Module 1

MODULE 1
INTRODUCTION TO BUSINESS LAWS

Business laws are essential for the students of different backgrounds who wish to pursue
different careers 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 begin
with and some of 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 we all know, in the ancient times the society was far from being organized.

The rights of the individuals were not recognized. Gradually, when the individuals surrendered
certain rights to the State and the State in turn, promised to protect its subjects, the society
evolved and the State came into being as a Sovereign power. 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
which plays an important role in business dealings of that trade. To have a binding force, the
custom or usage must be certain, reasonable, must have been followed for a considerably long
period of time, and must be 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 is 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 times, 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
isCompanies Act, 2013 [hereinafter referred as ‘2013 Act’]. It is a recent development by the
Government of India to enable growth, regulation and greater accountability of the corporate
sector in India. 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
sections and 29 chapters as against 658 sections and 23 chapters in the older Act of 1956. This
Act has not only brought changes with regards to certain terminologies 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 the past, shaken the foundation of corporate governance in India
and projected a very unpromising picture of India in the global market,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 a new concept but rather is more defined and increased as
per a provision in Section 135 of 2013 Act.

Directors are the 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 with regards to the provision for performance evaluation of these
Independent Directors which will hopefully in future come out as a powerful provision. Along
with legal provisions, their 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 as per Section 408 of the 2013 Act.

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

8th day of August 2013 marked an event in the history of corporate India. This was when the new
Companies Act was enacted, 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
2013.1The new Companies Act is undoubtedly more promising and covers 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.

1Sources, 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

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
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 the 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-

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

3Section 3(1), Companies Act 2013.

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, to act as a
specialised skills development advisor. Their term is mainly 5 years (original term) + 5 years
(additional term subject to a special resolution).

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 a
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

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
5Section 149, Companies Act, 2013.
6Section 455, Companies Act, 2013.

meetings at prescribed intervals and so on so forth. Maximum period to continuewith 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 a Dormant Company.

Companies that may apply for such status are as follows:

Companies incorporated for a future project
Companies incorporated to hold an asset or intellectual property
A company which has not filed its financial statement and annual returns for the last two
financial years
A Company which 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 Section 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 241.

As per drafts rules and Companies Act, 2013, the requisite number of minimum members for this
purpose shall be:

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.

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 number 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.

1.2.5. CORPORATE SOCIAL RESPONSIBILITY
Corporate Social Responsibility is now an 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 the 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.

1.2.6. 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 the
earlier legislation as well; 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
needed to enact such an 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.

1.2.7. 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 in 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 woman
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).

1.2.8. KEY MANAGERIAL PERSON

Section 203(5) provides for the appointment of the Key managerial person and after 2018
amendment, fine has been replaced with penalty. Special provisions have 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:

The Chief Executive Officer or the managing director or the manager;
The company secretary;
The whole-time director;
The Chief Financial Officer; and
Such other officer as may be prescribed.

1.3 A COMPARISON IS DRAWN BETWEEN COMPANIES ACT, 2013 and
COMPANIES ACT, 1956

1.3.1 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.

1.3.2 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. However, in 2018 amendment
Section 164 a new clause (i) after clause (h) has been inserted in Section 164(1), whereby a
person shall be subject to disqualifications if he exceeds the maximum number of directorships
mentioned under the Act.

1.3.3 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.

1.3.4 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. However in 2018 amendment ,section 105(3) that talks
about default in providing a declaration with regard to appointment of proxy in a notice calling
for general meeting says that non-compliance would result in penalty instead of fine.

1.3.5 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, upon
meeting of certain criteria, 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.

1.3.6 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. Section 165 (6) talks about
imposing fine for accepting directorships beyond specified limits but after 2018 amendment the
fine has been replaced with penalty. 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.

1.3.7 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.