LAW CORPORATE LAW. Business Organizations and Corporate personality: its nature, advantages, disadvantages and types

Transcription

1 LAW CORPORATE LAW Business Organizations and Corporate personality: its nature, advantages, disadvantages and types

2 Q1: E-TEXT Module ID: 1Business organizations and corporate personality: its nature, advantages, disadvantages and types Module Overview: The topic of business organizations and corporate personality has become an important part of the field of business studies. It closely studies the types of business organizations and advantages and disadvantages of doing business in different business organizations. The knowledge of this topic is necessary not only for the commerce students, but also for all those who want to enter into any line of business. In the present module, we will discuss in detail about the various forms of business organizations that exist in India. The module primarily is concerned with the regulation of organizations- corporate and incorporated one, and requires the students to understand the concept of corporate personality. This way module will help the students who want to work in industry, financial services, and law-related professions or manage their own business. Subject Name: Law Paper Name: Corporate Law Module ID: 1 Pre-requisites: For understanding the module, basic understanding of business organizations and related legal concepts is required. Objectives: To know about the various forms of business organizations in India. To know the meaning, features, merits, demerits and suitability of Sole Proprietorship. To know the meaning, features, merits, demerits and suitability of HUF. To know about the advantages and disadvantages of companies, partnerships and limited liability partnerships What is meant by corporate personality? To develop an understanding of the core principles of the laws that regulate business organizations Keywords: business organizations, business law, companies, partnerships, corporate personality, sole proprietorship, traditional partnership, limited liability partnership

3 INTRODUCTION Meaning of business: An organization or enterprising entity may be engaged in commercial, industrial or professional activities. A business can be a for-profit entity, such as a publicly-traded corporation, or a non-profit organization engaged in business activities, such as an agricultural cooperative. 1 L.R. Dickson has defined business as a form of activity pursued primarily with the object of earning profit for the benefit of those on whose behalf the activity is conducted. Business involves production and/or exchange of goods and services to earn profits or in a broader sense, to earn a living. Profit is not the sole objective of the business. It may have other objectives like promotion of welfare of the workers and the general public. Business activities include production and distribution of goods and services which can satisfy human wants. 2 The term business should be used to convey the same meaning as the term trade simply denotes purchase and sale of goods whereas business includes all activities from production to distribution of goods and services. It embraces industry, trade and other activities like banking, transport, insurance and warehousing which facilitates production and distribution of goods and services. According to F.C. Hopper, The whole complex field of commerce and industry which includes the basic industries, processing and manufacturing industries, and the network of ancillary services: distribution, banking, insurance transport and so on, which serve and inter penetrate the world of business as a whole are called business activities. 3 Learning outcomes By the end of this module and having completed the essential reading and activities, students would be able to: 1http:// accessed on 5th August https:// accessed on 5th August Ibid

4 Nature of Business: A business enterprise has the following characteristics: Dealing in Goods and Services: The first basic characteristic of a business is that it deals in goods and services. Goods produced or exchanged may be consumer goods such as bread, rice, cloth, etc., or capital goods such as machines, tools, etc. (v) Production and Exchange: Every business is concerned with production and exchange of goods and services for value. Thus, goods produced or purchased for personal consumption (or) for presenting to others as gifts do not constitute business because there is no sale or transfer for value involved. Regularity and Continuity in Dealings: One single sale transaction cannot strictly constitute a business. A sale of a product can be called a business if it is undertaken frequently. Uncertainty or Risk: It is true that the element of risk is present in almost all economic activities. But it is undoubtedly more significantly present in business activities. 4 Profit Motive: Everyone engages in business primarily with a view to earn profits and acquire wealth. Profit motive is also accepted as a desirable objective even for the 4 accessed on 6th August 2014

