The formation of a company involves several crucial steps that transform a business idea into a legally recognized corporate entity. The initial phase begins with the conceptualization and is followed by legal procedures that culminate in the incorporation of the company. Among the first and most important phases are promotion and incorporation. These stages lay the groundwork for a company to begin its operations legally and functionally within the framework provided by corporate law.
Role and Meaning of a Promoter
The journey of a company begins with the involvement of a promoter. Promoters are the individuals or groups who take the initiative to form a company. They are responsible for executing all preliminary tasks necessary to establish the company and set it on the path to incorporation. Promoters play a vital role in shaping the foundation of the company by conducting negotiations, securing initial funding, drafting foundational documents such as the memorandum and articles of association, and ensuring that the company meets all statutory requirements for registration.
Under Section 2(69) of the Companies Act, a promoter is defined in three ways. First, a person who has been named as such in a prospectus or is identified by the company in the annual return filed under Section 92. Second, a person who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director, or otherwise. Third, a person by whose advice, directions, or instructions the Board of Directors is accustomed to act. However, any person who is acting merely in a professional capacity, such as a solicitor, banker, accountant, or consultant, is not regarded as a promoter, even if they assist in the company formation process.
Functions and Duties of Promoters
Promoters carry the responsibility of taking an idea and initiating all actions needed to establish a company. This includes deciding the company name, identifying and negotiating for business opportunities, preparing the necessary documents, securing seed capital, appointing the first directors, and filing for registration with the Registrar of Companies. They are the primary movers behind the company until its legal existence is recognized through incorporation.
The relationship between a promoter and the company is unique and complex. Although a promoter is neither an agent nor a trustee in the strict legal sense since the company is not yet formed, the law recognizes their position as being one of fiduciary duty. This means that promoters are obligated to act in the best interest of the company and not for personal gain. Any benefit or profit gained during the promotion must be disclosed to the company, either through its board of directors, shareholders, or in its public documents,, such as the prospectus.
Legal Position of Promoters
Legally, the promoter does not have a standard contractual relationship with the company, because the company does not exist at the time the promoter begins their work. Despite this, courts have developed the concept of a fiduciary relationship to impose duties and obligations on the promoter. This fiduciary relationship is based on trust and confidence. A promoter must disclose all material facts, especially those involving transactions from which they might earn profit. Failure to make such disclosures can lead to legal action, including the setting aside of contracts and personal liability for damages or secret profits.
Promoter as an Agent
Although promoters act on behalf of the proposed company, they do not qualify as agents in the conventional sense because a principal-agent relationship requires the principal to exist and provide authority. Since the company is not incorporated when the promoter is acting, the promoter cannot legally be considered an agent. However, in practice, the promoter acts in a representative capacity, making arrangements and decisions that will eventually benefit the company.
Promoter as a Trustee
Similarly, a promoter cannot be considered a trustee in the traditional sense, because there is no trust entity in existence when they act. Nevertheless, their role resembles that of a trustee because they are expected to act honestly and in good faith for the benefit of the future company. They are responsible for safeguarding the interests of the company and its future shareholders during the formation stage.
Promoter’s Fiduciary Duties and Case Law
The fiduciary relationship between a promoter and the company implies a duty to act in utmost good faith and avoid conflicts of interest. This principle has been established through various landmark judicial decisions.
In the case of Erlanger v. New Sombrero Phosphate Co., a syndicate led by Erlanger purchased a property for £55,000 and later sold it to a company promoted by them for £110,000. The board of directors who ratified the transaction were all appointed by the promoters. The shareholders later challenged the transaction, and the court held that the promoters had breached their fiduciary duty. Lord Cairns stated that promoters stand in a fiduciary position and must ensure that transactions are ratified by an independent board capable of exercising independent judgment.
In Lidney & Wigpool Iron Ore Co. v. Bird, Lord Justice Lindley emphasized that although a promoter is not technically an agent or trustee, the legal principles that govern those relationships are applicable. Promoters are accountable for secret profits and must act in good faith.
In Gluckstein v. Barnes, the court reiterated the principle that promoters must not make secret profits. Any undisclosed gain made by a promoter must be returned to the company. Disclosure can be made either to an independent board of directors, the entire body of shareholders, or in the public documents of the company such as its prospectus or articles of association.
