Nature and Characteristics of a Company | Company Law - CLAT PG PDF Download

Understanding Corporate Entities: The Legal Perspective

A corporate body, such as a company, is established through legal means and is considered an artificial juridical person, distinct from a human being. Despite its non-human status, a company is endowed with various rights, obligations, powers, and duties as prescribed by law, which is why it is referred to as a 'person' in legal terms.

The Nature of Corporate Entities

• A corporate body, like a company, is created by law and is therefore not a natural person but an artificial juridical person.
• As a creation of law, a company is granted certain rights, obligations, powers, and duties, similar to those of a natural person.

Memorandum of Association

• The Memorandum of Association serves as the charter of the company, outlining the powers and scope of activities the company is authorized to undertake.
• Being a legal entity, a company can only exercise the powers conferred upon it by its Memorandum of Association.
• Within the limits set by this charter, a company can perform all actions that a natural person is legally allowed to do.

Characteristics of a Company

When we talk about the defining traits of a company, two key aspects come into play: corporate personality and limited liability. Let's break these down.

Corporate Personality

• A company, once incorporated under the Act, is granted a corporate personality. This means it has its own name, can act under that name, has its own seal, and its assets are separate from those of its members.
• The company is considered a different "person" from its members, which allows it to own property, incur debts, borrow money, have a bank account, employ people, enter into contracts, and sue or be sued, just like an individual.
• While the members are the owners of the company, they can also be creditors. A shareholder cannot be held responsible for the company's actions, even if they own almost all of the shares.
• A company is an artificial person created by law. It is not a human being, but it acts through people. As a legal person, it can enter into contracts, own property, sue, and be sued. It is called an artificial person because it is invisible and intangible, existing only in the eyes of the law. It has rights and duties like any other person.

Limited Liability

• Limited liability is a major advantage of doing business as a corporation. Since a company is a separate entity, it owns its assets and is responsible for its liabilities.
• A member's liability as a shareholder is limited to their contribution to the company's capital, up to the nominal value of the shares they hold and have not paid for. Members, even collectively, are not the owners of the company's assets or responsible for its debts. However, there are exceptions to this principle.
• In simple terms, a shareholder is only liable to pay the remaining balance on their shares when called upon, and nothing more, even if the company's liabilities far exceed its assets. This means a member's liability is limited.

Perpetual Succession

An incorporated company continues to exist indefinitely, unless it is legally dissolved. Being a separate legal entity, a company is not affected by the death or departure of its members. Its existence remains unchanged, even with a complete turnover of membership. The lifespan of a company is determined by the terms set out in its Memorandum of Association.

Key Points about Perpetual Succession

• Definition: Perpetual succession refers to the company’s ability to continue its existence despite changes in membership.
• Membership Changes: Membership in an incorporated company can change when a shareholder sells or transfers their shares, or when shares pass to legal representatives upon a member's death. Membership can also change due to other reasons specified in the Companies Act.
• Continuity: The company’s continuity is not affected by changes in its membership. New members can take the place of those who leave, ensuring the company's ongoing existence.
• Memorandum of Association: The Memorandum of Association specifies whether a company has perpetual succession or if it is set up for a specific period to achieve certain objectives.
• Example: Professor L.C.B. Gower illustrates perpetual succession by noting that a company can survive even if all its members die simultaneously. For instance, during a war, a private company continued to exist despite the death of all its members in a bomb attack.

Separate Property

A company, being a separate legal entity from its members, has the ability to own, enjoy, and dispose of property in its own name. All property is vested in the company, which controls, manages, and disposes of it. Members do not have ownership claims over the company’s property during its existence or winding-up. In fact, members lack even an insurable interest in the company’s property.

The Madras High Court Ruling

• In the case of R.F. Perumal v. H. John Deavin, the Madras High Court highlighted that no member can claim ownership of the company’s property while it is operational or during its winding-up process.

