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MODULE 1: INTRODUCTION TO CORPORATE LAWS

Business laws are essential for the students of different backgrounds, such as entrepreneurs,
employees, managers and lawyers, as to understand the legal rules and aspects of business.
Just like any other study even business management is incomplete without proper study of its
laws. Any form of business needs legal sanction. Therefore, it is imperative that a manager
understands the various ways in which businesses can be organized. This subject introduces
some of the common forms of business organizations, including some forms unique to India like
the Joint Hindu Undivided Family firm. Different types of organizations like Sole
Ownership, Partnership, Private Limited Company, Public Limited Company, Joint Stock
Company along with the rationale for adopting these forms are explored. What form of
business organization is the best under particular set of conditions? What advantage or
disadvantage does it have over other forms of business? Formalities to begonia through and
some the quasi-legal processes required for starting a business will be discussed in detail in this
subject. For the proper working of the society, there must exist a code of conduct. As you all
know, in the ancient times the society was not organized.

The rights of the individuals were not recognized. Gradually, the society evolved and the
state came into being. As we all know, to regulate the state, there should be a specific code of
conduct, which should be followed by everyone. As a result of which law evolved as a system of
rights and obligations including all the rules and principles, which regulate our relations with
other persons and with the state. These rules and regulations took the form of statutes. To
enforce the law and to resolve the conflicts arising therefrom, courts of law were setup by the
state. Laws were made to govern almost every walk of life. For illustration one has an idea that
the criminal laws were made to control criminal activities in the society like Indian Penal Code,
which enumerates which activities are considered criminal and what will be the punishment for
committing a crime. Likewise, mercantile law was evolved to govern and regulate trade and
commerce. Hence, the term mercantile law can be defined as that branch of law, which
comprises laws concerning trade, industry and commerce. It is an ever-growing branch of law
with the changing circumstances of trade and commerce. Now the question arises as to what
are the sources of mercantile law in India. The answer is

• The Indian statutes on mercantile law.

• English/ Foreign law

• Precedents (previous judgments of the courts.)

• Customs and usage

Most of the Indian Mercantile Law is contained in the statutes. The prime legislation is the
Indian Contract Act 1872 but it is not exhaustive to deal with all kinds of contracts. In addition
to this there are the Sale of Goods Act, 1930, The Indian Partnership Act 1932, The Negotiable
Instruments Act 1881 etc. wherever the Indian Contract Act is silent, the Indian courts may
apply the principles of the English Common Law. It is interesting to know that in England there
is no English Contract Act in the form of a statute. It has been derived from common law, the

usage of merchants and traders in different spheres of trade, substantiated or ratified by
decisions in the court of law. The judicial precedents are an important source of law.
Sometimes, there is no provision, which can answer a particular question of law. In such cases
the court will look into the previous decisions on similar matters to find the relevant custom
and usage of a trade play an important role in business dealings of that trade. To have a binding
force, the custom or usage must be certain, reasonable and well known. Now it is more than a
century that that the mercantile laws are governing trade and commerce. The law of contract is
the foundation upon which the superstructure of modern businesses built. It is common
knowledge that in business transactions quite often promises are made at one time and the
performance follows later. In such a situation if either of the parties were free to go back on its
promise without incurring any liability, there would be endless complications and it would
be impossible to carry on trade and commerce. Hence the law of contract was enacted which
lays down the legal rules relating to promises, their formation, their performance, and their
enforceability. Explaining the object of the law of contract Sir William Anson observes. “The
law of contract is intended to ensure that what a man has been led to expect shall come to
pass, that what has been promised to him shall be performed”. The law of contract is applicable
not only to the business community but also to others. Every one of us enters into a number of
contracts almost every day, and most of the time we do so without even realizing what we are
doing from the point of law. A person seldom realizes that when he entrusts his scooter to the
mechanic for repairs, he is entering into a contract of bailment; or when he buys a packet of
cigarettes, he is making a contract of the sale of good; or again when he goes to the cinema to
see a movie, he is making yet another contract; and so on.

1.1 NEW FACE OF BUSINESS LAWS: COMPANY LAW 2013 AMENDMENTS

Corporate India continues to develop at a very fast pace and is witnessing the emergence of
new and diverse stakeholders. A legislation to regulate stakeholders and corporate bodies in
India is Companies Act 1956 which will remain in force for very short time in future. Recently
enacted Companies Act 2013 [hereinafter referred as ‘2013 Act’] is the new development by
Government of India to enable growth, regulation and greater accountability of the corporate
sector in India and will very shortly be completely in action. After about half a century of
reviews and consultations, Companies Act 2013 is a welcome addition to corporate governance
and management. This 2013 Act will have 470 clauses and 29 chapters as against 658 section
and 23 chapters in the older Act of 1956. This Act has not only changed certain terminology but
has also been instrumental in introducing new definitions like that of Key Managerial Personnel,
Subsidiary Company etc.