Remuneration of Promoters
There is no specific provision in corporate law that mandates remuneration for promoters. However, in practice, promoters are often rewarded for their efforts. The reward can take various forms, including a share in the company’s profits, allotment of shares, or reimbursement for expenses incurred. However, any such profit or remuneration must be disclosed to avoid violating fiduciary duties. Undisclosed profits or benefits are treated as secret profits and can result in legal liability.
Liability of Promoters
Promoters can be held liable under various circumstances. These liabilities can arise from actions taken during the promotion, incorporation, or even after the company has been registered if any fraudulent activity is discovered.
One area of liability is related to the incorporation process. Section 7(6) of the Companies Act provides that if it is proved that a company was incorporated by furnishing false information or by suppressing any material fact, promoters can be prosecuted under Section 447. This section deals with punishment for fraud and includes both civil and criminal penalties.
Promoters are also liable under Section 26 if they are involved in issuing a prospectus that does not comply with the law. If the prospectus omits material facts or includes misleading information, every promoter who knowingly participated in its issuance can be fined. The penalty ranges from a minimum of fifty thousand rupees to a maximum of three lakh rupees.
If an investor suffers loss or damage as a result of a misleading prospectus, the promoter is civilly liable to pay compensation. This is separate from any criminal liability that may arise if the misleading statements are found to be intentional.
Pre-Incorporation Contracts
Pre-incorporation contracts are agreements entered into by promoters before the company is legally formed. These contracts typically relate to purchasing assets, leasing premises, or hiring employees for the proposed company. Traditionally, such contracts were considered non-binding on the company because it did not exist at the time of the agreement.
This legal position was confirmed in the case of Kelner v. Baxter, where it was held that pre-incorporation contracts are not binding on the company and that promoters are personally liable. However, the enactment of the Specific Relief Act, 1963 changed this stance. Sections 15(h) and 19(e) of the Act allow pre-incorporation contracts to be enforced if certain conditions are met. These include that the contract was entered into for the purpose of the company, was warranted by the terms of incorporation, and was adopted by the company after incorporation, with such acceptance being communicated to the other party.
Formation of a Company Under Section 3
Section 3 of the Companies Act provides the statutory basis for forming a company. A company may be formed for any lawful purpose by a specific number of persons, depending on the type of company. A public company requires at least seven persons, a private company requires at least two, and a one-person company can be formed by a single individual.
A company can be formed as a company limited by shares, a company limited by guarantee, or an unlimited company. The formation process involves subscribing to the memorandum of association and complying with other legal requirements related to registration under the Act.
Incorporation of a Company under Section 7
The process of incorporation under Section 7 of the Companies Act is a comprehensive legal procedure. It begins when the promoters submit an application for registration of the company with the Registrar of Companies in whose jurisdiction the registered office of the proposed company will be situated. This application must be accompanied by several mandatory documents and declarations, all of which must comply with the requirements of the Act and its corresponding rules.
Documents Required for Incorporation
The legal documents essential for registration include the memorandum of association signed by all subscribers and the articles of association also signed by the subscribers. The memorandum sets out the company’s objectives and scope, while the articles contain the internal regulations governing the company’s management.
A declaration in Form INC-8 must be submitted by professionals such as advocates, chartered accountants, cost accountants, or company secretaries in practice, who are engaged in forming the company. The declaration confirms that all legal requirements relating to incorporation and matters incidental to it have been complied with.
Additionally, a declaration in Form INC-9 must be provided by each subscriber and first director. This declaration confirms that the individual has not been convicted of any offence involving promotion, formation, or management of any company, or found guilty of fraud, misfeasance, or breach of duty in the preceding five years. It also affirms that the documents filed with the Registrar contain complete and correct information to the best of their knowledge and belief.
Other Particulars and Consents
The application must include the address for correspondence until the registered office is formally established. It must also contain identity proofs of each subscriber and first director, along with the particulars of their interests in other firms or corporate bodies. The consent of persons mentioned as first directors must be submitted using Form DIR-2. This form records their willingness to act as directors.
Issue of Certificate of Incorporation
Once the Registrar is satisfied that all the required documents and declarations have been submitted and are in order, the company’s name is entered into the register of companies. The Registrar then issues a certificate of incorporation in Form INC-11. This certificate confirms that the company has been incorporated under the Companies Act and is legally recognized.
