideration to support
the promise on the part of the bailee to return the goods.”

6.6 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-7
PLEDGE

CONTENTS
7.0 . Aims and objectives
7.1. Introduction
7.2 Essentials of Pledge
7.3 Rights of Pawnor
7.4 Duties of Pawnor
7.5 Rights of pawnee
7.6 Duties of Pawnee
7.7 Bailment and Pledge Compared
7.8 Pledge and Bailment distinguished
7.9 Let us sum up
7.10 Questions for discussion
7.11 Model answer to check your progress
7.12 References

7.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning and essential of bailment,

rights and duties of bailor and bailee. In this lesson we have briefly touched
upon the meaning , Essential of pledge and Rights and Duties of Pawnor and
Pawnee. After going through this lesson, you will able to
1. know the meaning of and definition of Pledge
2. understand various essential of pledge
3. know rights and duties of pawnor
4. understand rights and duties of pawnee

7.1 INTRODUCTION

In this section, we have briefly touched upon the meaning, definition and parties
to a pledge

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7.1.1 Meaning

When goods are delivered as securities by one person to another, for the purpose
of loan to be advanced, or already advanced by other, the transaction is known
as pledge or pawn. Pledge is also a case of a bailment, but it is a special kind of
a bailment.

7.1.2 Definition

According to Section 172 of the Contract Act, “The bailment of goods as security
for payment of a debt or for performance of a promise is called pledge. The bailor
in this case is called the pawnor. The bailee is called the pawnee”.

7.1.3 Parties to a pledge

(i) The person who delivers the goods is known as Pawnor or pledger. (ii) The
person to whom the goods are delivered as security is known as Pawnee or
Pledgee. Example: Raja borrows Rs. 3,000 from Rukmani and keeps his scooter
as security for repayment of the debt. This kind of bailment of property is called
a pledge or pawn. Here Raja is the pawnor and Rukmani the pawnee.

7.2 ESSENTIALS OF PLEDGE

In this section, we shall see the essentials of a valid pledge.

1. The goods must be delivered by borrower to the lender as a security for
repayment of debt or for performance of a promise.
2. The possession of the goods passes from one person to the other person
and not the ownership.
3. Pledge can be of only movable goods - documents of title, shares-,
valuables etc. Immovable properties cannot be pledged.
4. The goods, pledged with the pawnee, to be returned on receipt of his full
dues.

7.3 RIGHTS OF PAWNOR

In this section, we discuss the rights of Pawnor.

1. The pawnor has the right to take back the goods pledged provided that he
has paid the whole of the amount of debt along with any interest or
charges thereon, to the pawnee.

2. The duties of the pawnee are the rights of the pawnor. Therefore, the
pawnor can enforce by suit all the duties of the pawnee

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3. Usually a time may be stipulated for the payment of the debt, or

performance of the promise, for which the pledge is made. If the pawnor
makes default in payment of the debt or performance of the promise at the
stipulated time he may redeem the goods pledged at any subsequent time
before the actual sale is made. But on exercising such right of redemption
the pawnor must pay any expenses which might have arisen from his
default (Sec. 177).

7.4 DUTIES OF PAWNOR

In this section, we discuss the duties of Pawnor.

1. It is the duty of the pawnor to repay the loan taken from the pawnee
within the time and in the manner specified in the contract
2. He has to compensate the pawnee for any extraordinary expenses incurred
by him.
3. Default or risk, if any, in the goods pledged, should be known to pawnee

Check your progress - 1

How pledge is differ from mortgage?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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7.5 RIGHTS OF PAWNEE

In this section, we discuss the rights of Pawnee

7.5.1. Right of retainer. The pawnee may retain the goods pledged until
his dues are paid. He may retain them not only for the payment of the
debt or the performance of the promise, but for (a) the interest due on the
debt, and (b) all necessary expenses incurred by him in respect of the
possession or for the preservation of the goods pledged (Sec. 173). He can
however exercise only a particular lien over the goods.

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7.5.2. Right of retainer for subsequent advances. When the pawnee lends
money to the same pawnor after the date of the pledge, it is presumed that
the right of retainer over the pledged goods extends to subsequent
advances also. This presumption can be rebutted only by a contract to the
contrary (Sec. 174).
7.5.3.Right to extraordinary expenses. The pawnee is entitled to receive
from the pawnor extraordinary expenses incurred by him for the
preservation of the goods pledged (Sec. 175). For such expenses, he has no
right to retain the goods ,he can only sue to recover them.
7.5.4.Right against true owner, when the pawnor's title is defective.
When the pawnor has obtained possession of the goods pledged by him
under a voidable contract (i.e., by fraud, undue influence, coercion, etc.)
but the contract has not been rescinded at the time of the pledge, the
pawnee acquires a good title to the goods, provided he acts in good faith
and without notice of the pawnor’s defect of title (Sec. 178-A).
7.5.5.Pawnee’s rights where pawnor makes default (Sec. 176). Where the
pawnor fails to redeem his pledge, the pawnee can exercise the following
rights:
(1) He may file a suit against the pawnor upon the debt or promise and
may retain the goods pledged as a collateral security.
(2) He may sell the goods pledged after giving the pawnor a reasonable
notice of the sale. of these two rights, while the right to retain or sell the
pawned goods are not concurrent, the right to sue and sell are concurrent
rights, i.e., the pawnee may sue and at the same time retain the goods as
concurrent security or sell them after giving reasonable notice of the sale
to the pawnor
(3) He can recover from the pawnor any deficiency arising on the sale
of the goods by him. But he shall have to hand over the surplus, if any,
realised on the sale of the goods to the pawnor.

7.6 DUTIES OF PAWNEE

In this section, we discuss the duties of Pawnor.The duties of pawnee are

similar to bailee:
1. He has to take reasonable care of the goods pledged.
2. He is not permitted any unauthorised use of the goods pledged.
3. He has to return the pledged goods on the payment of debt.
4. He should not do any act in violation of the terms of the contract.
5. He should not mix the goods pledged with his own goods.
6. Any accruals to the goods pledged belong to the pledgor and should be
delivered accordingly.

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7.7 BAILMENT AND PLEDGE COMPARED

In this section, we discuss similarities between bailment and pledge

1. In both, delivery of goods is important.
2. In both, possession of goods alone is transferred and the ownership is
retained by owner.
3. Both are created by agreement between the parties.
4. In both, moveable goods are the subject matter.
5. In both, the goods are returned on the fulfilment of purpose

7.8 PLEDGE AND BAILMENT DISTINGUISHED

In this section, we discuss similarities between bailment and pledge

1. In pledge, goods are pledged as a security. In bailment goods are bailed for
carrying out specific purpose
2. In pledge, In case of default, the pawnee may retain the goods. He can sell
the goods.In bailment, the bailee can retain the goods baild but he cannot
sell it.
3. In pledge, Pawnee has no right to use the goods. In bailment, Bailee may
use the goods bailed as per the terms of the contract.

7.9 LET US SUM UP

In this lesson, we have briefly touched upon the following points. The bailment
of goods as security for payment of debt or performance of a promise is called
“pledge”. The bailor is, in this case, called the 'pawnor' or “pledger” and the
bailee is called the “pawnee” or “pledge”
The essential of pledge is the goods must be delivered by borrower to the lender
as a security for repayment of debt or for performance of a promise, and the
possession of the goods passes from one person to the other person and not the
ownership.
Rights of pawnor: The pawnor has the right to take back the goods pledged
provided that he has paid the whole of the amount of debt along with any
interest or charges thereon, to the pawnee. The duties of the pawnee are the
rights of the pawnor. Therefore, the pawnor can enforce by suit all the duties of
the pawnee.

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Duties of pawnor: He has to compensate the pawnee for any extraordinary

expenses incurred by him. Default or risk, if any, in the goods pledged, should
be known to pawnee.
Rights of pawnee. (1) Right to retain goods for debt, interest and expenses, and
for subsequent advances. (2) Right to extraordinary expenses. (3) Right against
true owner when the pawnor's title is defective. (4) Rights where pawnor makes
default (a) Suit against the pawnor. (b) Retention of the goods as a collateral
security, (c) Suit for the sale of the goods pledged. (d) Right of sale, (e) Right to
recover deficiency on sale.

7.10 QUESTIONS FOR DISCUSSION

1. Define pledge
2. What are the rights and duties of pawnor and pawnee?
3. What are essentials of a valid pledge?
4. Distinguish between pledge and bailment.

7.11 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 How pledge is differ from mortgage?

1. Only one loan can be taken at a time on the pledge of the same time. On a
mortgage of asset more than one loan can be taken.
2. Moveable property is the subject matter in pledge. Immoveable property is
the subject matter in mortgage.
3. A pawnee is not allowed to use the goods pledged. Mortgagee has the right
to use the property mortgaged.

7.12 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-8
CONTRACT OF SALE OF GOODS ACT 1930

CONTENTS
8.0 . Aims and objectives
8.1. Introduction
8.1.1 Scope
8.2 Goods
8.3 Classification of Goods
8.4 Contract of Sale
8.5 Sale and an Agreement to sell Distinguished
8.5.1. Nature of contract
8.5.2. Creation of right
8.5.3. Passing of property
8.5.4. Remedies in case of breach of contract
8.5.5. Risk of loss
8.5.6. Insolvency
8.6 Essential of a Contract of Sale
8.6.1 Offer and Acceptance
8.6.2 Two Parties
8.6.3 Goods
8.6.4 Transfer of Property
8.6.5 Price
8.6.6 Contract
8.7 Performance of Contract of sale
8.8 Definitions of Delivery of Goods
8.9 Mode of Delivery
8.10 Rules regarding Delivery of goods
8.11 Let us sum up
8.12 Questions for discussion
8.13 Model answer to check your progress
8.14 References

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8.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning, essential of pledge and rights
and duties of Pawnor and Pawnee. In this lesson, we discuss in detail about
contract of sale of goods Act 1930.After going through this lesson, you will able
to
1. know the meaning and definition of a contract of sale
2. understand various essential characteristics of a contract of sale
3. know the different kinds of goods
4. understand rules regarding delivery of goods

8.1 INTRODUCTION

The law as to the sale of goods was originally embodied in section 76 to 123 of
the Indian Contract Act 1872. However, as the provisions of the sections76 to
123 were found inadequate to meet the complexities of growing mercantile
transaction, the said sections were repealed and the Sale of Goods Act 1930 took
its birth. It is well known that our Sale of Goods Act 1930 is largely based of the
English Sale of Goods Act 1893. Law relating to the sale of goods is a branch of
Contract Law as the general principles of contract are applicable to contracts for
sale of goods such as offer and acceptance, capacity of parties, free consent,
consideration and legality of the object. Here, we discuss the scope and meaning
of goods and its kinds

8.1.1 Scope
The law relating to sale of goods is contained in the Sale of Goods Act 1930,
which came into force on 1st July 1930. The sale of Goods Act applies only to
movables other than actionable claim and money and not to immovable property
is governed by the Transfer of Property Act, 1882. “Actionable claims” and
“money” are excluded from “goods”. Actionable claims mean ‘chose in action’ or
‘thing in action’. It means the person has a right to recover a thing by suit but
does not have the enjoyment of the thing. Money is excluded from the definition
of goods for two reasons (a) that it constitutes the price for exchange of goods
sold and (b) that it is governed by a different principles of law due to its being
currency. Foreign currency may, however, be bought or sold.

8. 2 GOODS

In this section, we discuss meaning of goods. Goods form die subject matter of
contract of sale. According to Sec. 2 ( 7 ) “Goods” means (i) every kind of movable
property other than actionable claims and money and includes, (ii) stock and (iii)
shares, (iv) growing crops, grass and (v) things attached to or forming part of the
land which are agreed to be separated before sale or under the contract of sale.

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8.3 CLASSIFICATION OF GOODS

In this section, we discuss different types of goods

Goods may be
i) Existing goods
ii) Future goods
iii) Contingent Goods
8.3.1 Existing Goods
According to section 6 (1), Goods owned and possessed by the seller at the time
of making the contracts of sale are called existing goods. The existing goods may
be of the following types:
(a) Specific Goods: According to sec 2 (14), Goods identified and agreed upon at
the time of the making of the contract of sale are called specific goods. [Sec.
2(14)] Where there is a contract for specific goods, the seller would not fulfil his
contract by delivering any goods other than those agreed upon. For example, if A
who owns a number of horses, promises to sell one of them, the contract is for
unspecified goods. But if the horse that is to be sold has been singled out, the
contract is for specific goods.
(b) Unasertained Goods: The goods which are not specifically identified at the
time of contract of sale are known as unascertained goods. In other words,
unascertained goods are indicated by description and not separately identified
Example:
Sale of one kg of oil from 100 kgs of oil with the merchant is a sale of un-
ascertained goods. When one kg is separated from 100 kgs of oil the sale is of
specific goods.
8.3.2 Future Goods
“Future Goods” means goods to be manufactured or produced or acquired by
the seller after making the contract of sale" [Sec. 2(6)].)These are the goods
which are not in existence at the time of contract of sale. The seller acquires
such goods after the making of the contract of sale. But subsequently come into
existence.
8.3.3 Contingent Goods
Contingent goods are future goods. According to Sec. 6 (2) “there may be a
contract for the sale of goods, the acquisition of which by the seller depends
upon a contingency which may or may not happen.”
Example:
A agrees to sell B a certain paintings provided he is able to purchase it from its
present owner. This is an agreement for the sale of contingent goods.

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8.4 CONTRACT OF SALE

In this section, we discuss definition of sale and agreement to sell. A contract of

sale of goods is a contract where by the seller transfer or agrees to transfer the
property in goods to the buyer for a price. Such a contract of sale may be
absolute or conditional. Absolute contract is without any conditions. Conditional
contract may be a contract with condition precedent or condition subsequent. A
contract of sale of goods may be either a ‘sale’ or an ‘agreement to sell.’
Sec. 4 (1) of the Sale of Goods Act defines a contract of sale of goods as “a
contract whereby the seller transfers or agrees to transfer the property in goods
to the buyer for a price”. Here property means the right of ownership.

8.4.1 Sale
Where under a contract of sale the property in the goods is transferred from
seller to the buyer, the contract is called a ‘sale’. In a sale immediate payment is
not necessary. Payment may be done at a future date. But the ownership of
goods i.e., the property in the goods must be transferred immediately from the
seller to the buyer.
Examples:
A sells his bike for Rs. 10,000 to B. It is a sale, as the ownership of the bike has
been transferred to B by A for a price.

8.4.2 Essentials of a Valid Sale

1. Property: There must be a transfer of general property in the goods i.e.,
transfer of ownership in the goods, and not merely special property or
special interest, from the seller to the buyer.
2. Movable goods: Transfer of goods must be that of movable goods only.
3. Price: The price or consideration of goods must be money. Where goods
are exchange for goods, it is nor a sale.
4. Parties: There must be two parties, i.e., buyer and seller. The parties
must be competent to contract as under the Indian Contact Act, 1872.
The seller and buyer must be two different persons.
5. Form: no particular form is necessary to constitute a contract of sale. A
contract of sale may be made in writing or by word of mouth, i.e., may be
express or it may be implied from the conduct of the parties, or from the
course of dealings between the parties [Sec. 5 (2)]. It may also be made
partly in writing or partly by word of mouth. Proposal and acceptance
must be made.
Sec. 4 (3) states “where under a contract of sale the property in the goods is
transferred from the seller to the buyer, the contract is called a sale, but where
the transfer of the property in the goods is to take place at a future time or
subject to some condition thereafter to be fulfilled, the contract is called "an
agreement to sell”.

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8.4.3 Agreement to Sell

Where the transfer of the property i.e., ownership in the goods is to take place at
a future date or subject to some condition to be fulfilled, the contract is called an
agreement to sell. Where by a contract of sale the seller purports to effect the
present sale of future goods, the agreement operates as an agreement to sell.

Examples:

A agrees with B to sell his bike after two months for Rs. 10,000. It is an
agreement to sell as the bike is to be transferred on a future date.

8.4.4 When agreement to sell becomes sale?

An agreement to sell neither does nor involves any immediate transfer of

property in the goods. An agreement to sell becomes a sale when the time lapses
or the conditions are fulfilled subject to which the property in the goods is to be
transferred.

8.5 SALE AND AN AGREEMENT TO SELL DISTINGUISHED

In this section, we discuss difference between sale and agreement to sell.

8.5.1. Nature of contract:
Sale is an ‘executed contract’ while an agreement to sell is an ‘executed
contract’. In an executed contract, one of the parties has already performed his
part of the contract. On the other hand, in an executory contract, both the
parties are yet to perform their mutual promises.
An agreement to sell becomes a sale when, (i) agreed time of the fulfillment of the
performance of the contract elapses, or (ii) the conditions of the sale are fulfilled.
Till then the transaction is an agreement to sell and not a sale. On the other
hand in a sale, there is an immediate transfer of ownership in the goods. Sale is
a contract plus a conveyance, while an agreement to sell is only a pure contract.
A sale is therefore, an executed contract while an agreement to sell is an
executory contract.
8.5.2. Creation of right:
Sale creates a ‘jus-in-rom’ i.e., a right on the goods against the whole world,
while an agreement to sell creates a jus-in-personam, i.e., a personal right only
against the person for any default in fulfilling his part of the agreement.
8.5.3. Passing of property:
In a sale, the property in the good passes to the buyer with the risk while in an
agreement so sell, risk and property does not pass to the buyer immediately.

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8.5.4. Remedies in case of breach of contract:

In a sale, the seller is entitled to sue for the price of the goods and also has a
right of lien, stoppage in transit and re-sale. In an agreement to sell, the seller
has the right only to sue for damages for non-performance of the contract.
8.5.5. Risk of loss:
In case of loss to good, in sale, the loss will be borne by the buyer even if the
possession of good is with the seller while in an agreement to sell, the seller will
have to pay for the loss since the ownership in the goods has not passed to the
buyer.
8.5.6. Insolvency:
(i) Insolvency of buyer: In a sale, the seller must deliver the good to Official
Assignee or Receiver and can claim rateable dividend for the goods, while in an
agreement to sell, the seller may refuse to deliver the goods unless paid for.
(ii) Insolvency of seller: In a sale, the buyer is entitled to receive the goods from
the Official Assignee or Receiver, while in an agreement to sell, the buyer has to
prove the amount he has paid to the seller and he can only claim a reteable
dividend. He cannot compel the Receiver to sell and deliver the goods.

8.6 ESSENTIAL OF A CONTRACT OF SALE

According to Sec. 4 of the Sale of Goods Act defines “sale” as “a contract of sale
of goods is a contract whereby the seller transfers or agrees to transfer the
property in goods to the buyer for price”. In this section, we attempt to make a
brief study of the essentials of a contract of sale.
Contract of sale how made?
According to Sec. 5 (1). “A contract of sale is made by an offer to buy or sell
goods for a price and the acceptance of such offer. The contract may provide for
the immediate delivery of the goods or immediate payment of the price or both,
or for the delivery or payment by instalments, or that the delivery or payment or
both shall be postponed”
According to Sec. 5 (2). “Subject to the provisions of any law for the time being
in force, a contract of sale may be made in writing or by word of mouth, or
partly in writing and partly by word of mouth or may be implied from the
conduct of the parties”
The definition reveals the following essentials of a contract of sales of good

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8.6.1 Offer and Acceptance:

An offer to buy or sell goods by one party for a price and acceptance of such an
offer by another party is necessary
8.6.2 Two Parties
To constitute a contract of sale, there must be a transfer or agreement to
transfer the property in goods by the seller to the buyer. That is, there must be
two parties in a contract of sale - seller and buyer. Buyer means a person who
buys or agrees to buy goods. Similarly seller is a person who sells or agrees to
sell his goods. Sec. 2 (1). The seller and the buyer must be two different
persons, for a man cannot purchase his own goods.
8.6.3 Goods
The subject matter of the contract of sale must be “goods”. According to Sec.
2(7), “goods means every kind of moveable property other than actionable claims
and money; and includes stock and shares, growing crops, grass and things
attached to or forming part of the land which are agreed to be severed before
sale or under the contract of sale”. Goods which form the subject matter of sale
may be either existing goods or future goods. Money, actionable claims and
immovable property cannot form the subject matter of sale within the meaning
of Sec. 2(7).
8.6.4 Transfer of Property
‘Property’ here means ‘ownership’. In every contract of sale, the ownership of
goods must be transferred by the seller to the buyer; where should be an
agreement by the seller to transfer the ownership to the buyer. According/to
Sec. 2 (11) “Property means the general property in the goods, and not merely a
special property.” The property in the goods means the general property i.e., ‘all
ownership right of the goods. Though passing of the title in the goods is an
ingredient of sale, physical delivery of goods is not essential. The term ‘property’
as used in the Sale of Goods Act means general property in goods as
distinguished from special property. For example, if A who owns certain goods
pledges them to B, he has general property in the goods, whereas B has special
property or interest in the goods to the extent of the amount of advance he has
made.
8.6.5 Price
The term ‘price’ is defined in Section 2 (10) as “Price means the money
consideration for of goods.” Consideration in a contract of sale has necessarily to
be-money i.e., legal tender. If goods ‘are sold or exchanged for other goods, the
transaction is barter and not a sale of goods under this Act. As a matter of fact,
the requirement is that the goods must be sold for a definite” sum of money and
it may be partly in cash and partly in valued op goods. For example, when an old
bike is returned to the dealer for a new one and the difference is paid in cash
that would also be a sale. (Aldridge Vs. Johnson 1857).

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8.6.6 Contract
All the essential elements of a contract must be present in a contract of sale. the
word contract means an agreement enforceable at law. If any of the essential
elements’ of a valid contract is missing, then the contract of sale will not be
valid.
It may be noted that no particular form is necessary for the making of a contract
of sale. It may be in any form. A contract of sale may be made (a) in writing or (b)
by words of mouth or (c) partly in writing and partly by words of mouth, or {d)
may be implied from the conduct of the parties. However, if any particular mode
is prescribed by any law, then the contract of sale must be made in that
particular mode. (Sec. 5 (2))

8.7 PERFORMANCE OF CONTRACT OF SALE

In this section, we attempt to make a brief study of the performance of a

contract of sale. After the formation of a valid contract of sale, the next stage is
its performance. Contract of sale imposes some duties on the seller and the
buyer. It also confers some rights to the seller and the buyer. The seller's main
duty is to deliver the goods to the buyer. Similarly, the buyer's main duty is to
accept the goods and pay the price to the seller as per the terms of the contract.
The term “performance of contract of sale” may be defined as the performance of
the respective duties of the seller and the buyer as per the terms of the contract.
The buyer and the seller are free to provide any terms them like in their contract
about the time, place, delivery of goods, payment of the price etc. But when the
parties are silent and do not provide any terms and conditions in the contract,
then the rules contained in the Sale of Goods Act are applicable.

8.8 DEFINITIONS OF DELIVERY OF GOODS

In this section, we attempt to make a brief study of the definition of delivery of

goods

According to Sec. 2(2), “delivery means voluntary transfer of possession from one
person to another”. Delivery is a bilateral act. It requires two parties to act. If
transfer of possession of goods is not voluntary i.e., possession is obtained by
theft etc., there is no delivery.

The performance is mutual and is laid down in Sec. 31 of the Act states that, “It
is the duty of the seller to deliver the goods and of the buyer to accept and pay
for them, in accordance with the terms of the contract of sale.”

The primary rule to be followed is that the payment of price and the delivery of
goods are to be concurrent. Sec. 32 lays down that “Unless otherwise agreed,
delivery of the goods and payment of the price are concurrent conditions, that is

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to say, the seller shall be ready and willing to give possession of the goods to the
buyer in exchange for the price, and the buyer shall be ready and willing to pay
the price in exchange for possession of the goods.”

8.9 MODE OF DELIVERY

In this section, we attempt to make a brief study of the different mode of

delivery.
According to sec. 33 states that “Delivery of goods sold may be made by doing
anything which the parties agree shall be treated as delivery or which has the
effect of putting the goods in the possession of the buyer or of any person
authorised to hold them on his behalf.” Thus delivery need not mean the
transfer of physical possession of goods. The essence of delivery is placing the
buyer in such a position as to enable him to exercise his rights of ownership
over the goods. Therefore, the delivery of goods may be made in any of the
following ways:
8.9.1 Actual Delivery (Physical Delivery)
Where the goods are actually handed over by the seller to the buyer or his duly
authorised agent, it is called actual delivery. Further Sec. 33 states that,
delivery of goods may also be made by doing anything which has the effect of
putting the goods in the possession of the buyer

8.9.2.Symbolic Delivery
Where a bulk of goods is sold, it is not possible to give actual delivery of the
goods. In such case the control over the goods is transferred by delivery of a
symbol For example, the delivery of keys of the godown in which goods are
lying, transfer of documents (railway receipt, delivery orders etc.) are the
instances of symbolic delivery.

8.9.3 Constructive Delivery

Sec. 36 (3) of the Act states that “Where the goods at the time of sale are in the
possession of a third person, there is no delivery by seller to buyer unless and
until such third person acknowledges to the buyer that he holds the goods on
his behalf.” Constructive delivery may be defined as the delivery when a third
person, in possession of the goods, acknowledges holding the goods on behalf of
the buyers. In such cases, three persons are required - the seller, the person
holding the seller’s goods and the buyer.

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Check your progress - 1

What do you mean by Barter?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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8.10 RULES REGARDING DELIVERY OF GOODS (SEC. 33 TO 39)

In this section, we attempt to make a brief study of the provisions relating to the
delivery of goods by the seller to the buyer:

8.10.1. Possession of Goods (Sec. 33)

The delivery of goods should be such which enables the buyer to exercise his
control over the goods. Thus the delivery of the goods may be either actual or
symbolic or constructive. These terms have been explained under the preceding
heading.

8.10.2. Delivery and Payment are concurrent Conditions (Sec. 32)

Sec. 32 lays down that “Unless otherwise agreed, delivery of the goods and
payment of the price are concurrent conditions, that is to say, the seller shall be
ready and willing to give possession of the goods to the buyer in exchange for
the price, and the buyer shall be ready and willing to pay the price in exchange
for possession of the goods.” The delivery of the goods and the payment of their
price are the concurrent conditions, i.e., both these conditions should be
performed simultaneously, as in the case of cash sales at the counter.

8.10.3. Demand for Delivery of Goods (Sec. 35)

Sec. 35 lays down that “Apart from any express contract, the seller of goods is
not bound to deliver them until the buyer applies for delivery.” When the goods
are subsequently acquired by the seller, he should inform this to the buyer and
the buyer should then apply for delivery. The buyer will have no cause of action
if he fails to apply for delivery.

8.10.4. Time of Delivery [Sec. 36(2)]

Sec. 36 (2) lays down that, “Where under the contract of sale the seller is bound
to send the goods to the buyer, but no time for sending them is fixed, the seller
is bound to send them within a reasonable time.” According to the terms of the

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contract, the seller has to deliver the goods to the buyer and where no time for
delivery is fixed, and then the delivery of goods must be made within a
reasonable time. In commercial dealings, time is the essence of contract. As
such it is usual to find a provision in a contract of sale regarding the time of
delivery.

8.10.5. Place of Delivery [Sec. 36(1)]

Sec. 3.6 (1) lays down that “whether it is for the buyer to take possession of the
goods or for the seller to send them to the buyer is a question depending in each
on the contract, express or implied, between the parties. Apart from any such
contract:
(a) goods sold are to be delivered at the place at which they are at the time of
the sale; and
(b) goods agreed to be sold are to be delivered at the place at which they are at
the time of the agreement to sell or
(c) if not then in existence, at the place at which they are manufactured or
produced."

8.10.6. Goods in the Possession of Third Person [Sec. 36 (3)]

Sec. 36 (3) lays down, “Where the goods at die time of sale are in the possession
of a third person, there is no delivery by seller to buyer unless and until such
third person acknowledges to the buyer that he holds the goods on his behalf.”
The third person must inform the buyer that he holds the goods on his behalf.
When the goods have been sold by the transfer of the document of title to goods,
for example, railway receipt or Bill of Lading, the buyer is deemed to be in
possession of the goods represented by such document and the assent of the
third party is not required.

8.10.7. Effect of Part Delivery (Sec. 34)

Sec. 34 states that “A delivery of part of goods, in progress of the delivery of the
whole, has the same effect, for the purpose of passing the property in such.
Goods, as a delivery of the whole; but a delivery of part of the goods, with an
intention of severing it from the whole, do not operate as a delivery of the
remainder." Delivery of part of goods sold may amount to delivery of the whole if
it is so intended and agreed. But, however where the part is intended to be
severed from the whole, part delivery does not amount to be delivery of the
whole.

8.10. 8.Expenses of Delivery [Sec. 36 (5)]

Sec. 36 (S) lays down that “Unless otherwise agreed, the expenses of and
incidental to putting the goods into a deliverable state shall be borne by the
seller.”

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8.10.9. Instalment Delivery (Sec. 38)

Sec. 38 (1) lays down that “Unless otherwise agreed, the buyer of goods is not
bound to accept delivery there of by instalments.” Unless there is a term in the
contract of sale, the seller is not entitled to deliver the goods in instalments and
if he does so, the buyer is not bound to accept them.

8.10.10. Delivery of Wrong Quantity (Sec. 37)

The seller is under a duty to comply with the order of the buyer in quality and
quantity. Sometimes, the delivery of goods may be of a quantity less than that
contracted for, or a quantity larger than agreed, or may be contract goods mixed
with goods of a different description. A defective delivery may be either of the
following:

(a) Short Delivery (Sec. 37 (1))

“Where the seller delivers to the buyer a quantity of goods less than he
contracted to sell, the buyer may reject them, but if the buyer accepts the goods
so delivered he shall pay for them at the contract rate.”

(b) Excess Delivery (Sec. 37 (2))

“Where the seller delivers the buyer a quantity of goods larger than he
contracted to sell, the buyer may accept the goods included in the contract
and reject the rest or he may reject the whole. If the buyer accepts the whole
of the goods so delivered, he shall pay for them at the contract rate”.

(c) Mixed Delivery [Sec. 37 (3)]

“Where the seller delivers to the buyer the goods he contracted to sell mixed
with goods of a different description not included in the contract, the buyer
may accept the goods which are in accordance with the contract and reject
the rest, or may reject the whole.”

8.10.11. Delivery to a Carrier or Wharfinger (Sec. 39)

Where the seller is required, under the terms of the contract to send the goods
to the buyer, delivery to a carrier or wharfinger, whether named by the buyer or
not, for the purpose of transmission to the buyer is prima facie delivery to the
buyer. However, if the goods are lost in transit and the seller has not made any
contract with the carrier on behalf of the buyer, the seller shall be required to
bear the loss. (Sec. 39).

8.1.0. 12. Delivery at a Distant Place (Sec. 40)

Where the seller agrees to deliver goods at his own risk at a place other than
that where they are sold, the buyer shall have risk of any natural deterioration
in the goods incidental to the transit, unless otherwise agreed between the
parties. (Sec. 40)

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Check your progress - 2

What do you mean by Earnest Money?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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8.11 LET US SUM UP

In this lesson, we have briefly touched upon the following points

Contract of sale: A contract of sale of goods is a contract whereby the seller
transfers or agrees to transfer the property in goods to the buyer for a price
(Sec.4).
Sale and agreement to sel1: Where under a contract of sale the property in the
goods is transferred from the seller to the buyer, the contract is called a sale,
but where the transfer of the property in the goods is to take place at a future
time or subject to some condition thereafter to be fulfilled the contract is called
an agreement to sell. An agreement to sell becomes a sale when the time elapses
or the conditions are fulfilled subject to which the property In the goods is to be
transferred.
Subject-matter of sale: “Goods” form the subject of a contract of sale. They mean
every kind of movable property other than actionable claims and money, and
include stock and shares, growing crops, grass and things attached to or
forming part of the land which are agreed to be severed before sale or under the
contract of sale [Sec. 2(7)1 Goods may be: (1) Existing goods. i.e., goods which
are owned and possessed by the seller at the time of sale. These goods may be
specific ascertained or unascertained. (2) Future goods, i.e., goods which the
seller does not possess at the time of the contract and which will be acquired,
manufactured or produced by him at some future date. (3) Contingent goods
i.e.,, goods the acquisition of which by the seller depends upon a contingency
which may or may not happen.
Delivery of goods: Delivery means voluntary transfer of possession of goods
from the seller to the buyer. It may be (t) actual, [i$ symbolic, or (tii)
constructive. But it must be according to the rules as given below :
Rules as to delivery: 1. Unless otherwise agreed, delivery of the goods and
payment of the price are concurrent conditions. (2) A delivery of part of the
goods, in progress, of the delivery of whole, amounts to, for the purpose of

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passing the property in such goods, as a delivery of the whole. (3) Apart from
any express contract, the seller of goods is not bound to deliver them until the
buyer applies for delivery. (4) The place of delivery is the place at which they are
at the time of the sale. (5) If the goods are in possession of a third party, there is
no delivery until such third party acknowledges to the buyer that he holds the
goods on his behalf. (6) Where the seller is bound to send the goods to the buyer
but no time for sending -them is fixed, they must be sent within a reasonable
time. (7) Expenses of making delivery are borne by the seller and expenses of
obtaining delivery by the buyer. (8 the seller sends to the buyer a larger or a
smaller quantity of goods than he ordered, the buyer may (a) reject the whole, or
(b) accept the whole, or (c) accept the quantity he ordered and reject the rest. (9)
If the seller delivers, with the goods ordered, goods of a wrong description, the
buyer may accept the goods ordered and reject the rest or reject the whole. (10)
Unless otherwise agreed, the goods are net to be delivered by instalments.

8.12 QUESTIONS FOR DISCUSSION

1. What is the scope of the Sale of Goods Act?

2. Define the term Goods. What are the different types of goods?
3. Distinguish between sale and agreement to sell.
4. “Sale is an executed contract but an agreement to sell is an executory
contract”-Discuss
5. Is time with regard to payment of price is the essence of the contract of
sale?

8.13 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 what do you mean by Barter?

Barter is nothing but transfer of goods by one party to the other in consideration
for another’s goods and which is not for price or money.
Check-2 what do you mean by Earnest Money?
It is a common practice among businessmen to advance a portion out of the
purchase price payable to the seller as earnest money in order to show their
sincerity and seriousness in performing the contract.

8.14 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-9
RIGHTS AND DUTIES OF A BUYER AND SELLER

CONTENTS
9.0 Aims and objectives
9.1 Introduction
9.2 Rights of Buyer
9.3 Duties of Buyer
9.4 Rights of Seller
9.5 Duties of Seller
9.6 Let us sum up
9.7 Questions for discussion
9.8 Model answer to check your progress
9.9 References

9.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning of Contract of sale of Goods

Act 1930 and rules regarding delivery of goods. Here, we have briefly touched
upon the rights and duties of buyer and seller. After going through this lesson,
you will able to
1. know the Rights of Buyer
2. understand Duties of Buyer
3. know rights and duties of seller

9.1. INTRODUCTION

The property in the goods is transferred from the seller to the buyer for a price;
the contract is called a sale. In sale of goods, there are two parties involved in
sale of goods. Both buyer and seller have some rights and duties.

9.2 RIGHTS OF A BUYER

In this section, we attempt to make a brief study of the rights of a buyer of

goods.

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9.2.1. Right to have Delivery of Goods (Sec. 32)

The buyer has the right to take delivery of the goods on payment of price when
delivery of goods and payment of price are concurrent conditions in the contract
of sale.

9.2.2. Right to Reject the Goods (Sec. 37)

The buyer is entitled to reject the goods in the following cases :
(a) Where the seller delivers lesser quantity than that contracted for
(b) Where the seller delivers larger quantity than that contracted for
(c) Where the seller mixes the contracted goods with goods of a different
description.

9.2.3.Right not to Accept instalments (Sec. 38)

Subject to contract, the buyer is under no obligation to accept delivery of the
goods by instalments. He can repudiate the contract in such circumstance. [Sec.
38 (1)]

9.2.4.Right to Examine the Goods (Sec. 41)

The buyer is not deemed to have accepted the goods unless and until:
(i) he has reasonable opportunity to examine the goods;
(ii) he is afforded a reasonable opportunity of examining the goods to see
whether the goods are in conformity with the contract.

9.2.5. Right not to return the Rejected Goods (Sec. 43)

Subject to agreement, the buyer is not liable to return the goods rejected by him
rightfully. It is sufficient if he intimates the seller that he refused to accept the
goods.
9.2.6. Right to the Notice of Insurance [Sec. 39 (3)]
It is the duty of the seller to give notice to die buyer to enable him to insure the
goods during the sea transit. If he fails to do so, the buyer is not liable for
destruction of goods in transit.
Right against the Seller for Breach of Contract
9.2.7.Suit the Seller for non-delivery (Sec. 57)
Sec. 57 lays down that, “Where the seller wrongfully neglects or refuses to
deliver the goods to the buyer, the buyer may sue the seller for damages for
non-delivery.”

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9.2.8. Suit for Specific Performance (Sec. 58)

The buyer may sue the seller for specific performance of the contract of sale. If
the goods are specific or ascertained, the court may order for the specific
performance of the contract.
9.2.9.Suit for Breach of Warranty (Sec. 59)
Section 59 lays down that, “Where there is a breach of warranty, by the seller, or
where the buyer elects or is compelled to treat the breach of condition by the
seller as a breach of warranty, the buyer may:
(a) set up against the seller the breach of warranty in dimunition or extinction
of the price; or
(b) sue the seller for damages for the breach of warranty.
9.2.10. Repudiation of the Contract before due Date (Sec. 60)
In such a case the buyer has the right for anticipatory breach of contract. Sec.
60 states that where the seller repudiates the contract before the date of
delivery, the buyer may either treat the contract as subsisting and wait till the
date of delivery or treat the contract as rescinded and sue for damages for
breach of contract
9.2.11. Suit for Interest (Sec. 61 (2) (b) )
Where there is a breach of contract on the put of the seller and as a result the
price is to be refunded to the buyer, the buyer has a right to claim interest on
the amount of price.

9.3 DUTIES OF THE BUYER

The buyer, in respect to the contract of sale, has to perform some duties. Here,
we shall see, the duties perform by a buyer one by one.

9.3.1. Duty to Pay Price and Accept the goods (Sec. 31)

It is the duty of the buyer to take the delivery of the goods and pay for them in
accordance with the terms of the contract.

9.3.2. Duty to Apply for delivery (Sec. 35)

The seller is not bound to deliver the goods to the buyer until the buyer applies
for delivery, in the absence of any contract to the contrary.

9.3.3. Duty to Demand Delivery at a Reasonable Hour [Sec. 36 (4)]

As per Sec. 36 (4), “Demand or tender of delivery may be treated as ineffectual

unless made at a reasonable hour. What is a reasonable hour is a question of
fact.”

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9.3.4. Duty to Accept Instalment Delivery and Pay far It [Sec. 38 (2)]

Where there is a contract for the sale of goods to be delivered by stated

instalments which are to be separately paid for, it is the duty of the buyer to
accept the instalment delivery and pay for it.

9.3.5. Duty against Deterioration (Sec. 40)

Unless otherwise agreed, the buyer has to take the risk of deterioration of the
goods incidental to the course of transit.

9.3.6. Duty to Intimate the Seller when Reject the Goods (Sec, 43)

Unless otherwise agreed, it is the duty of the buyer to inform the seller in case
he refuses to accept the goods.

9.3.7.Duty to take delivery (Sec. 44)

It is the duty of the buyer to take delivery of the goods within a reasonable time
after the tender of delivery. He will be becomes liable to the seller for any loss
occasioned by hi» neglect or refusal to take delivery. .

9.3.8.Duty to Pay Price (Sec. 55)

Sec. 55 (1) lays down that “Where under a contract of sale the property in the
goods has passed to the buyer and die buyer wrongfully neglects or refuses to
pay the goods according to the terms of the contract, die seller may sue him for
the price of the goods.”

9.3.9.Duty to Pay Damages for Non-acceptance (Sec. 56)

Where the buyer wrongfully neglects or refuses to accept and pay for the goods,
the seller may sue him for damages for non-acceptance.