A man is known by the company he keeps. The 2013 Act pays attention to a newly developed
fact of “One Person Company”. This concept can be the stepping-stone towards the
corporatization of the sole proprietorship businesses. When major corporate frauds like Satyam
Scam, to name a few have in past has shaken the foundation of corporate governance in India
and projected a very unpromising picture of India around the globe. The 2013 Act lays special

stress on this aspect of corporate mismanagement and misdemeanour by introducing wider
Director and Management responsibility.

Even the provisions of 2013 Act lays down provisions relating to offences, penalties and
prosecution which are refreshingly different from the existing code. It aims at corporate with
greater freedom but with severe consequences of non-compliance. A Company is a separate
legal entity and a legal personality. It has all those rights that a legal person in the country has.
So, it also owes responsibility to pay back to the society for development. The induction of
concept of Corporate Social Responsibility is not new concept but rather is more defined and
increased as per a provision of 2013 Act.

Directors are key to managerial and corporate success. The 2013 Act lays down necessary
conditions to appoint the Directors and Independent Directors with requisite qualifications. But
the new addition is in regard to provision for performance evaluation of these Independent
Directors which will hopefully in future come out as a powerful provision. Along with legal
provisions, there applicability and enforcement is a pre-requisite for desired results. And in
cases where the enforcement is not in consonance with the Act, it calls for adjudication of the
matter and dispensation of justice. Provision for establishment of National Company Law
Tribunal (NCLT) is a new provision in 2013 Act.

Introduction of the concept of internal audit is also a welcome provision in the 2013 Act. Earlier
only producer companies were directed to do so but now maximum companies are required to
comply with the provision. This Draft mainly focuses upon addressing the new highlights of the
Act and an analysis has been drawn by comparing it with the older Companies Act, 1956.

8th day of August 2013 marked an event in the history of corporate India by enacting new
Companies Act, namely, “Companies Act 2013”. It was given assent by Hon’ble President Sh.
Pranab Mukherjee and thereby was published in Gazette of India on 30th August 2013.1 New
companies Act is undoubtedly more promising and is covering a wide range of newly discovered
areas along with well-established principles. The new Act is a historic piece of legislation aimed
at improving transparency and accountability in India’s corporate sector. The new Companies
Act will give this country a modern legislation, which will contribute to the growth and
development of the corporate sector in India.

If we take a statistical snapshot, it is very clear that the Companies Act 2013 has different
number of sections and schedules etc. as compared to Companies Act 1956. Companies Act
2013 has 470 sections, 29 chapters and 7 schedules.2 The promulgation of the new law is a step

1 Sources, Ministry of Corporate Affairs, Press Information Bureau, Government of India as on dated 5th January
2014.
Can be Accessed athttp://pib.nic.in/newsite/erelease.aspx?relid=99049
2ET Bureau, “Second Set of Draft Norms Released”, Economic Times, Sept 21st 2013.
Can be Accessed at http://articles.economictimes.indiatimes.com/2013-09-21/news/42272627_1_draft-rules-
nclt-draft-norms

towards globalisation and is a successful attempt to meet the changing environment and is
progressive and futuristic duly envisaging the technological and legal developments.

1.2 HIGHLIGHTS OF NEW COMPANIES ACT 2013

There have been a number of additions to the new bill. New definitions, new clauses, new
characterisations of terms and rules have a very significant role in any legislation and this new
Act is no exception to the rule. Certain very significant developments are explained as below:

1.2.1 ONE PERSON COMPANY

A person is known by a company he keeps. But rarely had one ever thought of having a
company comprising of one person as Owner, director etc. The 2013 Act introduces a new type
of entity to the existing list i.e. apart from forming a public or private limited company, the
2013 Act3 enables the formation of a new entity a ‘one-person company’ (OPC). An OPC means
a company with only one person as its member. One Person Company is a Private Company
formed by subscribing the name of such one person to the Memorandum and complying with
the requirements of the Act in respect of registration. As regards the name of One Person
Company, the Act provides that the words “One Person Company” or “OPC” shall be mentioned
in brackets below the name of such company, wherever its name is printed, affixed or
engraved.