5 Government enterprises engaged in business. In case of government enterprise profit is termed as surplus. Functions of Business 5 : Production Function Marketing Function Finance Function Personnel Function To achieve its objectives, a business endeavor performs many functions which may be broadly grouped under the following headings: Production, Marketing, Finance and Personnel. Production Function: Under this function a business organization transforms its inputs like manpower, material, machinery, capital, information and energy into particular outputs as demanded by the society. Marketing Function: This is concerned with distribution of goods and services produced by the production department. As we all know that in order to make a business successful how important is marketing, the marketing department guides the production department in product planning, development and prices of various products produced by the business, it also promotes the sale of goods through advertisement and sales promotion. Finance Function: Money is an important factor in any business, thus arrangement of sufficient capital for the smooth running of business is an important function for a business organization to undertake. Many important decisions such as sources of finance, investment of funds in productive ventures, and levels of inventory of various items are undertaken. Personnel Function: As we know that if you want to make your business successful, then you need to have people who can help you in making it successful and achieving the business objectives, hence, this function is concerned with finding suitable employees, giving them training, fixing their remuneration and motivating them. 5 Ibid

6 FORMS OF BUSINESSORGANIZATIONS 6 Meaning: A business enterprise may be owned by one person or a group of persons. When it is owned by one person, it is known as sole proprietorship. Apart from this form of organization, other forms of business organizations which come under the category of group ownership or joint ownership 7 include Joint Hindu Family, Partnership firms, co- operatives and Limited Liability Partnership Firms. Limited liability partnerships and companies are body corporates which are incorporated by group of persons interested in running any lawful business for motive of earning profit. Such persons incorporate the body corporate and transfer their business to it in order to limit their liability. SOLE PROPRIETORSHIP Business which runs under the exclusive ownership and control of an individual is called the sole proprietorship or single entrepreneurship. Under this form, an individual may run the business alone with the help of his own skill and intelligence or may employ a few employees for helping him in conducting the business. It is the simplest and the oldest form of business organization. Features of sole proprietorship (v) (vi) (vii) This is owned by one man who contributes capital for conducting business. He has absolute control over the affairs of the concern. His decision is final. The attraction of reaping the entire profits motivates him to put forth the best in him. The liability of the sole proprietor is unlimited and he earns all profits. A sole proprietary concern is free from Government regulations. No formalities are to be observed in its formation, management or in its closure. It is not a separate entity; consequently the business comes to an end with the permanent disability or death of the proprietor. It has limited capital as only the sole proprietor contributes capital for the business. 6 accessed on 6th August www.b-u.ac.in/sde_book/bcom_bs.pdf accessed on 7th August,2014

7 Merits: (v) (vi) (vii) (viii) No legal formalities are required to complied with in order to start a sole proprietary business, it is one of the most easy form of business organization to start, easy to form and dissolve too. Under this form of business organization, sole proprietor enjoys the entire profits and hence is inspired and motivated to give his best of efforts and skills in running the business. The sole proprietor is free to direct and control the operations of his business. Business secrecy is maintained and to face the challenge of competition in the market, maintenance of business secrecy provides an edge to the firm over its rival firms. More prompt and quick decisions can be taken, as being a sole proprietor he doesn t need to consult anyone. Sole proprietorship offers the scope for flexibility in business operations by allowing the business to adapt and adjust itself to changing times and situations. As the size of a sole proprietary business is small and the owner maintains a personal touch with the employees and customers, it brings in efficiency and motivation. Government interference in the business activities under this form of business is least and in the day-to-day running of the business also there is no interference by the government. Demerits: (v) Large units which require enormous capital cannot be started by an individual as he can contribute only a limited capital in the business. Limited Managerial Skill As the liability of a sole trader being unlimited, even his private assets are in danger of being lost in order to meet liabilities of his business. Uncertainty of continuity It s very difficult to lock maximum advantage under this form of business, as the financial recourses are limited. HINDU UNDIVIDED FAMILY: The Joint Hindu Family firm is a form of business organization in which the family possesses some inherited property and the Karta, the head of the family, manages its affairs. It comes into existence by the operation of Hindu Law and not out of contract between the members or