9.3.10. Duty to Pay Increased Hut (Sec. 64 A)

The buyer is liable to pay so much as will be equivalent to the amount

paid or payable in respect of such tax imposed or increase of tax which may be
chargeable at die time of sale, in die absence of any contract to contrary

9.4 RIGHTS OF A SELLER

In this section, the rights of seller may be discussed as under:

9.4.1. Right to Claim Compensation (Sec 44)
If is the right of the seller to claim compensation for the loss occasioned by the
buyer's neglect or refusal to take delivery and also reasonable charges for the
care and custody of the goods.

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9.4.2. Might to Sue for Price [Sec. 55 (1)]

Sec 55 (1) lays down that “Where under a contract of sale the property in the
goods has passed to the buyer and the buyer wrongfully neglects or refuses to
pay for the goods according to the terms of the contract, the seller may sue him
for the price of the goods.”
9.4.3. Right to Sue for Price against Contract [Sec. 55 (2)]
Sec. 55 (2) lays down that, “Where under a contract of sale the price is payable
on a certain day irrespective of delivery and the buyer wrongfully neglects or
refuses to pay such price, the seller may sue him for the price although the
property in the goods has not passed and the goods have not been appropriated
to the contract.”
9.4.4. Right to sue for Damages (Sec. 56)
Sec. 56 lays down that, “Where the buyer wrongfully neglects or refuses to
accept and pay for the goods, the seller may sue him for damages for non-
acceptance.”
9.4.5. Right to Treat the Contract as Subsisting (Sec. 60)
Sec. 60 states, “Where the buyer repudiates the contract before the date of
delivery of goods, seller may either treat the contract as subsisting or wait till
the date of delivery, or he may treat the contract as repudiated and sue for
damages for the breach.”
9.4.6. Right to Interest by Way of Damages [Sec. 61 (1)]
It is the right of the seller to recover interest or special damages in any case
where by law interest or special damages may be recoverable.
9.4.7. Rights of an Unpaid Seller
(a) Right against the goods
(b) Right against the buyer personally

9.5 DUTIES OF A SELLER

In this section, the duties of the seller may be discussed as follows:

9.5.1. Duty to Deliver the Goods (Sec. 31)
It is the duty of the seller to deliver the buyer goods in accordance with the
terms of the contract.
9.5.2. Duty to Deliver the Goods at the Agreed Place (Sec. 36 (1))
It is the duty of the seller to send the goods to the buyer at the place at which
they are contracted to be delivered.

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9.5.3. Duty to Supply the Goods within Specified time [Sec. 36 (2)]
It is the duty of the seller to send the goods to the buyer within die fixed time or
within reasonable time when no time for sending the goods is fixed.

9.5. 4. Duty to Send the Goods at Reasonable Hour [Sec. 36 (4)]

Tender of delivery may be treated as ineffectual unless made at a reasonable
hour. What is reasonable hour is a question of fact.

9.5.5. Duty to Bear the Expenses of Putting the Goods in Deliverable State
[Sec. 36]
It is the liability of the seller to bear the expenses of and incidental to putting
the goods into a deliverable state.

9.5.6.Duty to make Contract with Carrier and Wharfinger [Sec. 39 (2)]

It is the duty of the seller to make such contract with the carrier or wharfinger
on behalf of the buyer as may be reasonable, having regard to the nature of the
goods. If he fails to do so he is liable to bear loss if any, incurred in course of
transit of the goods.

9.5.7. Duty to Give Notice to the Buyer [Sec. 39 (3)]

Subject to the agreement, it is the duty of the seller to give notice to the buyer
to get the goods insured while the goods are sent by a route involving sea
transit. If he fails to do so, goods shall be deemed to be at seller’s risk during
such sea transit.

9.5.8. Duty to Give Reasonable Opportunity to Examine the Goods (Sec. 41)
It is the duty of the seller to afford the buyer a reasonable opportunity of
examining the goods for the purpose of ascertaining whether they are in
conformity with the contract.

Check your progress – 1

When can stoppage of goods in transit right be exercised ?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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9.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points

Rights of Buyer:Right to have Delivery of Goods, Right to Reject the Goods, Right
not to Accept instalments, Right to Examine the Goods, Right not to return
the Rejected Goods, Right to the Notice of Insurance, Right against the Seller for
Breach of Contract, Suit the Seller for non-delivery, Suit for Specific
Performance , Suit for Breach of Warranty , Repudiation of the Contract before
due Date .
Duties of the Buyer:Duty to Pay Price and Accept the goods, Duty to Apply for
delivery, Duty to Demand Delivery at a Reasonable Hour, Duty to Accept
Instalment Delivery and Pay far It, Duty against Deterioration, Duty to Intimate
the Seller when Reject the Goods, Duty to take delivery, Duty to Pay Damages
for Non-acceptance, Duty to Pay Increased Hut.
Rights of a Seller: Right to Claim Compensation, Might to Sue for Price, Right to
Sue for Price against Contract, Right to sue for Damages, Right to Treat the
Contract as Subsisting, Right to Interest by Way of Damages ,Rights of an
Unpaid Seller
Duties of a Seller: Duty to Deliver the Goods, Duty to Deliver the Goods at the
Agreed Place, Duty to Supply the Goods within Specified time ,Duty to Send the
Goods at Reasonable Hour, Duty to Bear the Expenses of Putting the Goods in
Deliverable State , Duty to make Contract with Carrier and Wharfinger ,Duty to
Give Notice to the Buyer.

9.7 QUESTIONS FOR DISCUSSION

1. Discuss the rights and duties of buyer.

2. Explain the rights and duties of seller.

9.8 MODEL ANSWER TO CHECK YOUR PROGRESS

The right of stoppage in transit means the right of stopping further transit of the
goods while they are with a carrier for the purpose of transmission to the buyer,
resuming possession of them and retaining possession until payment or tender
of the price.

9.9 REFERENCES

1. M.C. Kuchhal - Mercantile Law

2. R.S.N Pillai & Bagavathi - Business Law
3. N.D. Kapoor - Elements of Company Law

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LESSON-10
COMPANY FORM OF BUSINESS – ON OVER VIEW

CONTENTS
10.0 Aims and objectives
10.1 Introduction
10.1.1 Companies Act 1956
10.1.2 Meaning
10.1.3 Definition of Company
10.2 Characteristics or Essential Features of a Company
10.3 Kinds of Company
10.3.1 Basis of Classification
10.3.2 Distinction between a public company and a private company
10.4 Special Privileges of a Private Company Over Public Company
10.5 Let us sum up
10.6 Questions for discussion
10.7 Model answer to check your progress
10.8 References

10.0 AIMS AND OBJECTIVES

In the ninth lesson, we discussed the rights and duties of buyer and seller .In
this lesson we discuss the meaning, definition and characteristics of company,
different types of companies and privileges of private company. After going
through this lesson, you will able to
1. know the meaning and definition of company
2. understand various kinds of the companies
3. know privileges of private company

10.1 INTRODUCTION

Nowadays, to start or carry on a business requires huge investments. It may not

be possible for a single person to fulfill all his financial requirements. Thus, the
persons are generally desirous of carrying on joint business enterprises. To

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such persons, the law offers a choice between a partnership and a company.
The partnership is suitable for small-scale business, in which the partners take
personal interest and work together with mutual trust and confidence. But
sometimes, the persons like to start business on large scale requiring huge
investments which cannot be financed by the resources of a few persons. In
such cases, the formation of a company is the only choice. It may, however, be
noted that even for a small-scale business, a company offers certain privileges as
compared to partnership, such as the limited personal liability of the members.
A company means a group of persons associated together to achieve some
common objective. In this section, we discuss the companies Act 1956,
meaning and definition of company.

10.1.1 Companies Act 1956

The law relating to companies is contained in The Companies Act, 1956. It came
into force on 1st April, 1956, and it applies to the whole of India. It is amended
up-to-date. The last amendment to the Act has been made in 1999 by the
companies (Amendment) Act 1999.
10.1.2 Meaning
A company is a voluntary association of persons formed to achieve some
common objectives, having a separate form its members, with a perpetual
succession and a common seal, and with capital divisible into transferable
shares.

10.1.3 Definition of Company

The term ‘company’ may be defined as a group of persons associated together to
achieve some common objective. This, how, ever, is not the legal definition. The
legal definition of a company is given in Section 3 (1) (i) of the Companies Act,
which reads as under: “Company means a company formed and registered
under this Act or an existing company”.

L.J. Lindley’s defines a company as “an association of many persons who

contribute money or money’s worth to a common stock, and employ it in some
common trade or business and who share the profit or loss arising therefrom.
The common stock so contributed is denoted in money and is the capital of the
company. The person who contribute it , or whom it belongs, are members. The
proportion of capital to which each member is entitled is his share. Shares are
always transferable although the right to transfer them is often more or less
restricted.”

10.2 CHARACTERISTICS OR ESSENTIAL FEATURES OF A COMPANY

The meaning and nature of the company becomes clear after looking into its
characteristics. The legal meaning of the term ‘company’, as revealed by these
characteristics, may be summed up as under

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10.2.1 Registration
A company is to be compulsorily registered under the Companies Act.

10.2.2 Distinct person-Separate legal entity

A company is a distinct person possessing its own identity. It is altogether a
separate legal entity, independent from its members, though controlled by the
Board of Directors.

10.2.3 Perpetual succession

A company incorporated never dies. It has a perpetual succession. Its members
may come and go but the company can go on for ever and remain the same
entity. The death or insolvency of the members does not affect the corporate
existence of the company. It may be wound up. On winding up it ceases to exist.
Prof. Grover in his book on Modern Company Law says that “A company
continues to exist even if all the members are dead. During the war all the
members of one private company while in general meeting were killed by a
bomb. But the company survived. Not even a hydrogen bomb could destroy it.”

10.2.4 Artificial person but not a citizen

The Company is an artificial person. It functions through its Board of Directors.
However, it is not a citizen as it cannot enjoy the rights under the Constitution
of India or Citizenship Act. In State Trading Corporation of India V. C. T. O.
(1963 S. C. J. 705), it was held that neither the provisions of the Constitution
nor the Citizenship Act apply to it. It may have a domicile. It should be noted
that though a company does not possesses fundamental rights, yet it is a person
in the eyes of law. It can enter into contracts with its Directors, its members
and outsiders.

10.2.5 Transferable Shares

A company has the greatest advantage of its shares being easily transferable.
Unlike a partnership concern, where against the will of the partners, the
transferee does not become a partner, the members in an incorporated company
can easily transfer their shares. Section 82 of the Companies Act provided for in
the articles of the company. However, in a private limited company, there are
certain restrictions on the transferability of its shares.

10.2.6 Limited liability

The novel idea of limited liability was for the first time introduced by the
Companies Act of 1857. Any person can participate in the share capital of an
incorporated company and limit his liability to the extent of his participation.
Limited liability in other words means, the members cannot be called upon, in
case of liquidation or winding up of the company to contribute more than what
has been agreed by them to subscribe, by way of participation in the share

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capital of the company. In an incorporated company, the members can call

upon to contribute only to the extent of their unpaid up capital on the shares
subscribed by them. This secures the members and encourages large scale
investments in an incorporated form of organization.

10.2.7 Common Seal

The company has a separate legal existence under its own common seal. It can
enter into contracts with outsiders, with its Directors or with its members. The
common seal of the company gives it an independent existence.

10.2.8 Separate Property

The company being a distinct and legal personality can won, enjoy and dispose
of property in its own name. It is the owner of its capital and assets though
contributed by its members. The shareholders are not the owners of the
company’s property. In Hyderabad (Sind) Electric Supply Co. v. Union of India
(A.I.R. 1959 Pinj. 99), it was held that the property of the company is not the
property of the shareholders. It is the property of the Company.

10.2.9. Capacity to sue and be sued

A company can sue and be sued in its corporate name.

Check your progress 1

A Company is an artificial person- Explain
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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10.3 KINDS OF COMPANY

Depending upon the capital to be mobilized, and the structure to be organized,

and in conformity with the Government policy, companies have to be formed
with the following classifications. In this section, we attempt to make a brief
study of the kinds of company .The companies may be broadly classified as
incorporated Companies and unincorporated Companies

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i) Incorporated Companies
An incorporated company is one which is formed for the purpose of carrying on
a business and is incorporated under the Companies Act, 1956, or some earlier
Companies Acts.
ii) Unincorporated Companies
Unincorporated companies are to all intents and purposes large partnerships.
These are not regarded as distinct entities separate form the members
constituting them. Their shares may be transferable, but liability of their
members is unlimited. These companies continue even after the death or
insolvency of a member, and their management is vested in a select body of
directors to the exclusion of members generally. Such companies can no longer
be formed under the Companies Act, 1956, if the number of their members
exceeds 10 in the case of companies carrying on banking business, and 20 in
the case of any other business (Sec. 11).

10.3.1 Basis of Classification

Companies may be classified into various kinds on the following basis
I. On the Basis of Incorporation
1. Statutory Companies
2. Registered Companies.
II. On the Basis of Liability
1. Companies which limited liability. These may be
(a) Companies limited by shares
(b) Companies limited by guarantee
2. Companies with unlimited liability [Sec. 12(2)]
III. On the Basis of Number of Members
1. Private Company
2. Public Company.
IV. On the Basis of Control
1. Holding Companies
2. Subsidiary Companies (Sec. 4)
V. On the Basis of Ownership
1. Government Companies
2. Non Government Companies

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VI Foreign Companies
VII Investment Company
VIII One – Man company

1.On the Basis of Incorporation

1. Statutory Companies
2. Registered Companies
1. Statutory companies. These are the companies which are created by a
special Act of the Legislature, e.g., the Reserve Bank of India, the State Bank of
India, the Life Insurance Corporation, the Industrial Finance Corporation, and
the Unit Trust of India. These are mostly concerned with public utilities, e.g.,
railways, tramways, gas and electricity companies and enterprises of national
importance. The provisions of the Companies Act, 1956 apply to them, if they
are not inconsistent with the provisions of the special Acts under which they are
formed.

2. Registered companies. These are the companies which are formed and
registered under the Companies Act, 1956, or were registered under any of the
earlier Companies Acts. These are by far the most commonly found companies.

II. On the basis of liability

On the basis of liability companies may by classified into :
1. Companies which limited liability. These may be
(a) Companies limited by shares
(b) Companies limited by guarantee
2. Companies with unlimited liability [Sec. 12(2)]

1. Companies with limited liability

(a) Companies limited by shares.
Companies limited by shares are the most common. Where the liability of
members of a company is limited to the amount unpaid on the shares, such a
company is known as a company limited by shares. The liability can be enforced
during the existence of the company as also during the winding up of the
company. If the shares are fully paid, the liability of the members holding such
shares is nil. A company limited by shares may be a public company or a private
company.

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(2) Companies limited by guarantee.

Where the liability of the members of a company is limited to a fixed amount
which the members undertake to contribute to the assets of the company in the
event of its being wound up, the company is called a company limited by
guarantee. It has a legal personality distinct from its members. The liability of
its members is limited. .

2. Unlimited Companies
Sec. 12 specifically provides that any 7 or more persons (2 or more in case of a
private company) may form an incorporated company, with or without limited
liability. A company without limited liability is known as an unlimited company.
In case of such a company, every member is liable for the debts of the company,
as an ordinary partnership, in proportion to his interest in the company.
An unlimited company may or may not have share capital. If it has a share
capital, it may be a public company or a private company. It must have its own
Articles of Association. The Articles must state the number of members with
which the company is to be registered. It the company has a share capital, the
Articles must also state the mount of share capital with which the company is to
be registered.

III. On The Basis of Number of Members

From the point of view of the general public and on the basis of number of
members, a company may be–
1. Private Company
2. Public Company

1. Private company. A private company is normally what the Americans call a

‘close corporation’. According to Sec 3 (1) (iii), a ‘private company’ means a
company which has a minimum paid-up capital of Rs.1,00,000 or such higher
paid-up capital as may be prescribed, and by its Articles–
(a) restricts the right to transfer its shares, if any. This restriction is meant to
preserve the private character of the company;
(b) limits the number of its members to 50 not including its employee-
members (present or past) ;
(c) prohibits any invitation to the public to subscribe for any shares in, or
debentures of, the company.
(d) prohibits any invitation or acceptance of deposits from persons other than
its members, directors or their relatives.

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2. Public company. A public company means a company which

(a) is not a private company ;
(b) has a minimum paid-up capital of Rs.5,00,000 or such higher paid-up
capital, as may be prescribed ;
(c) is a private company which is a subsidiary of a company which is not a
private company. A public limited company may be :
(1) Listed public company
(2) Unlisted public company.
Listed public company means a public company which has any of its securities
listed in any recognized stock exchange [Sec. 2(23-A) as inserted by the
Companies (Amendment) Act, 2000].
Unlisted public company is one whose securities are not listed in any recognized
stock exchange.

IV. On the basis of control, companies may be classified into:

1. Holding companies, and
2. Subsidiary companies.

1. Holding company [Sec. 4 (4)]

When one company controls another company it is called a holding company
According to Sec. 4 (4), a company is “deemed to be the holding company of
another, if but only if, that other is its subsidiary.” One company may control
another company in any of the following ways:
(i) when it controls the composition of the Board of Directors of another
company;
(ii) where it controls more than half of the total voting power of the other
company; or
(iii) where it holds more than half of the nominal value of equity share capital
of the other company; or
(iv) where it is a subsidiary of any company which is the subsidiary of some
other company.
2. Subsidiary company [Sec. 4(1)]
When one company is dominated over by another (a) by virtue of control over
more than half of the nominal equity shares belonging to the former company,
the company whose shares are thus controlled is known as subsidiary company.
In other words, a company is known as a subsidiary of another company when
control is exercised by the latter (called holding company) over the former called
a subsidiary company.

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V. On the Basis of Ownership

On the basis of ownership, a company may be a
1. Government Company, or
2. Non-Government Company
1. Government Company
A Government company means any company in which not less than 51 percent
of the paid- up share capital is held by the Central Government or Sate
Governments or both the governments.
2. Non-Government Company
All companies other than government company are known as non- Government
companies.
V Foreign Companies
It means any company incorporated outside India which has an established
place of business in India [Sec. 591 (1)]. Where, for example, representatives of a
foreign company frequently come and stay in a hotel in India for purchasing raw
material, machinery, cotton etc., the foreign company has a place of business in
India.
VI Investment Company
The company Law under section 372 imposes restrictions on investments made
by the public companies in other body corporate, which should not exceed 30 %
of the paid up equity capital of the investment company
VII One-Man Company
One-man company is a Company in which the whole share capital is held by a
single individual.
10.3.2 Distinction between a public company and a private company
1. Minimum number
The minimum number of persons required to form a public company is 7. It is ‘2
in case of a private company.
2. Maximum number
There is no restriction on maximum number of members in a public company,
whereas the maximum number cannot exceed 50 in a private company.
3. Number of directors
A public company must have at least 3 director whereas a private company must
have at least 2 directors (Sec. 252).

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4. Restriction on appointment of directors

In the case of a public company, the directors must file with the Registrar
consent to act as directors or sign an undertaking for their qualification shares.
The directors of a private company need not do so (Sec. 266).

5. Restriction on invitation to subscribe for shares

A public company invites the general public to subscribe for the shares in, or the
debentures of, the company. A private company by its Articles prohibits any
such invitation to the public.

6. Transferability of shares/debentures
In a public company, the shares and debentures are freely transferable (Sec. 82).
In a private company the right to transfer shares and debentures is restricted by
the Articles.

7. Special privileges
A private company enjoys some special privileges. A public company enjoys no
such privileges.

8. Quorum.
It the Articles of a company do not provide for a larger quorum, 5 members
personally present in the case of a public company are quorum for a meeting of
the company. It is 2 in the case of a private company (Sec. 174).
9. Managerial remuneration.
Total managerial remuneration in a public company cannot exceed 11 per cent
of the net profits (Sec. 198). No such restriction applies to a private company.

Check your progress -2

How a Company is defer from partner ship
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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10.4 SPECIAL PRIVILEGES OF A PRIVATE COMPANY

Both private and public companies are regulated by the provisions of the
Companies Act, 1956. However, certain provisions of the Act do not apply to
private company. These are the privileges which private company enjoys over
the public company under the Act. In this section we summarized privileges of
private company

1. The minimum number of members in a private company can be two only

as against seven in a public company.

2. Provisions regarding minimum subscription before allotment of shares do

not apply to a private company.

3. A private company need not file a prospectus or a statement in lieu of

prospectus with the Registrar.

4. Further issue of shares need not be offered to the existing members.

5. Private company may issue share capital of such kinds, in such forms and
with such voting rights, as it may think fit.

6. Private company can commence business immediately on incorporation.

7. It need not keep an index of members.

8. It need not hold statutory meeting or file statutory report.

9. Provisions as to overall maximum managerial remuneration and

remuneration to directors, do not apply to a private company.

10. Minimum number of directors is only two in a private company.

11. Provisions as to proportion of directors liable to retire by rotation do not

apply to a private company.

12. Director’s consent to act as such is not required.

13. Restrictions on appointment of Directors as regards their consent and

holding qualification shares do not apply to a private company.

14. Government approval to appointment or amendment of provisions relating

to managing or whole-time or non-rotational directors is not required.

15. Directors’ contract to take up qualification shares need not be filed with
the Registrar of companies.

16. Provisions regarding loans to directors do not apply.

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17. Provisions regarding interested directors not to participate or vote in

board’s proceedings do not apply.

18. Provisions requiring Government approval for increasing remuneration of a

director or managing director do not apply.

19. Prohibition regarding appointment of a managing director for more than

give years at a time do not apply.

20. Restrictions on advancing loans to other companies do not apply.

10.5 LET US SUM UP

In this lesson, we have briefly touched upon the following points. A company
means a group of persons associated together to achieve some common
objective. The law relating to companies is contained in The Companies Act,
1956. The company has a separate legal existence under its own common seal.
Companies may be classified into various kinds on the following basis
I. On the Basis of Incorporation:1. Statutory Companies
2. Registered Companies.
II. On the Basis of Liability: 1. Companies which limited liability.(a) Companies
limited by shares (b) Companies limited by guarantee. 2. Companies with
unlimited liability. III. On the Basis of Number of Members: 1. Private Company
2. Public Company. IV. On the Basis of Control : 1. Holding Companies 2.
Subsidiary Companies .V. On the Basis of Ownership:1. Government Companies
2. Non Government Companies. VI Foreign Companies VII Investment
Company
VIII One – Man company . These are the privileges which private company enjoys
over the public company under the Act
1. The minimum number of members in a private company can be two only
as against seven in a public company.
2. Provisions regarding minimum subscription before allotment of shares do
not apply to a private company.
3. A private company need not file a prospectus or a statement in lieu of
prospectus with the Registrar.
4. Further issue of shares need not be offered to the existing members.
5. Private company may issue share capital of such kinds, in such forms and
with such voting rights, as it may think fit.
6. Private company can commence business immediately on incorporation.
7. It need not keep an index of members.

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10.6 QUESTIONS FOR DISCUSSION

1. Define a company. State the characteristic features of a company.

2. Distinguish between private company and public company
3. Explain what is meant by a ‘holding company’ and a ‘subsidiary company’
4. What is a government company?
5. Explain the various privileges of private company.
6. Write notes on: Foreign Company

10.7 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 A Company is an artificial person- Explain

A company is an artificial person in the sense that it is constituted by a group of
peoples associating themselves to form such company. A company does not
possess the attributes of a natural person. A company cannot enjoy certain
rights there are exercised by a natural citizen It has to exercise its rights only
through and in compliance with the procedures prescribed under company Law.
Check – 2 How the Company is defer from partner ship
A company has separate existence apart from the members constituting it. In
case of Partnership firm it has no separate existence apart from the members
constituting it. In the case of a public Ltd., co., liability of the members is
limited to the extent of the face value of the shares. In case of Partnership,
every partner is jointly and severally liable for the debt of the firm.

10.8 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-11
FORMATION OF A COMPANY

CONTENTS
11.0 Aims and Objectives
11.1 Introduction
11.2 Definition of Formation of a Company
11.3 Stages in Formation of a Company
11.3.1 Promotion of a Company
11.3.2 Registration and Incorporation of a Company
11.3.3 Certificate of Incorporation
11.3.4 Commencement of Business
11.3.5 Companies Amendment Act, 1965
11.4 Procedure for Incorporation of Company
11.5 Advantages of Incorporation
11.6 Disadvantages of Non-Registered Company
11.7 Let us sum up
11.8 Questions for discussion
11.9 Model answer to check your progress
11.10 References

11.0 AIMS AND OBJECTIVES

In the 10th lesson, we discussed the meaning, definition and characteristics of

company, different types of companies and privileges of private company. In this
lesson we discuss the meaning, definition of formation of a Company and Stages
in formation of a Company, Certificate of Incorporation, Commencement of
Business, Procedure for registration or incorporation of company and Effect of
Registration. After going through this lesson, you will able to
1. know the meaning and definition of formation of a company
2. understand various stages in formation of a Companies
3. identify various documents required by The Registrar of Companies.
4. understand the Procedure for registration of a company
5 learn the advantages of registration of a company
6. known the disadvantages of registration of a company

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11.1 INTRODUCTION

We know that a company is separate legal entity which is formed and registered
under the Companies Act. It may be noted that before a company is actually
formed (i.e. formed and registered under the Companies Act), certain persons,
who wish to form a company, come together with a view to carry on some
business for the purpose of earning profits. Such persons have to decide various
questions such as (a) which business they should start (b) whether they should
form a new company or take over the business of some existing company, (c) if
new company is to be started, whether they should start a private company or
public company, (d) what should be the capital of the company etc. After
deciding about the formation of the company, the desirous persons take
necessary steps, and the company is actually formed. Thereafter, they start their
business. Thus, there are various stages in the formation of a company form
thinking of starting a business to the actual starting of the business. In this
section, we shall discuss these stages along with the legal provisions relating to
them.

11.2 DEFINITION OF FORMATION OF A COMPANY

Formation means establishment or creation of a corporate body by a group of

persons known as association of person for the purpose of carrying on either
commercial activities or non commercial activities with the approval of the
government. It also signifies compliance with certain formalities prescribed
under law to become a legal entity as a company.

11.3 STAGES IN FORMATION OF A COMPANY

Formation of a company is considered to be a responsible job. It involves

compliance with technical formalities of the provisions under the companies Act
by the promoter, who are the architects or founder father of the company. Here
the entire formation of a company could be studied under following stages.
1. Promotion of a company.
2. Registration and incorporation of a company.
3. Commencement of business
11.3.1 Promotion of a Company
It is the first stage in the formation of a company. The promotion of a company
refers to all those steps which are taken from the time of having an idea of
starting a company to the time of the actual starting of the company business.
Thus, ‘formation of a company’ means originating the idea of forming a
company, and taking necessary steps in this regard. The persons who think of
forming a company and take necessary steps in its formation are known as
‘promoters’ or ‘company promoters’.

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11.3.2 Registration and Incorporation of a Company

It is the second stage in the formation of a company. We know that a company
comes into existence when it is registered under the Companies Act. If the
company is to be formed as a public company, any seven or more persons
associated for any lawful purpose may form the same by getting it registered
with the Registrar of Companies. A company is to be formed as a private
company and two or more (but not more than 50) persons may get the same
registered. The company so formed, whether public or private, may be of the
following two types, namely [Section 12]
1. Limited company (limited by shares or limited by guarantee).
2. Unlimited company.
A company is got registered by filing an application with the Registrar of
Companies of the area in which registered office of the company is to be
situated. Such an application is filed by the approval of the proposed name from
the Registrar of Companies.
After getting the approval of name, the application for registration of the
company should be filed with the Registrar along with the following documents
and particulars [Section 33]
1. The ‘memorandum of association’. It is the document which describes the
scope of company activities. It must be signed by the required number of
persons which are necessary for the formation of company, and who come
forward to form it (i.e. seven in case of public, and two in case of private
company). The memorandum of association will be discussed in detail in
following lesson.
2. The ‘articles of association’. It is the document which contains the rules and
regulations of the company. It must also be signed by the persons who sign the
memorandum of association. It may be noted that the filing of the ‘articles of
association’ is compulsory for three types of companies, namely, (a) unlimited
companies, (b) private companies, and (c) companies limited by guarantee.
However, the filing of this document is not compulsory for a public company
limited by shares [Section 26]. If a ‘public company limited by shares’ does not
file this document, it is deemed to have adopted ‘Table A’. This table is a model
set of articles of association given in Schedule I of the Companies Act. The
articles of association will be discussed in detail in following lessons
3. The agreement which the company proposes to enter into with any individual
for appointment as company’s managing director, or whole-time directors or
manager.
In case the company has entered into any such agreement, the same must also
be filed with the Registrar at the time of registration of the company. This clause
has been added by the Companies (Amendment) Act, 1988.

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4. The declaration that all the requirements of the Companies Act relating to the
registration of the company have been complied with. Such a declaration must
be signed by any one of the following persons [section 33(2)]
(a) An advocate of the Supreme Court or of a High Court.
(b) An attorney or pleader entitled to appear before High Court.
(c) A secretary in whole-time practice in India, who is engaged in the
formation of a company.
(d) A chartered accountant in whole-time practice in India, who is engaged in
the formation of a company.
(e) A person named n the articles of association as a director, manager or
secretary of the company.
The above-mentioned are the document which must be presented for registration
to the Registrar at the time of formation of the company. By Section 33, these
documents are specifically required to be registered for the incorporation (i.e.
formation) of the company. Sometimes, the proposed public company having a
share capital decides to appoint its first directors by its articles of association. In
such case, the following three additional documents (Sr. No. 5 to 7) must also be
filed with the Registrar by such a company [Section 266]:
5. A written consent of such directors to act as director of the company. It
should be signed by the director himself or by his agent authorised in writing.
6. A written undertaking by such directors to take and pay for their qualification
shares, if any. It should be signed by each such director.
7. A list of persons who have agreed to become the first directors of the
company. Such a list becomes necessary in view of the aforesaid written consent
and undertaking to be given by such persons.
The Registrar of Companies may himself ask for the above three documents in
case of a public company having a share capital.
Following are some other documents which, though not required for the purpose
of registration of the company, but are usually delivered by both the public and
private companies to the Registrar along with the above documents:
(a) The notice stating the situation i.e. addresses of the registered office of the
company. If this notice is not filed at the time of registration, it has to be filed
within 30 days after the date of incorporation of the company [Section 146 (2)]
(b) The particulars (i.e. name, address, nationality, business etc.) regarding the
directors, managing directors, manager, and secretary of the company. If these
particulars are not filed at the time of registration, it has to be filed within 30
days from the appointment of the first directors [Section 303].
(c) A letter from the Registrar of Companies intimating that the proposed name
of the company is available for adoption and may be adopted by the company

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[Rule 4-A of the Companies (Central Government’s) General Rules and Forms,
1956]
When the application for registration of the company along with the requisite fee
and above documents is presented to the Registrar for registration, the Registrar
shall satisfy himself regarding the following points, that;
(a) The company is proposed to be formed for lawful object.
(b) The ‘memorandum of association’ has been signed by the requisite number
of persons (i.e. seven in case of public, and two in case of private
company).
(c) The ‘memorandum of association’ and the ‘articles of association’ are
prepared according to the provisions of the Companies Act i.e. they do not
go against the Companies Act.
(d) The statutory declaration has been duly signed by the authorised person.
(e) The name of the company is acceptable i.e. the name is neither prohibited
nor is similar to the name of any existing company.
On being satisfied with all the above points, the Registrar will register the
company and other documents, and place the name of the company in a register
known as the ‘Register of Companies’. After the registration, the Registrar issues
a ‘certificate of incorporation’ (i.e. a certificate of the formation of company).
Thereafter the company comes into existence.
11.3.3 Certificate of Incorporation
A certificate of incorporation is one which certifies that the company is
incorporated (i.e. formed). It is issued by the Registrar of Companies. It contains
the name of the company, the date of its issue, and the signature of the
Registrar with his seal. This certificate brings the company into existence. The
legal effects of the certificate of incorporation may be state as under [Section 34]
1. The company comes into existence and it becomes a legal entity
independent from its numbers.
2. The company’s life starts from the date of the certificate of incorporation.
3. The ‘memorandum, and ‘articles of association, become binding upon the
company and all its members.
4. The liability of the members of the limited company becomes limited.
It may, however, be noted that if the company is registered with illegal objects,
then the objects do not become legal by the issue of certificate of incorporation.
In other words, the certificate of incorporation is not conclusive of the legality of
the objects stated in the memorandum of association.

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11.3.4 Commencement of Business

We have already discussed in above that a company comes into existence when
it is registered and a certificate of incorporation is issued by the Registrar of
Companies. Thereafter, the company becomes entitled to commence its
business. On the point of commencement of business, there is some difference; a
private company can start its business immediately after obtaining the
certificate of incorporation. But a public company, will have to obtain a further
certificate known as the ‘certificate to commence business,’ before it can start its
business. However, such a certificate is not necessary for a public company
which has no share capital. It there fore, follows that a public company, having
share capital, must obtain a ‘certificate to commence business’ from the
Registrar of Companies. Before this certificate is obtained by the company, it is
required to fulfill certain formalities (Section 149). Such formalities are different
for a company which issues a ‘prospectus’ inviting the public to subscribe for its
shares, and for a company which does not issue a prospectus, and are
discussed separately in the following pages.
1. Public company which issues a prospectus inviting the public to subscribe for
its shares: Such a company is entitled to obtain the ‘certificate to commence
business’ on fulfilling the following conditions:
(a) The shares payable in cash must have been allotted up to the amount of
‘minimum subscription’. The ‘minimum subscription’ is the amount which is
stated the in the ‘prospectus’, and which is enough for preliminary expenses,
working capital and to pay the purchase price of the property.
(b) The directors must have paid in cash, the application money and the
allotment money on the qualification shares taken by them.
(c) Any money is not liable to become refundable to the applicants by reason of
failure to apply for the permission or by failure to obtain permission to deal on
the stock exchange.
(d) A statutory declaration duly verified by one of the directors or secretary of the
company stating that all the above requirements have been complied with must
have been filed with the Registrar of Companies.
2. Public company which does not issue a prospectus inviting the public to
subscribe for its shares: Such a company is entitled to obtain the ‘certificate to
commence business’ on fulfilling the following conditions:
(a) A ‘statement in lieu of prospectuses must have been filed with the Register of
Companies.
(b) The directors must have paid in cash the application money and the
allotment money on the qualification shares taken by them.
(c) A statutory declaration signed by one of the directors or secretary of company
stating that all the above requirements have complied with must have been filed
with the Registrar of Companies.

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On fulfilment of the above conditions the Registrar shall certify that the
company is entitled to commence its business, and shall issue a certificate
known as the ‘certificate to commence business’. This certificate is the
conclusive evidence that the company is entitled to commence the business. It
may be noted that no public company having share capital can commence any
business or exercise any borrowing power unless this certificate is obtained. Any
contract made before obtaining the certificate to commence business, shall be
provisional and shall not be binding on the company until this certificate is
obtained [Section 149 (4)].
11.3.5 Companies Amendment Act, 1965
The Companies Amendment Act of 1965 has amended Section 13, which
provides that the ‘object clause’ of the memorandum of a company, incorporated
after this amendment, must be divided into two sub-clauses namely:
1. Main objects clause. This clause will state the main objects of the company,
and also the objects which are incidental to the attainment of main objects.
2. Other objects clause. This clause will state those objects of the company
which have not been mentioned in the above clause.
However, the objects clause of a company which is existing before the
commencement of the Amendment Act of 1965, shall remain as it is. The
Companies Amendment Act of 1965 has also added two sub-sections to Section
149, and has introduced a new condition for the commencement of business by
a company. The effect of this amendment is that in the following cases, a public
company, having a share capital, can commence its business only if it has
obtained the prior approval of the shareholders by passing a special resolution
in the general meeting:
1. When a company incorporated after the Amendment Act of 1965 wishes to
start a business included in the ‘other objects clause’.
2. When a company existing before the Amendment Act of 1965 wishes to
start a business which though included in its objects but is not germane to
(i.e. related to) the business which the company is carrying on at the
commencement of the Amendment Act.
In both the above cases, a statutory declaration signed by one of the directors or
secretary of the company stating that the requirement as to special resolution
has been complied with must have been filed with the Registrar of Companies.
When the Registrar is stratified about these requirements, then he will issue a
certificate to commence business. It will be interesting to know that the business
may also be commenced by passing an ordinary resolution if the approval of
Central Government is obtained for the same.

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11.4 PROCEDURE FOR INCORPORATION OF COMPANY (SECS.12 & 33)

In case of a public company any seven persons and in case of a Private Company
any two persons may join to form an incorporated company. They many form the
company with limited or unlimited liability, limited by shares or by guarantee. In
this section, we attempt to make a brief study on the formalities shall be
complied with to enable the Registrar of Companies to issue a certificate of
incorporation.

1. Application for availability of name under which the company proposes to

be incorporated is to be made to the Registrar of Companies in the
prescribed form in the State where the registered office of the company is to
be situated.

2. After the name is made available, Memorandum and Articles of Association

of the company is to be filed with the registrar of Companies with necessary
stamp duty and filling fees according to the authorised capital of the
company. In case of a private company any two persons and in case of a
public company any seven persons shall subscribe to the Memorandum and
Articles of Association of the company.

3. It is advisable to file with the Registrar along with the Memorandum and
Article of Association, particulars of the situation of the Registered Office of
the Company and the particulars of first Directors of the company. If at this
stage these particulars are not filed, then the same have to be filed with the
Registrar within 30 days of obtaining the certificate of incorporation.

4. A declaration by an advocate of the Supreme Court or of a High Court or

attorney or a pleader entitled to appear before a High Court or a Chartered
Accountant practicing in India who is engaged in the formation of a
company, or by a person named in the articles as Director, Manager or
secretary of the Company, that all the requirements of the act have been
complied with in respect of registration, shall be filed with the Registrar.
(sec. 33)

5. If a company intends to participate in an industry included in the Schedule

of Industries (Development and Regulation) Act 1951, a licence to that effect
must be obtained.

If all the above requirements are complied with under the provisions of the
Companies Act, the Registrar of Companies issues a certificate of incorporation.

In case of a public company, the following further requirements are to be

complied with:–

(i) A list of persons who have consented to act as directors.

(ii) A written consent of the directors to act in that capacity.

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(iii) A under taking by the directors to take up and pay for their qualification
shares.

If the Registrar is satisfied that all the requirements under the act for purposes
of registration of a company have been complied with he shall register the
company and issue a certificate of incorporation under his hand and seal. Once
a company is registered, the incorporation cannot be challenged even though
there may be irregularities prior to registration.

Check your progress - 1

What are the conditions to be fulfilled by a public company to obtain the

certificate to commence business?

Note:

a) Write your answer in the space given below

b) Check your answer with the ones given at end of this lesson ( pp)

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11.5 ADVANTAGES OF INCORPORATION

Here, we briefly explain the various advantages of incorporating a company

11.5.1 Corporate existence

The Company on incorporation obtains independent corporate existence. It is

vested with an independent legal personality distinct from the members who
compose it. It becomes a body corporate capable of immediately functioning as
an incorporated individual.

11.5.2. Liability

The liability of the members is limited to the extent of nominal amount of shares
subscribed in the company’s share capital. In case of the company limited by
guarantee, the liability of the members is limited to the extent of the amount
guaranteed by each member.

11.5. 3. Transferable shares

Shares in a company can be transferred easily without the consent of other

members.

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11.5.4. Perpetual succession

As the company has separate legal existence independent of its members, it is

not affected by the death or insolvency of a member. It has a perpetual
existence.

11.5.5. Members and the Company

Company being a separate legal entity it can sue its members in the ordinary
way, can give loans to members, enter into contracts with members, etc.

11.5. 6. Management

Management of the company can be vested in professionals and the members of

the company can appoint capable persons to manage the affairs of the company
to the general interests of the shareholders. Employees of the company can also
become its shareholders.