So, for the person wanting to venture alone, the only option was proprietorship, an onerous
task since it is not legally recognised as a separate entity. Now, after the recent passing of the
much-hyped Companies Act, 2013, by parliament, there may be hope for the budding
entrepreneur. Only Indian citizens can avail this new facility provided by new 2013 Act.4

1.2.2 INDEPENDENT DIRECTORS

Independent Director is defined under new companies Act 2013. Section 2(47) defines
Independent director as an independent director as under section 149 (5) of Companies Act
2013. The Provision to make companies have one-third of their board members is fine in
principle. Independent Directors are also more stringently defined, and their tenures will be
limited to two terms adding up to 10 years. Independent directors can also hold a maximum of
20 directorships.5 Role of Independent Directors is mainly to deliver impartial judgement, acts
as a specialised skills development advisor. Their term is mainly 5 years (original term) + 5 years
(additional term subject to a special resolution).

3 Section 3(1), Companies Act 2013.

4 Ashish Sinha, “Only Resident Indians can Avail of One Person Company Benefit”, Economic Times, Sep 26, 2013
Can be Accessed at http://www.financialexpress.com/news/only-resident-indians-can-avail-of-one-person-
company-benefit/1174267
5 Section 149, Companies Act, 2013.

With a view to add transparency, fairness and independence in decision making to safeguard of
stakeholders’ interest, the concept of Independent Directors was introduced. While the
concept was till date applicable on Listed Public Companies, the New Company Law proposes to
introduce the same upon big Public Companies as well. It is much likely that rationalism and
objectivity would be inducted in the processes of the Company with this initiative.

1.2.3 DORMANT COMPANY

The concept of Dormant Company is very significant in Companies Act 2013.6There are number
of Companies in India that are either incorporated for future project or hold only assets or IPRs
and are yet to carry out the operations or are in-operational for substantial period. Earlier,
there was no relaxation under the law to treat them at a different footing than the active
Companies of the same class. They were required to file forms as usual, hold board meetings at
prescribed intervals and so on so forth. Maximum Period to continue with status of Dormant
Company is of 5 consecutive years. Dormant status does not come automatically. An
application for the same has to be made for obtaining the status of Dormant Company.

Companies that may apply for such status are as follows:

1. Companies incorporated for a future project
2. Companies incorporated to hold an asset or intellectual property
3. Company has not filed financial statement and annual returns during the last two financial
years
4. Company has not been carrying on any business or operation i.e. an inactive Company

“Inactive company” means a company which has not been carrying on any business or
operation, or has not made any significant accounting transaction during the last two financial
years, or has not filed financial statements and annual returns during the last two financial
years.

1.2.4 CLASS ACTION

The provisions governing class actions are introduced through s. 245 of the new Act. These
provisions are included under ‘Chapter XVI – Prevention of Oppression and Mismanagement’:
however, class actions are evidently not the same as petitions against
oppression/mismanagement. Section 245(1) thus gives the right to the members/depositors to
file an application to the Tribunal “if they are of the opinion that the management or conduct of
the affairs of the company is being conducted in a manner prejudicial to the interests of the
company or its members or depositors…” Insofar as a member is concerned, the contours of
this section are not clearly delineated from the oppression section (s. 241).

6 Section 455, Companies Act, 2013.

As per drafts rules and Companies Act 2013, the requisite number of minimum members for
this purpose shall be:
(a) 100 or more for companies having share capital or 10% or more of the total members,
whichever is less or members having 10% or more of the issued share capital.
(b) One-fifth or total members of the company in case where company having no share
capital. The minimum number of depositors is 100 or 10% of total no. of depositors whichever
is less.

If this provision had been on the statute book in 2008, Satyam’s Indian shareholders could have
filed a class action suit against the Rajus, or even the Mahindra-run company that took over
Satyam’s assets. Mahindra Satyam settled lawsuits in the US and UK since these countries
enable class action suits, but in India shareholders were left twiddling their thumbs while
foreign shareholders were paid off.

1.3 CORPORATE SOCIAL RESPONSIBILITY
Corporate Social Responsibility is now accepted means to achieve sustainable development of
an organisation. Hence, it needs to be accepted as an organisational objective.

Corporate Social Responsibility is one of the prime developments in new Companies Act 2013.
Section 135 of the 2013 Act states that every company having net worth of Rs 500 crore or
more, or turnover of Rs 1000 crore or more , or net profit of Rs 5 crore or more during any
financial year shall constitute a Corporate Social Responsibility Committee of the Board. The
committee would comprise of three or more directors, out of which at least one director shall
be an independent director.