8 coparceners. As a result, the Joint Hindu Family Business is a business by co-parceners of a Hindu undivided estate. 8 Features of HUF: Membership of the family business is the result of status arising from birth in the family, and hence there is no question of the members being discriminated in terms of minority and majority on the basis of age. Only male persons, and not females, can claim co-parcenary interest in the Hindu Family business firm. The right to manage the business vests in Karta alone (i.e. the Head of the Family). Death or insolvency of a co-parcener or even that of the karta does not affect the existence of the Joint Hindu Family business. Merits of Joint Hindu Family: Irrespective of the contribution made, every co-parcener in the successful running of the business gets an equal share of profit. Unrestricted freedom is enjoyed by the karta of the family to run the business as no other co-parceners of the family interferes in the running of the business. As different generations of a family works in the same business, the younger generation gets an advantage and help to develop and acquire expertise without much difficulty. It serves as an insurance cover for maintaining the children, widows, and ailing or invalid members of the family. Demerits of Joint Hindu Family: As all the co-parceners have an equal right to share the profits made out of the joint business, there is no encouragement to work hard and to earn more and it makes the members of the family very un-enterprising. Initiative and sincerity showed by the younger generation is not used properly as the karta of the family has unchallengeable authority. It has been seen that sometimes the karta of the family misuses his freedom for his own person benefits and gains. There is a fear of disintegration under this form of business organization. PARTNERSHIP FIRM Section 4 of the Indian Partnership Act, 1932 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons entering into partnership agreement are known as partners and collectively as firm or partnership firm. The name in which the businesses carried on is called firm name. 8Hindu Succession Act, 1956

9 Features of a partnership firm (v) (vi) (vii) At least two persons are needed to form a partnership. The Partnership Act fixes no limit on the number of partners to form a partnership whereas the Companies Act, 1956 fixes some limit, it lays down that any partnership or association of more than 10persons in case of banking business and 20 persons in other business operations as illegal unless registered as a Joint Stock Company 9.According to the Companies Act 2013, the maximum number of persons/partners in any association/partnership may be upto such number as may be prescribed but not exceeding one hundred. This restriction will not apply to an association or partnership, constituted by professionals like lawyer, chartered accountants, company secretaries, etc. who are governed by their special laws. Under the Companies Act, 1956, there was a limit of maximum 20 persons/partners and there was no exemption granted to the professionals. Under this form of business organization agreement forms the basis of a relationship and not the status as in the case of Joint Hindu Family. There must be an agreement between two or more persons to enter into partnership. Simply holding a property in joint ownership cannot be considered as partnership, it should be accompanied by certain business activities and the partners must agree to carry some lawful business. There must be an agreement to share the profits and losses of the business of the partnership firm. However, sharing of profit is not a conclusive proof of partnership. Fundamental test to test the existence of a partnership firm is that there must be an agency relationship between the partners. Out of contractual relationship between the partners, all the partners are liable jointly and severally for all the debts and obligations of the firm. Partner himself being an agent of the partnership firm cannot delegate his proprietary interest to outsider and if he wants to then he cannot do it without the unanimous consent of the other partners. Merits of Partnership: This form of business organization like sole proprietorship is also relatively free from legal formalities in terms of its formation. Registration of partnership firm is not mandatory under the Partnership Act, Under this form of business organization, partners can pool larger amount of capital for the business. Better management of the business is ensured as the partnership combines abilities and skills of two or more persons (partners). There is a flexibility in the functioning of the day to day business of the firm, as partnership business is not regulated by any law in its day to day just as a company business is regulated by the Company Law. 9http://indiankanoon.org/doc/ / accessed on 6 th August 2014