11.5.7. Separate Property

Though capital and assets are contributed by its members, it is the company
which is the owner of the capital and assets and it can enjoy and dispose of
property in its won name.

11.5. 8. Capacity to sue and be sued

A company being a body corporate can sue and be sued in its own name.

Check your progress – 2

Write short notes on “Memorandum of association” “Articles of

association”

Note:

a) Write your answer in the space given below

b) Check your answer with the ones given at end of this lesson ( pp)

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11.6 DISADVANTAGES OF NON-REGISTERED COMPANY

Here, we briefly explain the various disadvantages of non-registered company

1. When it is not registered, it cannot sue nor be sued in its own name.
2. It cannot sell or assign or mortgage an immovable property without
obtaining the approval of the general body by a special resolution.
3. Non- registered company neither prospectus could be issued nor could
capital be obtained.
4. The liability of members is unlimited; each and every member will be
jointly and severely liable for company’s debt

11.7 LET US SUM UP

In this lesson, we have briefly touched upon the following points. The Company
obtains separate legal existence after it obtains a certificate of incorporation. It is
a documentary proof and conclusive evidence of the registration of the company
for all purpose.
Procedure for Registration: Any two persons in case of a private company and
any seven persons in case of a public company may associate themselves to
register a private company or a public company, as the case may be. The
following procedure is to be observed: (1) Application of availability of name is to
be made; (2) Memorandum and Articles of Association to be filed with the
Registrar of Companies; (3) Particulars of situation of the Registered Office of the
Company and particulars of the first Direction of the company to be filed; (4)
Declaration by an Advocate of the Supreme Court or High Court or by a person
named in the Articles as Director, Manager or Secretary of the Company that all
requirements have been complied with.
In case of a public company, list of person who have consented to act as
Directors, written consent of the Directors and undertaking of he Directors to
take up and pay for the qualification shares to be filed. Upon compliance of he
above formalities, a certificate of incorporation is issued.
Once the certificate of incorporation is issued, the company obtains a separate
legal existence and acquires perpetual succession. Property belongs to the
Company and not to any other shareholder.
Advantages of Incorporation:(1) Liability of the members is limited; (2) Shares are
easily transferable; (3) Company obtains a separate legal entity; (4) Company can
sue its members; (5) Management of the Company can be vested in
professionals; (6) The company can enjoy and dispose of property in the own
name.

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11.8 QUESTIONS FOR DISCUSSION

1. How is a company formed under the companies Act 1956?

2. What is meant by certificate of incorporation?

3. What are the documents that should be filed with the registrar for
obtaining certificate of incorporation?

4. What are the advantages of incorporation?

5. What are the legal effects of the registration of a company?

11.9 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 what are the conditions to be fulfilled by a public company to

obtain the certificate to commence business?
A statement in lieu of prospectuses must have been filed with the Register of
Companies. The directors must have paid in cash the application money and the
allotment money on the qualification shares taken by them. A statutory
declaration signed by one of the directors or secretary of company stating that
all the above requirements have complied with must have been filed with the
Registrar of Companies.
Check-2 Write short notes on “Memorandum of association” “Articles of
association”
The ‘memorandum of association’ It is the document which describes the scope
of company activities. It must be signed by the seven people in case of public,
and two people in case of private company for the formation of company. . The
‘articles of association’. It is the document which contains the rules and
regulations of the company. It must also be signed by the persons who sign the
memorandum of association.

11.10 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-12
MEMORANDUM OF ASSOCIATION

CONTENTS

12.0 Aims and Objectives

12.1 Introduction
12.1.1 Meaning
12.1.2 Definition of Memorandum of Association
12.2 Purpose of Memorandum
12.3 Form of Memorandum
12.4 Contents of Memorandum of Association
12.4.1. Name clause
12.4.2. Registered Office of the Company
12.4.3. Objects Clause
12.4.4. Capital Clause
12.4.5. Liability Clause
12.4.6. Subscription or Association Clause
12.5 Alteration of memorandum of association
12.5.1 Alteration of Name Clause

12.5.2 Alteration of Registered Office Clause

12.5.3 Alteration of Objects Clause
12.5.4 Alteration of Liability Clause
12.5.5 Alteration of Capital Clause
12.6 Let us sum up

12.7 Questions for discussion

12.8 Model answer to check your progress
12.9 References

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12.0 AIMS AND OBJECTIVES

In the 11th lesson, we discussed the meaning, definition of formation of a

Company and Stages in formation of a Company, Certificate of Incorporation,
and Commencement of Business. In this lesson we discuss the meaning,
definition of Memorandum of Association and Purpose, form, contents,
Alteration of Memorandum of Association. After going through this lesson, you
will able to
1. know the meaning and definition of Memorandum of Association
2. understand various form of Memorandum of Association
3. identify purpose of Memorandum of Association
4. understand the contents Memorandum
5 learn how to alter the contents of Memorandum of Association

12.1 INTRODUCTION

The company to be registered under the Companies Act is required to have two
documents stamped, registered and filed with Registrar of Companies—they
being Memorandum of Association and Articles of Association. The
memorandum of association is a document of great importance in relation to the
proposed company. It contains the fundamental conditions upon which alone
the company is allowed to be incorporated. In this section, we attempt to make a
brief study of meaning and definition of Memorandum of Association

12.1.1 Meaning
Memorandum of Association is the document which contains the rules regarding
constitution and activities or objects of the company. It is a fundamental charter
of the company. Company is governed by the Memorandum of Association. Its
relations towards the members and outsiders are determined by this important
document. The company is allowed to function within the frame work of
Memorandum of Association. If it crosses the frame work, its act would be
construed as ultra vires and therefore void. The Memorandum of Association
defines the extent and powers of the company. A company cannot exceed the
powers conferred on it under its Memorandum of Association. Whether a
transaction entered into by a company can be said to be with in its powers or
not has to be decided on the basis of the facts established and the provisions in
its memorandum and not on the basis of any abstract rule. If the acts of the
company are beyond the limits of the Memorandum of Association, such acts
would be void and ultra vires. They cannot be ratified in order to be binding on
the company.

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The Memorandum of Association is designed to make the outside world known

the state of affairs of the company. The prospective investors, shareholders or
creditors, should know the extent of their risk and also possibilities of the
company to over come them. It is a public document and can be inspected by
anybody.
12.1.2 Definition of Memorandum of Association
Section 2 (28) of the Companies Act defines “Memorandum means the
memorandum of Association of a company, as originally framed or as altered
from time to time in pursuance of any previous companies law or of this Act”.

12.2 PURPOSE OF MEMORANDUM

In this section, we explain the purpose of the Memorandum is two-fold

1. The prospective shareholders shall know the field in, or the purpose for,
which their money is going to be used by the company and what risk they
are undertaking in making investment.
2. The outsiders dealing with the company shall know with certainty as to
what the objects of the company are and as to whether the contractual
relation into which they contemplate to enter with the company is within
the objects of the company

12.3 FORM OF MEMORANDUM

In this section, we attempt to make a brief study of the different form of

Memorandum. The memorandum of association of a company shall be in any
one of the Form in Tables B, C, D and E in Schedule I as may be applicable to
the company, or in a Form as near thereto as circumstances admit (Sec. 14).

Table B : Contains memorandum of association of a company limited by shares.

Table C : Contains memorandum of association of a company limited by

guarantee and not have a share capital.

Table D : Contains memorandum of association of a company limited by

guarantee and having a share capital.

Table E : Contains memorandum of association of an unlimited company.

The memorandum shall be printed, be divided into paragraphs numbers

consecutively and be signed by each subscriber (who shall add his address,
description, and occupation if any) in the presence of at least one witness who
shall attest the signature and shall likewise add his address, description and
occupation, if any (Sec. 15)

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12.4 CONTENTS OF MEMORANDUM OF ASSOCIATION

In this section, we attempt to make a brief study of the contents of

memorandum. According to Section 13 of the Act the memorandum of every
company shall state
(i) Name of the company with ‘Limited’ as the last word of the name in case of
a public company and ‘Private Limited’ in case if private company.
(ii) Registered office of the company.
(iii) Objects of the company.
(iv) Liability of the members.
(v) Details of share capital of the company.
(vi) Subscription of Association clause.
12.4.1. Name clause
Rules: Promoters of the company have to make an application to the Registrar of
Companies for the availability of name. The company can adopt any name if :-
(i) there is no other company registered under the same or under an identical
name; (ii) the name should not be considered undesirable and prohibited by the
Central Government (Sec. 20). A name with misrepresents the public is
prohibited by the Government under the Emblems & Name (Prevention of
Improper use) Act, 1950 for example, Indian National Flag, name and pictorial
representation of mahatma Gandhi and the Prime Minister of India, name an
emblems of the U.N.O., and W.H.O., the official seal and Emblems of the Central
Government and State Governments.
Where the name of the company closely resembles the name of the company
already registered, the Court may direct the change of the name of the Company.
(iii) once the name has been approved and the company has been registered,
then :
(a) the name of the company with registered office shall be affixed on outside of
the business premises;
(b) if the liability of the members is limited the words “Limited” or “Private
Limited” as the case may be, shall be added to the name; [Sec. 13(1)(a)].
(c) the name and address of the registered office shall be mentioned in all letter-
heads, business letters, notices and Common Seal of the company, etc. (Sec.
147).
The Central Government may be license under section 25 of the Act allow a
company to drop the word ‘Limited’ from its name.
12.4.2. Registered Office of the Company
The company shall, from the day on which it commences business or within 30
days atter the date of its incorporation, have a registered office to which all

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communications and notices may be addressed. The Memorandum must specify

the state in which the registered office of the company is to be situated.
Company shall give notice with in 30 days to the Registrar of the situation of the
registered office (Sec. 146)
Usually, the company while submitting its papers for incorporation also files a
notice of registered office of the company with Registrar of Companies. All
documents and notices and notices to be served on the company, must be
served at its registered office (Sec. 51). In Daimler Co. Ltd. V. Continental Tyre &
Rubber Co. (1916-2A. C. 307) its has been held that the situation of the
registered office of a company determines its domicile.
12.4.3. Objects Clause
The third and important clause which defines the limits and extent of the
activities of the company is its objects clause.
The Memorandum must state :-
(i) the main objects of the company to be pursued by the company on its
incorporation;
(ii) the objects incidental or ancillary to the attainment of the main objects;
and
(iii) other objects of the company [Sec. 13 (1) (d)].
In case of companies (other then trading corporations), with objects not confined
to one State, the memorandum shall state the States to whose territories the
objects extend.
The activities which the company proposes to pursue immediately on
incorporation are always embodied under the main objects followed by objects
incidental or ancillary to the attainment of the main objects. The other objects
clause includes other activities which the company may plan to pursue at any
later date. The objects should not be illegal and against the provisions of the
Companies Act.
The statement of objects informs the investors the purpose for which their
capital is proposed to be used by the company. It ensures the shareholders that
the funds raised for one undertaking are not going to be risked in another
(Waman Lal v. Scindia Steam Navigation Co-AIR-1944-Bom. 131). The statement
of objects serves the public interest and also prevents concentration of economic
power as the corporate activities are confined within a defined field.
The objects clause enables the subscribers to the shares and creditors of the
company :-
(i) to be fully aware of the objects to which their money can be employed; and
(ii) to protect the creditors by ensuring that the company’s funds to which
they must look for payment are not dissipated in unauthorized activities
(Ashbury Railway carriage Co. v. Riche 1875 LR 7LH 653).

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In Eastern Countries Railway Co.v. Howke – (1855-5 H. L. C. 331) it has been

declared that “it must be now considered as a well settled doctrine that a
company incorporated by Act of Parliament for a special purpose cannot devote
any part of its funds to objects unauthorized by the terms of its incorporation
however desirable such an application may appear to be.”
12.4.4. Capital Clause
In case of a company having a share capital unless the company is an unlimited
company, memorandum shall also state the amount of share capital with which
the company is to be registered and division thereof into shares of a fixed
amount [Sec. 13 (4) ].
The capital with which the company is registered is called the Authorised or
Nominal Share Capital. The amount of nominal or authorized capital of the
company would be normally, that which shall be required for the attainment of
the main objects of the company. In case of companies limited by guarantee, the
amount promised by each member to be contributed by them in case of the
winding up of the company is to be mentioned. No subscriber to the
memorandum shall take less then one share. Each subscriber of the
memorandum shall write against his name the number of shares he takes.
12.4.5. Liability Clause
The liability of the members is limited to the extent of the shares subscribed by
the members if the company is formed with share capital or to the extent of the
guaraness given by the members if the company is formed with guaranetee.
The memorandum of a company limited by shares or by guarantee shall state
that the liability of its members is limited [Sec. 13 (2) ]. This means that no
member can be called upon to pay anything more than the nominal value of the
shares held by him or so much thereof as remains unpaid. If shares are fully
paid-up then his liability is nil. The memorandum of a company limited by
guarantee shall also state that each member undertakes to contribute to the
assets of the company in the event of it being wound up while he is a member or
within one year after he ceases to be a member, for (i) payment of the debts and
liabilities of the company; or (ii) of such debts and liabilities of the company as
may have been contracted before he ceases to be a member; and (iii) of the costs,
charges and expenses of winding up, and (iv) for adjustment of the rights of the
contributories among themselves; such amount as may be required not
exceeding a specified amount [Sec. 13 (3) ].

12.4.6. Subscription or Association Clause

Each subscriber to the memorandum of the company shall take atleast one
share. It case of a public company at least 7 persons shall subscribe to the
memorandum of the company. The signatures of the subscribers shall be
attested by atleast one witness.
“We the several persons whose names and addresses are subscribed are
desirous of being formed into a company in pursuance of this memorandum of

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association and we respectively agree to take the number of shares in the capital
of the company set opposite our respective names.”
After incorporation, no subscriber can withdraw his name on any ground
whatsoever.
After the above clause, the name, age, address, description and occupation of
each subscriber is mentioned.

Check your progress - 1

What do you understand by Domicile clause?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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12.5 ALTERATION OF MEMORANDUM OF ASSOCIATION

The memorandum of association is a very important document of a company. It

cannot be altered by the sweet will of the members of the company. It can be
altered only by following the procedure as prescribed in the Companies Act. It
may be noted that the right of the company to alter its memorandum is strictly
limited to the provisions of the Companies Act. The procedure of alteration of
various clauses of the memorandum may be discussed under the following
heads:
1. Alteration of name clause.
2. Alteration of registered office clause.
3. Alteration of objects clause.
4. Alteration of liability clause.
5. Alteration of capital clause.
There clauses are also known as conditions of memorandum and can by altered
in accordance with the legal provisions as discussed in the following pages.

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12.5.1 Alteration of Name Clause

A company may later (i.e. change) its name at nay time. The only requirement is
that the change must be made by following the prescribed procedure. The
procedure for the change of name of the company is contained in Sections 21 to
23 of the Companies Act any may be summed up as under :
(a) By passing a special resolution; and
(b) By obtaining the approval of Central Government in writing.
However, the approval of Central Government is not required when the change
involves the addition or deletion of the word ‘Private’ on the conversion of a
public company into a private company or vice versa.
2. Sometimes, a company has been registered with a name which is identical
with the name of an existing company or which, in the opinion of Central
Government, is undesirable. In such cases, the company may change its name
by adopting following procedure [Section 22 (1) (a)]
(a) By passing an ordinary resolution, and
(b) By obtaining the previous approval of the Central Government in writing.
3. The change of name must be communicated to the Registrar of Companies
within thirty days of the change [Section 192]. On such communication, it
becomes the duty of the Registrar to enter the new name in the Register of
Companies, and to issue a fresh certificate of incorporation with necessary
alterations. The change of name becomes effective on the issue of fresh
certificate of incorporation. The Registrar shall also make necessary alterations
in the Memorandum of Association. It will be interesting to know that the
change of name does not affect the rights and obligations of the company. It
also does not affect the pending legal proceedings by or against the company.
Such legal proceedings may be continued by its new name [Section 23]
After the change of name has been effected and registered in the register of
companies, the legal proceedings, if any, should be commenced by the company
in its new name. The legal proceedings commenced by the company in its old
name may not be held competent by the court.
However, where, after the change of name, any legal proceeding is commenced
against the company in its old name, it is a case of mere misdescription of name.
Such a defect can be cured by substituting the new name with the permission of
the court.
12.5.2 Alteration of Registered Office Clause
The procedure for the alteration (i.e. change) of registered office of the company
is contained in Section 17, 18 and 146 of the Companies Act, and may be
summed up as under
1. Change of registered office from one place to another within the same city.
Such a change in the registered office of the company may be made without any

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formality. The only requirement is that the notice of such change must be given
to the Registrar of Companies within 30 days of the change.
2. Change of registered office from one city to another within the same State.
Such a change in the registered office of the company may be made by passing a
special resolution to that effect. When the registered office is shifted to the new
location, then the notice of the same must be given to the Registrar of
Companies with in 30 days of the shifting of the office.
3. Change of registered office from one city to another. Such a change in the
registered office of the company may be made by adopting the following
procedure:
(a) By passing a special resolution, and
(b) By obtaining the confirmation of the Company Law board.
Thus, the change of registered office from one State to another involves a
difficult and complicated procedure. It may be noted that before confirming the
alteration (i.e. change), the Company Law Board will consider the objections of
the persons whose interest will be affected by such change in the registered
office. Thus, the Board should give an opportunity of being heard to the
members, creditors and other persons interested in the company such as the
State or the Registrar. The Board will confirm the change only if the shifting of
the registered office from one State to another is necessary for any one of the
following purposes as mentioned in Section 17 (1) of the Companies Act
(a) to carry on its business more economically or more efficiently.
(b) to attain its main purpose by new or improved means.
(c) to enlarge or change the local are a of its operation.
(d) to carry on some business which under existing circumstances, may
conveniently or advantageously be combined with the business of the
company.
(e) to restrict or abandon any of the objects specified in the memorandum.
(f) to sell or dispose of the whole or any part of the undertaking of the
company.
(g) to amalgamate with any other company or body of persons.
When the company Law Board is satisfied with regard to the above points it may
confirm the change in registered office from the State to another. After the
Company Law Board has confirmed the alteration (i.e. change), a certified copy
of the order of the company Law Board must be filed with the Registrar of
companies of both the States within three months from the date of the order
(Section 18). Thereafter, the Registrar of each state shall register the alteration.
The Registrar of the State where the office was originally situated shall send to
the Registrar of the other State all records and documents relating to company.
When the registered office of the company is shifted to its new location, the

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notice of the same must be given to the Registrar of Companies within 30 days of
the shifting of the office.
Sometimes, the shifting of registered office from one State to another is opposed
by the State concerned on various grounds such as (a) loss of revenue, and (b)
adverse effect on employment opportunities etc. In such cases, whether or not
the Company Law board should confirm the shifting of office is to be seen in the
light of the judicial decisions.
In two cases before the Orissa High Court, the shifting of registered office of
certain companies to a place outside Orissa was opposed by the State on the
ground of loss of revenue, and employment opportunities. In both these cases,
the courts declined confirmation of shifting of registered office from Orissa to
another State. While deelining the confirmation in these cases, the court
observed in one case that every State has got the right to protect its revenue
and, therefore, the interest of the State must be taken into account in
confirming the shifting of company’s registered office from one State to another.
However, the reasoning given by the Orissa High Court is not adopted by the
other High Courts as is evident from the following example.
The above opinion of the Calcutta High Court was followed by this court in
subsequent cases, and also by the Bombay High Court. Keeping in view the
judicial trend, it is submitted that the view expressed by the Calcutta, and
Bombay High Courts is correct. And State’s objection to the shifting of
registered office out of State on the ground of loss of revenue or adverse effect on
employment opportunities, is not a relevant consideration.

12.5.3 Alteration of Objects Clause

We know that the objects clause of memorandum is the most important clause.
The alteration (i.e. change) in this clause involves a difficult and complicated
procedure. The reason for the same is that it requires the alteration of the
memorandum itself. Moreover, certain limited are also imposed on company’s
powers of alteration. These limits will be discussed in the next article. The
procedure for the change of objects of the company is contained is Sections 17
and 18 of the companies Act. The company may change its objects by adopting
the following procedure:
1. By passing a special resolution, and
2. By obtaining the confirmation of the Company Law Board
Thus, for effecting a change in the objects clause, first the company should pass
a special resolution authorizing such a change (alteration). After passing the
special resolution, a petition should be filed before the Company Law Board for
confirmation of the alteration. It may be noted that obtaining confirmation of
Company Law Board is not an easy task Before confirming the alteration, the
Company Law Board must be satisfied on the following points :

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(a) That a sufficient notice has been given to every debenture-holder, and to
every other person whose interest is likely to be affected by the proposed
alteration.
(b) That either the consent of those creditors has been obtained who have
raised an objection to the alteration, or their claims have been satisfied.
The Company Law Board must serve a notice, of the petition for confirmation of
the alteration, on the Registrar of Companies. And the Registrar must also be
given an opportunity to appear before the Company Law Board and state his
objections and suggestions with respect to the confirmation of alteration. On
being satisfied, the Company Law Board may pass an order confirming the
alteration. The Board has discretionary powers in this regard. It may confirm
the alteration either fully or in part, or subject to such conditions as it thinks fit.
However, the Board must exercise its discretionary powers fairly and judicially.
Moreover, while exercising this power, the Board must have regard to the right
and interest of every class of members and creditors of the company. It may
also be noted that the Board can confirm the alteration if it is for the purposes
stated in Section 17 (1) of the Companies Act as discussed in the next article.
The alteration of the objects clause of memorandum of association must be
registered with the Registrar of Companies. As regards the registration of
alteration and its effect, the following legal provisions may be noted:
1. After the confirmation order is made by the Company Law Board, a
certified copy of the Board’s order and a printed copy of the altered
memorandum shall be filed with the Registrar of Companies within three
months of the data of order [Section 18 (1)]
2. Thereafter, the registrar of Companies shall register the alteration, and
issue a certificate of registration of alteration within one month of the filing
of documents [Section 18 (1)]
3. The certificate of registration of alteration shall b3e the conclusive evidence
to alteration. In other words, this certificate implies that all the legal
requirements with respect to alteration have been complied with. The
alteration is effective from the date of registration of the alteration [Section
18 (2)]
4. In case the copy of Company Law Board’s order and the copy of altered
memorandum is not filed with the Registrar within a period of three
months, as stated in point (1) above, then the alteration and entire
proceedings connected with it shall become void and inoperative. However,
the Company Law Board may revive the order of alteration if an application
for revival is made to it within a further period of one month after the laps
of alteration (i.e. after the expiry of said period of three months) [Section 19
(2)]
5. The Company Law Board may extend the period of three months for filing
the documents, as stated in point (1) above, also the period of one month
for registration of alteration as stated in point (2) above, by such period as
it thinks proper [section 18 (4)]

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12.5.3.(i) Limits on Alteration of Objects Clause

We have discussed, in the last section, the procedure for the alteration of the
objects clause of memorandum. It may be noted that there are certain limits on
company’s power of alteration of the objects clause. The company can alter its
objects clause only if it is necessary for any one of the purposes specified in
Section 17 (1) of the companies may alter its objects, may be discussed under
the following heads
1. To carry on company’s business more economically or more efficiently.
The company may bring such a change in the objects clause of its
memorandum which enables it to carry on its business more economically
or efficiently. It may be noted that under this provision, the business the
company is not changed. Only the mode of conducting the business is
made more economical and efficient.
2. To attain the main purpose by new or improved means. The company may
bring such a change in the objects clause of its memorandum which
enables it to extend its trade to new areas. Here also the company’s
business remains the same.
3. To enlarge or change the local area of company’s operation. The company
may bring such a change in the objects clause of its and technical
memorandum which enables it to extend its trade to new areas. Here also
the company’s business remains the same.

Thus, by altering its memorandum, a company can extend its existing business
to new areas of operation.
4. To carry on some business this may be combined with the business of the
company. The company may bring such a change in the objects clause of
its memorandum which enables it to carry on some business which, under
the existing circumstances, may conveniently or advantageously be
combined with the business of the company. The requirement for the
same is that the new business must be such which can be conveniently or
advantageously combined with the existing business, and the existing
circumstances must also permit the starting of such business. In other
words, the new business must not be inconsistent with the existing
business. Thus, if the company is financially sound, the company may
start a new business which is not inconsistent with the existing business.
5. To restrict or abandon any of the objects. The company may bring such a
change in the objects clause of its memorandum which is necessary to
restrict or abandon any of the objects specified in the memorandum.

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6. To sell the undertaking. Sometimes, a company may like to sell or dispose

of the undertaking. In such cases, the company may change the objects
clause of its memorandum which enables it to sell or dispose of the whole
or any part of the undertaking of the company. The expression
‘undertaking’ here means a business unit or enterprise in which a
company may be engaged as a gainful occupation e.g. each one of several
factories or manufacturing plants of a company will be considered as an
undertaking from the business point of view. Thus, the term ‘undertaking’
signifies a going concern engaged in the production, distribution etc. of
goods or services. Sometimes, it also means the entire business or
organization of a company [Rustom Cavasjee Cooper V. Union of India
(1970) 44 Company Cases 325 (SC)].
7. To amalgamate with any other company. The company may like to
amalgamate with any other existing company or body corporate. In such
cases, the company may bring such a change in the objects clause of its
memorandum which enable the amalgamation.
Thus, a company is not empowered to change the objects clause of its
memorandum in whatever manner it likes. It can bring a change in the objects
clause only if the same is necessary for any of the above stated purposes

12.5.4 Alteration of Liability Clause

We know that an important characteristic and advantage of a company is the
limited liability of members (shareholders). As a matter of fact, it is the main
attraction for persons to invest their money in the company. Generally, the
company cannot alter the liability clause of its memorandum so as to increase
the liability of the members. The liability of members can be increased only if
the concerned member agrees in writing. Thus, an alteration which imposes
additional liability on a member or which compels the member to buy additional
shares of the company can be made only if the concerned member gives his
consent in writing (Section 38).
It will be interesting to know that the liability clause may also be altered so as to
make the liability of the directors or manager unlimited. However, this can be
done if the company is so authorized by its ‘articles of association’. In such a
case, the company may alter the liability clause by passing a special resolution.
But such alteration applies to the directors or manager who shall be appointed
after the alteration. The existing directors or manager are bound by the
alteration only if they give their consent to it. Thus, the liability of members,
directors or manager cannot be increased without the consent of the concerned
persons.

12.5.5 Alteration of Capital Clause

The company may alter the capital clause of its memorandum by adopting the
procedure prescribed in the Companies Act. It may, however, be noted that the
company can alter (change) its capital only of it is so authorized by its ‘articles of
association’. Certain alterations in the capital clause may be made by passing

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an ordinary resolution and certain by a special resolution. Following types of

alterations can be made simple by passing an ordinary resolution:
1. Increase of share capital by issue of new shares.
2. Consolidation or sub-division of existing shares into shares of larger or
smaller amount.
3. Conversion of fully paid shares into stock and conversion of stock into fully
paid shares.
4. Cancellation of unissued shares.
However, if the alteration is by way of ‘reduction of share capital’, it can be
made only by passing a special resolution and obtaining the confirmation form
the court.
Check your progress - 2
What do you understand by subscription clause?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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12.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points:

Memorandum of Association: The company is required to file two documents

with the Registrar of Companies, i.e., the Memorandum of Association and the
Articles of Association. Memorandum of Association contains the rules regarding
the constitution and activities or objects of the company. It is a fundamental
charter of the company. The company is governed by the Memorandum of
Association. It is to work within the framework of the Memorandum of
Association as otherwise its acts would be ultra -uires and void.

Contents of Memorandum of Association:

(1) Name of the Company. (2) Registered Office of the Company. (3) Objects of
the Company divided into (a) main objects; (b) objects incidental to the main

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objects; and (c) other objects. (4) Liability of the members. (5) Share capital of
the company. (6) Subscription of Association clause

Alteration of Memorandum of Association:

(1) Change of Names: The Company shall effect the change in its name by
passing a special resolution at the General Meeting and after obtaining Central
Government approval thereto. The change of name shall not affect any rights or
obligations of the Company. The alteration effected is only in the name and not
in the identity of the company.

(2) Change in the registered office of the company: In case of change of registered
office from one place to another in the same city, the change shall be effected by
an ordinary Board resolution. In case of change in the registered office of the
company from one city to another city in the same State, the change shall be
effected by a special resolution. Incased of change in the registered office of the
company from one State to another State in India, a special resolution is
required besides confirmation of the change shall be obtained from the Company
Law Board.

(3) Alteration of Objects Clause: Alteration in the Objects Clause shall be

approved by a special resolution of the embers in general meeting and there after
it shall be confirmed by the Company Law Board on petition. The alteration
maybe approved wholly or in part or on such terms and conditions as may be
through fit.

(4) Alteration in capital clause: The alternation of share capital may involve: (1)
increase of share capital; (2) reduction of share capital; and (3) conversion of
shares into stock.

Increase of share capital: The share capital of the company may be increased by
further issue of capital or by consolidating and dividing all or any of its share
capital into shares of larger amount. The change in the capital clause can be
effected only if authorized by the Articles of the Company. It ma be done so by
an ordinary resolution or by a special resolution as provided by the Articles.

Reduction of share capital: The reduction of share capital can be effected by a

special resolution and by an application made by a petition to the Court of
confirmation. The Court shall settle the list of creditors who may object to the
reduction of share capital. On the Court, being satisfied, it may confirm the
reduction of he capital on such terms and conditions as it thinks fit. The order of
the Court shall be registered with the Registrar of Companies. On such
registration, the Registrar shall issue a certificate which shall be conclusive
evidence for reduction in he share capital of the company.

Conversion of Shares into Stock: Fully paid up shares can be only converted into
stock. A sum total of fully paid up shares is stock. Fully paid up shares can be
converted into stock and stock can be reconverted into fully paid up shares.
Such conversion must be authorized by the Articles.

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(5) Change in liability clause: The liability of the members cannot be altered so
as to increase their liability. The alternation can be effected only with the
consent of the members in writing.

Any other provision in the Memorandum can be altered by a special resolution.

12.7 QUESTIONS FOR DISCUSSION

1. Explain the contents of the Memorandum of Association of a Company?

2. Explain the significance of the object clause of Memorandum of
Association.
3. Explain the provisions of the Companies Act relating to the alteration of
Memorandum of Association.
4. Explain the significance of the object clause of Memorandum of
Associations and state the procedure for alteration thereof.

12.8 MODEL ANSWER TO CHECK YOUR PROGRESS

Chcek-1 what do you understand by Domicile clause?

Domicile clause: Every company shall have a registered office from where it has
to carry on its business. The name and address of the registered office shall be
the address of the company
Check- 2 what do you understand by subscription clause?
We the several persons whose names and addresses are subscribed are desirous
of being formed into a company in pursuance of this memorandum of
association and we respectively agree to take the number of shares in the capital
of the company set opposite our respective names

12.9 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-13
DOCTRINE OF ULTRAVIRES

CONTENTS
13.0 Aims and Objectives
13.1 Introduction
13.1.1 Categories of ultra-vires
13.2 Summarized of legal position of the ultra- vires
13.3 Effects of Ultra- vires Acts
13.4 Exceptions to the Doctrine of Ultra-vires
13.5 Doctrine of Ultra-vires an Illusory Protection
13.6 Let us sum up
13.7 Questions for discussion
13.8 Model answer to check your progress
13.9 References

13.0 AIMS AND OBJECTIVES

In the 12th lesson, we discussed the meaning, definition of Memorandum of

Association and Purpose, form, contents, Alteration of Memorandum of
Association. In this lesson we discuss the meaning, category, the legal position,
Effects of Ultra- vires Acts and Exceptions to the Doctrine of Ultra-vires. After
going through this lesson, you will able to
1. know the meaning of Doctrine of Ultra-vires
2. understand various category of Doctrine of Ultra-vires
3. known the legal position of Doctrine of Ultra-vires
4. understand the Effects of Doctrine of Ultra-vires
5 understand the Exception of Doctrine of Ultra-vires

13.1 INTRODUCTION

The term ‘ultra’ means beyond, and the term ‘vires’ means powers. Thus term
‘ultra-vires’ means doing an act beyond the powers. In this section, we explain
the ultra-vires acts may be categorized as under

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13.1.1 Categories of ultra-vires

1. An act ultra-vires the directors. It is an act which is beyond the powers of
the directs.
2. An act ultra-vires the articles of association. It is an act which is beyond
the powers given by the articles of association.
3. An act ultra-vires the memorandum of association. It is an act which is
beyond the powers given by the memorandum of association. As a matter
of fact, such act is beyond the legal powers of the company, and is also
known as ‘ultra-vires the company’.
It the company does any act which is ultra-vires the directors; the act is not
altogether void and inoperative. It can be ratified by the general body of
shareholders. Whe the act is so ratified, the company becomes bound by the
same. Similarly, an act which is ultra-vires the articles of association, is also
not altogether viod and inoperative. It can also be ratified by the company by
making necessary alterations in the articles of association by passing a special
resolution. Thereafter, the company becomes bound by such act. It may,
however, be noted that such an act can only be ratified if it is intravires the
company i.e. within the powers of the company.
The acts which are ‘ultra vires the company’ are wholly void and inoperative as
they are beyond the legal powers of the company. The company is not bound by
such acts. It may be noted that such acts cannot be ratified even by the whole
body of shareholders. The doctrine of ultra-vires is generally meant for this
category of ultra-vires is generally meant for this category of ultra-vires acts. We
know that a company is formed only for the objects stated in its memorandum of
association. The company, therefore, has the powers to do the following acts :
(a) Which are essential for the attainment of the objects stated in
‘memorandum of association’.
(b) Which are reasonably and fairly incidential to the attainment of its objects.
(c) Which are otherwise authorized by the Companies Act.
If the company does any other act which is not covered by the above powers,
that will be ultra vires the memorandum (or company), and shall be wholly void
and inoperative. The company is not bound by the acts which are ultra vires the
‘memorandum of association’ i.e. beyond the legal powers of the company.
However, if the acts are within the powers of the company, any irregularity in
doing the acts may be cured with the consent of all the shareholders. The
purpose of this doctrine is to protect the interest of the investors and creditors.
The interest of investors is protected in a way that they know the purpose for
which their money is going to be used, and due to this doctrine the company
cannot depart from its objects. Similarly, the interest of creditors is also
protected as they fell assured that company’s assets will not be risked in
unauthorised business activities. The application of the doctrine of ultra vires is
clear from the following examples based on decided cases.

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The doctrine of ultra vires has also been affirmed by the Supreme Court of India
in a case before it which is disuussed in the following example.
Whether a particular act on the part of the company is within its powers is a
question of fact, and is to be decided on the construction of the terms of its
‘memorandum’. However, the doctrine of ultra vires should not be understood
and applied unreasonably. The acts which are reasonably fair and incidental to
the objects of the company, should not be regarded as ultra-vires unless they
are expressly prohibited. The Compani9es Act itself requires that the incidental
objects should be stated in the objects clause. Even if they are not stated, they
should be allowed by the principle of reasonable construction.
It may, however, be noted that a company cannot carry on the activities which
are neither essential nor incidental to the fulfillment of its objects.
Sometimes, company’s main object comes to an end, or the company abandons
its main object. In such cases, the company cannot continue to pursue its
subsidiary objects.

13.2 SUMMARIZED OF LEGAL POSITION OF THE ULTRA- VIRES

In this section, we summarized the legal position of the ultra- vires acts:
1. An act which is ultra vires the director i.e. beyond the powers of the
directors is not altogether void and inoperative. It can be ratified by the
general body of shareholders if it is within the powers of the company.
2. An act which is ultra views the articles of association i.e. beyond the
powers given by the articles, is also not altogether void and inoperative. It
can be ratified by the company by making necessary alteration in its
articles by passing a special resolution.
3. An act which is ultra views the memorandum i.e. beyond the powers given
by the memorandum is in fact ultra- vires the company itself.

13.3 EFFECTS OF ULTRA- VIRES ACTS

The effects of ultra- vires acts may be discussed under the following heads :
1. Injunction against the company. In case any ultra- vires act has been
done or is about to be done, any member of the company can obtain an
injunction from the court i.e. he may obtain a court order restraining the
company from proceeding with the ultra- vires acts.
2. Personal liability of directors to the company. The direetors of the
company are personally liable to the company for the ultra- vires acts. It is
the duty of the directors to see that company’s capital is used for the
legitimate objects of the company. If company’s money is used for any
purpose which is in no way connected with the company’s objects, the
directors will be personally liable for the same i.e. they can be compelled to
restore such fund to the company.

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Sometimes, the persons receiving the money know that the payment to them is
ultra- vires. In such cases, the directors can recover the money from such
persons.
3. Personal liability of directors to third party. The directors of the company
are also personally liable to the third party as they exceed their authority
by doing ultra- vires acts. It is the duty of an agent to act within the scope
of his authority. If he exceeds his authority he will be personally liable to
the third party. The directors are the agents of the company, therefore
they should not go beyond their authority. If they induce any outsider
(third party), to contract with the company in a matter in which the
company has no power to act, they will be personally liable for any loss
suffered by the outsiders.
4. Ultra- vires contracts are void. A contract which is ultra-v the company
i.e. beyond company’s powers, is void and without any legal effect. This is
so because the company is not at all competent to enter into such
contracts. It may be noted that the ultra-vires contracts cannot become
ultra-vires by subsequent ratification.
Though the ultra vires acts are void, but the company is entitled to bring a legal
action for the protection of its property even if acquired by unauthorised acts or
expenditure.

13.4 EXCEPTIONS TO THE DOCTRINE OF ULTRA-VIRES

We have discussed, the doctrine of ultra-vires according to which the ultra-vires

acts i.e. the acts which are beyond the powers of the company, are void and
inoperative. However, in the following exceptional circumstances, the ultra-vires
acts are not absolutely inoperative.
1. If the company acquires some property by ultra-vires expenditure, the
company’s right over the property will be protected. The reason for the
same is that such property though acquired by making unauthorized
expenditure, represents the company’s property.
2. If the company acquires some property under an ultra-vires contract, the
same can be recovered from the company it if exists and is traceable in the
hands of the company.
3. If the company takes an ultra-vires loan and uses it to pay of its own
debts, then the money-lender gets the rights of that creditor whose loan
has been paid by the company, and can recover him money from the
company.
4. If any person borrows money from the company under an ultra-vires
contract, the company has the right to sue and recover the money from
him.

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5. If a director of a company makes payment of certain money, which is ultra-

vires the company, he can be compelled by the company to refund it.
However, the director may claim indemnity (i.e. compensation) from the
person who received the money knowing that it is ultra-vires.
6. The company may be held liable for the ultra-vires torts (i.e. civil wrongs) of
its employees. However, the company will be liable only if the following
points are proved, that
(a) The tort was committed in the course of an activity which falls within the
scope of company memorandum, and
(b) The employee committed the tort within the course of his employment.

Check your progress -1

What do you mean by Ultra vires contract?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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13.5 DOCTRINE OF ULTRA-VIRES AN ILLUSORY PROTECTION

We know that the purpose of the doctrine of ultra-vires is to protect the interest
of the shareholders and creditors of the company. But it has been criticized by
the Bhabha Committee on Company Law Reforms which has observed that
“doctrine is an illusory protection to the shareholders, and a pitfall for third
parties dealing with the company”. The reason for such criticism of this doctrine
is that it has not been proved effective in protecting the interest of the
shareholders and creditors. This criticism of the doctrine is due to the following
reasons :
1. The ‘memorandums of association’ are so widely drafted that all probable
acts are covered in the objects clause. It is then possible for the company
to extend its operations at any time and therefore, the doctrine becomes
ineffective However, this has been protected by the Companies
(Amendment) Act 1965 to some extent. After this amendment, the
companies are required to state their objects in two sub-clauses namely (a)
main objects clause, and (b) other objects clause.