The mandate of the said CSR committee shall be to formulate and recommend to the Board, a
Corporate Social Responsibility Policy, which shall indicate the activities to be undertaken by
the company as specified in Schedule VII to recommend the amount of expenditure to be
incurred on the activities referred to above to monitor the Corporate Social Responsibility
Policy of the company from time to time.

CSR activities to include eradicating extreme hunger and poverty, promotion of education,
promoting gender equality and empowering women, reducing child mortality and improving
maternal health, combating human immunodeficiency virus, acquired immune deficiency
syndrome, malaria and other diseases, ensuring environmental sustainability, employment
enhancing vocational skills, social business projects, contribution to the Prime Minister's
National Relief Fund or any other fund set up by the Central Government or the State
Governments for socio-economic development and relief and funds for the welfare of the
Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women and
such other matters as may be prescribed.

1.4 NATIONAL FINANCIAL REPORTING AUTHORITY (NFRA)

One of the foremost step for improving corporate governance since birth of concept of
corporate governance is improving quality of accounting and auditing of companies. Audit
Committee is one of these measures, which has been taken to improve standard of financial
reporting. But concerns related to quality of financial reporting are not new. We can trace these
concerns in earlier legislation, all earlier versions of the Companies Act in general and the
Chartered Accountants Act, 1949. Without going deep in these laws, we simply say; what was
otherwise need to enact such Act to regulate a profession of accounting and auditing,
standardizing whole process of accounting and auditing.

The National Financial Reporting Authority is a quasi-judicial body to regulate matters related
to accounting and auditing. With increasing demand of non-financial reporting, a National
Financial Reporting Authority will regulate standards of all kinds of reporting, financial as well
as non-financial companies.

An independent authority, viz. National Financial Reporting Authority(NFRA) to be constituted
to make recommendations to Central Government on formulation and laying down of
accounting and auditing policies and standards, monitor and enforce compliance therewith and
oversee the quality of service of relevant professions. NFRA has been vested with quasi-judicial
powers to investigate matters of professional or other misconduct (as defined in CA Act) by
chartered accountants ‘for such class of bodies corporate or persons’ as may be prescribed. At
present matters relating to professional or other misconduct are handled by the Institute of
Chartered Accountants of India. The new provisions would raise a number of practical issues
apart from questioning the validity of the concept that a professional should be judged by his
peers.

1.5 WOMEN DIRECTORS

It is important for corporate boards to ensure gender diversity, but before that happens, a
supply of women eligible for board positions needs to be created. According to GMI Ratings’
Women on Boards Survey 2013, even on the world’s best-known companies, women account
for only 11 percent of total directorships. In India, a sample of 89 companies with more than $1
billion in market valuation, the women percentage is less than 7 percent. And we are talking
only about the biggest companies here. Clearly, major efforts will have to be made to create
more women directors, but before that there have to be more women reaching the top of the
corporate hierarchy.

The Government of India has for first time introduced this provision regarding presence of
woman in Board of Directors. This is undoubtedly a welcome step. Proviso to section 149(1)
stipulates that companies shall employ at least one woman Director.

Directors: Maximum number of directors to be appointed is 15 as compared to 12 at present.
This number can be enhanced by special resolution without Central Government approval. At
least one director should be a person who has stayed in India for a total period of not less than

182 days in the previous calendar year. Certain class of companies shall have at least one
women director. The 1956 Act prescribed minimum 2 directors for a private and 3 for a public
company respectively to constitute a Board. This criterion has been retained by the new Act,
but the maximum limit of directors on the Board has now been raised from 12 to 15. The Act
has also removed the stringent compliance of securing prior Central Government approval for
raising the number of directors beyond the prescribed limit and, instead, a comparatively
simpler method of approval by means of a special resolution of the shareholders has been
introduced.
The legislation clearly defines the role of such independent directors and has a detailed "Code
for independent directors” appended to it, which contains explicit guidelines for professional
conduct, roles and responsibilities of such directors. They are bound by this Code to play a role
in the appointments, determination of remuneration and removal of executive directors,
managers and key managerial personnel. At least one Director should be a person who has
stayed in India for a total period of not less than 182 days in the previous calendar year
(Resident Director).