Transferability of Shares

The capital of a company is divided into parts called shares, which are considered movable property and, subject to certain conditions, freely transferable. This ensures that no shareholder is permanently or necessarily tied to a company.

Historical Context

When joint-stock companies were established, one of the main objectives was to make shares easily transferable.

Legal Framework

• Section 44 of the Companies Act, 2013: This section establishes that shares held by members are movable property and can be transferred from one person to another as per the company’s articles.
• Transfer Without Articles: If the articles do not specify transfer procedures and the regulations in Table “F” of Schedule I to the Companies Act, 2013 are excluded, share transfers are governed by general law on movable property transfer.

Member Rights and Marketability

• A member can sell shares in the open market, allowing them to recoup their investment. This feature provides liquidity to members (as they can freely sell their shares) and ensures stability for the company (as members are not withdrawing their money).
• Stock exchanges facilitate the buying and selling of shares.

Modern Practices

• In most listed companies today, shares are transferable electronically through Depository Participants in dematerialized form, rather than through physical transfers.
• However, there are restrictions on the transferability of shares in a Private Limited Company, which are addressed in Chapter 2.

Common Seal

A common seal is an essential tool for a company to authenticate documents, acting as its official signature. Here's a breakdown of its significance and usage:

• A company, once incorporated, becomes a legal entity with perpetual succession and a common seal. Since it lacks a physical presence, it must operate through agents. All contracts made by these agents need to bear the company's seal.
• The common seal serves as the company's official signature, with its name engraved on the seal. A rubber stamp does not fulfill this purpose.
• If a document requires the common seal for execution as per a Board resolution and does not bear the seal, it is considered inauthentic and lacks legal validity.
• A person authorized through a power of attorney under the company's common seal can execute documents without affixing the seal.
• The individual authorized to use the seal must keep it under personal custody and use it with care. Improper or fraudulent use of the seal can lead to legal action against the company.

Key Points:

• Legal Entity: A company becomes a legal entity upon incorporation with perpetual succession and a common seal.
• Official Signature: The common seal acts as the official signature of the company, with its name engraved on it.
• Document Authentication: All contracts entered by the company's agents must be under the seal of the company.
• Rubber Stamp Not Valid: A rubber stamp does not serve the purpose of the common seal.
• Board Resolution: A document not bearing the common seal when required by a board resolution is not authentic and has no legal force.
• Power of Attorney: A person authorized to execute documents under a power of attorney granted by the company does not need to affix the common seal.
• Seal Custody: The person authorized to use the seal must keep it under personal custody and use it carefully.
• Legal Implications: Improper or fraudulent affixing of the seal can involve the company in legal action and litigation.

Capacity to Sue or Be Sued

A company, as a distinct legal entity, has the capacity to sue and be sued in its own name. This means that it can initiate legal proceedings against others or defend itself in court without involving its individual members. Here are the key points regarding a company's capacity to sue or be sued:

Right to Sue

• A company has the right to sue when it suffers a loss, which can be to its property or its reputation.
• For example, a company can sue for damages in cases of libel or slander if false statements harm its business.

Suing Members

• A company can sue one of its own members because it is considered a separate legal entity from its shareholders or members.
• This means that the company has the right to take legal action against individuals who are part of it if necessary.

Defamation Cases

• If defamatory material is published about a company and it affects the company's business, the company has the right to seek damages.
• For instance, if a video cassette produced by workers shows their struggle against the company's management, it may not be actionable unless the content is proven to be defamatory.

Contempt by Officers

• A company is not held liable for contempt of court actions committed by its officers in some cases.
• For example, in the case of Lalit Surajmal Kanodia v. Office Tiger Database Systems India (P) Ltd., the court ruled that the company was not responsible for the contempt actions of its officer.