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2. The company may do any act which is ‘incidental to and consequential

upon the main objects’. This also provides a scope of ambiguity.
3. The company may also start new business under certain circumstances.
This power may be misused by the company. Section 17 (1) (d) of the
Companies Act provides that the company may alter its objects clause so
far as it is necessary “to carry on some business which, under the existing
circumstances, may conveniently or advantageously be combined with the
business of the company”. This is also against the interest of the
shareholders and the creditors because they never know at what time the
company may start a new business. However, as the sanction of Company
Law Board is compulsory for this purpose, and the members and creditors
are also given the notice, the misuse of this clause may be checked.
4. The directors generally consider that all their activities are within the
powers until they are challenged in the courts of Law. The shareholders
may not go to courts all the time. And thus they may not be actually
protected by the doctrine of ultra-vires.
Thus, certain complications are there in the application of the doctrine of ultra-
vires. The English Company Law Revision Commission (known as the Cohen
Committee, 1945) recommended the abolition of the doctrine of ultra-vires. It
was further suggested that the memorandum should make a contract only
between the shareholders and company. Every contract made on behalf of the
company whether within or beyond its powers should be make valid. Thus,
some efforts are necessary to protect the interest of share holders and the third
parties dealing with the company.

13.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points.

Doctrine of ultra vires: Any act done by the company which is neither authorized
by its objects nor by the Companies Act is called an ultra vires act. Such an act
cannot bind the company.
The act may be ultra vires the Articles, but intra vires the Memorandum. An act
ultra vires the Articles; but not the Memorandum can be ratified by the
shareholders. An act ultra vires the Articles but within the powers of the
Memorandum, can be ratified by altering the Articles. But an act ultra vires the
Memorandum is ultra vires the Company and, therefore, void and as such
cannot, be ratified. The aggrieved party has a relief against the Directors of the
Company for ultra-vires acts.

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13.7 QUESTIONS FOR DISCUSSION

1. Explain fully the doctrine of Ultra Vires in relation to companies.

2. What are the liabilities of a company and its agents for ultra-vires acts?
3. What is meant by Doctrine of Ultravires ?
4. Explain with an illustration. State the effect of Doctrine of Ultravires
transaction on the company, and on its directors.

13.8 MODEL ANSWER TO CHECK YOUR PROGRESS

Check -1 what do you mean by Ultra vires contract?

Any contract entered into by a company with others or vice veres upon an ultra
vires Act, is void ab initio and it has no legal effect.

13.9 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-14
ARTICLES OF ASSOCIATION

CONTENTS
14.0 Aims and Objectives
14.1 Introduction
14.1.1 Meaning
14.1.2 Definition
14.2 Contents of Articles
14.3 Model form of Articles
14.4 Regulations required
14.5 Adoption and application of Table A
14.6 Alteration of Articles
14.7 Procedure of Alteration
14.8 Distinction between Memorandum of Association and Articles of
Association
14.9 Doctrine of Indoor management
14.10 Let us sum up
14.11 Questions for discussion
14.12 Model answer to check your progress
14.13 References

14.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning, category, the legal position,
Effects of Ultra- vires Acts and Exceptions to the Doctrine of Ultra-vires. In this
lesson we discuss the meaning, definition of Contents of Articles, Model form of
Articles, Regulations required, Adoption and application of Table A, Alteration of
Articles. After going through this lesson, you will able to
1. know the meaning and definition of Articles of Association
2. understand various item contents of Articles of Association
3. known various Model form of Articles 5 learn how to alter the contents of
Articles of Association

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14.1 INTRODUCTION

The Articles of Association or just Articles are the rules, regulations and bye-
laws for the internal management of the affairs of company. They are framed
with the object of carrying out the aims and objects as set out in the
Memorandum of Association.In this section , we discuss the meaning and
definition of Articles of Association
14.1.1 Meaning
The Articles of Association is next in importance to Memorandum. The Articles
are next in importance to the Memorandum of Association which contains the
fundamental conditions upon which alone a company is allowed to be
incorporated. They are as such subordinate to, and controlled by, the
Memorandum
14.1.2 Definition
‘Articles’ mean “the Articles of Association of a company as originally framed or
as altered from time to time in pursuance of this Act. They include the
regulations contained in Table A in Schedule I to the Act, in so far as they apply
to the company” [Sec. 2 (2)].
Must not violate the Memorandum and the Act. In framing the Articles of a
company care must be taken to see that regulations framed do not go beyond
the powers of the company itself as contemplated by the Memorandum or the
Association. They should also not violate any of the provisions of the Companies
Act. If they do, they would be ultra vires the Memorandum or the Act and will
be null and void. For example, according to Sec. 250, dividend can be paid by a
company only out of profits. Any provision in the Articles contrary to this
provision of the companies Act is void. The following cases illustrate the point:
Peveril Gold Mines Ltd., Re (1898) 1 Ch. 122. The Articles of company provided
that no petition for a winding up could be presented unless [a] 2 directors
consented in writing, and [b] the petitioner held 1/5th of the issued share
capital. Neither of these conditions was fulfilled. Held, the restrictions were
invalid and perdition could be presented.

14.2 CONTENTS OF ARTICLES

In this section, we discuss the Articles contain provision relating to the following
matter:
[1] Share capital, rights of shareholders, variation of these rights, payment of
commissions, share certificate.
[2] Lien on shares.
[3] Calls on shares.

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[4] Transfer of shares.

[5] Transmission of shares.
(6] Forfeiture of shares.
[7] Conversion of shares into stock.
[8] Share warrants.
[9] Alteration of capital.
[10] General meetings and proceedings thereat.
[11] Voting rights of members, voting and poll, proxies.
[12] Directors, their appointment, remuneration, qualifications, powers and
proceedings of Board of directors.
[13] Manager.
[14] Secretary.
[15] Dividends and reserves.
[16] Accounts, audit and borrowing powers.
[17] Capitalisation of profits.
[18] Winding up.

14.3 MODEL FORM OF ARTICLES

Schedule I to the Act gives various model forms of Memorandum of Assoication

and Articles of Association of various types of companies. The Schedule is
divided into Tables which serve as a model for various companies.
Table A deals with regulations for management of a company limited by shares.
Table B contains a model form of Memorandum of Association of a company
limited by shares.
Table C gives model forms of Memorandum and Articles of Association of a
company limited by guarantee and having a share capital.
Table D gives model forms of Memorandum and Articles of Association of a
company limited by guarantee and having a share capital. The Articles of such a
company contain in addition to the information about the number of members
with which the company proposes to be registered, all other provisions of Table
A.
Table E contains the model forms of Memorandum and articles of Association of
an unlimited company.

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Companies which must have their own articles [Sec. 26]

The following companies shall have their own Articles, namely,
[a] unlimited companies,
[b] companies limited by guarantee,
[c] private companies limited by shares.
The Articles shall be signed by the subscribers of the Memorandum and
registered along with the Memorandum.

14.4 REGULATIONS REQUIRED

In this section, we attempt to make a brief study of the regulations required. A

public company may have its own Articles of Association. If it does not have its
won articles, it may adopt table A given in Schedule I to the Act. Regulations
required in case of an unlimited company, a company limited guarantee and a
private company [Sec. 27]
1. Unlimited company. In the case of an unlimited company, the Articles
shall state : -
[a] the number of members with which the company is to be registered and
[b] if it has a share capital, the amount of share capital with which the
company is to be registered.
2. Company limited by guarantee. In the case of company limited by
guarantee, the Articles shall stat the number of members with which the
company is to be registered.
3. Private company. In the case of a private company having a share capital,
the articles shall contain provisions which --
[a] restrict the right to transfer shares.
[b] limited the number of its members to 50 [not including employee-
members], and
[c] prohibit any invitation to the public to subscribe for any shares in, or
debentures of, the company.
In the case of any other private company, the Articles shall contain provisions
relating to matters specified in Clauses [b] and [c] given above.

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14.5 ADOPTION AND APPLICATION OF TABLE A [SEC. 28]

There are 3 alternative forms in which a public company may adopt Articles:
1. It may adopt Table A in full
2. It may wholly exclude Table A and set out its won Articles in full.
3. It may frame its own Articles and adopt part of Table A.
In other words, unless the articles of a public company expressly exclude any or
all provisions of Table A, Table A shall automatically apply to it.
For of Articles in the case of other companies [Sec. 29]
The articles of any company, not being a company limited by shares, shall be in
such one of the forms in Tables C, D, and E in Schedule I to the Act, as may be
applicable, or in a Form as near thereto as circumstances admit. Further, such
a company may include any additional matters in its Articles in so far as they
are not inconsistent with the provisions contained in the form in any of the
Tables C, D, and E adopted by the company.
Form and signature of Articles [Sec. 30]. The Articles shall be—
[a] printed,
[b] divided into paragraphs, and
[c] signed by each subscriber of the Memorandum [who shall add his address,
description and occupation, if any] in the presence of at least 1 witness
who will attest the signature and likewise add his address, description and
occupation, if any.
The articles of Association printed on computer laser printer should be accepted
by the Registrar for registration of a company provided they are neatly and
legible printed [Press Note, issued by the Department if Company Affairs, dated
22-6-1993].

14.6 ALTERATION OF ARTICLES

In this section, we attempt to make a brief study of the meaning of Alteration of

Articles. Companies have been given very wide powers to alter their Articles. The
right to alter the Articles is so important that a company cannot in any manner,
either by express provision in the Articles or by an independent contract, deprive
itself of the power to alter its Articles. Any clause in the Articles that restricts or
prohibits alteration of Articles is invalid. If, for example, the Articles of a
company contain any restriction that company shall not alter its Articles, it will
be contrary to the companies Act and, therefore, inoperative.

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Check your progress - 1

List out companies which must have their own Articles
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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14.7 PROCEDURE OF ALTERATION [SEC. 31]

A company may, by passing a special resolution, alter its Articles any time Again
any Articles may be adopted which could have been lawfully included originally.
A copy of every special resolution altering the Articles shall be filed with the
Registrar with the Registrar within 30 days of its passing and attached to every
copy of the Articles issued thereafter. Any alteration so make in the articles
shall be as valid as if originally contained in the Articles. In this section, we
attempt to make a brief study of the procedure of alteration of Articles .
14.7.1Madhav Ramchandra kamath v. Canara Banking Corpn. Ltd., A.I.R.[1941]
ad. 354. A company passed a resolution expelling a member and authorising
the directors to register the transfer of his shares without transfer deed. Held,
the resolution was in violation of provision relating to transfer under the Act.
14.7. 2. Must not conflict with the Memorandum. The alteration of the Articles
must not exceed the power given by the Memorandum, or conflict with the
provisions of the Memorandum shall prevail. Reference may, however, be made
to the Articles to explain any ambiguity in the Memorandum. The articles may
also be referred to in case the Memorandum is silent on a particular point.
14.7.3. Must not sanction anything illegal. The alteration must not purport to
sanction anything which is illegal. But if it is legal and it is not clearly
prohibited by the Memorandum, it may be held to be valid even where it alters
the whole structure of the company.
Andrews v. Gas Meter Co. Ltd., (1897) 1 Ch. 361. The Memorandum of a
company provided that the nominal capital of the company was £ 60,000 divided
into 600 shares of £ 100 each. The Memorandum and the Articles did not
contain any express provision as to issue of preference shares. The company, by
a special resolution, altered its Articles so as to give itself power to issue
preference shares, and then issued then. Held, the issue was valid.

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14.7.4 Must be for the benefit of the company. The alteration must be made
bona fide for the benefit of the company as a whole. On Allen v, Gold Reefs of
West Africa Ltd., (1900) 1 Ch. 656, it was observed that the power of alteration
must be “exercised subject to those general principles of law and equity which
are applicable to all powers conferred on majorities and enabling them to bind
minorities.”
The phrase ‘the company as a whole’ means the company as a general body. It
should not discriminate between the majority shareholders and the minority
shareholders so as to given the former an advantage of which the letter are
deprived. Not the following cases:
Shuttleworth v. Cox Bros. & Co. [Maidenhead] Ltd., [1927] 2 K.B. 9 [C.A.]. The
Articles of a company provided that S and 4 others should be permanent
directors of the company. They could however be disqualified by any of the 6
specific events. S failed to account for the company’s money on 22 occasions
within 12 months. The Articles were accordingly altered and a 7th event
disqualifying a director was added. The event added was that if a director was
so requested in writing by all the other directors he should resign. S was so
requested to resign. Held, the alteration was bona fide for the benefit of the
company as a whole, and was valid.
Greenhalgh v. Arderne Cinemas, ltd., [1951] Ch. 286 [C.A.]. The Articles of
company prohibited transfer of its shares to a non-member so long as the other
members were willing to buy them. The holders of the majority of the shares
wished to transfer some of the shares to a non-member. The Articles were
accordingly altered so as to permit a transfer to any person with the sanction of
an ordinary resolution. Held, the alteration was valid as it was made in good
faith and for the benefit of the company.
It is for the company to decide whether the alteration is for the benefit of the
company as a whole.
Brown v. British Abrasive Wheel Co. Ltd., [1919] 1 Ch. 290. A company was in
financial difficulties. The majority of the shareholders were willing to provide
more capital if the remaining 2 per cent shareholders would sell them their
shares. The majority then passed a special resolution altering the Articles so as
to enable 9/10ths of the shareholders to buy out any other shareholders. Held,
the alteration of the articles could be restrained as it was designed to allow the
majority to do compulsorily what they could not do by agreement and it was not
for the benefit of the company as a whole.
But if an alteration is bona fide and is made for the benefit of the company as a
whole it is immaterial that it inflicts hardship on a minority. The leading case
on the point is :
Sidebottom V. Kershaw Leese Co. Ltd., [1920] 1 Ch. 154 [C.A.]. In a private
company the directors held a majority of the shares. The company altered its
Articles so as to give power to the directors to require any shares, at their full
value, to the nominees of the directors. S held a minority of the shares and was
made bona fide for the benefit of the company as a whole.

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14.7. 5. Must not increase liability of members [Sec. 38]. The alteration must
not in any way increase the liability of the existing members to contribute to the
share capital of, or otherwise pay money to, the company unless they agree in
writing before or after the alteration is make. But where the company is a club
or association, the Articles may be altered to provide for subscription or charges
at a higher rate.

14.7. 6. Alteration by special resolution only. The alteration can be made only
by a special resolution. Even clerical errors in the Articles should be set right by
a special resolution [Evans v. Chapman, [1902] 18 L.T. 506

14.7. 7. Approval of Central Government when a public company is converted

into a private company. The alteration in the Articles which has the effect of
converting a publish company into a private company can be made only if it is
approved by the Central Government, a printed copy of the Articles as altered
shall be filed by the company with the Registrar within 1 month of the date of
receipt of order of the approval.

14.7. 8. Breach of contract. A company is not prevented from altering its Articles
even if such an alteration would result in breach of some contract. The affected
party may, however, files a suit for damages for the breach of contract.

Chidambaram Chettiar v. Krishna Iynger, I.L.R. 33 Mad. 36. The Articles of a

company contained a clause that the company’s secretary shall get a salary of
Rs.25,000 per month. S accepted the post on this salary Later on, the company
altered its Articles reducing the salary to Rs.20,000 per month. S could not
succeed in an action against the company as any one dealing with the company
must take the risk of the Articles being altered.

Southern Foundries (1926) Ltd. V. Shirlaw, (1940) A.C. 701. S, a director of

company B, was appointed to the manager director for 10 years by a contract
outside the Articles. The Articles, however, provided that he would cease to be
the managing director if he ceased to be a director. Company F acquired nearly
all the shares of Company B. The Articles of Company B were altered to given
power to Company F to remove any of the directors. S was upheld by the court,
but since it was an implied term of the contract that Company B would not
remove S from his position as director duration the term of 10 years, Company
B was held liable to S for breach of contract.

Where compensation would not be an adequate remedy, the Court may restrain
the company from altering its Articles

British Murac Rubber Syndicate Ltd. V. Alperton Rubber Co. Ltd., (1915) 2 Ch. 1
86. Company A entered into a contract with Company B whereby it was agreed
that so long as Company A held 5,000 shares of Company B, Company A should
have the right to nominate 2 of the directors in Company B. It was also agreed
that a clause in the Articles providing for this right of nomination should not be
altered by Company B. Company B disapproved of the nominees of Company A

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and a notice was given of a meeting at which it was proposed to pass a

resolution altering the Articles and depriving company A of the right to
nominate. The Court issued an injunction restraining Company B from altering
the Articles.
14.7. 9. Must not result in expulsion of a member. An assumption by the Board
of directors of a Company of any power to expel a member by amending its
Articles is illegal and void. Any provision in the Articles conferring such a power
on the Board of directories is repugnant to the various provisions in the
Companies Act pertaining to the rights of a member in public limited company.
14.7.10 No power of the Court to amend Articles. The Court has no power to
amend or rectify the Articles even where there is a mistake or drafting error
which the Court would rectify in the case of any other contract [Evans v.
Chapman, (1902) 18 L.T.R. 506]. The Court can only declare some clause to be
ultra vires [Scott v. Frank Scott (London), Ltd., (1940) Ch. 794].
14.7. 11. Alteration may be with retrospective effect. The Articles may be altered
with retrospective effect and the fact the some members suffer a detriment does
not make it void.
Allen v. Gold Reefs of West Africa Ltd., (1900) 1 Ch. 656. The Articles of a
company gave lien to the company on all shares “not fully paid up”, for calls due
to the company. Z was the only of fully paid shares. He also owed money to the
company for calls due on other shares. After his death, the company altered the
Articles so as to give it a lien over his fully paid shares. Held, as the lien was for
the benefit of the company as a whole, the alteration was valid, notwithstanding
that in effect it was retrospective and to Z’s disadvantage.

Check your progress - 2

What are the alternative forms in which a public company may adopt
Articles
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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14.8 DISTINCTION BETWEEN MEMORANDUM OF ASSOCIATION AND

ARTICLES OF ASSOCIATION

In this section, we attempt to make a brief study of the distinction between

Memorandum of Association and Articles of Association

Memorandum of Association Articles of Association

(1) It is a charger of a company (1) It contains rules and regulation

determining constitution and regarding internal management of
activities of the company. the company.
(2) It is a fundamental charter. (2) It is subsidiary to memorandum.
In case of conflict between the two
memorandums prevails.
(3) Every company must have a
(3) Public company limited by share
memorandum.
may or may not have articles.
(4) Alteration of Memorandum is
(4) Articles can be easily altered by a
much difficult and strictly
special resolution.
regulated.

14.9 DOCTRINE OF INDOOR MANAGEMENT

There is one limitation to the doctrine of constructive notice of the Memorandum

and the Articles of a company. The outsiders dealing with the company are
entitled to assume that as far as the internal proceedings of company are
concerned, everything has been regularly done. They are presumed to have read
these documents and to see that the proposed dealing is not inconsistent
therewith, but they are not bound to do more; they need not inquire into the
regularity of the internal proceedings as required by the Memorandum and the
Articles. They can presume that all is being done regularly. This limitation of the
doctrine of constructive notice is known as
(a) the “doctrine of indoor management”, or
(b the rule in Royal British Bank v. Turquand, or
(c) just Turquand Rule.
Thus, whereas the doctrine of constructive notice protects the company against
outsiders, the doctrine of indoor management seeks to protect outsider against
the company. If the directors have power and authority to bind the company but
certain preliminaries are required to be gone through on the part of The|
Company before that power can be duly exercised, then the person contracting
with the directors is not bound to see that all these preliminaries

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have been observed. He is entitled to presume that the directors are acting
lawfully in what they do.
The gist of the rule is that persons dealing with limited liability companies are
not bound to inquire into the regularity of the internal proceedings and will not
be affected by irregularities of which they had no notice.
First: The memorandum and Articles are public documents. They are open to
inspection by everybody. But the details of internal proceedings are not open to
public inspection. An outsider is presumed to know the constitution of a
company, but not what may or may not have taken place within the doors it are
closed to him.
Secondly, the lot of creditors of a limited liability company is not a particularly
happy one it would he unhappier still if the company could escape liability by
denying the authority of the officers to act on its behalf.
Exceptions to the doctrine of indoor management
1. Knowledge of irregularity. Where a person dealing with a company has
actual or constructive notice of the irregularity as regards internal management,
He cannot claim the benefit under the rule of indoor management. He may in
some cases be himself a part of the internal procedure. The rule is based on
Common sense and any other rule would “encourage ignorance and condone
dereliction of duty.”
2. Negligence. Where a person dealing with a company could discover the
irregularity if he had made proper inquiries, he cannot claim the benefit of the
rule of indoor management. The protection of the rule is also not available
where the circumstances surrounding the contract are so suspicious as to invite
inquiry, and the outsider dealing with the company does not make proper
inquiry. If, for example, an officer of a company purports to act outside the
scope of his apparent authority, suspicion should arise and the outsider should
make proper inquiry before entering into a contract with the company.
3. Forgery. The rule in Turquand’s case does not apply where a person relies
upon a document that turns out to be forged since nothing can validate forgery.
A company can never be held bound for forgeries committed by its officers.
4. Acts outside the scope of apparent authority. If an officer of a company
enters into a contract with a third party and if the act of the officer is beyond the
scope of his authority, the company is not bound. In such a case, the plaintiff
cannot claim the protection of the rule of indoor management simply because
under the Articles the power to do the act could have been delegated to him. The
plaintiff can sue the company only if the power to act has in fact been delegated
to the officer with whom he entered into the contract A. But if an officer of a
company acts fraudulently under his ostensible authority on behalf of the
company, the company is liable for his fraudulent act.

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14.10 LET US SUM UP

In this lesson, we have briefly touched upon the following points.

Articles of Association

The Articles contain rules and regulations for the internal management of the
company subject to provisions of the Companies Act. Table A of Schedule I to
the Act gives the proforma form of the Articles. A public company may or may
not have the Articles. However, a public company limited by guarantee or a
private company limited by shares shall file with the Registrar the Articles of
Association for registration along with the Memorandum of Association.

Contents of Articles

The Articles shall state the number of members with which the company is to be
registered. It shall state the share capital in case the company is to be registered
with a share capital. The private limited company shall specifically provide for
three restrictions under section 3 (1) (iii) of the Act. The Company may adopt all
or any of the regulations contained in Table A in Schedule I of the Act. The
Articles of Association of the Company not limited by shares shall be in such
forms as in Table C, D and E in Schedule I as may be applicable. Articles of
Association shall also contain particulars regarding the alternation of capital,
transfer, lien, transmission, forfeiture, etc., of shares, rights of shareholders,
meetings of the companies; appointment, remuneration, qualification, powers,
etc., of the Board of Directors, accounts and audit, dividends, indemnity, and
winding-up.

Alteration of Articles and limitations thereto:The Articles subject to the

Companies Act and the Memorandum may be altered by a special resolution.
The alteration of Articles shall not violate the provisions of the Memorandum.
Clauses in the Articles which are ultra vires the Memorandum shall be null and
void. The intimation of the alteration of the Articles shall be filed by the company
with the Registrar of Companies.

14.11 QUESTIONS FOR DISCUSSION

1. What must be the contents of Articles of a company?

2. Define Articles of Association? Is it necessary for a company to have its
own articles.
3. “Articles of Association is a mandatory document for incorporation of any
company”. Discuss.

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14.12 MODEL ANSWER TO CHECK YOUR PROGRESS

Chick-1 List out companies which must have their own Articles
The following companies shall have their own Articles, namely i) unlimited
companies, ii) companies limited by guarantee and iii) private companies limited
by shares
Check-2 What are the alternative forms in which a public company may
adopt Articles
There are three alternatives 1.It may adopt Table A in full.2.It may wholly
exclude Table A and set out its own Articles in full.3.It may frame its own
Articles A and adopt part of Table A.

14.13 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-15
PROSPECTUS OF A COMPANY

CONTENTS
15.0 Aims and Objectives
15.1 Introduction
15.1.1 Meaning
15.1.2 Definition
15.2 Contents of Prospectus
15.2.1 Matter Contained in Part I of Schedule II of the Companies Act
15.2.2 Reports contained in Part II of Schedule II of the Companies Act
15.2.3 Part III of Schedule II
15.2.4 Dating of prospectus
15.3 Registration of prospectus
15.3.1 Penalty for non-registration of prospectus
15.3.2 Objects of registration of prospectus
15.4 Deemed Prospectus
15.4.1 The provisions of Sec. 64 are summed up as under
15.5 Mis-Statements In The Prospectus
15.5.1 Civil Liability
15.5.2 Criminal Liability:
15.5.3 Defences against Civil Liability
15.5.4 Defences against Criminal Liability
15.6 Let us sum up
15.7 Questions for discussion
15.8 Model answer to check your progress
15.9 References

15. 0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning, definition of Contents of

Articles, Model form of Articles, Regulations required, Adoption and application
of Table A, Alteration of Articles In this lesson we discuss the meaning,

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Definition of prospectus, Contents of Prospectus of a company, Deemed

Prospectus and Misstatement in Prospectus.. After going through this lesson,
you will able to
1. know the meaning and definition of Prospectus
2. understand the contents of Prospectus
3. known “Deemed Prospectus”
4. study the different of liabilities regarding Misstatement in Prospectus

15.1 INTRODUCTION

Capital is very much needed for any activity of corporate enterprise. Mobilisation
of capital from the public is not an easy task. Unless the public is made aware of
the purpose for which capital is required, they will not come forward to invest
their hard earned savings in companies’ business. For disclosing to the public,
the sum of money that is required and the purpose for which it is to be used ,
the company has to issue a circular, notice, advertisement or document
revealing the nature of the business it proposes to conduct along with other
details regarding resource facilities and managerial abilities, etc. In terms of
Company Act, such document is termed as “Prospectus”. In this section, we
discuss meaning and definition.
15.1.1 Meaning
After formation, the Company needs the necessary amount of money to fiancé its
business activities. The necessary money for this purpose may either be raised
from the general public, or be obtained through private contracts. The money
from the general public is raised by inviting deposits from the public, or inviting
offer to purchase the shares or debentures of the company. Such deposits or
offers may be invited from the public by issuing a document knows as
“prospective”. A private company cannot invite public to subscribe towards its
share capital in view of the restriction. Hence private companies need not issue
a prospectus. It is only the privilege of a public company to invite general public
to participate in its investments. In simple words prospectus means “any
document inviting deposits from the public. Such invitation may be in the form
of a document or a notice, circular, advertisement etc. The only requirement is
that the invitation must be made to the public.
15.1.2 Definition
The term “prospectus” is defined in sectim 2 (36) of the companies Act, “A
prospectus means any document prescribed or issued as a prospectus and
includes any notice, circular, advertisement, or other document inviting deposits
from the public or inviting offers from the public for the subscription or
purchase of any shares in, or debentures of, a body corporate”.

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15.2 CONTENTS OF PROSPECTUS

We know that a prospectus is issued to the public to purchase the shares or

debentures of the company. Every person wants to invest his money in some
sound undertaking. The soundness of a company can be known from the
prospectus of a company. Thus, the prospectus must disclose the true nature of
company’s activities which enable the public to decide whether or not to incest
money in the company. In fact, the public invest money in the company on the
faith of the representation contained in the prospectus. Therefore, everything
should be stated with strict accuracy, and the complete and true position of the
company should be disclosed to the public. Every prospectus should disclose
the following matters (Section 56) :In this section, we explain in detail the
content of prospectus.
1. Matters contained in Part I of Schedule II of the Companies Act.
2. Reports contained in Part II of Schedule II of the Companies Act.

15.2.1 Matter Contained in Part I of Schedule II of the Companies Act

The following matters are contained in Part I of Schedule II of the Companies

Act, which are to be specified in the prospectus:

1. The main objects of the company and the names, addresses, description
and occupation of the signatories to the memorandum of association.
However, this is not necessary when the prospectus is published as a
newspaper advertisement (Section 66).

2. The number and classes of shares. And if the company issues redeemable
preference shares, their number and date of redemption.

3. The interest of shares fixed by the articles of association as the

qualification share of directors.

4. The names, description and addresses of directors, proposed directors,

managing directors or managers along with their terms of appointment,
remuneration or compensation payable for loss of office.

5. The names, description and addresses of directors, proposed directors,

managing directors or managers alongwith their terms of appointment,
remuneration or compensation payable for loss of office.

6. The amount of minimum subscription, where the shares are offered to the
public. The term ‘minimum subscription’ means the minimum amount
which, in the opinion of prometers, of required for certain purposes such
as (a) for the payment of preliminary expenses, (b) for the payment of
underwriting commission, (c) for the repayment of any money borrowed by
the company, and (d) for the working capital.

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7. The time of opening of the subscription list. This time cannot be earlier
than the beginning of the 5th day after the publication of prospectus.

8. The amount payable on application and allotment on each share.

9. The particulars of any option or preference right to be given to any person

to subscribe for the shares or debentures of the company.

10. The number of shares or debentures which have been issued for a
consideration other than cash within the preceding two years.

11. The particulars about the premium received or to be received on shares

within the preceding two years.

12. The names of the underwriters alongwith the opinion of the directors that
the resources of underwriters are sufficient to discharge their obligations.
It is required to be stated when any issue of shares or debentures is
underwritten.

13. The particulars of a vendor from whom any property has been purchased
or is to be purchased by the company. The amount of purchase
consideration should also be stated in the prospectus.

14. The amount or rate of underwriting commission paid within the two
preceding years. Any amount which is payable to the underwriters should
also be stated in the prospectus.

15. The amount or estimated amount of preliminary expenses alongwith the

names of persons by whom these expenses are payable.

16. The name and addresses of the auditors, if any.

17. The amount or estimated amount of preliminary expenses alongwith the

names of persons by whom these expenses are payable.

18. The particulars as to date, parties and nature of the material contracts.

19. The full particulars of interest of directors or promoters in the promotion of

the company alongwith their interest in the property acquired or proposed
to be acquired by the company within two years of the date of prospectus.

20. The voting right and the rights as to the capital and dividend attached to
different classes of shares. It is required to be stated where the shares are
of more than one class.

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21. The nature and extent of restrictions if any, imposed by the articles on the
members’ right to attend, speak, or vote at meetings of the company, and
also on their rights to transfer shares. Moreover, the restrictions upon
directors in respect of their powers of management should also be stated in
the prospectus.
22. The length of time during which the company has carried on the business.
And if the company proposes to acquire a business which has been carried
on for less than three years, then the length of time during which the
business has been carried on should be stated in the prospectus.
23. The particulars of capitalization of reserves or profits of the company.
Moreover, the particulars of the surplus which arise from any revaluation
of the assets of the company should also be stated in the prospectus.
24. The reasonable time and place at which copies of all accounts (i.e. Balance
Sheet, and Profit and Loss Accounts), on which the report of auditors is
based, may be inspected.

15.2.2 Reports contained in Part II of Schedule II of the Companies Act

The following reports are contained in Part II of Schedule II of the Companies Act
1956, which are to be set out in the prospectus:
1. Auditor’s report. In case of a company carrying on the business for the last
several years, an auditor’s report disclosing the following particulars must be set
out in the prospectus :
(a) The profits and losses of the company for the last five financial years before
the issue of the prospectus.
(b) The assets and liabilities of the company at the last date upto which
company’s accounts were made up.
(c) The rates of dividends paid by the company in respect of each class of
shares for the last five financial years before the issue of the prospectus.
In case the company also has subsidiary companies, then the auditor’s report
shall also disclose the particulars of profits and losses, and of assets and
liabilities of the subsidiary companies.
(2) Accountant’s report. In case of a company which purchases some business
or acquires some shares in another company which becomes a subsidiary of the
company acquiring shares, an accountant’s report disclosing the following
particulars must be set out in the prospectus:
(a) The profits and losses of that business or of subsidiary company for the
last five financial years before the date of issue of the prospectus.
(b) The assets and liabilities of that business or of subsidiary company at the
last date upto which the accounts were made up. In case of assets and
liabilities of the business purchased, such a date must be within 120 days
before the issue of the prospectus.

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The name of the account who prepared the report should also be disclosed in the
prospectus.
In addition to the matters discussed in the provisions of Section 68A (1) of the
Companies Act must also be reproduced in the prospectus. This section reads
as under:
Any person who
(a) makes in a fictitious name an application to a company for acquiring, or
subscribing for any shares therein, or
(b) otherwise induces a company to allot, or register any transfer of shares
therein to him or any other person in a fictitious name, shall be punishable
with imprisonment for a term which may extend to five years”.
15.2.3 Part III of Schedule II
1. If a prospectus is issued more than 2 years after the date at which the
company is entitled to commence business, it need not give particulars of
the signatories of the Memorandum and the shares subscribed for by them
and the details of the preliminary expenses.
2. If the company has been carrying on business for less than five financial
years, reference to that number of financial years for which business has
been carried on.
3. Any report required by Part II shall make adjustments or indicate
adjustments as respects figures of any profit or loss or assets and liabilities
which appear to be necessary.
4. Any report by accountants required by Part II shall be made by qualified
auditors.
15.2.4 Dating of prospectus
A prospectus issued by or in relation to an intended company must be dated
and that date is, unless the contrary is proved, taken as the date of publication
of the prospectus.
Check your progress – 1
List out characteristics of Prospectus
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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15.3 REGISTRATION OF PROSPECTUS (SEC. 60)

In this section, we attempt to make a brief study of meaning of registration of

prospectus. A prospectus can be issued by or on behalf of a company only when
a copy thereof has been delivered to the Registrar for registration. The
registration must be made on or before the date of publication thereof. The copy
must be signed by every person who is named therein as director or proposed
director of the company, or by his agent authorized in writing. Further such a
prospectus must state on the face of it that a copy of it has been delivered to the
Registrar for registration on or before the date of its publication. The copy for
registration must be accompanied with the following documents :
1. Consent of the expert to the issue, if a report by the expert is to be
published.
2. A copy of every contract, appointing or fixing remuneration of a managing
director of manager.
3. A copy of every material contract, not being a contract entered into in the
ordinary course of the business or a contract entered into more than 2
years before the date of the prospectus.
4. A written statement by the persons making any report relating to the
adjustments, if any, as respects the figures of any profits or losses or
assets and liabilities dealt with by the report set out in the prospectus in
pursuance to Part II of Schedule II, giving the reasons therefore.
5. The consent in writing of the person, if any, named in the prospectus is
issued without a copy thereof being delivered to the Registrar for
registration, or without the necessary documents or the consent of the
experts, the company and every person, who is knowingly a party to the
issue of the prospectus, shall be punishable with fine which may extend to
Rs.50,000.
The prospectus must be issued within 90 days of the date on which a copy
thereof is delivered for registration. If a prospectus is not issued within this
period, it is deemed to be a prospectus, a copy of which has not been delivered
to the Registrar.

15.3.1 Penalty for non-registration of prospectus

If a prospectus is issued without a copy thereof being delivered to the Registrar
for registration, or without the necessary documents or the consent of the
experts, the company and every person, who is knowingly a party to the issue of
the prospectus, shall be punishable with fine which may extend to Rs.50,000.

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15.3.2 Objects of registration of prospectus

The objects of registration of a prospectus are
(1) to keep an authenticated record of the terms and conditions of issue of
shares or debentures, and
(2) to pinpoint the responsibility of the persons issuing the prospectus for
statements made by them in the prospectus.
Prospectus is not required to be issued. The issue of a prospectus is not
necessary in the following cases:
1. Where an offer is made in connection with a bona fide invitation to a
person to enter into an underwriting agreement with respect to the shares
or debentures.
2. Where the shares or debentures are not offered to the public. This will be
the case when promoters are confident of raising capital through private
shares and contacts.
3. Where the shares or debentures are offered to the existing members or
debenture-holders (i.e., right issue) of the company.
4. Where the shares or debentures offered are uniform in all respects with
shares or debentures previously issued and quoted on a recognized stock
exchange.
Where any prospectus is published as a newspaper advertisement, it is not
necessary to specify the contents of the Memorandum or the signatories thereto,
or the number of shares subscribed for by them.
Form of application to be accompanied by a memorandum containing salient
features of prospectus [Sec. 56 (3)]. No one shall issue any form of application
for shares in or debentures of a company, unless the form is accompanied by a
memorandum containing such salient features of a prospectus as may be
prescribed. The italicized words have been substituted by the Amendment Act of
the word ‘prospectus’. This has been done with a view
(i) to reducing the cost of public issue of capital, and
(ii) to giving brief and meaningful information to the prospective investors.
A copy of the prospectus shall however be furnished on a request being made by
any person before the closing of the subscription list.

15.4 DEEMED PROSPECTUS (SEC. 64)

In this section, we attempt to make a brief study of meaning of deemed

prospectus. The provisions relating to a prospectus (as regards registration,
contents and full disclosure) are very stringent and the duty of preparing and

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filing a prospectus in accordance with the law is extremely onerous. These

requirements used to be evaded by companies in the part by allotting the whole
of an issue of shares or debentures to an Issuing House at a certain price. The
Issuing House then published an advertisement in the nature of an offer for sale
inviting public to buy the shares or debentures from it at a higher price. Sec. 64
now specifically provides that a document by which an ‘offer for sale’ is made to
the public is within the definition of prospectus.
When application are received by the Issuing House, it renounces its interest in
the shares or debentures to the extent of the number of the number of shares or
debentures allotted in favour of the application. When this is done, the
applicant becomes an allottee of the company.

15.4.1 The provisions of Sec. 64 are summed up as under :

1. Prospectus by implication. All document containing offer if shares
debentures for sales are included within the definition of the term
‘prospectus’, and are deemed to be a prospectus by implication of law.
Where a company allots or agrees to allot any shares in, or debentures of,
the company to an Issuing House with a view to all or any of those shares
or debentures being offered for sale to the public, any document by which
the offer for sale to the public is make by the Issuing House is, for all
purposes, deemed to be a prospectus issued by the company and all
enactments and rules of law in regard to a prospectus are applicable
thereto.
2. Intention to offer shares or debentures to the public. Unless the contrary
is proved, an allotment of, or agreement to allot, shares or debentures to
an Issusing House is deemed to have been made with a view to the shares
or debentures being offered for sale to the public if it is shown--
[a] that the offer of shares or debentures for sale was made within 6 months
after the allotment or agreement to allot ; or
[b] that at the date when the offer was make, the whole consideration to be
received by the company in respect of shares or debentures had not been
received by it.
3. Additional information. The following additional information is required to
be given in the document deemed to be prospectus :
[a] Consideration and time and place of inspection of contract.
[i] The net amount of the consideration received or to be received by the
company in respect of the shares or debentures to which the offer relates ;
and
[ii] The place and time at which the contract under which the said shares or
debentures have been or are to be allotted may be inspected.
[b] Issuing House to be deemed director. The persons making the offer of sale
to the public are to be deemed directors of the company for the purpose of
registration of the prospectus.

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[c] Signing of prospectus. Where the Issuing House, i.e., the person making
the offer, is a company or a firm, it is sufficient if the prospectus is signed
on behalf of the company by 2 directors of the company or by not less
than one-half of the partners in the firm, as the case may be. Any such
director or partner may sign by his agent authorized in writing.

Check your progress – 2

Write short notes on ‘Deemed Director’
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp )
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15.5 MIS-STATEMENTS IN THE PROSPECTUS

In this section, we discuss the meaning and the person liable for mis-statements
in the prospectus and also different types of liabilities. Every person authorizing
the issue of prospectus has a primary responsibility to see that the prospectus
contains the true state of affairs of the company and does not give any
fraudulent picture to the public. People invest in the company on the basis of
the information published in the prospectus. They have to be safeguarded
against all wrongs or false statements in the prospectus. Prospectus must
therefore make full and honest declaration of material facts without concealing
or omitting any relevant fact. This is known as the Golden Rule for framing
prospectus as laid down in New Brunswick etc. Co. v. Muggeridge (1860 3 LT
651). The true nature of company’s venture should be disclosed. The
statements which do not qualify to the particulars mentioned in the prospectus,
or any information is intentionally and willfully concealed by the Directors of the
company, would be construed as mis-statement. They are in other words either
false or untrue statements in the prospectus, or information which ought to
have been disclosed is concealed, or omission of any material fact. Statements
which produce wrong impression of actual facts would also be construed as mis-
statements.
Mis-statements include : (i) untrue statements; (ii) statements which produce
wrong impression; (iii) statements which are misleading (iv) concealment facts;
and (v) omission of facts.