10 (v) (vi) (vii) A partnership firm is able to make decisions without delay because partners can meet and discuss the business problems more frequently. Since the liability of the partners is unlimited, they are more cautious in running the business. No major amendments can be made affecting the basic nature of partnership without the unanimous consent of all the partners. Thus every partner s viewsvoice carries weight in partnership. Demerits of Partnership Firm: (v) The partnership business works steady as long as there is harmony and mutual understanding among the partners. If there is any occasion when this harmony is adversely affected that is the beginning of the end of a good partnership. There is insecurity with the business after the death, retirement or insolvency of a partner. It fails to inspire public confidence as a partnership business is not subjected to detailed regulations just as a company business. A partnership is even worse than sole proprietorship because a partner is liable to the extent of his private property not only for his own mistakes and lapses but also for the mistakes, lapses and even dishonesty of his fellow partner or partners. As no partner can transfer his interest to an outsider without the unanimous consent of all the partners, it makes investment in partnership business reluctantly difficult. COMPANY A company is an incorporated voluntary association of persons in business having joint capital divided into transferable shares of a fixed value, along with the features of limited liability, common seal and perpetual succession. 10 It may be a public, private, foreign, small, associate, holding or subsidiary company. Companies may be incorporated with limited liability of its members or with unlimited liability. Liability of members may be limited by shares or by guarantee. Features: A company is an artificial person created by law to achieve the objectives for which it is formed. A company exists only in the contemplation of law. It is an artificial person in the sense that it is created by a process other than natural birth and does not possess the physical attributes of a natural person. This form of business organization has a continuous existence and its life is not affected by the death, lunacy, insolvency or retirement of its members. Members 10 accessed on 8 th August,2014

11 may come and go, however, the company continues its operations so long as it fulfills the requirements of the law under which it has been formed. Merits of a Company: This form of business organization has become very popular not only in India but also outside India mainly for industrial and trading operations of a large scale. Advantages/merits enjoyed by the company form of organization are follows: (v) (vi) By issuing shares and debentures to the public, a public company can raise large amount of money. Under this form of business organization, shareholders have limited liability for the shares they hold in the company and their private property is not attachable to recover the dues of the company. As a consequence, the people who don t want to take big risk in the industries they find this kind of business organization really attractive. This form of business organization has a continuous existence and its life is not affected by the death, lunacy, insolvency or retirement of its members. Members may come and go, however, the company continues its operations so long as it fulfills the requirements of the law under which it has been formed. Transferability of Shares: Shares of a public company are freely transferable whereas restrictions are placed in case of transfer of shares in case of private companies. As we know that a company can raise large amount of capital this allows the company to take large scale operations. Scope for Expansion and Growth is much higher. Demerits of a Company: Large number of legal formalities has to be fulfilled by this form of a company, for which provisions of a Companies Act are to be complied. There is a divorce between ownership and management of the company. Under this form of business organization it has been seen that though every shareholder has a right to participate in the Annual General Meeting, but in practice, companies are managed by a small number of persons who are able to perpetuate their reign over the company from year to year. This is because of a number of factors like lack of interest on the part of the shareholders, low literacy level among the shareholders, and lack of sufficient information about the working of the company. CO-OPERATIVE SOCIETY

12 According to the International Labour Office, a cooperative organization is an association of persons, usually of limited means, who have voluntarily joined together to achieve a common economic end, through the formation of a democratically controlled business organization, making equitable contributions to the capital required and accepting affair share of risks and benefits of the undertaking. 11 Characteristics of Co-operative Organization: The cooperative organization, being different in its rationale and philosophy possesses certain features/characteristics which maybe briefly explained as follows: A cooperative organization is established principally with a view to rendering service to its members in particular and to the society in general. Yet, this does not mean that such an organization will not work for profit. The capital of the co-operative organization is collected from its members in the form of share capital, but as we know this constitutes only a limited source of business finance; as a result, major parts of capital is raised either by way of loan from the Government or by way of grants from the Government. Separate Legal Entity The management of cooperative organization vests in managing committee elected by members and it is the general body of the members which lays down the broad framework of policy within which the managing committee has to function. Merits: It is easy to form a cooperative society as it a voluntary association which does not require long and complicated legal preliminaries, as laid down by the law. Any 10 adult persons can voluntarily form themselves into an association and get it registered with the Registrar of Cooperatives. The management of cooperative organization vests in a managing committee elected by members and it is the general body of the members which lays down the broad framework of policy within which the managing committee has to function. Members in a cooperative organization have limited liability in contributing their capital share as shareholders have in a company. Similar to the company, the co-operative also enjoys a separate legal entity of its own; independent of the entity of its members who own it. That's why the life of co-operative organization remains unaffected by the death, insolvency of a member. Demerits: 11 last assessed on 25 th September,2014