From the date specified in the certificate, the company officially comes into existence. At this stage, the company becomes a separate legal entity with rights and responsibilities. The certificate also includes the company’s Corporate Identification Number, which is a unique 21-digit alphanumeric code assigned to every company upon incorporation.
Corporate Identification Number
The Corporate Identification Number serves as a distinct identity for the company and is required for all communications and filings with the Registrar. It contains information about the type of company, state of registration, year of incorporation, and registration number.
Online Registration of a Company
In recent years, the Ministry of Corporate Affairs has streamlined the process of company registration through online systems. The introduction of SPICe+ (Simplified Proforma for Incorporating Company Electronically Plus) Form INC-32 has revolutionized incorporation by integrating various services into one application. The process begins with the reservation of the company name through Part A of SPICe+.
Once the name is approved, it is valid for 20 days from the date of approval. With the introduction of Rule 9A, the name reservation period can now be extended. A payment of 1000 rupees allows the name to be reserved for 40 days if paid before the initial 20 days expire. A payment of 2000 rupees extends it to 60 days if made before 40 days. Alternatively, a payment of 3000 rupees can reserve the name for 60 days if paid within the first 20 days.
Integrated Filing Using SPICe+
Applicants can also choose to submit both Part A and Part B of SPICe+ simultaneously. Part B includes incorporation details and the filing of the memorandum and articles of association. SPICe+ also enables the issuance of Director Identification Numbers for up to three directors during the incorporation process, removing the need to obtain them beforehand.
The SPICe+ system allows for the incorporation of various types of companies, including private limited, public limited, one person, Section 8, and producer companies. Alongside SPICe+, applicants must also file e-form AGILE-PRO-S (Application for Goods and Services Tax Identification Number, Employees State Insurance Registration, Employees Provident Fund Registration, Professional Tax Registration for select states, opening of bank account, and Shops and Establishment Registration in Delhi). This linked form, known as INC-35, provides integrated compliance benefits.
Additional Requirements in SPICe+
Recent updates to the SPICe+ system have introduced the requirement of providing National Industrial Classification (NIC) codes to specify the proposed business activities of the company. Effective from January 2023, the system allows the selection of up to three NIC codes. This classification helps the government and regulatory bodies identify the sector and nature of operations of the company.
Further, if the correspondence address provided at the time of incorporation is the same as the registered office, the applicant must also provide geographical coordinates (latitude and longitude) of the location. This requirement improves location-based regulatory tracking.
Security Clearance for Directors
A significant regulatory change effective from June 2022 requires additional scrutiny for directors who are nationals of countries that share a land border with India. In such cases, security clearance from the Ministry of Home Affairs is mandatory before their appointment as directors. This measure enhances national security compliance in corporate governance.
Post-Incorporation Formalities
Once a company receives its certificate of incorporation, certain post-incorporation requirements must be fulfilled before it can commence business operations. Section 10A of the Companies Act mandates that companies with share capital cannot begin business or borrow funds unless they file a declaration and verify their registered office.
A declaration in Form INC-20A must be submitted by a director within 180 days of incorporation. This declaration must be verified by a chartered accountant, company secretary, or cost accountant in practice. It confirms that every subscriber to the memorandum has paid the value of the shares agreed upon.
The company must also file Form INC-22 to verify its registered office. Acceptable documents include the registered title document in the name of the company, a notarized lease or rent agreement with the rent receipt, an authorization from the owner to use the premises, and utility bills displaying the address.
If the address provided during incorporation is not the registered office, the company must inform the Registrar of the registered address within 30 days.
Penalty for Non-Compliance with Section 10A
Failure to comply with Section 10A attracts penalties. The company is liable for a fine of fifty thousand rupees. Each officer responsible for the default is subject to a fine of one thousand rupees per day, up to a maximum of one lakh rupees. This enforcement ensures timely compliance with post-incorporation formalities.
If the declaration is not filed, and the Registrar believes that the company is not conducting any business, he may initiate action under Section 248 to remove the company’s name from the Register of Companies. This process is a mechanism to prevent shell companies from continuing in the system without active operations.
Registration or Incorporation Stage
The registration or incorporation of a company refers to the legal process that results in the creation of a company. Once the company is registered under the Companies Act, it becomes a distinct legal entity, separate from its members. This is a crucial stage because, from this point, the company acquires legal recognition and can enter into contracts, own property, sue, and be sued in its name.
