COMPANY LAW (PART-18) (UNIT I) COMPANY AS A BUSINESS MEDIUM ADVANTAGES AND DISADVANTAGES 1. INTRODUCTION Dear students, welcome to the lecture series on Company law. In my previous lecture, I discussed the origin of the company form of the business organization. I also touched upon the objects of company law and we had a bird s eye view on the course content. Today we are going to discuss the meaning of the company, characteristics of the company and the disadvantages associated with the company form of the business organization. If we go by a laymen s definition of the company, then we find that company is an association of the person for the particular purpose, but this is not a legal definition. If we go by the legal definition of the company, then we can say company is the association of the persons formed together either under the existing company law or under any other act which was in existence prior to the existing law. Now, if we evaluate this definition, then we find company means a company which has been formed and incorporated under the existing Act 1956. So a company will be called as a company if it is formed and incorporated under the 1956 Act or a company which is formed and incorporated prior to the Act of 1956. Meaning there by we know it that prior to 1956 there were also companies Act which were in existence, Like 1866, 1882 and 1913, so a company which is incorporated either in 1956 Act or in these act that will also be called as a company. So this is the legal definition of the company and this definition only emphasis on the company formed and incorporated, but it is not mentioning what the company is? Company 1
has not been defined in the law, if we want what the company is, then we have to look into the characteristics of the company. 2. THE CHARACTERISTICS OF THE COMPANY After understanding the meaning of the company in the general parlance and after understanding the meaning of the company according to Act, now we will study the characteristics of the company. A company is a voluntary association of persons formed to achieve some common objectives having a separate legal entity, independent and separate from its members with a perpetual succession and a common seal and with the capital divisible into transferable shares. Now, if we analyze this definition, then we find that the company is an artificial person, when we talk about the company is an artificial person, there are two words in it, Artificial and Person meaning thereby company is not a natural person. It cannot get the natural birth like a natural person, it is an artificial person, when we say it is an artificial person it means company is formed according to the law and company dies according to the law. But the word which we are associating with it, that is the person it means certain characteristics of persons are associated with the company, though the company is an artificial person, it cannot have all the characteristics of a natural person, like a company cannot get married, company cannot take oath, company cannot seek divorce, where as a natural person can do all these things, so when we say company is an artificial person it means company has been formed and constituted or is incorporated by the provisions of the law and it will be wound up according to the provisions of the law. Therefore we can also say that company is an institution or it s a legal device which helps us in achieving the socio-economic goals of the society or of the nation, so after understanding the meaning of the company, like company is an artificial person it means company has got no soul, company has got no body, it cannot be shaken also, it cannot be given a shape yet it is an artificial person but we should remember, it is not a fictitious person, there is a difference between fictitious person and artificial person, so after understanding the meaning of the company, 2
we will get the company meaning more clear if we try to understand each and every characteristics of the company in detail. The first and the foremost characteristics of the company is, the company is a separate legal entity, separate legal entity means when the company is incorporated, then company is entirely different and its members are entirely different, it has got no association with the members, Members have got a separate existence and company has got a separate entity. This has been decided in a very prominent case Name of the case is Salomon and Salomon & CO. Ltd. In this particular case, it has been explained that company has a separate legal entity. 3. EXAMPLE COMPANY HAS GOT A SEPARATE LEGAL ENTITY Now let me take an example to explain it A is a person who is employed in a company as a peon but he has not got the salary since last three months. He filed a suit on the managing director of the company, in this case a decision was given that A is not entitled to file a suit on the managing director, he can file a suit on the company because company has got a separate legal entity, we will study it that company can file a suit and suit can be filed on a company The second important characteristics of the company is, it has got the perpetual succession, the meaning of the perpetual succession is that it never comes to an end, meaning thereby that the company is formed according to the law and company dies according to the law. The death of the member, insolvency of the member, insanity of the member has got no impact on the company s existence, man may come man may go but company always goes, it never comes to an end even a hydrogen bomb cannot kill a company, suppose a meeting is going on in a company and all the shareholders are present in the meeting and a bomb is dropped on the building where the shareholders are sitting and suppose all the shareholders dies, I put a question to you will you presume that company have also died, NO in spite of the fact that all the shareholders have died but company never dies even by dropping a bomb. It has got a perpetual succession, perpetual succession means if any member of the 3