Contractual Rights

• A company, as a separate legal entity from its members, has the ability to enter into contracts in its own name for conducting business. Shareholders do not have the right to enforce contracts made by the company, as they are not parties to these contracts and do not benefit from them. The company does not act as a trustee for its shareholders in this regard.
• Similarly, shareholders cannot be held liable for contracts made by the company. The distinction between the company and its members is fundamental to the law of contract. For example, if a director fails to disclose a breach of duty to the company, and a shareholder is led to enter into a contract with the director on behalf of the company without this disclosure, the shareholder cannot cancel the contract.
• Additionally, a member of a company cannot sue for torts committed against the company, nor can they be sued for torts committed by the company. The company, as a legal entity, has the right to enforce its legal rights and can be sued for breaches of its legal obligations. Its rights and duties are separate from those of its individual members.

Key Points

• Separate Legal Entity: A company can enter into contracts in its own name, separate from its members.
• Shareholder Limitations: Shareholders cannot enforce contracts made by the company or benefit from them.
• Privity of Contract: The distinction between the company and its members affects the whole law of contract.
• Director's Duties: If a director breaches their duties and a shareholder enters into a contract without disclosure, the contract cannot be rescinded.
• Torts and Company: Members cannot sue for torts against the company or be sued for torts by the company.
• Legal Rights: The company can enforce its legal rights and be sued for breaches, separate from its members.

Limitations of Action

A company is bound by the powers outlined in its Memorandum of Association. This document defines the company's powers and objectives, serving as the foundation for its entire structure.

• The actions and objectives of the company are confined within the limits set by its Memorandum of Association.
• To allow for necessary actions without restrictions, the Memorandum of Association usually grants sufficient powers. However, once these powers are established, the company cannot exceed them unless the Memorandum is amended.

Separate Management

• Members can enjoy profits without being burdened by the company's management.
• They do not have direct control over operations and elect representatives as Directors on the Board of Directors.
• The Board oversees corporate functions through hired managerial personnel.
• In other words, the company is managed and administered by its hired managerial staff.

Voluntary Association for Profit

• A company is a voluntary association formed for profit.
• It is established to achieve specific goals, and any profits earned are distributed among shareholders or reserved for future expansion.
• The only exception is a Section 8 company, which can be formed without a profit motive.

Termination of Existence

• A company, as an artificial legal entity, does not perish naturally.
• It is established by law, conducts its affairs according to legal regulations throughout its existence, and is eventually dissolved by law.
• Typically, a company's existence is terminated through winding up.
• However, to avoid this, companies sometimes opt for strategies like reorganization,reconstruction, or amalgamation.

Distinction Between Company and Partnership

• A company is a separate legal entity, while a partnership is not distinct from the individuals who form it.
• In a partnership, the firm's property belongs to the individual partners, whereas in a company, the property belongs to the company itself.
• Creditors of a partnership can claim against individual partners, while creditors of a company can only pursue the company.
• Partners act as agents of the firm, while company members do not have this authority.
• A partner cannot contract with the firm, but a company member can.
• A partner cannot transfer their share without the consent of other partners, while company shares can usually be transferred freely.
• Restrictions on a partner's authority do not bind outsiders, while restrictions in a company's Articles do.
• A partner's liability is unlimited, while a shareholder's liability may be limited.
• A company has perpetual succession, while a partnership may be dissolved by the death or insolvency of a partner.
• A company can have any number of members, while a private company is limited to 200 members, and a public company requires at least seven members. A one-person company can be formed with a single member.
• A company must have its accounts audited annually, while a partnership's accounts are audited at the partners' discretion.
• A company can only be dissolved as per legal provisions, while a partnership can be dissolved by mutual agreement.

Distinction Between Company and Hindu Undivided Family Business

• A company comprises diverse members, whereas a Hindu Undivided Family Business consists of members from the same joint family.
• In a Hindu Undivided Family business, the Karta has exclusive authority to incur debts for the business, a system not present in a company.
• Membership in a Hindu Undivided Family business is determined by birth, a provision not applicable in a company.
• Registration is not mandatory for a Hindu Undivided Family business, even with more than twenty members, whereas company registration is compulsory.