13 (v) (vi) The amount of capital that a co-operative can collect is very limited as of the membership remains confined to a particular locality or region and also because of the principle of one man-one vote. In the day to day functioning of the cooperatives State governments subject them to a variety of regulations which leads to interference and slow growth. Day to day affairs are managed by the members only because of which the organization has to suffer extremely limited managerial talent. Lack of secrecy is seen in this form of business organization. All the above reasons lead to lack of motivation. Although co-operatives are formed with great fan fare and with the great ideals of co-operation and self-help, but soon these higher values of human life disappear with the passage of time, as all the affairs are managed by the members only which leads to differences among themselves which marks the beginning of an end to the co-operative organization. CORPORATE PERSONALITY Corporate Personality is the creation of law. Both English and Indian law recognized legal personality of a corporation. 12 A corporation has a legal personality of its own and it can sue and can be sued in its own name. It does not come to end with the death of its individual members and therefore, has a perpetual existence. However, unlike natural persons, a corporation can act only through its agents. Law provides procedure for winding up of a corporate body. Besides, corporations the banks, railways, universities, colleges, church, temple, hospitals etc. are also conferred legal personality. Union of India and States are also recognized as legal or juristic persons. 13 Corporations are of two kinds: Corporation Aggregate: This is an association of human beings united for the purpose of forwarding their certain interest. A limited company is one of the best examples of corporate aggregate. This kind of a corporation is formed by the members who are in agreement to contribute to the capital of the company in furtherance of a common object. Thus, their liability is limited to the extent of their share-holding in the company. The shareholders have a right to receive dividends from the profits of the company and exercise voting rights in the general meeting of the company. The principle of corporate personality of a company was recognized in the case of Saloman v. Saloman& Co 14. Corporation Sole: This kind of a corporation is stated by a single person who is personified and regarded by law as a legal person, these single person exercises of some office function, deals in legal capacity and has legal rights and duties towards the same.the object of a corporation sole is similar to that of a corporation aggregate http:// accessed on 6th August Art 300 of Constitution of India 14 [ ] All ER Rep accessed on 6th August 2014

14 Advantages of Incorporation 1) Independent Corporate Existence:A corporate person have an independent corporate existence, it has distinct and legal personality independent of its members. 2) Limited Liability:One of the principal advantages of an incorporated company is the privilege of limited liability. This is the main feature of registered companies which attracts investors. 3) Perpetual Succession:An incorporated company has continuous succession that means the company shall retain its estate and possessions as the same entity with the same privileges and immunities, notwithstanding any change in its members. Corporate existence of a company is not affected by the death or insolvency of its members. The death or insolvency of individual member does not in any way, affect its corporate existence. In Gopalpur Tea Co. Ltd. v. Penhok Tea Co, Ltd., the court while applying the doctrine of company's perpetual succession observed that though the whole undertaking of a company was taken over under an Act which purported to extinguish all rights of action against the company, neither the company was thereby extinguished nor any body's claim against it 16. 4) Transferability of shares:section 82 of the Companies Act, 1956, specifically provides that the shares or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of association of the company. Thus, the member of an incorporated company can dispose of his share by selling them in the open market and get back the amount so invested. The transferability of shares has two main advantages, namely, it provides liquidity to investors and at the same time ensures stability of 16 (1982) 52 Comp. Out. 238