company transfer the shares to somebody, company will not come to the end, whereas in partnership you will find that if all the partner dies, the partnership will come to an end but here in the company form of the organization, if all the member dies, company will not come to an end because the shares of the company will be transferred to the legal representative of the shareholders, so they will become the member of the company. Let me give you another example, A, B, C are the members of a company and all of them died in an air crash, company will not come to the end. Therefore we can say company has got a perpetual succession, its life is more than the life of an individual provided, it is earning the profits and it is not wound up according to the law. We can take the example or we can understand this point by looking around us and we will find that there are certain organizations even 100 years old, Tata iron and steel company is more than 100 years old, so company has got a perpetual succession, another characteristic of the company is shares are freely transferable. If it is a public company the shares in a public company are freely transferable but if it is a private company there is a restriction on the transfers of the shares, but there also we have used the word restriction on the transfer of share, we have not used the word ban on the transfer of shares, when we say that shares are freely transferable, it means any member of the company can give his share or her share to somebody else and can get back his investment. Suppose A is a shareholder and has purchased the shares in a company of worth Rs. 10,000 but now he is in need of money, though A in this case can transfer his share to somebody. It is not going to affect the capital of the company. In partnership one partner cannot transfer his interest to another person without the consent of the other partners, the first characteristics, perpetual succession then we discussed the shares in the company are freely transferable. Now we come to another characteristic of the company, company can file a suit on or any individual and an individual can also file a suit on the company. Let us take an example; A company has given the order to the B company to supply the motor parts of a particular quality, B company has not provided the motor parts to the A company of the particular 4
standard or of the particular quality. Now in this case A company can file a suit on the B company and suppose B company has provided the motor parts of a particular quality which were required by the A company but A company has not paid the price to the B company, then the B company can file a suit on the A company. So a suit can be filed on the company and a person concerned or aggrieved party can also file a suit on the company, next characteristics is that company has got a common seal. You know we as an individual put our signatures for proving our identity on a particular paper or to make it more authentic. Company can also use its signature but it will be in the form of the common seal, the common seal should be kept in a proper place and it should be with the proper authority. You know on behalf of the company the board of directors or the authorize people will enter into the contract. So they will enter into the contract with somebody or with third party in that case to make the contract authentic company can use the common seal, another characteristics of the company is that liability in the company is limited, when we say that liability is limited, this is probably the biggest advantage or the characteristics of the company form of the organization. In partnership we have seen the liability is unlimited, the greatest disadvantage in the sole proprietorship form of the business is the liability is unlimited, so those defects were removed when the company form of the organization emerged, so the members of the company has got the limited liability. Limited liability means a shareholder in a company will be responsible up to the face value or the nominal value of the share. If company has incurred the loss more than the nominal value of share, then the shareholder will not be responsible for the loss which the company has incurred, let us take an example, A is a person who has got 100 shares of 100 Rs. each total liability of A is 10,000 Rs. (100 x 100 = 10,000). Now A will be responsible to pay or his liability will be up to Rs. 10,000, suppose company has incurred the loss in lakhs of rupees or in crores of rupees but A will be responsible only for 10,000 now suppose A has partially paid the money on the shares, say for example, A has paid 5000 Rs. on the shares, the remaining liability is now only of 5000, now if the company goes in winding up or company incur 5
some great loss or company wants to demand the money from A, then A will be responsible only for the 5000 A cannot be compelled to pay more than 5000 Rs. because A has already paid 5000 Rs. and remaining liability is of 5000 only. The concept of limited liability I will discuss with you in detail when we will talk about the kinds of companies, another characteristics of the company form of organization is that it has got separate property. It means companies property belongs to company, it doesn t belong to the member of shareholder, when we say so you will amaze to know that s companies property is purchased from the money of the investors or it is purchased from the money of the shareholders, but the property is not of the shareholders, no shareholder can say that he has got an insurable interest in the company s property. Another characteristics is that company has got the professional management, you know nowadays companies are been run on the basis of the professional management where in sole trading business or sole proprietorship business, the owner himself run the business, in partnership the group of the people runs it but in company since the shareholders are scattered in the remote areas or at a very distance places throughout the corner of the nation, now in that case to run the company, we require professionals so the characteristics of the company form of the organization is that we can hand over the reins of the company in the hands of the professionally qualified persons, so with this we end our discussion on the characteristics of the company. 4. DISADVANTAGES OF THE COMPANY FORM OF THE ORGANIZATION After understanding the advantages of the company form of the organization, now we will discuss the disadvantages of the company form of the organization. The first disadvantage is that company form of the organization requires lot many formalities and they are expensive also, you know when a company is to be formulated we had to prepare certain very important documents and they are to be submitted to registrar of 6