1.6 KEY MANAGERIAL PERSON

Special provision has been made for Key Managerial Personnel and a lot of significance is also
given to them. They are key to the working and development of business organisation. It mainly
includes:
(i) The Chief Executive Officer or the managing director or the manager;
(ii) The company secretary;
(iii) The whole-time director;
(iv) The Chief Financial Officer; and
(v) Such other officer as may be prescribed.

1.7 A COMPARISON IS DRAWN BETWEEN COMPANIES ACT 2013 and COMPANIES ACT
1956

1.7.1 BOARD OF DIRECTORS

The 1956 Act provided that the limit for maximum number of directors be based on its articles
or twelve whichever is lower. The 2013 Act provides that the company shall have a maximum of
fifteen directors on the Board of Directors (‘Board’) and appointing more than fifteen directors
would require approval of shareholders through a special resolution.

The 1956 Act did not prescribe any academic or professional qualifications for directors. The
2013 Act provides that majority of members of Audit Committee including its Chairperson shall
be persons with ability to read and understand the financial statements.

The 2013 Act provides for appointment of at least one woman director on the Board for such
class or classes of companies as may be prescribed.

1.7.2 DISQUALIFICATION OF DIRECTORS

The 2013 Act includes the following additional grounds of disqualification as a person who has
been convicted of an offence dealing with related party transactions at any time during the past
five years. Similar to the public companies under the 1956 Act, the directorship in private
companies has also been brought under the ambit of disqualification on ground for non-filing of
annual financial statements or annual returns for any continuous period of three years, or
failure to repay deposits (or interest thereon) or redeem debentures (or interest thereon) or
pay declared dividend and such failure continues for more than one year.

1.7.3 INDEPENDENT DIRECTORS

Under 1956 Act, there was no requirement to have Independent Directors. However, under the
Listing Agreement, the Board of listed entities having non-executive chairman and executive
chairman should comprise of at least one-third and one-half of the Board as Independent
Director (ID) respectively. The 2013 Act proposes that the Board of listed entities should
comprise at least one-third of the Board as ID.

1.7.4 BOARD MEETINGS

The 1956 Act required at least one Board meeting to be conducted in every three calendar
months and four such meetings in a financial year. Further, Listing Agreement requires at least
four meetings in a year with a maximum time gap of four months between two meetings. The
2013 Act, consistent with the Listing Agreement requirement, provides that the company
should have at least four meetings in a year with a maximum time gap of one hundred and
twenty days between two meetings.

The 2013 Act also requires that the first Board meeting of the company be held within thirty
days of incorporation of the company.

1.7.5 AUDIT REPORTING

The 1956 Act required at least one Board meeting to be conducted in every three calendar
months and four such meetings in a financial year. Further, Listing Agreement requires at least
four meetings in a year with a maximum time gap of four months between two meetings.

The 2013 Act, consistent with the Listing Agreement requirement, provides that the company
should have at least four meetings in a year with a maximum time gap of one hundred and
twenty days between two meetings. The 2013 Act also requires that the first Board meeting of
the company be held within thirty days of incorporation of the company.

1.7.6 CORPORATE SOCIAL RESPONSIBILITY

The 1956 Act did not mandate a company to spend on CSR activities and consequently, there is
no requirement to constitute a CSR Committee. The 2013 Act provides that a company meeting
certain conditions should constitute a CSR Committee of the Board, consisting of minimum of
three directors.

The CSR Committee should consist of a minimum of one ID. The CSR committee should
formulate and monitor CSR policies and discuss the same in the Board’s report.

1.7.7 DIRECTORS

The 1956 Act provided for maximum directorship of not more than fifteen companies and
following directorships were not considered in the limit:

• Private companies
• Unlimited companies
• Associations not carrying on business for profit or which prohibit payment of dividend
• Alternate directorships
• Foreign companies

The 2013 Act provides that a person cannot have directorships (including alternate
directorships) in more than twenty companies, including ten public companies. For
determination of public companies, directorship in private companies that are either holding or
subsidiary company of a public company shall be regarded as a public company.

It is noted that members at their discretion can prescribe a lower number of companies in
which a director of the company may act as a director. The 2013 Act provides for one year
period from the enactment to comply with this requirement. The provision increases the
number of directors from 15 to 20.

1.7.8 CLASS ACTION

Unlike the 1956 Act, the 2013 Act provides for class action suits, which will allow a requisite
number of members or depositors with common interest, in a matter, to file an application in
the National Company Law Tribunal (‘NCLT’) against the company/its management/its auditors
or a section of its shareholders for damages or compensation if they are of the opinion that the
management or conduct of the affairs of the company are being conducted in a manner
prejudicial to their interest.