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The prospectus must make all statements with absolute accuracy and not state
the facts which are not strictly correct. A statement may be false not only
because of what it states but also because of what it conceals or omits.
A statement included in a prospectus shall be deemed to be untrue, if
(i) the statement is misleading in the form and context in which it is included;
and
(ii) the omission from a prospectus of any matter is calculated to mislead (Sec.
65).
Who are liable for mis-statements in the prospectus ?
(i) Every person who is a director of the company at the time of the issue of
the prospectus;
(ii) Every person who has authorized himself to be named and is named in the
prospectus either as a director or as having agreed to become a director,
wither immediately or after an interval of time;
(iii) Every person who is a promoter of the company; and
(iv) Every other person who has authorized the issue of the prospectus.
Liability : The liability may be civil or criminal.

15.5.1 Civil Liability:

1. Compensation : The above persons shall be liable to pay compensation to
every person who subscribes for any shares or debentures for any loss or
damage sustained by him by reason of any untrue statement included therein
[Sec. 62 (1)].
In Me Connell v. Wright (1903 ICH 546) it has been held that the measure of the
damages is the loss suffered by reason of the un-true statements, omissions,
etc., the difference between the value which the shares would have had and the
true value of the shares at the time of the allotment.
2. Damages for deceit or fraud : Any person induced to invest in the company
by fraudulent statement in a prospectus can sue the company and person
responsible for damages. The shares should be first surrendered to the
company before the company is sued for damages.
Fraud occurs when any statement is made without belief in the truth or
carelessly. A statement made with knowledge that it is false, will constitute
fraud or deceit. In the leading case on the point—Derry v. Peek (1889-14 AC
337), it has been held that if the person making the statement honestly believes
it to be true, he is not guilty of fraud, even if the statement is not true. The fact
of this case were :
The Tramway Company has power by special act to make tramways and to use
steam power with the consent of the Board of Trade. The plans of the company
were approved. The directors of the company honestly believed that since the

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plans were approved, permission to use steam power from Board of Trade was
only a formality and would be granted. Prospectus was issued wherein the
directors stated that the consent to use steam power was obtained by the
Company. Subsequently the consent was refused and the Company has to be
would up. On the action by plaintiffs for deceit it was held that the directors
were not liable for fraud as they honestly believed that the consent would be
obtained, though the statement was untrue.
3. Recission of the contract for misrepresentation: Recission means avoiding
the contract. Any person can apply to the Court for recission of the contract if
the statements on which he has taken the shares are false or caused by mis-
representation whether innocent or fraudulent.
The misrepresentation must be false. It must be of material fact and not of law.
The applicant of shares must have acted on the statements contained in the
prospectus or must have been induced to act on the statements. It should be
noted that a person cannot claim recission of contract on mis-representation, if
he had the means of discovering the truth with ordinary diligence.
4. Liability for non compliance with Sec. 56 : A director or other person
responsible shall be liable in damages for non-compliance with or contravention
of any of the matters to be stated and reports to be set out in prospectus as
provided by Section 56 [Sec. 56 (4)].
5. Liability under General Law : Any person responsible for the issue of
prospectus may be held liable under the general law or under the Act for mis-
statements or fraud.
6. Penalty for contravening Secs. 57 or 58 : If any prospectus is issued in
contravention of section 57 (expert to be unconnected with formation or
management of company) or section 58 (expert’s consent to issue of prospectus
containing statement by him), the company and every person who is knowingly a
party to the issue thereof, shall be punishable with fine which may extend to
Rs.5,000/- [Sec. 59 (1)].
7. Penalty for issuing the prospectus without delivering for registration : If
a prospectus is issued without a copy thereof being delivered to the Registrar,
the company and every person who is knowingly a party to the issue of the
prospectus shall be punishable with fine which may extend to Rs.5,000/-

15.5.2 Criminal Liability:

Every person who authorizes the issue of prospectus shall be punishable for
untrue statements with imprisonment for a term which may extend to 2 years or
with fine which may extend to Rs.5,000/- or with both. [Sec. 63(1)].
Fraudulently inducing persons to invest money : (Sec. 68) Any person who either
knowingly or recklessly makes any statement, promises or forecasts which is
false, deceptive or misleading or by any dishonest concealment of material facts,
induces or attempts to induce another person to enter into;

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(i) any agreement with a view to acquiring, disposing of, subscribing for, or
underwriting shares or debentures; or
(ii) any agreement, the purpose of which is to secure a profit to any of the
parties from the yield of shares or debentures, or by reference to
fluctuations in the value of shares or debentures; shall be punishable with
imprisonment for a term which may extend to 5 years or with fine which
may extend to Rs.10,000/- or with both.

15.5.3 Defences against Civil Liability

Every person made liable to pay compensation of any loss or damages may
escape such liability by proving that:
(1) Withdrawal of consent before issue : Having consented to become a
director of the company, he withdrew his consent before the issue of the
prospectus and that it was issued without his authority or consent;
(2) Issued without knowledge : The prospectus was issued without his
knowledge or consent and that on becoming aware of its issue, he
forthwith gave reasonable public notice that it was issued without his
knowledge or consent; or
(3) Withdrawal of consent after issue : After the issue of prospectus, and
before allotment thereunder, he, on becoming aware of any untrue
statement therein withdrew his consent to the prospectus and gave
reasonable public notice of the withdrawal and the reasons therefor; or
(4) Reasonable belief : As regards every untrue statement not purporting to be
made on the authority of an expert or of a public official document or a
statement, he has reasonable ground to believe, and did upto the time of
the allotment of the shares or debentures, as the case may be, believe that
the statement was true; and
(5) Statement by an expert : As regards every untrue statement purporting to
be a statement by an expert or contained in what purports to be a copy or
an extract from a report or valuation of an expert, the person charged can
escape liability on proving that
(a) it was correct and fair representation of the statement; or
(b) a correct copy of, or a correct and fair extract from the report or valuation;
and
(c) he had reasonable ground to believe, and did up to the time of the issue of
the prospectus believe, that the person making the statement was
competent to make it; and
(d) that the person (expert) had given the consent to the issue of prospectus
and had not withdrawn that consent before delivery of a copy of the
prospectus for registration or before allotment.
(6) Statement by an official person or extract from public official document :

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As regards every untrue statement made by an official person or contained in

what purports to be a copy of or extract from a public official document, it was a
correct and fair representation of the statement, or a correct copy of, or a correct
and fair extract from the document.

15.5.4 Defences against Criminal Liability

Any person made criminally liable can escape the same on proving that :
(i) having given his consent, he withdrew it in writing before delivery of a copy
of the prospectus for registration;
(ii) after delivery of a copy of the prospectus for registration and before
allotment there under, he on becoming aware of the untrue statement,
withdrew his consent in writing and gave reasonable public notice of the
withdrawal and of the reason therefore; or
(iii) he was competent to make the statement and that he had reasonable
ground to believe, and did up to the time of the allotment of the shares or
debentures believe that the statement was true.

15.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points. Any invitation
to the public subscribes for shares or a debenture of the company is a
prospectus. A public company inviting public to subscribe towards its share
capital shall do so through a prospectus. This is done in order that the
prospective investor shall know the financial background of He Company.
Provisions or prospectus do not apply to a private company since it’s a governed
by three restrictions under section 3(1) of the Act. Any document containing
offer of shares or debentures for sale shall be deemed to be prospectus.
Contents of the prospectus:
Prospectus must state the matters specified in part I of Schedule II ad Reports
specified in Part II of Schedule II subject to he provisions contained in Part III of
Schedule II. The prospectus shall dated and that date shall be taken as the date
of the publication. Copy of the prospectus shall be registered with the Registrar
of Companies. The prospectus shall be attached with consent to the issue of the
prospectus from any person as an expert. It shall also have the required
documents when its is delivered for registration. It shall be issued within 90
days of the delivery of the copy for registration.
Mis-statements in the prospectus:
The prospectus shall make full and honest declaration of material facts without
concealing or omitting any relevant facts. This is known as the ‘Golden Rule’ for
framing the prospectus. Mis-statements may be either untrue statements or
statements which produce wrong impression or statements which are misleading
or those which conceal material facts or omit facts.

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Every person who is a director of the company, or who has authorized himself to
be named in the prospectus or who is a promoter of the company, or every other
person who has authorized the issue of the prospectus shall be liable for mis-
statements in the prospectus. The liability may be civil or criminal. Any person
induced to invest by fraudulent statement may sue the company and person
responsible for damages or he may apply to the Court for recession of the
contract if the statements are false or fraudulent.
Any person made liable to pay compensation may present the following defences:
(1) that he withdrew his consent before the issue of the prospectus. (2) that the
prospectus was issued without his knowledge; (3) that he withdrew his consent
after the issue of prospectus and before allotment, (4) that he had reasonable
ground to believe that the statement was true. (5) where the statement was
purported to be a statement by an expert, he can escape liability by proving that
there was a correct and fair representation of the statement or it was a correct
and fair extract from the document. The expert also has defences if he is made
liable.
A prospectus which containing misleading statements is called ‘Misleading
Prospectus’.
Statement in lieu of prospectus:
A company having a share capital and not issuing a prospectus or a company
which has issued a prospectus but has not proceeded to allot any of its shares
shall not allot its shares unless at least three days before the allotment of shares
or debentures it has filed with the Registrar of Companies, a statement in lieu of
prospectus. The statement in lieu of prospectus shall contain particulars as set
out in Part I of Schedule III and Reports as specified in Part II of Schedule III
subject to the provisions contained in Part III of that Schedule. The private
company on becoming a public company shall also file a statement in lieu of
prospectus containing particulars as specified in Part I of Schedule IV with the
Reports as specified in Part II of Schedule IV subject to the provisions in Part III
of that Schedule.

15.7 QUESTIONS FOR DISCUSSION

1. What is ‘Prospectus’? Explain the liability for mi-statements contained the

prospectus.
2. Who are liable for mis-statements in the prospectus? Explain the extent
civil and criminal liability for such mis-statements?
3. What are the remedies open to an allottee of shares who had applied them
on the face of a false and misleading prospectus?
4. What are the defences available to the Directors of the Company who have
issued false and misleading prospectus?
5. Define minimum subscription. What are the consequences if a company is
not able to raise minimum subscription?

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15.8 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 List out characteristics of Prospectus

1. A prospectus must be an invitation to offer.

2. A prospectus is a document meant for public.

3. Prospectus by implication

Check- 2 Write short notes on ‘Deemed Director’

The issuing houses offering the shares to the public are regarded as directors for
the purpose of registration of the prospectus.

15.9 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-16
SHARES

CONTENTS
16.0 Aims and Objectives
16.1 Introduction
16.1.1 Meaning
16.1.2 Definition
16.1.3 Nature of shares
16.2 Stock and share certificate
16.2.1 Stock
16.2.2 Share certificate
16.2.3 Distinction between share and stock
16.3 Types of shares
16.3.1 Equity or ordinary shares
16.3.2 Characteristics of the Equity Shares
16.3.3 Sweat Equity Shares
16.3.4 Preference shares
16.3.5 Kinds of preference shares
16.4 Let us sum up
16.5 Questions for discussion
16.6 Model answer to check your progress
16.7 References

16.0 AIMS AND OBJECTIVES

In the 15th lesson, we discussed the meaning, definition of prospectus, contents

of Prospectus of a company, Deemed Prospectus and Misstatement in
Prospectus. In this lesson we discuss the meaning, definition and types of
shares. After going through this lesson, you will able to
1. know the meaning and definition of share
2. understand various types of shares

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16.1 INTRODUCTION

The money required by the company for its business activities is raised by it
from the public. The money so raised is called to capital of the company which is
usually divided into different units of a fixed amount. These units are called the
“share”. In this section, we discuss the meaning, definition and nature of share
16.1.1 Meaning
A share in a company represents the unit into which the total capital of the
company is divided. In simple term, a share is nothing but a fraction of the
whole which goes to make up the capital as a whole. That portion or the part or
fraction of money contributed by a person to make up the capital is known as
the share. In simple word “Share” means share in the share capital of a
company.
16.1.2 Definition
The term “Share” is defined in section. 2 (46) of the companies act,
“Share means a share in the share capital of a company, and includes stock
except where a distinction between stock and share is expressed or implied”. The
persons who hold the share of a company are called the members of share
holders of the company. The definition of “share” given in section 2 (46) is
simple but not exhaustive.
A share is not a sum of money, but an interest measured by sum of money and
made up of various rights and liabilities of the share holders. In other words, a
share indicates the pecuniary interest of the share holders and their rights and
liabilities. In this sense, it may be defined as an “existing bundle of rights ad
liabilities”.
16.1.3 Nature of shares:
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.
The movable property of a person is of two kinds, namely (a) choose-in-
possession and (b) choose-in-action. Choose-in-possession means the property
which is in the physical possession of a person e.g., goods of any kind. The
shares also included in the legal definition of goods.
Choose-in-action means the property which is not in the immediate physical
possession of a person. But the person has right to the property which can be
enforced by legal action. This right is generally evidenced by a document e.g. a
bill of leading, railway receipt etc. A share certificate is the evidence of share
holder’s rights which can be enforced by legal action. Share certificate is not a
negotiable instrument.

Stock and shares of a company are goods. These can be bought, sold,
hypothecated and bequeathed.

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16.2 STOCK AND SHARE CERTIFICATE

In this section, we attempt to make a brief study of stock, share certificate and
Distinction between share and stock
16.2.1 Stock
Stock is the aggregate of fully paid-up shares, consolidated and divided, for the
purpose of convenient holding into different parts. It may be transferred split up
into fraction of any amount, without regard to the original face value of the
share.
16.2.2 Share certificate:
A “share certificate” is a document which specifies the shares held by any
member. It is issued by the company under its common seal. Every person
whose name is entered as a member in the register of members, is entitled to
receive share certificate from the company. The share certificate may be in any
form. But a valid share certificate must satisfy the following requirements.
1. It must have the common seal of the company affixed on it.
2. It must specify the number of share. The nominal value of shares and the
amount actually paid should also be stated in it.
3. It must also state the name, address and occupation of the shareholder.
4. It must be signed by one or more directors of the company.

16.2.3 Distinction between share and stock

Share Stock

1. Shares cannot be issued or Stock can be divided into unequal

transferred in fragments amount and therefore can be
issued and transferred in
fragments.

2. Shares need no e fully paid up. Stock is always fully paid up

3. Shows bear distinctive Fractions of stock do not bear

numbers. distinctive numbers.

4. Shave an issued directly Stock cannot be issued directly.

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Check your progress -1

What do you mean by Right share?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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16.3 TYPES OF SHARES

In this section, we attempt to make a brief study of different types of share

Share can be classified into following three types

1. Ordinary shares
2. Preference shares
3. Deferred shares

According to section 85 of the companies Act 1956,companies can issue the

following two types of shares
1. Equity shares
2. Preference shares

Note: These shares were mostly taken by the founders of the company. These
shares often used to get the remaining profits of the company after preference
share holders and ordinary share holders were paid out. Deferred shares which
were previously in existence are no longer in use now

16.3.1 Equity or ordinary shares:

The equity shares are these which are not preference shares. Equity shares do
not enjoy any preferential rights thus for the purpose of dividend and repayment
of capital, the equity shares rank after the preference shares generally, their rate
of dividend is not fixed equity share holders are entitled to share the whole
surplus profit next to preferences share holders. It the rate of dividend varies
from year to year depending upon the profits of the company. The rate of
dividend is determined by the directors of the company.

The equity shareholder are entitled to get dividend only when the company
makes profit and furthermore, on the recommendation of the Board of Directors.

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Sometimes, in spite of huge profits made by the company, the Directors may not
recommend for payment of dividend. That is the reason for calling the Equity
capital as ‘Risk capital’. In other words, the fortune of the equity shareholders is
tied up with ups and downs o the performance of the company. If the company
fails to make profit, the risk falls mainly on the shareholders with no return for
their investment in shares. If the company is successful in its business, the
equity shareholder equally get benefited by its profit.

According to Section 87 (1) (a), the equity shareholders have normal voting rights
on every resolution that is passed in the Annual General Body meetings. Equity
shares are always irredeemable and the liability of the members is limited to the
face value of the shares. Equity shares with reference to company limited by
shares are those which are not preference shares [Section 85 (2)].

16.3.2 Characteristics of the Equity Shares

The characteristics of the equity shares are as follows:

(a) Equity shares carry voting rights at the annual general body meetings of
the company and they have the right to control the management of the
company.

(b) Equity shares always enjoy the right to participate in the profits of the
company in the form of distribution of dividend.

(c) In the case of winding up of the company, the equity shareholders will be
entitled for the return of their capital only after the claims of all creditor
and preference shareholders are satisfied.

(d) Besides the above, the equity shareholders enjoy the following rights

(i) Right of Pre-emption in the matter of fresh issue of capital (Section 81)

(ii) Right to apply to the Court to have variation of their right set aside
[Section 10 (7)].

(iii) Right to receive copy of the statutory report [Section 165].

(iv) Right to apply to Central Government to call for annual general body
meeting when the company has defaulted (Section 167).

(v) Right to apply to the Company Law Board for calling an Extraordinary
general body meeting of the company (Section 186).

(vi) Right to recover copy of the Annual Accounts along with Auditor’s Report
[Section 210 & 21a].

16.3.3 Sweat Equity Shares [Section 79 (A)]

Sweat equity shares means (a) equity shares issued at discount or (b) for
consideration other than cash; (c) These shares are given in lieu of cash for

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providing know-how to the company; (d) The shares may be allotted to a party in
consideration for making available rights in the nature of Intellectual property
rights to the company; (e) the shares may be given to the party who has added
value to the company.

Conditions for issue of Sweat Equity Shares

(a) Companies can issue swear equity shares which should belong to or form
part of the shares already issued. Further, the following conditions must
also be fulfilled.

(b) The issue of sweat equity shares should be authorized by a special

resolution.

(c) The resolution that is passed must specify the following details with regard
to issue of sweat equity shares.

(i) the number of shares that are to be issued.

(ii) the current market price at which these shares have to be sold.

(iii) the class or classes of directors or employees to whom such shares have to
be issued.

(iv) One year should have passed since the date on which the company was
entitled to commence business for issuing this kind of sweat equity shares.

(v) The sweat equity shares issued by the company where equity shares are
already listed on recognized Stock Exchange must be issued according to
the guidelines prescribed by Security Exchange Board of India.

(vi) All restrictions and provisions relating to equity shares shall be applicable
to sweat equity shares also.

16.3.4 Preference shares:

The preference shares are these which have some preferential rights over the
other types of shares i.e., which some priority over the equity shares preference
shares got a preference of privilege over payment of divided and repayment of
capital.

Preference shares have the following characteristics

1. Preference shares have a preferential right to be paid dividend during the

lifetime of the company.

2. Preference shares have a preferential right to the return of capital when the
company goes into liquidation.

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16.3.5 Kinds of preference shares:

Preference shares may be of the following kinds.

1. Cumulative preference shares
2. Non-cumulative preference shares
3. Participating preference shares
4. Non-participating preference shares
5. Convertible preference shares
6. Non-convertible preference shares
7. Redeemable preference shares
8. Irredeemable preference shares

1. Cumulative preference shares:

The cumulative preference shares are those which are assured of the dividend
every year even it there are no profits in a particular year. It in a particular year
there are no profit to pay the dividends, the unpaid dividend of such preference
share is treated as arrear and is carried forward to the subsequent years. Thus,
the unpaid dividend goes on accumulating and is paid when there are sufficient
profits in the subsequent years.

It the company goes into liquidation, no arrears of dividends are payable unless
either the articles contain an express provision to this effect.

2. Non-cumulative preference shares:

These are the shares on which the dividend does not go on accumulating. It have
is no profit the company cannot pay dividend to its share holders. If company
fails to pay dividend in one year on non-cumulative preference shares, it cannot
carry forward such arrears of dividend for the next year. It no dividend is paid in
any particular years, it lapses. The non cumulative preference share will be
treated as in equity shares in case dividend has not been paid for a total period
of three years out of six years ending the expiry of the financial year. In the
absence of any specific provision to the contrary, preference shares are
presumed to be cumulative. Whether preference shares are cumulative or non
cumulative depends upon the terms of issued and provisions contained in the
article.

3.Participating preference shares

These shares are not only entitled for payment of a fixed rate of dividend, but
they are also entitled to a share in the surplus profit remaining as residue after
distribution of dividend to the equity shareholders. They are entitled to share
profit upto a limit of 15%. The surplus profits are distributed in accordance with
the agreed ratio between the holders of the participating preference shares and
the equity shares. If the Articles and Memorandum and silent with regard to
participating preference shares, all the preference shares are treated as non
participating preference shares.

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4.Non participating preference shares

These kinds of share are entitled only to a fixed rate of dividend. The
shareholders do not have a right in the surplus of profits which go only to the
equity shareholders. All preference shares are non participating shares, if the
Articles are silent.

5.Convertible preference shares

The holders of the shares are given the option to convert the shares held them
into equity shares within a certain period.

6.Non convertible preference shares

These kinds of shares do not confer on the holder a right of conversion of these
shares into equity shares. If the Articles are silent, all preference shares are
deemed to be non-convertible preference shares.

7.Redeemable preference shares

One of the best methods adopted for economy in the long range capital planning
is the issue o redeemable preference shares. Section 80 of the Companies Act
authorizes a company limited by shares, to issue redeemable preference shares’.
Redeem means to ‘pay back’. In this kind of shares, the capital the capital
contributed by the shareholders could be returned to them after a certain period
in accordance with the terms of issue. The paying back of capital is called
redemption. After the Companies Amendment Act of 1988 i.e., from 15.6.1988,
only such preference shares as are redeemable within 10 years from the date of
issue can be allotted. But for the purpose of issue of these kinds of shares, the
company has to observe the following conditions-

(a) Articles must authorize to issue these kinds of shares.

(b) Only fully paid up shares can be redeemed. The shares may have to be
redeemed from out of profit.

(c) If profit haws been used for redeeming these kinds of shares, an equal
amount has to be credited into an account known as Capital Redemption
Reserve Account.

(d) If adequate profits are not available for redemption of these shares, fresh
issue of shares can be made. But this has to be made under the authority
given to the company by its Articles.

(e) The proceeds out of the fresh issue must be realized within a period of one
month failing which the company may have to pay stamp duty on excess
portion of the capital.

(f) If any premium is payable on redemption of the redeemable preference

shares, such premium must be paid from out of the share premium
account.

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(g) Redemption of preference shares should not be taken as reduction of

capital.

(h) The new issue of shares for the purpose of redemption shall not amount to
increase in share capital for stamp duty purposes, provided the shares are
redeemed within one month after making fresh issue.

Penalty: Every officer found guilty of contravention or violation of the provisions

of the Companies Act shall be punishable with fine which may extend to
Rs.1,000/-.

Notice to Registrar: The redemption of redeemable preference shares must be

notified to the Registrar within 30 days from the date of redemption.

8.Irredeemable Preference Shares

Irredeemable Preference Shares are shares allotted to the shareholder with no

option given to them to get back the value they have paid on their shares. In
other words, the company which allotted the shares will not repay the
subscription to the shareholders who had paid on those shares.

The repayment by company on such shares is possible only on winding up of the

company. After the commencement of the Companies (Amendment) Act 1988
(W.e.f. 15.6.88), issue of any future Irredeemable preference shares is prohibited
(New Subsidies 80 (5A).

9.Redemption of Irredeemable Preference Shares (Section 80A)

The gist of the 1988 Amendment Act is as follows:

(i) All existing irredeemable Preference shares must be redeemed by the

company within a period of five years from commencement of the
Amendment Act 1988 i.e., from 15.6.88.

(ii) All existing redeemable preference shares which are not redeemable before
the expiry of ten years from the date of issue must be redeemed as per the
terms of the issue or within a period of ten years from the commencement
of the Amendment Act 1988, whichever is earlier.

(iii) A company may have to issue further redeemable preference shares of an

equal amount to irredeemable preference shares with the approval of the
Company Law Board. This would arise only if the company is unable to
redeem the said irredeemable shares as per the Section.

Penalty: If default is made in complying with the provisions of Section 80A,

(a) the company making such default shall be punishable with fine which may
extend up to Rs.10,000 for every day during which such default continues:
(b) every officer of the company who is in default shall be punishable with
imprisonment for a term which may extend upto 3 years and shall also be
liable for fine.

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Check your progress -2

What do you mean by share certificate?

Note:

a) Write your answer in the space given below

b) Check your answer with the ones given at end of this lesson (pp)

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13.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points; Share means a
share in the share capital of the company. It includes stock. The holder of a
share is entitled to a share certificate. It is a movable property and transferable.
Each share is distinguished by its appropriate number. Shares can be converted
into stock when they are fully paid up.
Classification of shares:
Shares under the Act are classified into (1) Preference shares; (2) Equity shares.
Preference share capital is a sum total of preference shares that carry
preferential rights as regards dividends and as regards return of capital on
winding up. Preference share are further divided into Cumulative Preference
Shares and non-Cumulative Preference Shares. Where the dividend is
accumulated on he shares, they are called Cumulative Preference Shares Where
the dividends do not accumulate or lapse, they are called non-Cumulative
Preference Shares.
Preference shares are further classified into Redeemable Preference Shares and
Irredeemable Preference Shares.
Redeemable Preference Shares:
The company reserves its rights to call back the shares at any time. These
shares are called redeemable preference shares. The shares can be redeemed
only out of the profits of the company or out of the proceeds of the fresh issue of
shares. Only fully paid-up shares can be redeemed. The premium payable on
redemption shall be provided only out of the profits or out of the company’s
share Premium Account.
Irredeemable Preference Shares:
These shares cannot be purchased back by the company.

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Preference shares are also classified into participating preference shares and
convertible preference shares.
Equity Shares:
All shares which are not preference shares are called equity shares. These share
do not enjoy any special preferences like the preference shares.

13.7 QUESTIONS FOR DISCUSSION

1. What is a Share?
2. What different class of shares can be issued?
3. Distinguish between stock and shares

13.8 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 what do you mean by Right share?

According Section 81, the existing equity shareholders have a first right to be
allotted the new issue of shares. Shares so issued are called Right shares
Check-2 what do you mean by share certificate?
A “share certificate” is a document which specifies the shares held by any
member. It is issued by the company under its common seal. Every person,
whose name is entered as a member in the register of members, is entitled to
receive share certificate from the company. The share certificate may be in any
form. But a valid share certificate must satisfy the following requirements

13.9 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON - 17
DEBENTURE

CONTENTS
17.0 Aims and Objectives
17.1 Introduction
17.1.1 Meaning
17.1.2 Definition
17.2 Characteristic Features of Debentures
17. 3 Classification of Debenture
17.3.1. Classification according to Transferability
17.3.2 Classification According to securities
17.3.3 Classification According to permanence
17.3.4 Classification According to Convertibility
17.3.5 Classification according to Priority
17.4 Legal provision relating to debentures
17.5 Comparison between a share-holder and a debenture-holder
17.6 Let us sum up
17.7 Questions for discussion
17.8 Model answer to check your progress
17.9 References

17.0 AIMS AND OBJECTIVES

In the 16th lesson, we discussed the meaning, definition and types of shares. In
this lesson we discuss the meaning, definition and types of debenture. After
going through this lesson, you will able to
1. know the meaning and definition of debentures
2. understand various types of debentures

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17.1 INTRODUCTION

The money required by the company for its business activities is raised by it
from the public by borrowing. The most usual form of borrowing by a company
is by the issue of debentures. In this section, we discuss the meaning, definition
and characteristic of debentures
17.1.1 Meaning
Debenture means a document which either creates a debt or acknowledges. It is
issued by a company and is usually in the form of a certificate. The amount
might be payable by instalments on application, allotment and calls. But usually
the amount is payable in one lump sum.
17.1.2 Definition
According to Sec 2 (12), Debenture has been defined “as one that includes
debenture stock, bonds and any other security of a company, whether
constituting charge on the company’s assets or not which either create a debt or
acknowledgement and any document which fulfils either of these conditions is a
debenture”. Mr.Topham has stated that “debenture is a document given by a
company as evidence of a debt to the holder usually arising out of a loan and
most commonly served by charge”.
In common sense, we can define a debenture as a deed of document
acknowledging the loan adcanced by third party creditors under certain terms
and conditions to the company. [Levy vs Abercorris State Slab & Co., (1887) 37
Ch.D. 260] Debenture issue is one of the methods under which a company could
mobilize funds for its capital. It is issued like shares through publication of
prospectus. Funds got through debentures issue form part of borrowed capital.

17.2 CHARACTERISTIC FEATURES OF DEBENTURES

In this section, we explain the Characteristic Features of Debentures

1. Debenture can be issued at any time by all companies, whether private or
public. The power to issue the debentures rests with the Board of Directors
of the company (Section 292).
2. Debenture is a bond which acknowledges the loan advanced by third party
creditors to the company.
3. It must have serial number and must be duly signed by the directors and/
or officers as per the regulations contained in the Articles with the
Common Seal of the company.
4. The debenture deed should bear the date of issue and the date on which
the amount secured on it is repayable. On that date, the said debenture
deed must be presented to the company for repayment. Of late, issue of
perpetual debenture has been prohibited.

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5. Debentures are usually issued to the creditors, with security i.e., with
charge over specific property or one the overall assets of the company. It
may also be issued without charge or security. This is known as Debenture
without security or charge.
6. A debenture holder has no right to participate in the shareholders’
meeting.
7. Holding debentures is not an eligible qualification to become a director.

Check your progress -1

What is the nature of debenture?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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17. 3 CLASSIFICATION OF DEBENTURE

In this section, we attempt to make brief explain of different kinds of debentures.

Debenture may be classified according to the following characteristics, viz.,
1. Transferability
2. Security
3. Permanence
4. Convertibility
5. Priority
17.3.1. Classification according to Transferability
From the point of transferability, debentures could be divided as Bearer
debenture and Registered debentures.

i) Bearer Debenture
(a) A bearer debenture conveys title or ownership by mere delivery and
transfer of possession.
(b) It is a chose in possession in that sense mere possession conveys
ownership.
(c) It is payable to the bearer of the deed.

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(d) It can also be termed as a negotiable instrument and is transferable by

delivery.
(e) A bona fide transferee for value is not affected by any defect in the title of
the transferor.
Example:
A bearer debenture deed was kept in the safe, payable to B Company. The
secretary, stole the bearer debenture and pledged the debenture with a bank as
security for a loan taken by him. The bank took the debenture bona fide. The
court held that the bank was entitled to the debentures as against the company,
as it happened to be Bearer debenture
ii) Registered Debentures
These are the debenture which are payable to the registered holders. A holder is
one whose name appears both on the debenture certificate and in the company’s
register of debentures. The registered holder of the debenture can transfer them
like shares but a transfer to be complete has to be registered with the company.
17.3.2 Classification According to securities
From the angle of security, debentures are dividend as secured and unsecured
debentures.

i )Secured Debentures: These debentures that are held by persons who are said
to be secured creditors. This is due to the reason that secured debentures are
supported with fixed property or assets that are given as security and charged
therein for the long obtained on the said debentures.
Fixed Charge: When a specific property asset is given as security and charged
for the loan on the debenture, then the said debenture is termed as debenture
with fixed charge.
Floating charge: When overall assets are given as security and charged therein
for the loan obtained on the debenture, then it is known as Debenture with
floating charge.
ii) Unsecured Debentures or naked debentures: These debentures are not
supported by any security or assets with which charge is created for the said
debentures. Therefore, they are known as naked or unsecured debentures. The
holders of these debentures are ordinary creditors or unsecured creditor of the
company.

17.3.3 Classification According to permanence

Form the point of view of permanency, company creditors are classified into
Redeemable and Irredeemable debenture holders.
i) Irredeemable or Perpetual Debentures: When the principal amount secured
on the debenture is not repayable, then such debentures are known as

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irredeemable debentures. When no period is fixed for repayment of the principal

sum on the debenture or repayment is made conditional on the happening of an
event, which is not likely to happen, then such debenture is known as
irredeemable debenture. When the principal sum is made payable only at the
time of winding up, then such debentures on which the loan is obtained are
known as irredeemable debentures. (Section 120).
In a case 75 houses and other properties belonging to a company were
mortgaged to secure Rs. 10,000 repayable by instalments over 40 years. No
repayment of principle was allowed before 40 years. No repayment of principal
was allowed before 40 years. The court held that the mortgage was a debenture
and valid under law. [Knightbridge Estates vs Byrne (1940) A.C. 613]
ii) Redeemable Debentures: When the principal amount secured on the
debenture is repayable, and then such debentures are known as redeemable
debentures.
17.3.4 Classification According to Convertibility
On the basis of convertibility, debentures can be classified as convertible and
non convertible debentures.
i) Convertible Debentures: The debenture holders of this type are given the
option to convert the same into equity shares at certain rates of exchange after a
particular period. Once the holders of debentures convert them into equity
shares, they are no longer creditors of the company, but become members of the
company.
Convertible debentures may be further classified as Fully convertible debentures
(FCD) and partially convertible debentures (PCD). The former could be fully
exchanged for shares and in the latter only a portion of it could be exchanged for
shares.
ii) Non convertible debentures: In this kind of debentures, option is not given
to the holders of debentures to convert the loan covered under the debenture
into shares. These debentures have to be paid on the due date of maturity.
Sometimes, even non convertible debentures also could be converted as shares
according to the direction of the Central government through Company Law
Board.
17.3.5 Classification according to Priority
i) First come should be first served is the principle. If any of the creditors
had advanced loan to the company against issue of debentures, they shall be
paid first on the maturity of the debenture deed. Subsequent creditors who had
advanced loan to company on later dates are entitled to get back the loan
according to the order of priority. On the basis of priority with regard to
repayment of loan, money due on debentures will be divided into (a) debentures
without pari passuclause and (b) debenture with pari passu clause.

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Meaning of pari passu clause: Pari passu clause means a clause that is found
in the debenture deed in respect of repayment of loan advanced by the third part
creditors to the company on priority basis. The term pari passu clause signifies
discharge of loan to several creditors on equal footing, on prorate basis and
particularly on priority basis. That is to say, first receipts of loan to be
discharged first in order of the series.
Debenture without pair passu clause: If no mention is made in the debenture
deed with regard to repayment of loan on maturity, it is understood that those
creditors who had advanced loan earlier would get back their funds prior to the
other creditors who had advanced subsequently. This is said to be the ordinary
way of redeeming the debentures. Debentures without pari passu clause are to
be repaid according to the date on which they have been issued.
Debenture with pari passu clause: A number of creditors would have advanced
loan to the company on different months throughout the year. For example, a
company may be its Articles, may treat the debenture issued during April, May
June as falling in one category. During July, August, September as another
category and October, November and December as yet another category. And
January, February and March as another category. Those debentures in the
first batch will be numbered under A series, the debentures in the second batch
under B series, 3rd under C series and 4th under D series. All those creditors
who were issued debenture bonds during April, May and June would be treated
equally on a par with one another. Repayment of their loans would be made
ratably or in proportionate order among them. It is only after the 1st series, the
2nd, 3rd and 4th would be taken for repayment.

17.4 LEGAL PROVISION RELATING TO DEBENTURES

In this section we attempt to make a brief study of the various provisions of the
companies act relating to the debentures.
1. Issue of debentures. The debentures are issued in the same manner as
shares in a company. Thus, the legal provisions as to the prospectus,
application for debentures, allotment, issue of certificate etc. applicable to
shares is also applicable to debentures. However, the condition of minimum
subscription is not applicable to the issue of debentures.
The debentures are issued in accordance with he provisions of articles of
association, and usually by a resolution of the Board of Directors. The
debentures may be issued at par, at premium or at a discount. In case of issue
at discount, no formalities like those in case of issue of shares at discount are
required to be observed. Thus, the debentures can be issued at a discount
without any restrictions. The reason for the same is that they do not form part of
the capital of the company. It may, however, be noted that the convertible
debentures cannot be issued at a discount entitling the holders to exchange
them for the shares of par value. Because , it would base an indirect way of

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issuing shares at discount. It convertible debentures are to be issued at

discount, and then the legal provisions relating to the issue of shares at
discount must be complied with. The debentures hall not be taken to have been
issued until actually issued to the holders of the debentures.
Note. The interest payable on debentures may be paid out of capital.
2. Debentures not to carry any voting right. The companies cannot issue any
debentures carrying voting rights at any meeting of the company (Section 117).
This provision is made so that the debenture-holders may not be in a position to
influence the policy of the company which may be detrimental to the interest of
the general body of share-holders. However, the debentures issued before the
commencement of the companies Act (i.e. before April 1956) may continue to
have voting rights.
3. Re-issue of redeemed debentures (Section 121). The debentures which
have been redeemed (i.e. paid off) by the company may be kept alive for re-issue.
The company may re-issue such debentures unless here is no contrary provision
in the articles of association, or in the conditions of previous issue, or in any
other contract entered into by the company, or the company has not shown any
intention to cancel them e.g. by passing a resolution to that effect. Such re-issue
may be made either by re-issuing the same debentures, or by issuing other
debentures in their place.
It will be interesting to know that one that reissue of the redeemed debentures,
the new debenture-holder shall have the same rights re-issued debentures are
treated as new debentures for the purpose of stamp duty.
4. Debentures with pari-passu clause. The term ‘pari-passu’ may be defined as
‘to rank together’ as regards security. The debentures with pari-passu clause
means that all the debentures of the same series are to rank together, without
any priority of one over the other, as regards the charge created by them. It is
immaterial that these are issued at different and varying times. The effects of
such a clause is that the debentures are to be discharged rateably. And in the
event of insufficient assets to pay in full al the debenture-holders secured by the
charge, the amount is distributed in proportion to the amount owing to each of
them. Thus, each of them will lose rateably (i.e. proportionately). It may,
however, be noted that a company cannot create a new series to rank pari-passu
with the old series, unless the power do so is expressly reserved by the company
with itself.
In the absence of pari-passu clause, the debentures will be payable according to
the date of issue. And if all of them were issued on the same data and are
serially numbered, they will be payable according tot their numerical order.
5. Transfer of debentures. We have already discussed that the debentures may
be bearer debentures (payable to the holder), or registered debentures (payable
to the person in whose favour these are registered). The bearer debentures are
transferable by simple delivery. And any person holding the debentures become
entitle to the payment of money on due date. And the registered debentures are

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transferable in the same manner in which the shares and stamped transfer
document, which should be submitted to the company for registration.
6. Register of debenture-holders (Section 152). Every company issuing the
debentures must maintain a register of its debenture-holders. The following
particulars should be entered in the register:
(a) The name, address and occupation, if any, of each debenture-holder.
(b) The debentures held by each holder, showing the amount paid or
considered as paid on these debentures. And each debenture should be
distinguished by its number.
(c) The date at which each person was entered in the register as debenture-
holder.
(d) The date at which any person ceased to be debenture-holder.
It may be noted that if the company has more than 50 debenture-holders, it
must maintain and index of the names of the debenture-holders.
The register of debenture-holders may be maintained in such a manner which
constitutes an index. Or the company may maintain a separate index. The index
must contain a sufficient indication t enable the entries relating to each
debenture-holder in the register to be readily found. Any alteration in the
register should be entered in the index within 14 days of the change.

17.5 COMPARISON BETWEEN A SHARE-HOLDER AND A DEBENTURE-

HOLDER

In this section, we attempt to make a brief study of the comparison between a

share-holder and a debenture-holder.

S.No. Share-holder Debenture-holder

1. He is the member and joint He is simply a creditor of the
owner of the company. company who has given some loan
at time company.
2. He has a right to vote at the He has no right to vote at any
meetings of the company. meeting of the company.
3. He is entitled to get dividends He is entitled to fixed rate of
only out of profits. interest whether there are profits
or not.
4. He has full right to control He has no right to interfere with
company’s affairs. In fact, the the business of the company.
ultimate destiny of the However, in case of company’s
company is in the hands of default in paying their debt, he
share-holders. may enforce their security.

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5. He cannot be paid back so He can be paid back unless he is

long as the company is a a perpetual debenture-holder.
going concern.
6. I case of winding up of the In case of winding up, a secured
company, he is paid after debenture-holder is paid prior to
satisfying all other claims. the share-holder.