companies like we have to prepare the memorandum of association, article of association and the prospectus, not only they are to be properly drafted but they are have to be printed, so preparation stage requires the time and getting it printed is an expensive process. This is the stage when we want to bring the company into the existence but when the company comes into the existence and when the company is in operation and then to run the company smoothly, we had to conduct the meetings, we had to pass the resolutions, we had to note down minutes or we had to bring some changes at certain places, now all these things are to be fulfilled according to the requirements of law. Law is to be observed at every step when we are running company, when we are not observing the law then the penalty has to be paid by the company for the violation of the law, so when we are paying the penalty, it becomes an expensive process so when a company is formulated, it is requiring number of formalities and expensive exercise also. It is not just like a sole trading business or sole proprietorship form of the business where one man can easily start the business because there is no special legislation is attach with that form of the business, we know that we are govern by the Indian Companies Act 1956 we had to honour the law and if we do not honour, we will be penalized and that will be an expensive thing for us. The second disadvantage and company is not a citizen, we had mention that company is an artificial person but company is not a citizen of the nation, the constitution of India has not recognized the company as a citizen nor the citizenship act has recognized company as a citizen, if the shareholders or the members of the company are citizens of this nation but they have incorporated the company outside the nation or outside India, then company will not become an Indian company. Say for example A and B, are the Indians and has formulated a company in England, the company will not become an Indian company, though the people those who formulated are Indians but company will not be known as the Indian company, it will be known as the company which is incorporated in England in spite of the fact that the company is doing the business in India but it will be treated as a Foreign Company. So if the citizens are Indians but the company has been incorporated outside, the company will 7
not get the citizenship of this nation, companies member cannot have the effective control, this is the another disadvantage which is associated with the company form of the organization. When we say the members cannot have an effective control, it means that a company is situated in one particular state and the shareholders are at the distance places, say for example Reliance industry has got large number of the shareholders and shareholders are scattered throughout India, they are in every corner of this nation but they cannot have an effective control in running the company, A shareholder of the company has invested the money in the company but does not know what company is doing because his participation in the company is not there In sole proprietorship, a person himself can have an effective control. In partnership the person can have effective control in the management of the partnership firm but in the company form of the organization, when the large number of the shareholders are there, the management cannot be controlled by each and every shareholder, so this is the another disadvantage with the company form of the organization. The next disadvantage is the company has got a tax burden which is very high, Sometime, there are certain companies which are been released by the policies of the government or under the Act and they are given certain privileges but generally the different slab of income tax is applicable on the company form of the organization, therefore company has to pay the huge amount in form of a tax. The another disadvantage associated with the form of the organization is that company has to fulfill the social responsibility, when we say the social responsibility it means company cannot do an act which is against the environmental law of the country which is against the pollution Act of the country and which is detrimental to the health of the citizens of the society, so a company has to fulfill the social responsibility company has to look into the interest of the society first and then company has to take the decision accordingly, this variable also plays a very prominent role in the decision making. The decision of the management should not harm the citizens or the society at large; another disadvantage of the company form of the organization is that it s a winding up process also very lengthy. The first point which I discussed 8
with you was that formation process expensive process and is a lengthy process; similarly the winding up process of the company is also very lengthy. It s not just like as a sole proprietorship form of the business where the winding up can be done within no time but in company sometime it has been observed that winding up process takes more than one to two years and the legal formalities are to be complied, therefore this process also becomes expensive. Last but not the least is that separate legal entity of the company can be ignored in certain cases, when the separate legal entity is ignored that is known as the Lifting of corporate veil, there are certain circumstances where the separate legal entity is ignored by the law when we started the advantages of the company form of the organization, we mentioned that the biggest advantage with the company is that it has got separate legal entity but this advantage sometime becomes disadvantage also when the law decides or the things are so apparent or the things are so visible, the separate legal entity can be ignored, In this case the members and the company are treated one. When we discuss the separate legal entity, there we mention that the members are different and company is different, but when we are going according to the doctrine of lifting of corporate veil, then in that case we submerge the member with the company and we say that they are not different, they are the one, this concept also will be discussed by me later on when we will discuss the lifting of corporate veil in great detail. So before I finish my discussion with you, I would like to remind you that we started the discussion with the definition of the company and we mention that a company which is registered under 1956 or under any previous act which was prevailing prior to the 1956 we discuss that it is an artificial person, then we went on discussing the characteristics of the company and in the last we have discussed the disadvantages associated with the company form of the organization. Thank you. 9