15 the company. Similar position regarding the transferability of shares applies in the Companies Act, ) Separate Property: Incorporation helps the property of the company to be clearly distinguished from that of its members. The property is vested in the company as a body corporate, and no changes of individual membership affect the title. In case of a company, it being a legal person is capable of owning, enjoying and disposing of property in its own name. The company becomes the owner of its capital and assets. The shareholders are not the several or joint owners of company s property. 17 In R.T. Perumal v. John Deavin 18, it has been observed that a company is a real person in which all its property is vested, and by which it is controlled, managed and disposed of. Their Lordships further observed that "no member can claim himself to be the owner of the company's property during its existence or in its winding up." 6) Corporate Finances:The shares of an incorporated company being transferable, it can raise maximum capital in minimum possible time. That apart, an incorporated public company has the privilege of raising its capital by public subscriptions either by way of shares or debentures. 7) Centralized Management: The shareholders have no direct concern with the management of the company. They exercise, only a formative control. Thus, the management of the company is altogether different from its ownership. Independent functioning of managerial personnel attracts talented professional persons to work for the company in an atmosphere of independence thus enabling them to achieve highest targets of production and management leading to company's overall prosperity. 8) Capacity to sue and to be sued:a company being a body corporate can sue and can be sued in its own name. A criminal complaint can be filed by a company, but the company has to be represented by a natural person. In TVS Employees Federation v. TVS & Sons Ltd 19 it was held that the preparation of a video cassette by the workmen of a company showing their struggle against the company's management and exhibition could be restrained only on showing that the matter would be defamatory. In R v. Broadcasting Standards Commission, the court of appeal held that a company can complain under the Broadcasting Act, 1996 about unwarranted infringement of its privacy. In this case, the complaint was about the secret filming of transactions in shops by the BBC and the allegation was that this constituted an infringement of the company s privacy (1955) 1 SCR AIR 1960 Mad (1996) 1 WLR 132 (CA) 20 [2000]3 All ER 989

16 Disadvantages of Incorporation 1) Far more compliance and regulation to deal with increasing the risk of penalties. 21 2) A company is more complicated and costly to wind up. 3) Directors are personally subject to regulations and can be fined or found guilty of a criminal offence for failing to comply. Director shall be held personally liable if he/she acts beyond the provisions of the Companies Act, Memorandum and Articles of Association as it being ultra vires the company or the directors. 4) Lifting the Corporate veil-corporate personality is considered to be the most fundamental principle of Company law. When a company is incorporated it is considered as a separate entity from its shareholders and directors, for this reason the concept of lifting of corporate veil has come up. Lifting or piercing the veil is corporate law s most widely used doctrine to decide when a shareholder or shareholders or directors will be held liable for obligations of the corporation. In the case of Salomon v. Salomon & Company 22 passed by the House of Lords in 1897, it was laid down that a company is a distinct legal person, entirely different from the members or the shareholders of that company. The courts have come up with some ground on which veil can be lifted and they are firstly, where fraud is intended to be prevented, the veil of a corporation is lifted by judicial decisions and the shareholders 21 accessed on 5th August [1897] A.C. 22

17 are held to be persons who actually work for the corporation ; secondly, In the case of group enterprises, the veil may be lifted to look at the economic realities of the group; thirdly, in order to look at the characteristics of the shareholder, the corporate veil may be lifted by the courts and lastly, the lifting of the corporate veil has at times been warranted by the tax legislations also. Courts have struggled for years to develop and refine their analysis of these claims. However, each new action brings a different set of facts and circumstances into the equation and a separate determination must be made as to whether the plaintiff has adduced sufficient evidence of control and domination, improper purpose, or use and resulting damage. 23 5) Company is not given citizenship rights. Summary: In the module, different types of business organizations, their features, merits and demerits have been discussed. Incorporated and unincorporated associations and their distinctions have been discussed. Advantages of a corporate personality and its disadvantages including the doctrine of lifting the corporate veil have been discussed accessed on 28 th September,2014