17.6 LET US SUM UP

In this lesson, we have briefly touched upon the following points; Debenture
means a document which either creates a debt or acknowledges “debenture is a
document given by a company as evidence of a debt to the holder usually arising
out of a loan and most commonly served by charge”. Debenture is a bond which
acknowledges the loan advanced by third party creditors to the company. It
must have serial number and must be duly signed by the directors and/ or
officers as per the regulations contained in the Articles with the Common Seal of
the company. Debenture may be classified according to the following
characteristics, viz, Transferability, Security, Permanence, Convertibility, and
Priority.

17.7 QUESTIONS FOR DISCUSSION

1. What is debenture?
2. What are the different kinds of debentures?
3. What is meant by a debenture payable pari- passu ?

17.8 MODEL ANSWER TO CHECK YOUR PROGRESS

Chcek -1 Nature of debenture: The debentures of a company are a movable

property, transferable in the manner provided by the Articles.

17.9 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON -18
DIRECTORS
CONTENTS
18.0 Aims and Objectives
18.1 Introduction
18.2 Number of Directors
18.3 Qualification of Director
18.4 Disqualification of Director
18.5 Appointment of Director
18.5.1 First Directors
18.5.2 Appointment in Board Meetings
18.5.3 Appointment by central Government
18.5.4 Appointment by Proportional Representation
18.5.5 Restrictions on appointment of directors
18.6 Removal of Director
18.7 Remuneration of Director
18.8 Power of Director
18.9 Duties of Director
18.10 Disabilities
18.11 Rights
18.12 Liabilities of Director
18.13 Let us sum up
18.14 Questions for discussion
18.15 Model answer to check your progress
18.16 References

18.0 AIMS AND OBJECTIVES

In the 17th lesson, we discussed the meaning, definition and type of debenture.
In this lesson we discuss the meaning, Number of Directors, qualification,
disqualification of director, appointment, removal, remuneration, power, duties
and liabilities of Director of a company. After going through this lesson, you will
able to

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1. know the meaning of Director

2. understand Qualification and disqualification of Director of a company
3. study the methods of appointment of Director
4. know the power, duties and liabilities of Director of a company

18.1 INTRODUCTION

The company being an artificial person carries on its activities and business
through individual called directors. Director includes any person occupying the
position of a director by whatever name called. The directors of a company
collectively are referred to as “Board of Directors” or “Board”. A director controls
the company’s affairs. If a person performs the functions of a director, he will be
deemed to be a director, even if he is not so designated.

18.2 NUMBER OF DIRECTORS

In this section, we discuss the number directors required for different type of
companies. According to section 252; every public company shall have at least 3
directors. Every other company shall have at least 2 directors. The maximum
number of directors is fixed by the articles. The maximum permissible limit of
directors is12.Any increase in number beyond 12 directors requires Central
Government approval.

18.3 QUALIFICATION OF DIRECTOR

In this section, we discuss the Share Qualification of a Director. Share

qualification means the shares to be taken by a director to qualify him as a
director of the company. It shall be the duty of every director who is required by
the articles of the company to hold a specified share qualification, and who is
not already qualified in that respect, to obtain his qualification within 2 months
after his appointment as director.
The Act however does not prescribe any share qualification. If the articles of a
company do not provide for share qualification, beneficial ownership of share sis
not necessary. A company can by provision in its articles exempt itself from the
above provision.
The nominal value of the qualification shares shall not exceed Rs.5,000/- or the
normal value of one share, where it exceeds Rs.5,000/-. The office of the
director shall fall vacant if a director fails to acquire his qualification shares
within the prescribed period.

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18.4 DISQUALIFICATION OF DIRECTOR

In this section, we discuss the disqualification of Director .A person shall not be

capable of being appointed director of a company if
(1) he has been found to be of unsound mind by a Court of competent
jurisdiction and the findings are in force;
(2) he is an undercharged insolvent;
(3) he has applied to be adjudicated as an insolvent and his application is
pending;
(4) he has been convicted by a Court of any offence involving moral turpitude
and sentenced in respect thereof to imprisonment for not less than 6
months period and a period of 5 years has not elapsed from the date of
expiry of the sentence;
(5) he has not paid any call in respect of shares of the company held by him,
whether alone or jointly with others, and 6 months have elapsed from the
last day fixed for the payment of the call; or
an order disqualifying him from appointment as a director has been passed by a
Court on account of fraud or misfeasance, and is in force, unless the leave of the
Court has been obtained for his appointment

18.5 APPOINTMENT OF DIRECTOR

In this section, we discuss the various methods of appointment of Directors.

18.5.1 First Directors: If directors are not duly appointed, then subject to any
regulation in the articles of the company, subscribers of the Memorandum who
are individuals shall be deemed to be the first directors of the company. The
Memorandum and Articles when filed for registration with the Registrar usually
mention the first directors of the company. They hold office until directors are
duly apointed in the general meeting.
Appointment in General Meeting: The directors shall be appointed by the
company in the general meeting (Sec. 255). It has been held in Ram Kissandas
v. Satyacharan (A.I.R. 1950 PC 81) that the articles may, however, be so
expressed as to delegate the power of appointing new directors to the Board to
the exclusion of the general meeting.
However, where the power of appointment vested in the shareholders, having
been usurped by the directors, the appointment by directors shall be void.
Where there are no validly appointed directors functioning, the4 shareholders
have the right to appoint directors at the annual general meeting.
Right of persons to stand for directorship: A person who is not a retiring director
shall be eligible for appointment to the office of a director at any general

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meeting, if he or some member intending to propose him, not less than 14 days
before the meeting, leaves at the office of the company a notice in writing under
his name, certifying his candidature for the office of the director or the intention
of such member to propose him as a candidate for that office, as the case may
be.
The company shall inform its members of the candidature of a person for the
office of a director or the intention of a member to propose such person as a
candidate for that office by serving individual notices on the members not less
than 7 days before the date of the meeting.
The above provision shall not apply to a private company, unless it is a
subsidiary of a public company and also to a Government company in which the
entire paid-up capital is held by the central Government or by any State
Government or governments or by the Central Government or by the Central
Government and any one or more State Governments (Sec 257).
18.5.2 Appointment in Board Meetings:
1. Casual Vacancies: The Board of directors at a meeting of the Board may fill
in casual vacancy among the directors. A casual vacancy among the directors, A
casual vacancy arises when the office of any director appointed by the company
in a general meeting is vacated before his term of office expires in the normal
course. Any person so appointed shall hold office only upto the date upto which
the director in whose place he is appointed would have held office if it would not
have been so vacated (Sec. 262).
2. Additional Directors: The Board of Directors may appoint additional
directors to hold office only upto the date of the next annual general meeting of
the company. However, the number of the directors and additional directors
together shall not exceed the maximum strength fixed for the Board by the
articles (Sec. 260)
In Krishna Prasad Pilani V. Colaba Land & Mills co. (1959 Com case 273) it has
been held that a director appointed as an additional director vacates his office at
the latest on the last day on which the annual general meeting could have been
called and cannot continue in office thereafter on the ground that the meeting
was not or could not be called within the time prescribed. The expression “upto
the date of the annual general meeting” means “upto the date when the next
annual general meeting ought to be held at the latest”.
3. Alternate Director: The Board of directors of the company may, if so
authorised by the articles, or by a resolution passed by the company in a general
meeting, appoint an alternate director to act for the original director during his
absence for a period of not less than 3 moths from the State in which meetings
of the Board are ordinarily held.
An alternate director shall not hold office as such for a period longer than that
permissible to the original director in whose place he has been appointed and
shall vacate office if and when the original director returns to the State in which
meetings of the Board are ordinarily held (Sec. 313).

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18.5.3 Appointment by central Government:

The Central Government may appoint such umber of persons as it may by order
in writing specify as being necessary to effectively safeguard the interests of the
company or its share holders or the public interest to hold office as directors
there of for such period not exceeding 3 years on any one occasion as it may
think fit to, in order to prevent the affairs of the company being conducted either
in a manner which is oppressive to any member of the company or in a manner
which is prejudicial to the interests of the company or to public interest.
Directors so appointed shall not be required to hold any qualification shares nor
shall their period of office be liable to determination by retirement of directors by
rotation. Such a director may be removed by Central government at any time.
The Central Government may require the persons appointed directors or
additional directors to report to the Central government from time to time with
regard to the affairs of the company (Sec. 408).
18.5.4 Appointment by Proportional Representation :
The articles of a company may provide for the appointment of not less than
2/3rds of the total number of directors of a public company or of a private
company which is a subsidiary of a public company, according to the principles
of proportional representation, whether by the single transferable vote or by a
system of cumulative made one in every 3 years and interim casual vacancies
must be filled in by the Board of directors in the Board meetings.
The directors of a company shall be appointed by election, by the members at a
general meeting. At a general meeting of a public company or a private company
which is a subsidiary of a public company, a motion shall not be made for the
appointment of two or more persons as directors of the company by a single
resolution, unless a resolution that it shall be so made has first been agreed to
by the meeting without any vote being given against it. A resolution moved in
contravention shall be void, whether or not objection was taken at the time of it
being so moved. (Sec. 262).
Consent of Directorship : Every person proposed as a candidate for the office of
the director sign, sign, and file with the company, his consent in writing to act
as a director, if appointed.
Consent in writing to act as director need not be filed in the following cases:-
(i) a person other than a director re-appointed after retirement by rotation or
immediately on the expiry of office; or
(ii) an additional or alternative director, or a person filling a causal vacancy in
the office of a director, appointed ad director or re-appointed as an
additional or alternation director, immediately on the expiry of his term of
office; or
(iii) a person named as a director of the company under its articles as first
director.
(iv) A person who is appointed as a Director of a private limited company.

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Except in the above cases, no person shall act as a director of the company
unless he has within 30 days of his appointment signed and filed with Registrar
his consent in writing to act as a director.
Non-filling of consent with the company is at the most only an irregularity and
will not render invalid an appointment made without such consent having been
filed.
The above provisions shall not apply to a private company unless it is a
subsidiary of a public company (Sec. 209).
Acts done by a person as a director shall be valid, not with-standing that it may
afterwards be discovered that his appointment was invalid by reason of any
defect or disqualification or had terminated by virtue of any provision contained
in the act or in the articles (Sec. 290).
18.5.5 Restrictions on appointment of directors:
Number of Directorships: No person shall hold office at the same time as director
in more than 20 companies (Sec. 275).
Where a person already holding the office of director in 20 companies, is
appointed, as a director of any other company, the appointment shall not take
effect unless such person has within 15 days thereof effectively vacated his office
as director in any of the company in which he was already a director. The
appointment shall become void immediately on the expiry of 15 days if he has
not, before such expiry, effectively vacated his office as director in any of the
other company (Sec. 277).
Exclusions: In calculating the number of companies of which a person my be a
director, the following companies shall be excluded:
(i) a private company which is neither a subsidiary nor a holding company of
a public company;
(ii) an unlimited company;
(iii) an association not carrying on business for profit or which prohibits the
payment of a dividend; or
(iv) a company in which such person is only an alternate director (Sec. 278).
[[

18.6 REMOVAL OF DIRECTOR

In this section, we discuss the various methods of removal of Directors.

18.6.1. By Shareholders: (Sec. 284)
A company may by ordinary resolution remove a director before expiry of his
period of office by:

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(i) Special notice of any resolution to remove a director at a meeting at which

he it to be removed;
(ii) On receipt of notice of a resolution to remove a director, the company shall
forthwith send a copy there of to the director concerned. The director shall
be entitled to be heard on the resolution at the meeting.
Where notice is given of a resolution to remove a director and the director
concerned makes representations in writing to the company and requests the
notification of representations to members of the company, the company shall :
(i) In any notice of the resolution given to members of the company state the
facts of the representations; and
(ii) Send a copy of the representation to every member of the company to
whom the notice of the meeting is sent. If a copy of the representations is
not sent because they were received too late or because of the company’s
default the director may require that the representations shall be read out
at the meeting.
Copies of the representations need not be sent out and the presentations need
not be read out at the meeting if:
(i) on the application either of the company or of any other person who claims
to be aggrieved, Court is satisfied that the rights are being sucure needless
publicity for defamatory matter; and
(ii) the Court may order the company’s costs of the application to be paid in
whole or in part by the director.
Exceptions: The following directors however, cannot be removed:
(i) directors appointed by the Central Government;
(ii) in the case of a private company, the director holding office for life as on 1-
4-1952;
(iii) when the director has been appointed by the principle of proportional
representation.
A vacancy so created by the removal of a director may, if appointed by the
company in general meeting or by Board, be filled by appointment of another
director in his place by the meeting at which he is removed, provided special
notice of the intended appointment has been given.
A director so appointed shall hold the office until the date up to which his
predecessor would have held office if he had not been removed as aforesaid. If
the vacancy is not so filled, it may be filled as a casual vacancy. However, a
director who was removed from office shall not be re-appointed as a director by
the Board of Directors.

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The person removed from the directorship shall not be deprived of any
compensation or damages payable to him in respect of the termination of his
appointment as a director (Sec. 284).
18.6. 2. By Central Government: (Secs. 388B—388E)
The Central Government may state a case against any person referring the same
to the High Court with a request that the High Court may inquire into the case
and record a decision as to whether or not such person is a fir and proper
person to hold the office of a director.
Every case shall be state in the form of an application to High Court containing
concise statement of such circumstances. The person against whom the case is
referred to the High Court shall be joined as a respondent to the application.
The High Court may direct during the pendency of a case that the director shall
not discharge any o the duties of his office until further orders and appoint a
suitable person in his place to discharge the duties. At the conclusion of the
hearing of the care, the High Court shall stall record its decision stating whether
or not the respondent is a fit and proper person to hold the office of the director.
The Central Government shall, by order, remove from office any director of a
company against whom there is a decision of the High Court. The person who is
so removed shall not hold office of a director during a period of 5 years from the
date of the order of removal. The director so removed shall not be entitled to, or
be paid, any compensation for the loss or termination of office. The company
may, with the previous approval of the Central Government, appoint another
person to that office.
18.6.3 By Court
On the application by any member of the company in cases of oppression (Sec.
397), or mismanagement (Sec. 398), the Court may terminate, set aside or
modify any agreement between the company and a director or managing director
(Sec. 402). No director or managing director whose office is so terminated shall
for a period of 5 years from the date of the order terminating or setting aside the
agreement, without the leave of the Court, be appointed, or act as the managing
or other director. Such a director or manager shall not be entitled to any claim
for damages or for compensation (Sec. 407).
18.6.4 Retirement of Directors by Rotation (Secs. 255 & 256)
Unless the articles provide for the retirement of all directors at every annual
general meeting, not less than 2/3rds of the total number of directors of a public
company, or of a private company which is a subsidiary of a public company,
shall be persons whose period of office is liable to determination by retirement of
directors by rotation [Sec. 255 (1)]. Only 1/3rd can be given permanent
appointment.
At the first annual general meeting of a public company or a private company
which is a subsidiary of a public company, held next after the date of the general
meeting at which the first directors are appointed and at every subsequent

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annual general meeting, 1/3rd of such of the directors for the time being as are
liable to retire by rotation or if the number is not 3 or a multiple of 3 then, the
number nearest to 1/3rd shall retire from office. In other words, at one annual
general meeting, only 1/3rd of such directors shall retire by rotation.
The directors to retire y rotation at every annual general meeting shall be those
who have been longest in office since last appointment. As between persons who
became directors on the same day, those who are to retire shall, in default of
and subject to any agreement among themselves, be determined by lot. A
director who is to retire by rotation at an annual general meeting cannot
continue in office after the last day on which the annual general meeting in each
year should have been held.
At the annual general meeting at which a director retires as aforesaid, the
company may fill up the vacancy by appointing the retiring director or some
other person thereto. The retiring director is therefore eligible for re-
appointment. If the place of retiring director is not so filled up, the retiring
director shall be deemed to have been reappointed at the adjourned meeting
unless:
(i) at the meeting a resolution for the reappointment of such director has been
put to the meeting and lost;
(ii) the retiring director has by a notice in writing addressed to the company or
its Board of Directors, expressed his unwillingness to be so reappointed; or
(iii) he is not qualified or is disqualified from appointment;
(iv) a resolution whether special or ordinary is required for his appointment or
reappointment;
(v) where a resolution for the appointment of two or more directors by a single
resolution is passed.
The above provisions shall not apply to a private company and also to a
Government company in which the entire paid-up capital is held by the Central
Government or by any State Government or Governments or by the Central
Government and any one or more State Governments.
18.6.5 Removal of Directors
In the absence of any provision either in the Companies Act, 1956 or in the
Memorandum of Association or Articles of Association of the Company,
regarding resignation by a Director the ordinary rule of common law must be
applied and a director who had submitted his resignation would be deemed to
have resigned from his office from the date of the submission of his resignation,
when his intention is unequivocally expressed either orally or by a letter (S. S.
Lakshmana Pillai v. Registrar of Companies and another – 1977-47 Comp. Cas-
652).

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The disqualification shall not take effect :

(a) for 30 days from the date of adjudication, sentence or order;
(b) where any appeal or petition is preferred within 30 days against the
adjudication, sentence or conviction resulting in the sentence or order, until
the expiry of 7 days from the date on which such appeal or petition is
disposed of, or
(c) where within 7 days aforesaid, any further appellation, sentence, conviction,
or order, resulting in the removal of the disqualification, until such further
appeal or petition is disposed of.
A private company which is not a subsidiary of a public company may, by its
articles provide that the office of director shall be vacated on any grounds in
addition to those specified above.

Vacation of Office of Directors: (Sec. 283)

The office of the director shall become vacant if:

1. he fails to obtain within 2 months, or at any time thereafter ceases to hold

the share qualification, if any, required of him by the articles of the
company;
2. he is found to be of unsound mind by a Court of competent jurisdiction;
3. he applies to be adjudicated insolvent;
4. he is adjudged insolvent;
5. he is convicted by a Court of any offence involving moral turpitude and
sentenced in respect thereof to imprisonment for not less than 6 months;
6. he fails to pay any call in respect of shares of the company held by him,
whether alone or jointly with other, within 6 months from the last date
fixed for the payment of the call unless the Central Government has, by
notification in the Official Gazette, removed the disqualification incurred by
such failure;
1. he absents himself from 3 consecutive meetings of the Board of Directors, of
from all meetings of the Board for a continuous period of 3 months,
whichever is longer without obtaining leave of absence from the Board;
2. of any firm in which he is a partner or any private company of which he is
director, accepts a loan, or any guarantee or security for a loan, from the
company without the approval of the Central Government;
3. he fails to make disclosures to the Board in respect of contracts in which he
is interested;

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4. he becomes disqualified by an order of Court for being convicted of an

offence in respect of the promotion, formation or management of a company,
or in the course of winding up he is guilty of fraud or misfeasance;
5. he is removed before the expiry of period of his office;
6. having been appointed a director by virtue of his holding any office or other
employment in the company, he ceases to hold such office or other
employment in the company;
7. he resigns from his office (resignation tendered cannot be withdrawn
without the Company’s or Board’s consent).
Check your progress - 1
What do you mean by Alternate director?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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18.7 REMUNERATION OF DIRECTOR

In this section, we discuss the various methods of remuneration of Directors The

remuneration payable to the directors of a company, including any managing of
whole-time director, shall be determined in accordance with provisions of
sections 198 and 309 either by the articles of the company, or by resolution, or
it the articles so require by a special resolution passed by the company in
general meeting.
Overall maximum remuneration : (Sec. 198) The total managerial remuneration
payable by a public company, or a private company which is a subsidiary of a
public company to its directors and its manager in respect of any financial year
shall not exceed 11% of the net profits of that company for that financial year.
The remuneration of the directors shall not be deducted from the gross profits.
The percentage aforesaid shall be exclusive of any fees payable to directors by
way of fee for each meeting of the Board; or a committee thereof, attended by
him.

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Limits in case of Managing or whole-time Director : If in any financial year, a

company has no profits or its profits are inadequate, the company may, subject
to the approval of the Central Government, pay to its directors (including any
managing or whole-time director) or manager, or if there are two or more of them
holding office in the company, to all of them together by way of minimum
remuneration, such sum not exceeding Rs. 50000/- per annum.
However, where a monthly payment is being made to any managing or whole-
time director or the manager, or to any one or more of them and the Central
Government is satisfied that for the efficient conduct of the business of the
company minimum remuneration of Rs. 50000/- per annum, is insufficient, the
Central Government may be order sanction any increase in the minimum
remuneration to such sum for such period and subject to such conditions, if
any, as may be specified in the order.
2. The remuneration payable to any such director shall be inclusive of the
remuneration payable to such director for services rendered by him in any
other capacity.
Any remuneration for services rendered by any such director in any other
capacity shall not be so included if :
(a) the services rendered are of a professional nature;
(b) in the opinion of the Central Government, the director possesses the
requisite qualifications for the practice of the profession [Sec. 309 (1)].
A director may receive remuneration as a director and he may also get it in a
capacity other than that of a director (Ramaben A. Thanawala v. Jyoti Ltd – AIR
1958 Bom. 214).
3. A director who is either in the whole-time employment of the company or a
managing director may be paid remuneration either by way of monthly
payment or at a specified percentage of the net profits of the company or
partly by one way and partly by the other.
Except with the approval of the Central Government, such remuneration shall
not exceed 5% of the net profits for one such director and if there is more than
one such director, 10% for all of them together [Sec. 309 (3)].
Limits in case of other directors : Remuneration to a director who is neither a
managing director nor a whole-time director, may be paid by way of monthly,
quarterly or annual payment with the approval of the Central Government or by
way of commission if the company by special resolution authorises such
payment. The special resolution shall remain in force for 5 years at a time.
However, the remuneration paid to such director or where there are more than
one such director, to all of them together, shall not exceed :
(i) 1% of the net profits of the company, if the company has a managing or
whole-time director or a manager;
(ii) 3% of the net profits of the company, in any other case.

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The company in general meeting may, with the approval of the central
government, authorise the payment of such remuneration at a rate exceeding
1%, or as the case may be, 3% of its net profits.
Summary of the provisions regarding remuneration of directors:
1. Remuneration of the directors shall be determined subject to the
provisions of sections 198 and 309, either by the articles or by resolutions
passed in general meeting of the members of the company.
2. If a director gives professional services, he may be paid for it by the
company provided the Central Government is satisfied that the director
has the requisite qualifications for the profession.
3. Overall remuneration of directors must not exceed 11% of the not profits or
Rs.50,000/- per annum, whichever is more.
4. A managing or whole-time director may receive remuneration by monthly
payment or at specified percentage of the net profits of the company or
partly by one way or partly by the other.
5. A whole-time director or managing director’s remuneration shall not exceed
5% of the net profits for one such director except with the approval of the
Central Government.
6. Remuneration of a director not being a managing or whole-time director
may be paid by way of monthly, quarterly or annual payment with the
approval of the Central Government, or by way of commission if authorized
by special resolution.
7. A director not being a whole-time or managing director may be paid
remuneration not exceeding 1% of the net profits in case the company has
a managing or whole-time director. The directors may be paid
remuneration – 3% of the net profits in any other case and not in excess of
it in any case, unless approved by the company in general meeting and by
the Central Government.
8. Excess drawn to be refunded to the company.
9. Remuneration of directors may be paid out of the capital if there are no
profits.
10. Ay increase in the remuneration requires Central Government approval.
11. The net profits of the company for a financial year shall be computed in the
manner laid down in sections 349, 350 and 351. Remuneration of the
directors shall not be deducted from the gross profits.
12. The above rules do not apply to a private company.
13. Directors may be paid over and above the limits of remuneration, feeds
upto Rs.250/- for attending Board Meetings. Any increase in fees above
Rs.250/- requires approval of Central Government.

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18.8 POWER OF DIRECTOR

In this section, we discuss the various powers of Directors. The Board of

directors derives their powers from
(i) The companies Act;
(ii) Articles of Association;
(iii) Board resolutions;
(iv) Resolutions in general meeting;
(v) Agreements or contracts with the company.
Subject to the provisions of this act, the Board of Director of a company shall be
entitled to exercise all such powers and do all such acts and things, as the
company is authorized to exercise and do. The Board shall not exercise any
power of thing with is required to be done by the company in a general meeting.
The Board of Directors shall exercise the following powers on behalf of the
company by means of resolutions passed at the meetings of the Board:
(i) the power to make calls on shareholders in respect of money unpaid on
their shares;
(ii) the power to issue debentures;
(iii) the power to borrow moneys otherwise than on debentures;
(iv) the power to invest the finds of the company; and
(v) the power to make loans
The Directors have power to change the method of accounting adopted by the
Company.
Restrictions on powers of Board: The Board of Directors of a public company; or
a private company which is a subsidiary of a public company, shall not exercise
the following powers except with the consent of the company in a general
meeting :
1. Sell, lease or otherwise dispose of the whole or substantially the whole of
the undertaking of the company;
2. Remit, or give time for the repayment of any debt due by a director;
3. Invest otherwise than in trust, securities the amount of compensation
received by the company in respect of the compulsory acquisition of any
undertaking or any premises or property;
4. Borrow moneys, where the moneys to be borrowed together with the
moneys already borrowed by the company (apart from temporary loans
obtained form the company’s bankers in the ordinary course of business)
will exceed the aggregate of the paid-up capital of the company and its free
reserves;

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5. Contribute to charitable and other funds not directly relating to the

business of the company or the welfare of its employees any amounts the
aggregate of which will, in any financial year exceed Rs. 50000 or 5% of its
average net profits, during the three financial years immediately preceding,
whichever is greater.
Directors are agents not of a majority of the shareholders but of a company, of
the whole entity made up of all the shareholders. If the whole entity of
shareholders has entrusted the directors with a particular power, a simple
majority could not interfere in the exercise of it. The members are not allowed to
interfere in the directors discretion, Similarly, the directors are not allowed to
exercise a poser expressly vested in the shareholders. However, where the
directors act mala fide, or where the Board becomes incompetent to act, the
majority of shareholders in a general meeting is competent to act and redress
the wrong, even in a matter delegated to the Board.
The Board of Directors shall not contribute to any political party or for any
political purpose to any individual or body. The Board of directors may
contribute such amount as it thinks fit to the National Defence. Fund or any
other Fund approved by the Central Government for the purpose of national
fund.
Check your progress - 2
What is the position of the Director?
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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18.9 DUTIES OF DIRECTOR

In this section, we discuss the various duties of Directors

1. Act honestly.
2. Employ reasonable degree of skill and diligence in the interest of the
company.

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The diligent director is one who exhibits in the performance of his duties the
same degree of care and prudence that men prompted by self-interest generally
exercise in their own affairs.
3. Must not make secret profits.
4. Attend board meetings.
5. Send his consent of his appointment as a director to the Registrar where
applicable.
6. Obtain qualification shares where applicable.
7. Pay call amount.
8. Disclose his interest in the contracts etc. Interest must conflict with the
director’s duties’ towards the company, Interest which is personal must be
disclosed.
9. Disclose his name, occupation, nationality, etc.
10. Not to delegate his functions except to the extent authorised by the act or
the articles of the company.
It should be noted that the duties of a director very according tot eh nature and
size of the company and have t be ascertained on the facts of each case.

18.10 DISABILITIES

The term “disability” means the restrictions on directors’ powers to do certain

act. To protect the interest of the company and the shareholder, the company
Act imposes certain restrictions on directors. In this section, we discuss the
various disabilities of Directors
1. He cannot assign his office or delegate his functions.
2. He cannot take any loan from the company except with prior approval of
the Central Government.
3. He cannot hold any place of profit in the company without consent of the
company by a special resolution.

18.11 RIGHTS

In this section, we discuss the various rights of Directors

1. To attend meetings of the company.
2. To participate in the management of the company’s affairs.
3. To received remuneration if any fixed.

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18.12 LIABILITIES OF DIRECTOR

In this section, we discuss the various liabilities of Directors. They may be held
liable to pay compensation for damages suffered by the company in case of
breach of their duties or negligence in performing their duties. The directors will
also be liable to the company where they commit breach of trust regarding
profits and funds of the company.
The directors are also liable to pay compensation to third parties in following
cases:
7. For untrue statements in the prospectus;
8. For contracts entered into on behalf of the company where the directory
act in their own name:
9. For ultra vires acts;
10. For irregular allotment of shares:
11. where the directors act unlaw fully:
Where directors fail to perform statutory obligation laid down in the act like
failure to maintain accounts, filling returns, etc., they render themselves liable
to penalties and prosecutions. They may also be held criminally liable with fine
and imprisonment for untrue statements in the prospectus, failure to keep
registers, finalization of books of accounts; filling of returns, etc.
If should be noted that a company is necessary party to the proceedings.
Directors can be convicted only if company is convicted. Complaint against
Direction alone is not cognizable. Complaint is bad if it does not state who the
officers were in default. (Ajit Kumar Sarkar v, Asstt. Registrar of companies
1979-99 comp. Cas-909).
Section 201 of the act lays down that any provision exempting any officer of the
company or indemnifying his agent against liability in respect of any negligence,
default, misfeasance, breach of duty or breach of trust of which he may be guilty
shall be void. The director the refore cannot ‘contract out’ of his liability.
However Section 633 of the act provides relief to the directors. If it appears to
the court that any officer of a company who may be liable in respect of the
negligence, default, misfeasance, breach of duty, or breach of trust, but that he
has acted honestly and reasonably and that he ought fairly to be excused, the
Court may relieve him, cither wholly or partly from his liability. But in a
criminal proceeding, the court shall have no power to grant relief from any civil
liability.
Directors with unlimited liability: The Memorandum of the company may
provide for unlimited liability of any director or directors or any member in a
limited company (Sec. 322). If memorandum does not so provide, then the
limited company may, if so authorised, by special resolution alter its
memorandum so as to render the liability unlimited of any its directors or
manager.

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No alteration of the memorandum making the liability unlimited shall apply, if

such director or manager was holding the office before the date of alteration,
until the expiry of his term, unless he accorded his consent to his liability
becoming unlimited (Sec. 323).

18.13 LET US SUM UP

In this lesson, we have briefly touched upon the following points; The company
carries on its business through individuals called Directors. Collectively they are
called Board of Directors. Every public company shall have at least three
Directors. Every other company shall have at least two Directors. The maximum
number shall be twelve. Any increase beyond twelve requires the Central
Government approval. Subscribers to the Memorandum of the Company shall be
deemed to be the first Directors of the Company.
Appointment of Directors: The Directors shall be appointed by election by the
members in the General Meeting. A person who is a retiring Director shall be
eligible for reappointment to the office of a Director at any General Meeting.
Share qualification of a Director: Share qualification means the shares to be
taken by a Director to qualify him as a Director of the company. The Director
shall obtain hi qualification shares within two months after his appointment as
a director. He shall vacate the office if he fails to acquire the qualification shares
within the prescribed time.
Disqualification of Directors: A person shall not be capable of being appointed as
a Director if he possesses any of the disqualification enumerated in section 274
of the Act.
Remuneration of Directors: The overall maximum remuneration shall not exceed
11% of the net profits or Rs.50,000 per annum, whichever is more. The Whole-
time Director or Managing Director’s remuneration shall not exceed 5% of the
net profits. The Director who is not a whole-time Director or Managing Director
may be paid remuneration not exceeding 1% of the net profits, where the
Company has a Managing or a Whole-time Director. In other cases, the Directors
may be paid remuneration not exceeding 3% of the net profits. The remuneration
shall be paid out of the capital when there are no profits. The Directors may be
paid sitting fees of attending Board Meeting upto Rs.250/-.
Powers of Directors: The Board of Directors derive their powers from the
Companies Act, Articles, Board Resolution, Resolutions in General Meetings and
Agreements, or contracts with the company. The Board shall exercise the power
of making calls on he shareholders, power of issuing debentures, power to
borrow moneys, power to invest the funds of the Company and power to make
loans, by means of Resolutions passed at the meetings of the Board. However,
certain powers of the Board of Directors cannot be exercised except with the
consent of the company in a general meeting. The Directors also enjoy certain
rights and have certain duties to be performed to the Company. They may be

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held liable to pay compensation for damage suffered by the company in case of
breach of their duties. They suffered also from certain disabilities. The
Memorandum of the Company may provide for unlimited liability of any Director
in a limited company.

18.14 QUESTIONS FOR DISCUSSION

1. Discuss briefly the provision of the companies Act in regard to the

appointment of and removal of directors.
2. Explain the categories of person who are disqualified from being appointed
as direction of a company.
3. What are the powers, rights, duties, liabilities and disabilities of directors?

18.15 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 what do you mean by Alternate director?

An alternate director is appointed to act in place of a director who is absent for a
period of more than three months from the state in which the board meetings
are ordinarily held.
Check-2 what is the position of the Director?
1. Directors as agent.
2. Directors as trustees.
3. Directors as managing partners

18.16 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-9
COMPANY SECRETARY

CONTENTS
19.0 Aims and Objectives
19.1 Introduction
19.2 Qualification of Secretary
19.3 Qualification of Secretary
19.4 Appointment of Secretary
19.5 Removal of Secretary
19.6 Duties of Secretary
19.7 Liabilities of Secretary
19.8 Let us sum up
19.9 Questions for discussion
19.10 Model answer to check your progress
19.11 References

19.0 MS AND OBJECTIVES

In the 18th lesson, we discussed the meaning, Number of Directors, qualification,

disqualification of director, appointment, removal, remuneration, power, duties
and liabilities of Director of a company .In this lesson we discuss the meaning,
qualification, disqualification of Secretary, appointment, removal, remuneration,
power, duties and liabilities of Secretary of a company. After going through this
lesson, you will able to
1. know the meaning of Secretary
2. understand Qualification and disqualification of Secretary of a company
3. study the methods of appointment of Secretary
4. know the power, duties and liabilities of Secretary of a company

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19.1 INTRODUCTION

The secretary is an important officer of the company who is appointed to perform

the ministerial or administrative duties. In modern times, the secretary has
become almost an indispensable person in trade, industry and other social
institutions. The secretary helps in conducting all correspondence, keeping all
records and accounts, writing of minutes, and also acts as public relations
officer of the employer i.e. acts as a liaison officer between the management and
the staff as well as the outsiders. The secretary is entrusted with the
responsibility for due compliance with all such legal formalities. As a matter of
fact, the secretary ensures that the affairs of the organization are conducted in
accordance with law.
19.1.1 Definition
The term secretary is defined in Section 2 (45) of the Companies Act, 1956 which
reads as under:
“Secretary means a company secretary within the meaning of clause (c) sub-
section (1) of Section 2 of the Company Secretaries Act, 1980, and includes any
other individual possessing the prescribed qualification and appointed to per
form the duties which may be performed by a secretary under this Act and any
other ministerial or administrative duties”.
Clause (c) of sub-section (1) of Section 2 of the Companies Secretaries Act, 1980,
referred to in the above section, reads as under:
“A company secretary is a person who is a member of the Institute of Company
Secretaries of India”.
Thus, it is evident from the above two provisions that a company secretary is a
person who is a member of the Institute of Company Secretaries of India, and
includes any individual who is appointed to perform ministerial or
administrative duties and to ensure that the affairs of the company are
conducted in accordance with the provision of the Companies Act, and articles of
association of the company. It may, however, he noted that a secretary duty is
not to mange the affairs of the company but to ensure that company’s affairs are
conducted in accordance with law. Thought, it is not secretary’s duty to manage
the affairs of the company, but he plays an important role in the day to day
business of the company. Now-a-days, he has become an important executive
officer of the company. He regularly makes representations on behalf of the
Company and enters into contracts on its behalf which come within the day-to-
day running of company’s business.

19.2 QUALIFICATION OF SECRETARY

In this section, we discuss the qualification of a secretary .The qualifications of a

secretary are prescribed in the companies (Appointment and Qualifications of
Secretary) Rules, 1988 . These qualifications are different for those companies

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having the paid up share capital of Rs.25lacs or more (i.e. not less than
Rs.25lacs), and for all other companies, and are discussed separately hereunder:
1. In the case of a company having a paid up share capital of not less than
rupees twenty five lacks. In the case of such a company, a person to be
appointed as a secretary must have the following qualification:
Membership of the Institute of Company Secretaries of India (ICSI).
2.In the case of ay other company. I the case of any other company i.e. other
than that mentioned above, a person to be appointed as secretary must have one
or more of the following qualifications:
(a) Member of the Institute of Company Secretaries of India.
(b) Membership of the Institute of Chartered Accountants of India.
(c) Membership of the Institute of Cost and Works Accountants of India.
(d) Membership of the Association of Secretaries and Mangers, Calcutta.
(e) Degree in law granted by any University.
(f) Post-graduate degree in commerce or corporate secretary-ship granted by
any University.
(g) Post-graduate degree of diploma in management sciences granted by any
University or by the Institute of Management, Ahemdabad, Bangalore,
Calcutta or Lucknow.
(h) Diploma in corporate laws and management granted by the Indian Law
Institute.
(i) Post-diploma in company secretary ship granted by the Indian Law Institute
of Commercial Practice, Delhi.
(j) Pass in the intermediate examination conducted by the Institute of
Company secretary of India.
It may, however, be noted that when the paid up share capital of such company
is increased to rupees twenty-five lacks or more, it must appoint a whole-time
secretary with the prescribed qualification (i.e. who is a member of the Institute
of Company Secretaries of India) within one year from the data of such increase
in the paid up share capital.

19.3 DISQUALIFICATION OF SECRETARY

In this section, we discuss the disqualification of secretary. Only an individual

can be appointed as a secretary. A firm or a body corporate cannot be appointed
as the secretary of the company

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19.4 APPOINTMENT OF SECRETARY

In this section, we discuss the methods of appointment of secretary. Normally,

the secretary is appointed by a resolution of the Board of Directors, and a
service agreement is executed between the company and the secretary in which
the terms and conditions of his appointment, remuneration, retirement etc. are
stated. The first secretary, if any, like the first directors, may be nominated in
company’s articles of association whose appointment may subsequently be
confirmed by a resolution of the directors passed in their first meeting after hiss
appointment. It may, however, be noted that a mere nomination in the articles of
association does not give a person the right to be appointed as the secretary,
unless an independent contract is proved between the company and the
secretary so named in the articles. As a matter of fact, a mere nomination in the
articles does not constitute a contract binding on the company to employ the
person so nominated. The person so nominated should ensure that his
appointment is confirmed at the first meeting of the Board of Directors after the
incorporation of the company. Otherwise, he will have no right against the
company.
The particulars about the appointment of a secretary by the company must be
sent to the Registrar of Companies within 30 days of appointment [Section 303].

19.5 REMOVAL OF SECRETARY

In this section, we discuss the methods of Dismissal of a secretary. We have

already discussed in the last article that a secretary is generally appointed by a
resolution of the Board of Directors. Likewise, a secretary may be dismissed (i.e.
remove from office) by a resolution of the Board of Directors. Since, the secretary
is an employee of the company, his dismissal is governed by the general law
applicable to master and servant. Thus, a notice of termination of secretary’s
employment must be given to him. In case, secretary’s contract of employment
provides for the notice of termination then his services can be terminated by
giving him the agreed notice. And if there is no express provision about such
notice in his contract of employment, then he is entitled to a respectable notice.
It will be interesting to know that in certain circumstances, a secretary may also
be dismissed from service without giving any notice of termination e.g., where he
is guilty of willful disobedience, misconduct or is incompetent or suffers from
permanent disability. The services of a secretary may also be terminated without
giving any notice if he makes secret profits.
It may be noted that even if the appointment of the secretary is for a fixed
period. He can be removed from office before the expiry of his term after giving
proper notice in this regard.

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Check your progress - 1

Explain the Status of Secretary
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson (pp)
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19.6 DUTIES OF SECRETARY

In this section, we discuss the various duties of a secretary. We know that a

secretary is an important officer of the company. However, he is only a
subordinate officer, and has no managerial functions. He being appointed by the
Board has no original authority. He is required to perform the duties assigned to
him under the Companies Act, and by the Board of Directors. The duties of a
secretary may be discussed under the following two heads, namely:
1. Statutory duties, and
2. General duties.