Steps for Registration of a Company
The steps involved in the registration or incorporation of a company include: 1. Application for Incorporation: The application must be submitted in the prescribed form along with necessary documents to the Registrar of Companies (ROC) within whose jurisdiction the registered office of the company is to be situated. 2. Filing of Documents: The following documents are required: a) Memorandum of Association (MOA) and Articles of Association (AOA), duly signed by the subscribers. b) Declaration by an advocate, a Chartered Accountant, a Cost Accountant, or a Company Secretary in practice that all requirements of the Act have been complied with. c) Affidavit from each subscriber and first directors that they are not convicted of any offense related to the formation, promotion, or management of a company and that they are not guilty of fraud or misfeasance. d) Address for correspondence until the registered office is established. e) Particulars of every subscriber to the MOA. f) Particulars of the first directors of the company, along with their consent to act as such. g) A copy of the utility bills such as electricity or telephone bill as proof of the premises, and a no-objection certificate from the owner. h) Payment of prescribed registration fees. 3. Issue of Certificate of Incorporation: If the Registrar is satisfied that all documents are in order and the provisions of the Act have been complied with, a Certificate of Incorporation is issued. The company then comes into existence as a legal entity.
Legal Effects of Incorporation
Upon incorporation, a company gains legal personality and becomes capable of performing various functions under the law. These effects include: 1. Separate Legal Entity: The company becomes distinct from its members. It can own property, incur debts, and sue or be sued in its name. 2. Perpetual Succession: The company continues to exist irrespective of changes in membership. 3. Common Seal: Although not mandatory under the Companies Act, a company may have a common seal to affix on official documents. 4. Limited Liability: Members are liable only to the extent of their shareholding or the amount guaranteed. 5. Capacity to Contract: The company can enter into valid contracts in its name. 6. Ownership of Property: The company can own, buy, and sell property in its name. 7. Transferability of Shares: In case of a public company, shares can be freely transferred. 8. Right to Sue and Be Sued: The company can enforce its legal rights and can be sued in its name. 9. Compliance Requirements: Once incorporated, the company must comply with the provisions of the Companies Act and other applicable laws, including filing annual returns and financial statements.
Commencement of Business
For companies incorporated before the Companies (Amendment) Act, 2015, a company having a share capital was required to obtain a Certificate of Commencement of Business before starting operations. However, the requirement was removed by the 2015 Amendment. Yet, with the Companies (Amendment) Ordinance, 2019, the requirement for filing a declaration of commencement of business has been reintroduced. The steps include: 1. The declaration must be filed by the director within 180 days of incorporation, stating that every subscriber to the memorandum has paid the value of shares agreed to be taken by him. 2. If the company fails to file the declaration, it may be struck off by the Registrar. 3. The declaration must be in Form INC-20A and accompanied by a bank statement of the company showing proof of deposit of the paid-up share capital by the subscribers.
Corporate Identity Number (CIN)
Once a company is incorporated, it is allotted a Corporate Identity Number (CIN). The CIN is a unique identification number that is used for all official correspondence and filings with the Registrar of Companies. It is a 21-digit alphanumeric number that reveals information such as the industry code, state of incorporation, year of incorporation, ownership type, and registration number.
Incorporation of One Person Company (OPC)
The concept of a One Person Company (OPC) was introduced by the Companies Act, 2013. An OPC allows a single individual to form a company with limited liability. The incorporation process of an OPC is similar to that of a private company but requires fewer compliances. Key features include: 1. Only one person can be a member and nominee of the company. 2. The memorandum must mention the nominee who will take over in the event of the subscriber’s death or incapacity. 3. OPCs enjoy various exemptions from compliance requirements applicable to other companies. 4. The words “One Person Company” must be mentioned in brackets below the name of the company. 5. If the paid-up share capital exceeds ₹50 lakhs or the average annual turnover exceeds ₹2 crores for three consecutive financial years, the OPC must convert itself into a private or public company.
Certificate of Incorporation and Its Effects
Upon successful registration, the Registrar issues a Certificate of Incorporation. This certificate is conclusive evidence that all the requirements of the Companies Act have been complied with. It marks the birth of the company as a separate legal entity. The date mentioned on the certificate is the date of incorporation, which is significant for determining the company’s legal existence, liability, and other statutory timelines. From this point forward, the company has perpetual succession and can enter into contracts, sue and be sued in its name, and acquire property.