1.Statutory duties

These are the duties which a secretary is required to perform under the
Companies Act. Following are some of the important statutory duties of a
secretary:

1. To keep and maintain various registers (i.e. statutory books) of the

company, such as

(a) Register of investments held by the company in the name of its nominees
[Section 49 (7)].

(b) Register of charges [Section 143].

(c) Register of members [Section 150].

(d) Register of debenture-holders [Section 152].

(e) Register of contracts in which directors are interested [Section 301].

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(f) Register of Directors, managing director, manager, and secretary [Section

303].

(g) Register of shares held by directors [Section 307].

t is also secretary’s duty to make available for inspection the aforesaid

registers.

2. o file with the Registrar of Companies, necessary documents and returns,

such as

(a) Return of allotment of shares [Section 75].

(b) Annual return [Section 159, 160].

(c) Special resolutions and agreements [Section 192].

(d) Annual accounts i.e. Balance sheet, and Profit & Loss Account [Section
220].

3. To give notice to the Registrar for increase of share capital [Section

97].

4. To issue the certificates of shares, debentures and debenture stock

[Section 113].

5. To make necessary entries in the Register of members re-cording the fact of

issue of share warrant [Section 115].

6. To deliver for registration, to the Registrar, the particulars of mortgages

and changes [Section 125-127, 142].

7. To make statutory declaration for obtaining the certificate of

commencement of business [Section 149].

8. To keep minutes of the general meetings and make them available for
inspection [Section 196].

9. To sing the annual accounts of the company and send out their copies to
every member [Sections 215, 219].

10. To issue the necessary notice for calling the meetings of the shareholders,
and of the directors on the instructions of the Board of Directors [Sections
171, 286].

11. To arrange for issue of capital, to send letters of allotment, to issue call
notices, to certify valid transfer of shares, and to prepare dividend
warrants etc.

12. To assist in preparing the statement of affairs, in the case of company’s

winding up, for the purpose of submitting it to the liquidator [Section 454].

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2.General duties

These are the duties which a secretary is required to perform independent of his
statutory duties. The general duties of secretary vary with the size and nature of
the company, and the terms of his contract of employment. These may be
summed up as under:
1. To carry out the orders of the Board of Directors, and to perform such
other duties as may be entrusted to him by the Board from time to time.
2. To perform all statutory requirements on behalf of directors, managing
directors etc.
3. To advise the chairman to convene general meetings and to make
necessary arrangements in this behalf.
4. To attend all meetings of the Board of Directors and of the shareholders,
and record the proceedings of all such meetings, and to carry out the
instructions given at these meetings.
5. To superwise all issues of shares and debentures, and to perform all
necessary things in this respect e.g., issuing prospectus, inviting
applications, arranging for allotment, and issuing share certificates and
debentures.
6. To conduct correspondence with the shareholders in respect of calls on
shares, transfers of shares, forfeiture etc. of shares, and also to conduct
correspondence with the debenture-holders and the public.
7. To act as link i.e. a medium of communication between the shareholders
and the company, and to furnish the information required by the
shareholders after taking permission of the directors.
8. To organize and control the staff of the company, and to supervise their
work.
9. To look after the internal or office management of the company, and to
perform all ministerial acts.
10. Not to make any secret profits on account of his position as a secretary.
Moreover, he should also not disclose the confidential information relating
to the affairs of the company.

19.7 LIABILITIES OF SECRETARY

In this section, we discuss the various liabilities of a secretary .We know that it
is the duty of a secretary to se that company’s affairs are conducted in
accordance with the provisions of the Companies Act, and articles of association.
If default is made in complying with certain provision of the Companies Act, the
secretary may be held liable for fine and punishment. The reason for the same is
that Companies Act impose criminal liability on the ‘officers in default’ for

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certain provisions. A secretary being an officer of the company [Section 2 (30)],

he is also liable in all such cases. The liability of the ‘Officer in default’ has
already been discussed in detail in Art. 12.20 under the heading ‘criminal
liability of directors’. Some of the important provisions are stated below, ad the
secretary may be held liable in these cases:
1. If default is made in filing the return of allotment of shares with the
Registrar, every officer in default shall be punishable with fine upto Rs.500
for every day during which the default continues [Section 75].
2. It default is made in delivering the certificates of share or debenture, every
officer in default shall be punishable with fine upto Rs.500 for every day
during which the default continues [Section 113].
3. It default is made in marinating the register of members, the company and
its every officer in default shall be punishable with fine upto Rs.50 for
every day during which the default continues [Section 150]. In case the
default is in respect of register of debenture-holder, the total fine is Rs.50
[Section 152].
4. It default is made in maintaining the register of directors, managing
director, the company and its every officer in default shall be punishable
with fine upto Rs.50 for every day during which the default continues
[Section 303]. In case the default is in respect of register of shares held by
directors, the total fine is Rs.5,000 [Section 307].
5. If default is made in exhibiting the name and address of the registered
office of the company, the company and its every officer in default shall be
punishable with the upto Rs.50 for every day during which the default
continues [Section 147] the Registrar of Company, every officer in default
shall be punishable with fine upto Rs.500 for every day during which the
default continues [Sections 125, 142].
6. If default is made in filling the annual return with the Registrar of
Companies, every officer in default shall be punishable with fine upto
Rs.50 for every day during which the default continues [Sections 159, 162].
The default in filling the copies of annual accounts (i.e. balance sheet, &
profit and loss account) is also punishable with the same fine as stated
above [Section 220].
7. If default is made in holding the statutory meeting, every officer in default
shall be punishable with fine upto Rs.500 [Section 165]. The default in
holding the annual general meeting is also punishable with fine upto
Rs.5,000, and if the default continues, a further fine may extend to Rs.250
for ever day during which the default continues [Section 168].
8. If default is made in circulating members’ resolution, every officer in
default shall be punishable with fine upto Rs.5,000 [Section 188].
9. If default is made in registering the resolutions and agreements requiring
registration under the Act, the company and ever officer in default shall be
punishable with fine upto Rs.20 for every day during which the default
continues [Section 192].

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10. If default is made in recording the minutes of the meetings of the

shareholders and of the Board, the company and every officer in default
shall be punishable with fine upto Rs.50 [Section 193].
11. If default is made in giving the due notice of the Board meetings, every
officer in default shall be punishable with fine upto Rs.100 [Section 286].
12. If with the intention of defrauding or deceiving any person, the secretary
destroys, mutilates, alters or falsifies any books, papers etc., he shall be
punishable with imprisonment upto seven years and shall also be liable to
fine. A secretary shall be liable to the same punishment if he makes any
false or fraudulent entry in any register, books of accounts or document
belonging to the company [Section 539].
13. If the secretary makes a false statement in any return, report, certificate,
balance-sheet, prospects etc., be shall be punishable with imprisonment
upto two years, and shall also be liable to fine [Section 628].
14. If the secretary intentionally gives the false evidence, he shall be
punishable with imprisonment upto seven years, and shall also be liable to
fine [Section 629].

19.8 LET US SUM UP

In this lesson, we have briefly touched upon the following points; The secretary
is a person who is appointed under the Act to perform the duties as a secretary
and carry out other ministerial or administrative duties. .The company having
the paid up share capital of such amount as may be prescribed by the Central
Government, must have a whole time secretary. If such company fails to comply
in default shall be punishable with fine. However, two or more small companies
having paid up share capital less than the amount prescribed by the Central
Government may employ a common part time secretary. A company may have
more than one secretary. A director can also be appointed as a secretary of the
company besides being a director. Only an individual can be appointed as a
secretary. A firm or a body corporate cannot be appointed as the secretary of the
company

19.9 QUESTIONS FOR DISCUSSION

1. Define “Secretary”
2. Which company should have a secretary?
3. What are the qualifications prescribed for a secretary?
4. What are the duties of secretary of a company?
5. What are the liabilities of secretary?

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19.10 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 Explain the Status of Secretary

1. Secretary is a mere servant
2. Secretary as a statutory officer
3. Secretary as a co-ordinator
4. Secretary as an administrative officer

19.11 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-20
MEETING

CONTENTS
20.0 Aims and Objectives
20.1 Introduction
20.2 Requisition of Valid Meeting
20.2.1. Proper authority
20.2. 2. Proper notice
20.2.3. Contents of notice
20.2.4. Quorum for meeting
20.2.5. Chairman of the meeting
20.3 Types of Meeting
20.3.1. Meeting of Members (shareholders
20.3.1 (i). Statutory Meeting
20.3.1. (ii) Annual General Meeting
20.3.1. (iii). Extra-ordinary General Meeting
20.3.1. (iv) Class meeting
20.3.2 . Other Meetings
20.3.2. (i). Meetings of directors
20.3.2. (ii). Meetings of creditors
20.3.2. (iii). Meetings of debenture-holders
20.3.3 One-member Meeting
20.4 Let us sum up
20.5 Questions for discussion
20.6 Model answer to check your progress
20.7 References

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20.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning, qualification, and

disqualification of Secretary, appointment, removal, remuneration, power, duties
and liabilities of Secretary of a company. In this lesson we discuss the meaning
of meeting, Requisites of Valid Meeting and types of meeting. After going through
this lesson, you will able to
1. know the meaning of meeting
2. Understand requisites of Valid Meeting
3. study the various types meeting

20.1 INTRODUCTION

We know that the business of the company is carried on by the selected

representatives of the members, called the directors. The directors take decision
by calling their meetings. There are also certain matters which are to be decided
by the whole body of shareholder of the company. The share holders also decide
the matters by calling their meetings from time to time. The matters are decided
by passing resolutions.

20.2 REQUISITION OF VALID MEETING

In this section, we attempt to make a brief study of the essentials and Legal
Rules for a Valid Meeting
The company meetings are called to take decisions on the matters discussed in
the meeting. And such decisions are binding on the persons in respect of whom
the matters are decided. However, the decisions will have binding effects only if
the meeting is valid and is conducted in accordance with the procedure. The
following are the essentials and legal rules (i.e. procedure) for a valid meeting:
20.2.1. Proper authority. It is an important requirement of a valid meeting
that it should be called by a proper authority. The proper authority to call a
general meeting of the members in the Board of Directors. The Board of
Directors should pass a resolution at Board meeting to call the general meeting.
If meeting of Board of Directors is itself unlawful (e.g., some lawfully constituted
directors are prevented from attending the Board meeting), then the decision
taken at such meeting to call the general meeting of the shareholders shall also
be invalid [Harben V. Phillips (1883) 23 Ch. D. 14].
But if the meeting of the Board of Directors is only irregular i.e. not properly
constituted (e.g., there is some defect in the appointment or qualifications of the
directors), then the general meeting of members called by a resolution at such
Board meeting may not be invalid [Brown V. La Trinidad (1887) 37 Ch. D. 1]

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20.2. 2. Proper notice. It is another important requirement of a valid meeting

that a proper notice to call the meeting should be given to every member of the
company. It may be noted that deliberate omission to give notice to a single
member may invalidate the meeting. However, an accidental omission to give
notice to, or non-receipt of it by, a member will not invalidate the meeting
[Section 172 (3)]. The notice should be in writing, and it should be given 21
days before the date of the meeting (Section 171). In computing the period of 21
days, the date of receipt of notice and the date of the meeting should be
excluded. Thus, the gap should be of 21 clear and whole days [Pioneer Motors
(P) Ltd. V. Municipal Council, Nagarcoil, AIR 1967 SC 684].
The period of 21 days is computed from the date of receipt of notice by the
members. It will be interesting to know that the notice is deemed (i.e.
considered) to have been received by the members at the expiration of 48 hours
after the letter containing the notice is posted [Section 53 (2) (b) (i)].
Similarly, a notice posted on 16th October, for a meeting to be held on 7th
November was held to be invalid. Here also the gap was only of 20 clear days
(i.e. from 18th October to 6th November).
It will be interesting to know that in the following circum-stances, a meeting can
also be called by giving a shorter notice (i.e. notice of less than 21 days). These
circumstances have been recognized by the Companies Act itself [Section 171
(2)]:
(a) In the case of annual general meeting, if all the members entitled to vote
agree for a shorter notice.
(b) In the case of any other meeting, if the members who hold 95% of the paid
yup share capital and are entitled to vote, agree for a shorter notice. If the
company has no share capital, the members who hold the 95% of the total
voting power agree for a shorter notice.
It may also be noted that the members may give their consent for a shorter
notice either before the meeting, at the meeting or after the meeting [re Self Help
Private Industries Estate Ltd. (1972) 42 Company Cases 605, (1975) 45
Company Cases 157].
20.2.3. Contents of notice. The notice of meeting must specify the following
particulars:
(a) The place, day and hour of the meeting.
(b) The nature of the business to be transacted at the meeting [Section 172 (1)].
The business to be transacted at the meeting may be of the following two
kinds (Section 173) :
(i) Special business, and (ii) General business.
The notices of special business must state the purpose giving full disclosure of
all facts for which the meeting is called. It is necessary to enable the
shareholders to understand the nature of the business so that they may make

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up their mind whether to attend the meeting or not. The purpose of meeting
may be made known to the members by annexing a explanatory statement to the
notice. If the notice does no given full disclosure of the purpose of the meeting,
it is bad in law i.e. invalid. And the meeting held in pursuance of such notice is
also invalid.
Thus, if the notice does not specify the nature of the business to be special and
does not give full disclosure in this regard, it is bad in law.

20.2.4. Quorum for meeting. The term ‘quorum’ may be defined as the
minimum number of members that must be present at the valid meeting so that
the business can be validly transacted at the meeting. If the quorum is not
present, the meeting shall not be valid and the proceedings of such meeting
shall be invalid. Generally, the quorum is fixed by the articles of association of
the company. However, Section 174 of the companies Act provides for the
minimum number of members to constitute the quorum.
(a) In case of public company, 5 members personally present at the meeting.
(b) In case of any other company, 2 members personally persent at the meeting.
Thus, the articles of association cannot provide for a smaller quorum than the
above though it may provide for a larger quorum. It may be noticed that for the
purpose of quorum, only the members present personally are counted, and no
‘proxy’ shall be counted. Even the company cannot, by its articles of
association, provide for the ‘proxy’ being counted for the purpose of quorum.

The following points are important in connection with the quorum of a meeting:
(a) The quorum required is the quorum to be present at the time of beginning
to consider the business, and it need not be present throughout or at the
time of taking vote on any resolution [Re Hartley Baird Ltd. (1955) 1 Ch.
143; (1954) All England Reporter 695
(b) Any resolution passed without a quorum is invalid.
(c) In case, the total number of members of a company becomes reduced below
the quorum fixed for a meeting, then the rules as to quorum will be satisfied
if all the members of the company are present e.g., where the number of
members of a company is 400 and the quorum fixed by the articles is 75
members. Subsequently 350 members have sold their shares to the
remaining 50 members. In this case, all the 50 members present
personally will constitute a valid quorum even if the quorum fixed by the
articles is 75 members.

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(d) In case, the meeting is called on the requisition of members, it shall stand
dissolved if the quorum is not present within half an hour from the time for
holding the meeting of the company. But in other cases (i.e. where it is not
called on the requisition of members), the meeting shall stand adjourned to
re-assemble in the next week on the same day at the same time and place,
or to such other day, time and place as the Board of Directors may
determine. And if at the re-assembled meeting also the quorum is not
present within half an hour from the time of holding the meeting, as many
members as are actually present shall constitute quorum. However, the
articles of the company may provide otherwise.

20.2.5. Chairman of the meeting (Section 175). A chairman is necessary for

conducting a meeting properly. He presides over the meeting, and his main
function is to keep order and see that the business is properly conducted.
Legally speaking, the chairman is the proper person to put resolution to the
meeting, count the votes, declare the result and authenticate the minutes by
signature.
The appointment of the chairman is usually regulated by the articles of
association of the company. But if there is nothing in the articles, the members
personally present at the meeting shall elect one of themselves to be the
chairman of the meeting. Sometimes, there are differences among the members,
and a peaceful meeting is impossible under the chairmanship of a person
appointed by one group. In such cases, the chairman may be appointed by the
court [Selvaraj V. Mylapore U.P Fund (1968) 1 Company Law Journal 93
(Madras)].

The duties of a chairman may briefly be stated as under:

(a) He must act honestly and in the interest of company as a whole.
(b) He must ensure that the meeting is properly called and constituted, and
also ensure that the proceedings at the meeting are properly and regularly
conducted.
(c) He must give a reasonable chance to members who are present to discuss
any proposed resolution.
(d) He must exercise correctly and honestly his powers of adjournment of the
meeting and of demanding a poll.
(e) He must preserve order in the meeting.

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Check your progress – 1

Explain with example “Ordinary business” and “Special business”
Note:
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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20.3 TYPES OF MEETING

In this section, we discuss different types of meetings. The meeting of a

company may broadly be classified into the following two categories:
1. Meeting of members
2. Other meetings
20.3.1. Meeting of Members (shareholders)
The meeting of the shareholders can be of four kinds, namely
1. Statutory meeting.
2. Annual general meeting.
3. Extra-ordinary general meeting.
4. Class meeting
20.3.1 (i). Statutory Meeting
It is the first meeting of the members of the company after its incorporation. It
must be held within 6 months from the date at which the company is entitled to
start business (Section 165). It may be noted that the statutory meeting is held
only once in the life time of the company. The purpose of this meeting is to
acquaint the members with all the important facts relating to the new company
to enable them to know the position and future prospects of the company. Every
public company limited by shares and every public company limited by
guarantee and having a share capital is required to hold this meeting. A private
company and a public company limited by guarantee which has no share
capital, is not required to hold the statutory meeting. The legal provisions

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relating to the statutory meeting are contained in Section 165 and may be
summed up as under
The statutory meeting must be held within a period of not less than one month
and not more than six months from the date of which the company is entitled to
commence business. In other words, it must be. held within 6 months from the
date on which the company is entitled to start the business but it cannot be held
within the first one month from that date, e.g., a company entitled to commence
business on 1st July 2002, must held its statutory meeting within the period
commencing from 1st August, 2002 to 31st December,2002 .
The Board of Directors is required to prepare a report called the ‘statutory
report’. This report must be sent to every member of the company at least 21
days before the day on which the meeting is to be held. However, the delay in
sending the report may be condoned by all the members who are entitled to
attend and vote at the meeting.
The statutory report is sent to the members to enable them to know the full
information on all the important matters relating to the company. It must
contain the following particulars:
(a) The total number of shares allotted giving their all details.
(b) The total amount of cash received by the company in respect of all the
shares allotted.
(c) An abstract of receipts and payments of the company and the particulars
of balance in hand.
(d) The particulars of directors, managers, secretary and auditors.
(f) The particulars of a contract requiring company's approval.
(g) The arrears of calls due from directors, managers.
4. The statutory report must be certified as correct by at least two directors,
one of whom must be a managing director if there is any. After the report
is certified as above, it should also be certified as correct by the auditors of
the company.
5. After the copies of the statutory report have been sent to the company, a
certified copy of the report should also be sent to the Registrar of
Companies for registration.
6. At the commencement of the meeting, the Board of Directors shall produce
a list of members showing their names, addresses and occupations along
with the number of shares held by them. Such list shall remain open and
accessible to any member of the company during the continuance of the
meeting.
7. The members present at the meeting shall be at liberty to discuss any
matter relating to the formation of the company. They may also discuss
any matter arising out of the statutory report.

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8. The meeting may adjourn from time to time. A resolution may be passed
at any such adjourned meeting if due notice has been given in the
meantime.
We have noted above that a private company is not required to hold a statutory
meeting. But if it subsequently becomes a public company under Section 43-A
i.e. a deemed public company (e.g., where 25% of the paid up share capital of a
private company is held by one or more body corporate), it is required to hold
the statutory meeting if such conversion from private to public company takes
place within six months of its incorporation.

20.3.1. (ii) Annual General Meeting

It is the regular meeting of the members of the company. It must be held in
each year in addition to any other meeting [Section 166 (1)]. The purpose of this
meeting is to provide an opportunity to the members of the company to express
their views on the management of company’s affairs. Thus, this meeting enables
the shareholders to exercise control over the company because they may discuss
and review the working of the company. They may ask any question relating to
the accounts and affairs of the company. The interest of the shareholders is
therefore, protected by the annual general meeting. The legal provisions relating
to the annual general meeting are contained in Sections 166 to 168, with may be
summed up as under:
1. The annual general meeting must be held once in each year in addition to
any other meetings. And the gap between one meeting and the next
should not be more than 15 months. However, for special reason, the
registrar of Companies may extend the time within which the annual
general meeting shall be hold, but the extension cannot exceed 3 months.
2. The first annual general meeting must be held within 18 months of the
incorporation of the company, and this time cannot be extended even by
the Registrar. The subsequent annual general meetings should be held in
each year within 15 months from the last meeting.
3. At least 21 days notice of the meeting in writing, must be given to every
member of the company. A shorter notice may also be given if agreed to by
all the members who are entitled to vote at the meeting. The place, day
and hours should be specified in the notice (Section 171,172).
4. The meeting must be held during the business hours and on a day which
is not a public holiday.
5. The meeting must be held during the business either at the registered
office of the company, or at some place within the city, town or village in
which the registered office is situated.
6. If the company fails to hold the annual general meeting, the consequences
will be as under:

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(a) Any member of the company can apply to the Company Law Board for
calling the meeting. On such application, the Company Law Board may
order the calling of the meeting or it may issue directions for calling the
meeting. A meeting called by the order of the Company Law Board shall be
deemed to be an annual general meeting of the company (Section 167).
(b) The company and every officer in default shall be punishable with fine up
to Rs. 5000, and if the default continues, with a further fine upto Rs.
250for every day after the first day of default during which the default
continues. This penalty is also there if the meeting is not held in
accordance with the directions of the Company Law Board (Section 168).
Thus, there must be one annual general meeting per year, and as may meetings
as there are years. If this meeting is not held in any year, the company and
every officer in default shall be punishable with fine, as stated above.
It may, however, be noted that when the first annual general meeting is held
within 18 months of incorporation of the company, than no annual general
meeting will be required for the year of incorporation or for the following year
[Section 166 ].
The annual general meeting is an important meeting of the company which gives
an opportunity to the members to review the working of the company and to
express their views on the management of company’s affairs. The importance of
this meeting is evident from the following points. :
(a) The annual accounts of the company are presented at this meeting for
consideration of the shareholders.
(b) The dividends are declared at that meeting.
(c) The auditors of the company retire at this meeting, and their appointments
are also made.
(d) The directors, liable to retire by rotation retire at this meeting, and
appointments in their place are also made at the meeting. This enables the
shareholders to appoint the directors who can best protect their interest.
20.3.1. (iii). Extra-ordinary General Meeting
It is the meeting other than the statutory and the annual general meeting of the
company (Clause 47 of Table A, Schedule I). This meeting is called for dealing
with some urgent special business which cannot be postponed till the next
annual general meeting. The legal provisions relating to the extra-ordinary
general meeting are contained in Section 169 and may be summed up as under:
1. The extra-ordinary general meeting may be called by the Board of Directors
on its own motion whenever it thinks fit to call the meeting (Clause 48 of
Table A, Schedule I).

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2. The extra-ordinary general meeting becomes necessary on the requisition

of members. As a matter of fact, on requisition of members, the directors
are bound to call an extra-ordinary general meeting.
3. The requisition for calling this meeting must be signed by such number of
members who hold at least 1/10 of the paid up capital of the company,
and have the right to vote at the meeting on the matter. And if the
company has no share capital it must be signed by such number of
members who have at least 1/10 of the total voting power.
4. The requisition must set out the matters for the consideration of which the
meeting is to be called, and it must be signed by the requisitionists. And it
should be deposited at the registered office of the company.
5. Only such matter can be taken up at the meeting which is specified in the
requisition and in respect of which the requisitionists have the voting
strength as stated in clause (3) above.
6. On deposit of a valid requisition at company’s registered office, the
directors must move to call a meeting within 21 days, and the meeting
must actually be held within 45 days from the date of deposit of
requisition.
7. If the Board does not proceed to call the meeting, the requisitionists may
themselves proceed to call the meeting. However, the requisitionists must
hold the meeting within 3 months from the deposit of the requisition.
Note. The requisitionists may also claim from the company the reasonable
expenses incurred by them in calling the meeting. And the company may
deduct such sums out of the remunerations payable to the directors in default.
8. The Company Law Board also has the powers to call extraordinary meetings
which may be discussed as under (Section 186) :
(a) Sometimes, it is impracticable to call, hold or conduct the meeting of a
company, other than, an annul general meeting. In such cases, the
Company Law Board is empowered to call, hold and conduct the meeting.
The term ‘impracticable’ means not possible to call, hold or conduct the
meeting in a manner prescribed by the Companies Act, or articles of
association of the company.
(b) The Company Law Board can order a meeting to be called, held or
conducted in accordance with its directions.
(c) The Company Law Board can make such order either of its own motion or
on the application of any director or member who is entitled to vote at the
meeting.
20.3.1. (iv) Class meeting
It is the meeting of a particular class of shareholders. Generally, the companies
have two classes of shareholders, namely (a) equity shareholders and (b)

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preference shareholders. In order to discuss the matters affection one class,

only a meeting of the particular class of shareholders is held. It may be noted
that at a class meeting, only the shareholders of the particular class have the
right to be present. E.g., if the rate of dividend on preference shares is to be
reduced, the meeting of preference shareholders will be called at which only the
preference shareholders are entitled to be present. The most frequent case of
holding the class meeting is that if the rights attached to the shares of any
particular class of shareholders are to be varied, a separate meeting (i.e. class
meeting) of that particular class of shareholders must be held and the matter
should be approved at the meeting by a special resolution (Section 106).
20.3.2. Other Meetings
We have discussed in previous sections, only the meetings of the members of the
company. In addition to these meetings, there are other company meetings also
which may be discussed under the following heads:
20.3.2.(i) Meetings of Directors.
According to Section 285, we know that the directors are responsible for the
overall control and supervision of the affairs of the company. The directors
generally act collectively i.e. as Board of Directors unless the powers have been
delegated to individual directors. It will be interesting to know that their
meetings are more frequent than the meetings of shareholders. A company
must hold meeting of its Board of Directors at least once in every three calendar
months. And there must be at least four meetings of the Board of Directors in
every year
20.3.2.(ii) Meetings of Creditors.
According to Section 391, the meetings of creditors are held by an order of the
court. Sometimes, a compromise or arrangement is proposed between a
company and its creditors or any class of creditors. In such cases, the court
may order a meeting of creditors or a class of creditors to be called, held and
conducted in such manner as the court directs. The court orders such a
meeting on the application of the company, or of any creditor or member of the
company. In case the company is in liquidation, the application may be filed by
the liquidator
20.3.2.(iii) Meetings of debenture-holders.
The meetings of the debenture-holders may be held from time to time in
accordance with the provisions contained in the debenture trust deed. Their
meetings are usually held when the conditions of the issue of debentures are to
be altered. Where a scheme of compromise or arrangement is proposed, the
meetings of the debenture-holders may also be held through an order of the
court.
20.3.3 One-member Meeting
We know that the quorum must be present for a valid meeting, which is five
members in case of a public company, and two members in case of private

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company. Thus, a single member cannot constitute a valid meeting. As a

matter of fact, the word ‘meeting’ means the coming together of more then one
persons. Moreover, Section 174 also states that the members actually present
shall be the quorum. Thus, where only one member attends the meeting, the
meeting cannot be validly held. This is known as the rule of Sharp V. Dawes as
this point was decided in this case which is discussed in the following example.
However, there are certain exceptional circumstances in which a single member
present may constitute a quorum, and meeting can be validly held. These are as
under:
1. Where one person holds all the shares of a particular class, he alone can
constitute a meeting of that class and can pass a resolution by signing it.
2. Where the general meeting is called by an order of the Company Law Board,
this Board may give the direction that one member of the company present
in person or by proxy shall be deemed to constitute a meeting (Section 167
Explanation).
3. Where the meeting (other than the annual general meeting) is called by an
order of the Company Law Board, this Board may give the direction that one
member of the company present in person or by proxy shall be deemed to
constitute a meeting (Section 186 Explanation).
Check your progress - 2
Note: List out the contents of the statutory report
a) Write your answer in the space given below
b) Check your answer with the ones given at end of this lesson ( pp)
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20.4 LET US SUM UP

In this lesson, we have briefly touched upon the following points: Meetings are
classified as under: (1) General Meetings; (2) Class meetings; (3) Meeting of
creditors and debenture holders; (4) Meetings of Directors. General Meetings are
meetings of the share-holders. They are further classified into: (1) Statutory
meeting: This is the first meeting of a public company which is to be held within
a period of not less than one month or more than six months from the date on
which the company is entitled to commence business 21 days before this
meeting, the Board of Directors shall forward a statutory report to every member

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of the company containing the prescribed particulars. At the statutory meeting,

the Board produces the list showing the names, addresses and occupations of
the members of the company. (2) Annual General Meeting: Every company shall
in each year hold, in addition to any other meeting, a general meeting as its
Annual General Meeting. Not more than 15 months shall claps between the date
of one annual general meeting and that of the next. The company shall hold its
first Annual General Meeting within 18 months from the date of its
incorporation. Annual General Meeting shall be called by giving 21 days’ prior
notice to the effect. It shall be called during busijness hours. T the Annual
General Meeting the members shall consider the accounts of the company,
appointment of auditors and fixation of their remuneration, declaring a divided
and appointing Directors in place of those retiring. (3) Extra-ordinary General
Meeting: Any meeting other than statutory and Annual General Meeting is called
an Extraordinary General Meeting. All business transacted at this meeting shall
be special. It shall be convened by the Board of Directors on the requisition of
not les than 1/40th of be members holdings paid-up capital of the company.
Within 21 days of the deposit of the requisition the Board shall proceed to call a
meeting within 45 days from the deposit of the requisition. 21 days notice of
such a meeting shall be given.
Class Meetings: These are the meetings of Equity shareholders and Preference
shareholders respectively. They are held in case where their rights are sought to
be affected. Meetings of creditors and debenture holders: These meetings are
held generally, in case of winding-up of the company or in case of proposed
scheme of arrangement compromise.
Meeting of Board of Directors: The meetings of Board of Directors shall be held
at leas once in every three months and at least four such meetings shall be held
in every year. The quorum of the meeting of the Board of Directors shall be 1/3rd
of its strength or two Directors, whichever is higher.
The company Law Board may on its own motion or on application of any
Director or member of the company, order a meeting of the company to be
called.
Essential of a valid meeting: (1) It shall be convened by the Board of Directors.
(2) 21 days prior notice in writing is to be given. (3) In case where special
business is to be transacted, explanatory statement is to be attached.
Quorum: Five members in case of a public company and two members in case of
any other company shall be the quorum for a meeting of the company if the
quorum is not present within half an hour from the time appointed for holding
the meeting and where such meeting has been called upon requisition of the
members, the same shall stand dissolved. In any other case the meeting shall
stand adjourned to the same day in the next week at the same time and place.
Chairman of the meeting: Members personally present shall elect one of
themselves to be the Chairman of the meeting. It poll is demanded, it shall be
taken forthwith. The Chairman shall conduct the proceedings at the meeting.

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20.5 QUESTIONS FOR DISCUSSION

1. Classify the different types of meetings under the Companies Act and
explain the provisions relating to each?
2. What are the essentials to be complied with for a valid meeting?
3. How are the matters in a meeting decided upon?
4. What us a statutory meeting?
5. What is a statutory report and what are its contents?

20.6 MODEL ANSWER TO CHECK YOUR PROGRESS

Check-1 Explain with example “Ordinary business” and “Special business”

In the case of an annual general meeting, the following business is deemed as
ordinary business 1.Business relating to the consideration of the accounts,
balance sheet and the reports of the Board of directors and auditors, and
declaration of dividend, the appointment of directors in place of those retiring ,
the appointment of auditors and the fixing of their remuneration.
Special business: In the case of an annual general meeting, any business other
than the ordinary business, and in the case of any other meeting, asll business,
is deemed special. Special businesses are removal of a director, issue of rights
and bonus shares and election of a person as director.
Check-2 List out the contents of the statutory report
a) Total shares allotted,
b) Cash received,
c) Abstract of receipts and payments,
d) Directors and auditors details e) Contracts
f) Underwriting of contracts
g) Arrears of calls
h) Commission and brokerage
i) Certification of report and a copy of the report to be sent to the registrar.
[

20.7 REFERENCES

1. “ Company law” -- A.K. Bagrial

2. “Principles of modern company law” – L.C.B. Gower
3. “Business Law” -- M.R. Sreenivasan

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LESSON-21
WINDING UP - COMPULSORY WINDING UP BY THE COURT

CONTENTS
21.0 Aims and Objectives
21.1. Introduction
21.1.1 Meaning
21.1.2 Definition of winding up
21.2 Modes of winding up
21.3 Compulsory winding up by the Court
21.3.1. Special resolution by the company
21.3.2. Default in holding statutory meeting
21.3.3. Failure to commence business
21.3.4. Reduction in membership
21.3.5. Inability to pay debt
21.3.6. Just and equitable
21.4 Persons Entitled to apply for winding up
21.4. 1. Petition by the company.
21.4.2. Petition by the creditors
21.4.3. Petition by the contributories
21.4.3. Petition by the contributories
21.4.3. Petition by the contributories
21.4.4. Petition by the registrar
21.4.5. Petition by any person authorized by the central government
21.5 Legal provisions applicable to compulsory winding up
21.5.1. Commencement of winding up
21.5.2. Powers of the court on the presentation of the petition
21.5.3. Consequences of winding up order.
21.5.4. Procedure for compulsory winding up.
21.5.5. Appointment of official liquidator.
21.5.6. Statement of affairs
21.5.7. Report by Official Liquidator

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21.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning of meeting, Requisites of Valid

Meeting and types of meeting. In this lesson we discuss the meaning of winding
up of a company and Modes of winding up. After going through this lesson, you
will able to
1. Know the meaning of winding up of a company
2. Understand the various Modes up winding up

21.1. INTRODUCTION

The term ‘winding up’ of a company may be defined as the proceedings by which
a company is dissolved (i.e. put to an end). In this section , we discuss the
meaning and definition of winding up of company.

21.1.1 Meaning

Winding up is the process of putting an end to the life of the company. And
during this process, the assets of the company are disposed of the debts of the
company are paid off out of the realised assets or from the contribution of its
members. If any surplus is left, it is distributed among the members in
proportion to their rights in the company. The winding up of the company is
also called the ‘liquidation’ of the company. The process of winding up begins
after the court passes the order for winding up. And till such order is passed
there cannot be any winding up in fact.

21.1.2 Definition of winding up

According to Prof. Gowar defines, “Winding up of a company is the process

whereby its life is ended and its property is administered for the benefit of its
creditors and members. And an administrator, called a liquidator, is appointed
and he takes control of the company, collects its assets, pays its debts and
finally distributes any surplus among the members in accordance with their
rights”.

It may be noted that the company is not dissolved immediately on the

commencement of the winding up proceedings. As a matter of fact, the winding
up of a company precedes its dissolution i.e. the winding up is the prior stage
and the dissolution, the next. On the dissolution, the company is no more in
existence, and its name is struck off by the Registrar from the register of
companies. But on the winding up, company’s name is not struck off from the
register. Thus, in between the winding up and dissolution, the legal status of
the company continues and it can be sued in a Court of Law.

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21.2 MODES OF WINDING UP

In this section, we discuss the modes of winding under the following three
heads, namely:
1. Compulsory winding up by the court.
2. Voluntary winding up without the intervention of the court.
3. Voluntary winding up with the intervention of the court i.e. under the
supervision of the court.

21.3 COMPULSORY WINDING UP BY THE COURT

The winding up of a company by an order of the court is called the compulsory

winding up. Section 433 of the Companies Act contains the cases in which the
company may be would up by the court. The court may wound up the company
on a petition submitted to it on any of the following grounds:

21.3.1. Special resolution by the company [Section 433 (a)]

Some-times, the company passes a special resolution to the effect that the
company be wound up by the court. In such case, the court may order the
winding up of the company on a (i.e. application) presented to it by company or
contributory.

It may be noted that the passing of special resolution by the company itself is a
ground for presenting a petition to the court. And no other ground (or reason) is
required for presenting the petition. Thus, a winding up petition under this
clause is maintainable simply if the company passes a special resolution that it
be wound up by the court. However, the court is not bound to order the wind
up of the company. It his discretionary power in this regards, and may refuse to
wind up the company, when it is opposed to public interest or company’s
interest. A winding up petition under this clause can be presented by the
company or the contributory.

21.3.2. Default in holding statutory meeting [Section 433 (b)]

We know that the company must hold the statutory meeting within 6 months
from the date on which the company is entitled to commence its business. And
before the holding of the meeting, the statutory report by the directors must also
be delivered to the registrar for registration (Section 165). If default is made in
delivering the statutory report to the Registrar, or in holding the statutory
meeting, the court may order the winding up of the company on a petition
presented to it by the Registrar or contributory. However, the court is not bound
to order the winding up of the company. Instead of making a winding up order,
the court may also direct that the statutory report be delivered to the court may

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also direct that the statutory report be delivered to the registrar, or that the
statutory meeting be held [Section 443 (3)].

A winding up petition under this clause can be presented by the Registrar of

Companies or the contributory (i.e. shareholder).A private company is neither
required to hold a statutory meeting nor to deliver a statutory report to the
Registrar. A petition for winding up of a private company is, therefore, not
maintainable under this clause [Sec (1978) 48 Company Cases, Page 672
(Madras)].

21.3.3. Failure to commence business [Section 433 (c)]

Sometimes, the company fails to commence the business within one year from
its incorporation, or suspends its business for the whole year. In such cases,
the court may order the winding up of the company on a petition presented to it
by the Registrar or contributory. However the court will exercise its power only
when there is a fair indication that there is no intention to carry on the
business, or that it is not possible for the company to carry on its business.

A winding up petition under their clause can be presented by the Registrar of

companies or contributory (i.e. shareholder).

It is, however, important to note that where the suspension of business is due to
temporary causes and is sufficiently accounted for (i.e. explained), the court may
refuse the winding up.

Similarly, where the suspension of business is due to depression in trade, and

the company has the intention to continue its business when trade prospectus
improves, the winding up is generally refused by the court.

Note. Sometimes, a company has many businesses. In such cases, it can not
be wound up if it has suspended or cased to carry on one of the several
businesses. As a matter of fact, the suspension must be of the entire business
and not of a part of it.

21.3.4. Reduction in membership [section 433 (d)]

We know that a public company must have at least seven members, and a
private company at least tow. If the membership of any company is reduced
below this limit, the court many order the winding up of the company.

A winding up petition, under this clause, can be presented by the Registrar of

Companies or contributory (a member i.e. shareholder who presents a winding
up petition is called contributory on the presentation of the petition).If the
company carries on its business with reduced members for more than 6 months,
the members will be personally liable for the payment of company’s debts
contracted during that time (Section 45).

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21.3.5. Inability to pay debt [Section 433 (e)]

Sometimes, the company is unable to pay its debts. In such cases, the court
may order the winding up of the company.

The term ‘debt’ here means a definite sum of money which is due and
immediately (i.e. presently) payable by the company. A conditional liability (i.e.
amount payable upon some condition) is not a debt unless the condition has
happened.

The term ‘inability to pay’ here means company’s inability to pay its current
liabilities. In other words, company’s inability to pay its liabilities (i.e. claims) as
and when they arise in the ordinary course of business. Thus, inability to pay
debts is to be taken in the commercial sense. The test of ‘inability to pay debts’,
therefore, is whether the company can pay its existing liabilities, a petition for
winding up is maintainable even if it may have very valuable assets not
presently realisable. The Companies Act recognises the following three cases in
which a company shall be deemed to be unable to pay its debts [Section 434]:

(a) It a creditor to whom the company owes a sum exceeding Rs.500, has
served on the company a demand notice for the payment of his amount.
And the company has for three weeks thereafter neglected to pay the
amount, or has otherwise neglected to satisfy his claim by compromise etc.

(b) If a creditor of the company obtains a decree from the court for the
payment of his debts by the company, and the execution issued on the
decree in favour of the creditor is returned unsatisfied in whole or in part.