The Certificate of Incorporation is the final step for private companies and public companies not intending to list on a stock exchange. These companies can now commence business activities. However, public companies intending to raise capital from the public must go through additional steps, such as obtaining a Certificate of Commencement of Business.
Commencement of Business by Public Companies
Under the Companies Act, a public company with share capital must obtain a Certificate of Commencement of Business before starting operations. To obtain this certificate, the company must file a declaration with the Registrar, stating that:
- Minimum subscription has been received.
- Every director has paid for shares agreed upon.
- No money is payable to applicants because of the failure of allotment.
The Registrar reviews the declaration and supporting documents. Upon satisfaction, a Certificate of Commencement of Business is issued. Only after this certificate is granted can the public company start business operations and exercise borrowing powers.
Memorandum and Articles of Association
The Memorandum of Association (MoA) and Articles of Association (AoA) are the two most important documents in the incorporation process. The MoA defines the scope of the company’s operations and its relationship with the external world. It contains the company name, registered office, objectives, liability of members, capital clause, and subscription clause.
The AoA lays down the rules for internal management, such as the appointment of directors, conduct of meetings, voting rights, dividend policy, and share transfer procedures. These documents must be filed with the Registrar during incorporation and are considered public documents. Anyone dealing with the company is presumed to know their contents.
Any act done outside the scope of the MoA is considered ultra vires and void. The company cannot ratify such acts even if all shareholders agree. Therefore, it is essential to draft the MoA carefully. Similarly, the AoA can be altered by special resolution, but such alterations must not contravene the MoA or the Companies Act.
Preliminary Contracts
Before the incorporation of a company, promoters often enter into contracts for acquiring property, hiring services, or setting up operations. These are known as preliminary or pre-incorporation contracts. Legally, a company does not exist before incorporation and hence cannot be a party to these contracts.
As per the Specific Relief Act, 1963, these contracts can only be enforced if they are warranted by the terms of incorporation and adopted by the company after incorporation. Until adoption, the promoters remain personally liable for these contracts. This legal position encourages promoters to be cautious and ensure that necessary clauses are included to limit their liability.
Incorporation of One Person Company (OPC)
The concept of a One Person Company (OPC) was introduced to encourage sole proprietors to enter the corporate framework. An OPC can be formed by one person as a shareholder and director. It enjoys many privileges like minimal compliance requirements and the absence of board meetings if there’s only one director.
To incorporate an OPC, the sole member must nominate a person who will become the member in case of the original member’s death or incapacity. The process involves name reservation, digital signature application, and submission of SPICe+ forms with required attachments. After verification, the Registrar issues a Certificate of Incorporation.
OPCs cannot carry out Non-Banking Financial Investment activities, cannot convert voluntarily into a private or public company within two years, and cannot have a paid-up capital exceeding the prescribed threshold.
Incorporation of a Section 8 Company
A Section 8 Company is a non-profit organization formed for promoting commerce, art, science, charity, or similar objectives. Unlike other companies, it applies its profits to promoting its objectives and prohibits dividend distribution.
To incorporate a Section 8 Company, a license must be obtained from the Registrar of Companies. The process involves:
- Drafting the MoA and AoA.
- Filing an application in Form INC-12 with the required documents.
- After the license is granted, incorporation forms are filed.
These companies enjoy various benefits like tax exemptions, concessional stamp duty, and credibility among donors and stakeholders. However, strict compliance is required, and any violation may lead to revocation of the license.
Post-Incorporation Compliances
After incorporation, a company must fulfill certain statutory compliances to remain active and legally valid. These include:
- Opening a bank account in the company’s name.
- Appointing the first auditor within 30 days.
- Holding the first board meeting within 30 days.
- Issuing share certificates to subscribers.
- Filing declaration of commencement of business (for companies with share capital).
Failure to comply can attract penalties and may lead to the company being declared inactive. Maintaining proper records, timely filings, and adherence to governance norms is crucial for the long-term success of the company.
Conclusion
The formation of a company is a structured and multi-stage process involving legal, procedural, and regulatory formalities. Starting from idea conceptualization and promotion to incorporation and post-incorporation compliance, each step requires due diligence and careful planning. Whether forming a private limited company, public company, OPC, or Section 8 entity, understanding the legal framework and fulfilling statutory obligations is essential to create a credible and sustainable business entity.