(c) If it is proved to the satisfaction of the court that the company is unable to
pay its debts.

It is important to note that under clause (a) above, a winging up petition can be
filed against the company only if the company owes Rs.500 or more to a creditor.
There is no such condition as to amount in respect of clause (b). The unsatisfied
execution of a decree for any amount, however, small, amounts to inability to
pay debts. The case of commercial insolvency (i.e. where a company is not in a
position to meet its current liabilities) are covered under clause (c). In company
the time of three weeks, the day on which notice is dispatched and the day on
which it is served should both be excluded.

A notice of demand giving less than three weeks time dose not makes the
demand ineffective. It only postpones the right of action to a date after the
expiry of three weeks. In execution proceedings, a person against whom a decree
is passed is ordered to pay the amount for which decree is passed. In fact, by
way of execution proceedings, a practical shape is given to a decree i.e. a court’s
final order in which a person is held liable to pay.

A creditor who has obtained a money decree against the company is not bound
to initiate execution proceedings in order to bring his case under clause (b) for
the purpose of winding up. He may also give a statutory notice to the company

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as required under clause (a) above if the amount of the decree is Rs. 500 or
more, and may file a winding up petition if the company neglects to pay.

A winding up petition on the ground of company’s inability to pay can be filed by

the creditor, contributory or Registrar of companies.

Above, we have noted the cases where the winding up of a company may be
allowed by the court on the ground of company’s inability to pay debts.
However, in the following cases, a winding up order will not be made by the
court:

(a) Where the debt it not presently payable by the company.

(b) Where the debt is not a definite (i.e. certain) amount, and includes
unliquidated damages.

(c) Where the debt has become time-barred on the date of petition. A ‘time
barred debt’ is that which cannot be recovered due to the expiry of
limitation period within which it should have been recovered.

(d) Where the debt is bona fide (i.e. honestly) disputed by the company. In
other words, when there is a bona fide and reasonable dispute about the
debt. In such cases, there will be valid and genuine excuse for non-
payment of the debts. However, if the dispute is not real but is raised by
the company for the sake of avoiding payment or raising a controversy on
flimsy (or false) grounds, the winding up order may be passed by the court.

(e) Where there is a bona fide counter claim put forward by the company. The
‘counter claim’ means the claim (i.e. amount) which the company has to
recover from the creditor who has presented the petition. In such cases
also, there will be a valid excuse for non-payment of the debts.

21.3.6. Just and equitable [Section 433 (f)]

Sometimes, the court is of the opinion that it is just and equitable that the
company should be wound up. In such cases, the court may order the winding
up of the company. This clause gives a very wide discretionary power to the
court to order the winding up whenever it appears desirable. The words ‘just
and equitable’ are not to be interpreted as covering the cases of like cases of like
nature as discussed above. Under this clause, the court may order winding up
on any ground. However, there must be some strong ground for winding up of
the company. The court may give due winding up on any ground. However,
there must be some strong ground for winding up of the company. The court
may give due weight to the interest of the company, its employees, creditors and
shareholders. The interest of general public should also be considered. The
court may refuse to make an order of winding up if it is of the opinion that some
other remedy is available to the petitioner, and instead of pursuing other
remedy, is available to the petitioner, and instead of pursuing other remedy, he
is acting unreasonable in seeking the winding up of the company.

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A winding up petition on ‘just and equitable’ ground can be filed by a

contributory, Registrar of companies or by a person authorised by the Central
Government.

Following are some of the circumstances in which the courts have ordered
winding up on ‘just and equitable’ grounds:

(a) Complete deadlock in the management of the company. Sometimes, there

is complete deadlock in the management of the company. In such cases,
the court may order the winding up of the company on just an equitable
ground. The ‘deadlock’ in company’s management occurs where the
directors lose confidence in each other and disagree on each and every
matter.

(b) Failure of company’s main object. Sometimes, the main object of the
company fails to materialize. In such cases, the court may order the
winding up of the company on just and equitable grounds.

Similarly, where the only business of a company was life insurance business, it
was ordered to be wound up on just and equitable ground when the life
insurance business was taken over by the central Government [See Re
Hindustan Co-operative Society Ltd, (1961) 31 Company Cases 193].

However, a winding up order is not passed on the basis of a temporary difficulty

which does not make it impossible for the company to carry out its objects.

(c) Recurring losses. Sometimes, it is not possible for the company to carry
on the business except at losses i.e. there is no reasonable hope of trading
at a profit. In such cases, the court may order the winding up of the
company on just and equitable grounds.

However, a winding up order is not passed by the court on the ground that the
company has made losses in the current year and is likely to make further
losses. As a matter of fact, a mere apprehension on the part of shareholders
that losses will occur in future is no ground for winding up. To obtain a winding
up order from the court, it must be shown that there is no reasonable prospect
of earning profit.

(d) Aggressive or oppressive policy of majority shareholders. Sometimes, the

majority shareholders adopt an aggressive or oppressive policy towards the
minority shareholders. In such cases, the court may order the winding up
of the company on ‘just and equitable’ ground.

(e) In corporation of company for fraudulent or illegal purpose. Sometimes,

the company is incorporated for fraudulent or illegal purposes. In such
cases, the court may order the winding up of the company on just and
equitable ground.
Similarly a company which has ceased to carry on its authorized business and is
engaged in illegal business is liable to be wound up on just and equitable
ground.

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21.4 PERSONS ENTITLED TO APPLY FOR WINDING UP

We have discussed, in the last article, the grounds on which the court may order
the winding up of the company on a petition presented to it. The petition for
winding up of a company may be presented to the court by any of the following
persons (Section 439):
21.4. 1. Petition by the company. The company may itself present a petition
in the court for its winding up. However, the company can do so when the
ground for winding up is that the company has passed a special resolution that
it be wound up.
We know that a company being an artificial person, cannot act personally.
Actions on its behalf are taken by its agents (i.e. director). However, a winding
up petition by a person on behalf of the company is valid only when the decision
to file the petition is taken by the company at its general meeting. If no such
decision is taken, then the winding up petition is not valid i.e. not maintainable.
Note. A company may present a winding up petition on any of the grounds
mentioned in clauses (a) to (f) of Section 433 discussed in the last article. A
special resolution resolution enables the company to present the winding up
petition under clause (a) But such a resolution is not necessary where the
company bases the winding up petition on any of the grounds mentioned in
clauses (b) to (f). [See State of Madras Electric Tramsway Ltd., (1955) 2 MLJ
640]

21.4.2. Petition by the creditors. The creditors of a company may present a

petition in the court for winding up of the company. The petition may be
presented by any creditor (or creditors). The creditors may present the petition
on the ground that the company is unable to pay its debts.
The expression ‘creditors’ means any person who has pecuniary (i.e. monetary)
claim against the company, and includes the following persons:

(a) A contingent (or prospective) creditor. He is a person whose claim is not

immediately due. A guarantor of company’s debt, and the holder of a bill
of exchange not yet due is a contingent creditor. It is, however, important
to note that a winding up petition filed by a contingent or prospective
creditor shall not be admitted unless the leave (i.e. permission) of the court
is obtained for the same.

(b) A secured creditor. He is a person who is having security (i.e. charge on

company’s assets) for the repayment of his dues. He can apply for the
winding up of the company even without giving up his security.

(c) A debenture-holder. He is a person who holds the debentures of a

company and has all the ownership rights in respect of debentures e.g.,
right to get payment of interest or debt amount directly from the company.

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(d) A trustee for debenture-holders. He is a person who holds the debentures

of the company for the benefit of the debenture-holders, and is given all the
rights of ownership in respect of the debentures e.g., right to receive
interest etc. directly from the company.

(e) The Central or State Government or a local authority to whom any public
charge i.e. tax etc. is due by the company.
In case of a winding up petition by the creditor, it is his duty to prove that he is
fact a creditor i.e. the company owes a debt to him and he is entitled to recover
the same.
Sometimes, the debt is disputed by the company, and the creditor threatens the
company to file a winding up petition. In such cases, the company may obtain a
court order restraining the creditor from bringing a threatened winding up
petition.
Note. As regards the injunction to restrain a creditor from filing a threatened
petition, the Calcutta High Court has differed on the point. It has held that
creditor’s right to present a winding up petition is a statutory right and not one
arising out of contract. Therefore, a creditor cannot be restrained from filing a
proposed petition [Re Chhayabani pvi. Ltd. (1981) 51 Company Cases 369].
21.4.3. Petition by the contributories. The term ‘contributory’ may be defined
as every person who is liable to contribute to the assets of a company in the
even of its being wound up. Thus, on the commencement of the winding up of a
company, its shareholders are called contributories. (Sections 426, 428). It will
be interesting to know that the holders of fully paid up shares are also included
in the term ‘contributory’ though their liability is nil.
The contributories of a company may present a petition in the court for winding
up of the company. The petition may be presented by any contributory or
contributories. Any contributory may present a winding up petition where the
ground for winding up is that the number of members is reduced below the
statutory limit. But when the petition is on any other grounds, than only the
following contributories shall be entitled to present the petition:
(a) Any contributory to whom the shares were originally allotted; or
(b) Any contributory who has been the registered holder of the shares for at
least 6 months out of the 18 months before the commencement of the
winding up; or
(c) Any contributory on whom the shares were devolved through the death of
the former holder of shares.
The purpose of above clauses restricting contributory’s right to file a winding up
petition is to prevent a person from buying shares of a company with the sole
intention of becoming eligible for bringing the winding up of the company.
It may, however, be noted that in the case of a legal representative of a deceased
shareholder, it is not necessary for his winding up petition that the shares
should have been held by him in his own name for 6 months during the 18

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months before the filing of the winding up petition. This requirement is only for
the transferee of shares (i.e. to whom the shares are transferred in a normal
way).

21.4.4. Petition by the registrar. The Registrar of Companies may also

present a petition in the court for winding up of the company. The Registrar
may present for winding up on all the grounds discussed in Art. 20.3 except one,
namely, that the company has passed a special resolution that it be wound up.
It may, however, be noted that before making a petition on any of the above
grounds the Registrar must obtain the previous sanction of the Central
Government. And the Central government shall not give its sanction unless an
opportunity has been given to the company to make its representations.
It is important to note that after obtaining the sanction of the Central
Government, the winding up petition must be filed by the Registrar within
reasonable time. If there is unreasonable delay in presenting the petition, the
court will not recognize the sanction as valid.

21.4.5. Petition by any person authorized by the central government. The

Central Government may authorize any person to present a petition in the court
for winding up of the company. Sometimes, it appears to the central
Government from the report of inspectors appointed to investigate the affairs of
the company that the business of the company has been conducted for
fraudulent or unlawful purposes. In such cases, the Central Government may
authorize any person to present a petition for the winding up of the company on
the ground that it is just and equitable that it should be wound up [Sections 439
(1) (f), 243]. The Registrar may also be authorized by the Central Government to
present a winding up petition.

21.5 LEGAL PROVISIONS APPLICABLE TO COMPULSORY WINDING UP

The legal provisions applicable to the compulsory winding up, as contained in

the Companies Act, may be discussed under the following heads:

21.5.1. Commencement of winding up. The winding up of the company shall

be deemed to commence from the time of the presentation of the petition, and
not from the date of the winding up order by the court. But where before the
presentation of winding up petition to the court, the company passes a
resolution for the voluntary winding up of the company, the winding up shall be
deemed to have commenced from the time of the passing of the resolution
(Section 441). The date of commencement of winding up is important for various
matters such as liability of past' members, avoidance of fraudulent preferences
etc.

21.5.2. Powers of the court on the presentation of the petition. On receipt of

the petition for winding up of a company, the court has the following powers:

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(a) Stay of proceedings against the company. Sometimes, at the time of winding
up petition, certain legal proceedings are pending against the company. In such
cases, before making the winding up order, the court may stay the further
proceedings on such terms as it thinks fit. The application for the stay of legal
proceedings may be made by the company, or any creditor or contributory
(Section 442).

It may be noted that where any suit or proceeding is pending in the Supreme
Court or in any High Court, the application for stay is to be made to the
concerned court in which suit or proceeding is pending. And where such
proceedings are pending in any other court, the application is to be made to the
court which has the jurisdiction to wind up the company.

(b) Making order on the petition. On hearing a winding up petition, the court
may exercise any of the following powers (Section 443)
i) It may dismiss the petition with or without costs,

ii) It may adjourn the hearing of the petition,

ii) It may make any interim order as it thinks fit.

v) It may make an order for winding up of the company with

or without costs.

v) It may make any order as it thinks fit.

21.5.3. Consequences of winding up order. The consequences of winding up

order are contained in Sections 444 to 447 of the Companies Act, which may be
summed up as under:
(a). On the making of the winding up order, the court must immediately send
the intimation of the winding up order to the Official Liquidator and the
Registrar (Section 444).
(b). On the making of the winding up order, the certified copy of the order must
be filed with the Registrar within 30 days from the date of the making of
the order. The duty to file it is of the petitioner and of the company (Section
445).
(c). The winding up order shall be deemed to be a notice of discharge to the
officers and employees of the company. This is so because the employment
being conditional on the continued existence of the company, it ceases
when the company is wound up. But where the business of the company
is continued, the order shall not be considered a notice of discharge
[Section 445(3)].
(d). The winding up order shall operate in favour of all the creditors and of all
the contributories of the company as if it had been made on the joint
petition of a creditor and contributory {Section 447).

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(e). After a winding up order has been made, no suit or other legal proceeding
shall be commenced against the company except with the leave
(permission) of the court. And if any suit or legal proceeding is pending at
the date of the order, it shall not be proceeded with except with the
permission of the court (Section 446).
21.5.4. Procedure for compulsory winding up.
The winding up proceedings are conducted by an official to be known as the
Official Liquidator. Thereafter, the procedure involves the appointment of Official
Liquidator, and the conduct of proceedings by him

21.5.5. Appointment of official liquidator.

An Official Liquidator is an officer who helps the court in conducting and
completing the winding up proceedings. For the purpose of winding up of a
company by the court, the Central Government shall appoint an Official
Liquidator who shall be attached to each High Court. Depending upon the
'Work, the Official Liquidator may be appointed either as a whole-time or a part-
time officer. In case of District Courts, the Official Receiver appointed for
insolvency purpose shall be the Official Liquidator. , And if there is no Official
Receiver, the Central Government may appoint the Official Liquidator who shall
be attached to the District Court (Section 448).
As soon as the winding up order is made, the Official Liquidator becomes a
liquidator of the company for conducting the winding up proceedings (Section
449). It may be noted that only the Official Liquidator can act as the liquidator of
the company. And the court has no power to appoint any other private person as
the liquidator of the company.
On the presentation of the winding up petition and before the making of a
winding up order, the court may appoint the Official Liquidator to act as the
Provisional Liquidator of the company. The powers of the Provisional Liquidator
shall be the same as of Official Liquidator unless the court orders otherwise. As
soon as the winding-up order is made, the Provisional Liquidator becomes the
liquidator of the company and ceases to be a Provisional Liquidator (Section 450)
It shall be the duty of the liquidator to conduct the proceedings in winding up
the company. And he shall perform such duties in reference to winding up as
the court may impose upon him (Section 451).
21.5.6. Statement of affairs. On the making of the winding up order by the
court, or on the appointment of the Official Liquidator as the provisional
liquidator, a statement as to the affairs of the company must be made out and
submitted to the Official Liquidator (Section 454 )The statement of affairs should
contain the following particulars :

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(a) The assets of the company stating separately the cash balance in hand and
at bank.
(b) The debts and liabilities of the company.
(c) The names, residences and occupations of company’s creditors stating
separately the amount of secured and unsecured debts. And also the
particulars of the securities given to the secured creditors.
(d) The debts due to the company along with the amount likely to be realised.
And the names and addresses of the persons from whom they are due.
(e) Such further or other information as may be required by the Official
Liquidator.
Note. The statement of affairs should be in the prescribed form and verified by
an affidavit. It must be submitted to the Official Liquidator within 21 days of the
date of winding up, or within 21 days of the date of appointment of the
provisional liquidator, as the case may be. However, for special reasons, this
period may be extended by the Official Liquidator or by the court upto the
maximum of 3 months from that date. The statement of affairs must be
submitted and verified by the director, manager, secretary or other chief officer
of the company, or by such other persons as the Official Liquidator, subject to
the directions of the court, may require.
21.5.7. Report by Official Liquidator. After receiving the statement of affairs,
as soon as practicable, the Official Liquidator is required to submit a preliminary
report to the court showing following information (Section 455):
(a) The amount of issued, subscribed and paid up capital of the company. And
the estimated amount of the assets and liabilities.
(b) Where the company has failed, the causes of the failure.
(c) Whether in his opinion, further enquiry is desirable as to any matter
relating to the promotion, formation or failure of the company or the
conduct of its business.
The report must be submitted to the court within 6 months from the date of the
order of winding up. And where this period is extended, within the extended
period
Dissolution of a Company
The dissolution puts an end to the existence of the company. And the Registrar
then strikes off company’s name from the Register of Companies. The company
is dissolved by an order of the court. The court shall make an order of
dissolution in any of the following cases (Section 481)
1. When the affairs of the company have been completely wound up.
2. When the court is of the opinion that the liquidator cannot proceed with
the winding up of the company for want of funds and assets or for any
other reason.
3. When the court is of the opinion that it is just and reason able to dissolve
the company.

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On the making of the order of dissolution, the company stands dissolved from
the date of the order. Within 30 days of the order, the liquidator must forward a
copy of the order to the Registrar who shall record the same in his books. If the
liquidator makes a default in forwarding a copy, he shall be punishable with fine
unto Rs. 50 for every day during which the default continues.
It will be interesting to know that the liquidator or any other interested person
may also apply to the court for an order declaring the dissolution to be void.
However, such an application must be made to the court within 2 years of the
dissolution. On such application the court may pass an order declaring the
dissolution to be void [Section 559]. The effect of such an order is that it makes
the dissolution void ab initio i.e.. ineffective from the very beginning and the
company revives as if it had never been dissolved. Consequently, all the
consequences resulting from the dissolution are avoided.
Within 30 days of the court order, the person on whose application the order
was made, must file a copy of the order with the Registrar of Companies who
shall register the same. If such person makes a default in filing the copy with the
Registrar, he shall be punishable with fine upto Rs. 50 for every day during
which the default continues [Section 559 (2)].

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LESSON-22
WINDING UP - VOLUNTARY WINDING UP

CONTENTS
22.0 Aims and Objectives
22.1. Introduction
22.1.1 by ordinary resolution
22.1.2.by special resolution
22.2 Kinds of voluntary winding up
22.3. Members’ voluntary winding up
22.3.1 Legal provisions applicable to members’ voluntary winding up
22.4 Creditors' voluntary winding up
22.4.1 Legal provisions applicable to creditors' voluntary winding up
22.5 Common provisions applicable to both kinds of voluntary winding up
22.6 Winding up with the intervention of the court
22.7 Winding up of unregistered companies
22.7.1 Courts having jurisdiction to wind up companies

22.0 AIMS AND OBJECTIVES

In the previous lesson, we discussed the meaning of meaning of winding up of a

company and Compulsory winding up by the court. In this lesson we discuss the
meaning of Voluntary winding up of a company and modes of Voluntary winding
up . After going through this lesson, you will able to
1. Know the meaning of voluntary winding up of a company
2. Understand the various modes up voluntary winding up

22.1. INTRODUCTION

In the preceding pages we have discussed the compulsory winding up of the

company i.e. the winding up by an order of the court. The company may also be
wound up without any intervention of the court. And it is called the voluntary
winding up. In other, words, the voluntary winding up means the winding up by

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the members or creditors themselves without any intervention of the court.

Thus, the members and the creditors are left free to settle their affairs without
going to the Court of Law. However, they may apply to the court for any
directions when necessary. Section 484 of the Companies Act contains the cases
in which the company may be voluntarily wound up, which are as under
22.1.1 By ordinary resolution
Sometimes, the article of the company fixes the period for the duration of the
company, or provides that the company shall be dissolved on the occurrence of
some event. In such cases, when that time expires or that event occurs, the
company may pass an ordinary resolution in its general meeting for its voluntary
winding up
22.1.2.By special resolution.
The company may, at any time, pass a special resolution that the company be
wound up voluntarily. It may be noted that when the company passes a special
resolution for its voluntary winding up, no reason is required to be given for
the winding up. Under this clause, the company may be wound up even if it is
prosperous.
Note. Within 14 days of the passing of a resolution (ordinary or special) for
voluntary winding up, the company must give a notice of the resolution by
advertisement in the Official Gazette, and also in some newspaper circulating in
the district where the registered office of the company is situated (Section 485).

22.2 KINDS OF VOLUNTARY WINDING UP

The voluntary winding up of the company is of two kinds, namely,

1. Members’ voluntary winding up
2. Creditors’ voluntary winding up

22.3. MEMBERS’ VOLUNTARY WINDING UP

It is the winding up in the case of which a ‘declaration of solvency’ is made and

delivered to the Registrar in accordance with the provisions of Companies Act
[Section 488 (5)]. The ‘declaration of solvency’ is the declaration made by the
directors stating that the company has no debts, or that it will be in a position to
pay its debts in full. The legal provisions relating to the declaration of solvency
are contained in Section 488 and may be summed up as under

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1. The declaration of solvency has to be made by the majority of directors at a

meeting of the Board of Directors, and verified by an affidavit.
2. The directors have to declare in it that they have made a full enquiry into
the affairs of the company and have formed the opinion about the
following:
(a) That the company has no debts, or
(b) That the company will be able to pay its debts in full within such period as
specified in the declaration, but not exceeding 3 years from the
commencement of the winding up.
3. The declaration must be made within 5 weeks immediately before the
passing of the resolution for winding up, and must be delivered to the
Registrar for registration before that date.
4. The declaration must be accompanied by a copy of the report of
company’s auditors on the profit and loss account, and the balance sheet
of the company prepared upto the latest practicable date before the making
of the declaration.
5. The declaration must also contain a statement of the assets and liabilities
of the company as at the latest practicable date before the making of the
declaration.

22.3.1 Legal Provisions Applicable to Members’ Voluntary Winding up

After a declaration of solvency, as aforesaid, is made and filed with the Registrar
of Companies, and the members pass a resolution for voluntary winding up, the
members’ voluntary winding up commences from the date of the resolution. The
legal provisions applicable to members’ voluntary winding up are contained in
Sections 490 to 498 of the Companies Act, which may be discussed under the
following heads:

1. Appointment of liquidators.
The liquidator is appointed to conduct the proceedings of members’ voluntary
winding up. He is appointed by the company in its general meeting of
shareholders for the purpose of winding up the affairs of the company, and for
distributing its assets. The company may appoint one or more liquidators as
may be necessary (Section 490). Within 10 days of liquidator’s appointment, the
company must give a notice of the same to the Registrar of Companies (Section
493).

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2. Board’s powers to cease on appointment of liquidator.

On the appointment of the liquidator, all the powers of the Board of Directors
including the powers of managing director, whole-time director and manager,
shall come to an end. However, the company in general meeting or the
liquidator may sanction the continuance of any power (Section 491).

3. Creditors' meeting in case of insolvency.

Sometimes, the liquidator is of the opinion that the company will not be able to
pay its debts in full within the period stated in ‘declaration of solvency.’ In
such cases, the liquidator should immediately summon meeting of the creditors
and lay before the meeting a statement of the assets and liabilities of the
company. The liquidator should also take such steps where the period specified
in the declaration of solvency has expired and the company has not paid its
debts in full. In case of default to summon creditors’ meeting the liquidator
shall be punishable with fine up to Rs. 500 (Section 495).

4. General meeting at the end of year.

Sometimes, the winding up continues for more than one year. In such eases,
the liquidator must call a general meeting of the company at the end of the first
year, and at the end of each subsequent year. He must also lay before the
meeting, an accountof his acts and dealings, and the progress of the winding up
during the year. If the liquidator fails to comply with this provision, he shall be
punishable with fine upto Rs. 100 for each failure (Section 496).

5.Final meeting and dissolution.

As soon as the affairs of the company are fully wound up, the liquidator must
make an account of winding up, showing how the winding up has been
conducted, and how the property of the company has been disposed of. There
after, he must call a general meeting of the company for the purpose of laying
before it the above said account of winding up. This is the final meeting of the
company. If the liquidator fails to call this final meeting, he shall be punishable
with fine upto Rs. 500 (Section 497). After the holding of the final meeting, the
proceedings take place as under:
(a) Within one week after the meeting, the liquidator shall send a copy of the
account and of the return of the meeting to the Registrar, and to the Official
Liquidator.
(b) On receipt of the account and the return, the Registrar shall register them,
and the Official Liquidator shall make a scrutiny of the books and papers of
the company. After the scrutiny, the Official Liquidator shall report to the
court the result of his scrutiny.
(e) If the report of the Official Liquidator shows that the affairs of the company
were not conducted in a manner prejudicial to the interest of its members or
to public interest, then the company shall be deemed to be dissolved from
the date of the submission of the report to the court.

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(d) If the report shows that the affairs of the company were conducted in a
manner prejudicial to the interest of its member or its members or to public
interest, the court shall direct the Official liquidator to make further
investigations of the affairs of the company. And on the receipt of the report
of the further investigation, the court may either make an order that the
company shall stand dissolved from the date specified in the order, or the
court may make such other order as the circumstances of the case permit.
If the company fails to pay its debts in full within the time specified in
declaration of solvency, then the meetings of creditors shall also be held
along with the company’ meeting as discussed in points 4 and 5 above (Sec-
tion 498).

22.4 CREDITORS' VOLUNTARY WINDING UP

It is the winding up in the ease of which a ‘declaration of solvency has not been
made and delivered to the Registrar [Section 488 (5)]. Thus, the question of
creditors’ voluntary winding up shall arise where the company is unable to pay
its debts in full. As in such a case, the interest of the creditors is involved, they
are given the powers to control and supervise the winding up of the company.
22.4.1 Legal Provisions Applicable to Creditors' Voluntary Winding up
The legal provisions applicable to creditors’ voluntary winding up are contained
in Sections 500 to 509 of the Companies Act, which may be discussed under the
following heads:
1. Meeting of creditors. We know that in case of creditors’ voluntary winding
up, the interest of the creditors is involved. Therefore they should be given an
opportunity to know how the assets of the company are realised and distributed.
This is possible by calling a meeting of creditors. It may be noted that the com-
pany must call a meeting of its creditors in case of creditors’ voluntary winding
up. The meeting of the creditors may be called on the same day on which the
meeting of the company is to be held at which a resolution for voluntary winding
up is to be proposed. However, the meeting of the creditors may also be held on
the next day following the day of company’s meeting.
The meeting of creditors shall be presided over by one of the directors appointed
for the purpose by the Board to lay the following before the meeting of creditors:
(a) A full statement of the position of the affairs of the company, and
(b) A list of the creditors of the company and the estimated amount of their
claims (Section 500).
Note. The notice of any resolution passed at the meeting of creditors must be
given by the company to the Registrar within 10 days of the passing of resolution
(Section 501).

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2. Appointment of liquidator.
We know that the liquidators appointed for the purpose of winding up the affairs
of the company, and for distributing its assets. In case of creditors’ voluntary
winding up, the liquidator is appointed by nomination made by both the
members and creditors at their respective meetings. If the creditors and the
members nominate different persons, the person nominated by the creditors
shall be the liquidator. However, within 7 days of the nomination made by the
creditors, any director, member or creditor of the company may apply to the
court for an order that the person nominated by the members should be the
liquidator, or that the Official Liquidator or some other person should be
appointed as the liquidator (Section 502). It may further be noted that if no
person is nominated by the members, the person nominated by the creditors
shall be the liquidator.
3.Committee of inspection.
Sometimes, the creditors think fit to appoint a committee of inspection to watch
and supervise the proceedings of the liquidator. In such cases, they (creditors)
may appoint a committee of inspection at their meeting. And the committee
shall not consist of more than five members appointed by the creditors.
When a committee of inspection is so appointed by the creditors, the company
may also at any general meeting appoint its own members (not exceeding five) to
the committee. However, the creditors may not accept all or any of the members
appointed by the company. In such eases, the members appointed by the
company cannot act as the members of the committee unless the court directs
otherwise. If the court thinks fit, it may also appoint other persons to act as the
members in place of the person not agreed to by the creditors (Section 503). The
committee of inspection shall have the right to inspect the accounts of the liqui-
dator at all reasonable times. The other provisions relating to the proceedings of
the committee of inspection shall be the same as in case of the committee of
inspection appointed in a compulsory winding up as discussed in above.
4. Board’s powers to cease on appointment of liquidator.
On the appointment of the liquidator, all the powers of the Board of Directors
shall come to an end. However, the committee of inspection, or if there is no
such committee, the creditors in general meeting may sanction the continuance
of the Board's powers (Section 505). It may be noted that under this section,
the powers of the managing director, whole-time director and manager do not
come to an end.
5. Meetings of company and of creditors at the end of year.
Sometimes, the winding up continues for more than one year; In such cases, the
liquidator must call a general meeting of the company, and a meeting of the
creditors at the end of the first year, and at the end of each subsequent years.
He must also lay before both the meetings an account of his acts and dealings,
and the progress of the winding up during the year. If the liquidator fails to
comply with this provision, he shall be punishable with fine up to Rs. 100 for
each failure (Section 508).

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6. Final meetings and dissolution.

As soon as the affairs of the company are fully wound up, the liquidator must
make an account of winding up, showing how the winding up was conducted
and how the property of the company has been disposed of. Thereafter, he must
call a meeting of the company, and a meeting of the creditors for the purpose of
laying before the meetings the above said account of winding up. These are the
final meetings of the company. Other provisions and the procedure to be
followed after holding the final meetings are the same as in case of members’
voluntary winding up as discussed in final meeting and dissolution (Section
509).
22.5 Common Provisions Applicable to Both Kinds of Voluntary Winding up
We have already discussed in Arts. 20.14 and 20.16, the respective legal
provisions applicable to members' voluntary winding up, and to creditors’
voluntary winding up. There are certain common provisions which apply to both
kinds of voluntary winding up. These provisions are contained in Sections 486,
487 and 511 to 520 of the Companies Act, and may be discussed under the
following heads:
1.Commencement of winding up (Section 486).
The voluntary winding up of the company shall be deemed to commence from
the time of passing of the resolution for voluntary winding up.
2.Consequences of voluntary winding up (Section 487)
On the commencement of the winding up, the company shall cease to carry on
its business. However, it may carry on its business where it is required for the
beneficial winding up of such business. Though the company shall stop its
business, but the corporate status and corporate powers of the company shall
continue until it is dissolved.
3.Distribution of company's property (Section 511)
On the winding up of the company, its assets shall be applied in satisfaction of
its liabilities pari passu (i.e. without any preference of one over the other). This
is, however, subject to any payments which are to be made on preference basis
under the Companies Act. After the satisfaction of the liabilities, the surplus
shall be distributed among the members according to their rights and interest in
the company.
4.Statement of affairs (Section 511 A)
On the commencement of the winding up of the company, a statement as to
the affairs of the company must be made out, and submitted to the liquidator.
The statement must be submitted to the liquidator with in 21 days of the
commencement of the winding up.

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5. Duties and powers of liquidator (Section 512)

The duties and powers of the liquidator in case of voluntary winding up are the
same as those of the liquidator in the case of compulsory winding up as
discussed in above section. The only difference is that the powers which in case
of compulsory winding up can be exercised with the sanction of the court, in
case of members’ voluntary winding up those can be exercised with the sanction,
of special resolution of the company; and in case of creditors’ voluntary winding
up with the sanction of committee of inspection, and if there is no such
committee, with the sanction of meeting of creditors. It may, however, be noted
that in case of creditors’ voluntary winding up those can also be exercised with
the sanction of the court. All other powers of the liquidator are the same as are
given to the liquidator in case of compulsory winding up.
In addition to the above powers, the liquidator may also exercise the following
powers:
a) The power of the court of setting list of contributories.
b) The power of the court of making calls.
c) The power to call general meetings of the company. He may call the
meetings for the purpose of obtaining the sanction of the company, or for
any other purpose as he may think fit.
It may, however, be noted that the exercise of powers by the liquidator shall be
subject to the control of the court. And any creditor or contributory may apply to
the court with respect to the exercise or proposed exercise of liquidator’s powers.
6. Court's powers to appoint and remove liquidator (Section515)
If from any cause whatever, there is no liquidator acting, the court may appoint
the Official Liquidator or any other person as the liquidator of the company.
The court may also remove a liquidator and appoint the Official Liquidator or
any other person as the liquidator in place of the removed liquidator.

7. Notice by the liquidator of his appointment (Section 516)

Within 30 days of the appointment of the liquidator, he must publish in the
Official Gazette the notice of his appointment. More over, he must also deliver
the same to the Registrar for registration.
8. Directions of court (Section 518)
The liquidator or any contributory or creditor may apply to the court to
determine any question arising in the winding up of the company. The applica-
tion may also be made to the court to exercise all or any of the powers which the
court may exercise if the company were being wound up by the court.
9. Public examination (Section 519)
Sometimes, the liquidator makes a report to the court stating that in his opinion
a fraud has been committed by any person in the promotion or formation of the

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company, or by any officer of the company in relation to the company since its
formation. In such cases, the court may direct that such person or officer
shall appear before the court and be publicly examined.
10.Costs of winding up (Section 520)
All costs, charges and expenses properly incurred in the winding up including
the remunerations of liquidator, shall be payable out of the assets of the
company in priority to all other claims. However, the priority of secured
creditors shall continue.

22.6 WINDING UP WITH THE INTERVENTION OF THE COURT OR WINDING

UP UNDER THE SUPERVISION OF THE COURT

The winding up with the intervention of the court is ordered where the voluntary
winding up has already commenced. As a matter of fact, it is the voluntary
winding up but under the supervision of the court.

At any time after a company has passed a resolution for voluntary winding up,
the court may make an order that the voluntary winding up shall continue but
subject to the supervision of the court. The order may be made by the court on
such terms and conditions as it thinks fit, and the court may also determine the
extent of the supervision. The application for court’s supervision may be made
by creditors, contributories, or by others as the court may think just [Section
522]. Ordinarily, such an order is passed by the court in the following
circumstances:
i) When the liquidator appointed under the voluntary winding up is partial or
negligent in collecting the assets of the company, or
ii) When the provisions relating to the winding up are not being
observed, or
iii) When the resolution for voluntary winding up was obtained by fraud.

It may be noted that a petition for the continuance of voluntary winding up

under the supervision of the court shall be considered to be a petition for
winding up by the court, and the court shall get the same jurisdiction over the
suits and legal proceedings as in case of compulsory winding up (Section 523).
The other provisions with respect to the winding up under the supervision of the
court may be summed up as under:
1. The court may appoint an additional liquidator. It may also remove any
liquidator, and may fill up the vacancy caused by the removal, death or
resignation of the liquidator (Section 524).
2. The additional liquidator appointed by the court shall have the same
powers and be subject to same obligations as if he had been duly
appointed in accordance with the provisions in respect of the appointment
of liquidators in a voluntary winding up. How ever, the liquidator’s powers
shall be subject to the restrictions imposed by the court [Sections 525, 526
(1)].

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3. For all purposes, any order made by the court for a winding up under the
supervision of the court shall be deemed to be an order of the court made
in compulsory winding up. And the court shall get all the powers as it has
in case of compulsory winding up [Section 526 (2)]. Thus, basically the
winding up remains a voluntary winding up, but it also has the advantages
of compulsory winding up. Because the court gets all the powers which it
can exercise in a compulsory winding up.

22.7 WINDING UP OF UNREGISTERED COMPANIES

The expression ‘unregistered company’ is defined in Section 582 of the

Companies Act. According to this section, an unregistered company includes any
partnership, association, or company consisting of more than seven members
at the time when petition for winding up is presented before the court. However,
it does not include the following:

a) A railway company incorporated by any Act of Parliament or other Indian

Law, or any Act of the British Parliament.

b) A company registered under the Companies Act, 1956.

c) A company registered under any previous company law other than those
having registered office in Burma, Aden, or Pakistan before their
separation from India. The above definition of an ‘unregistered company’
as contained in Section 582 states the associations etc. which are to be
included in the expression ‘unregistered companies’, and the associations
which are not to be included in it. It is, however, important to note that the
scope of Section 582 is wide and not limited to include only specified
associations. As a matter of fact, every association of persons consisting of
more than seven members (but not more than 10 in case of an association
carrying on a banking business, and 20 in case of any other business) is
an unregistered company if it is not registered under the Companies Act or
any other law for the time being in force in India.

An unregistered company may be wound up under the provisions of the

Companies Act, and all the provisions of this Act relating to the winding up are
applicable to the winding up of unregistered companies [Section 583 (1)].
However, certain provisions exclusively dealing with the winding up of
unregistered companies are contained in Part X (Sections 582 to 590) of the
Companies Act. These may be summed up as under :

1. An unregistered company can be wound up only by the court. It can

neither be wound up voluntarily nor subject to the supervision of the court
[Section 583 (3)].

2. An unregistered company may be wound up in the following circumstances

[Section 583 (4)] :

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(a) If the company is dissolved, or has ceased to carry on business, or is

carrying on business only for the purpose of winding up its affairs.

(b) If the company is unable to pay its debts.

(c) If the court is of the opinion that it is just and equitable to wind up the
company.

3. Every person shall be considered to be a contributory that is liable to pay

any of the following amounts [Section 585 (1)]

a) any debt or liability of the company.

b) any amount for the adjustment of the rights of the members among
themselves.

c) any costs, charges and expenses of winding up of the company.

It is important to note that every contributory (past or present) irrespective of the

fact when he ceased to be the member shall be liable to contribute to the assets
of the company all amount due from him to the company.

4. On the making of the winding up order, any suit or other legal proceeding
can be commenced (i.e. filed) against any contributory of the company only
with the leave (i.e. permission) of the court [Section 587]. The object of
this provision is to prevent a creditor of an unregistered company from
filing suit not only against the company but also against the contributory
of the company.

22.7.1 Courts Having Jurisdiction to Wind up Companies

The courts having jurisdiction to wind up the company (i.e. the courts in which
the winding up petitions can be filed) are specified in Section 10 of the
Companies Act. According to this section, the winding up petition can be filed in
the High Court which has the jurisdiction (i.e. power) to try the legal proceedings
in relation to the place at which the registered office of the company concerned
is situated e.g., if the registered office of a company is situated in the area which
falls within the territorial jurisdiction of Delhi High Court, the winding up
petition in respect of such a company can be filed in the Delhi High Court.

It is important to note that the Central Government may also by notification in

the Official Gazette empower any District Court to exercise the powers of
winding up of companies. However, in respect of companies having paid up
share capital of rupees one lack or more, only the High Courts shall have the
jurisdiction to try winding up petitions.

Following are some of the important provisions relating to the jurisdiction of

courts in respect of winding up of companies:

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1. The High Court, making an order of winding up of a company, may

transfer all subsequent proceedings to a District Court subordinate to it. It
may also, with the consent of any other High Court, transfer the
subsequent proceedings to that High Court or to a District Court
subordinate to that High Court [Section 435]. Such an action is taken
by the High Court if it thinks fit to do so.

2. The High Court may also withdraw the winding up proceedings pending
before a District Court, and transfer the same to itself or to any other
District Court [Section 436]. Such an action is taken by the High Court if it
appears to .the court that by doing so the winding up proceedings can
more conveniently be proceeded with.

3. The High Court may also allow a District Court to continue with the
winding up proceedings started by it although it may not be the court in
which the proceedings should have been commenced [Section 437].

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MODEL QUESTIONS

Answer any FIVE Questions 5 x 20 = 100

1. Discuss the essential elements of a valid contract.

2. What are remedies available to an aggrieved party in case of breach of
contract?
3. Discuss the circumstances under which an offer lapses.
4. Explain the rights and duties of a bailee.
5. Explain the different kinds of company.
6. Explain the provisions of the companies act relating to the alteration of
memorandum of association.
7. Classify the different types of meeting under the companies act and explain
the provisions relating to each?
8. Discuss briefly the powers, duties and liabilities of a company director?

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