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A fair share for all topics

S. Prasanna Venkatesh analyses some of the questions in the December 1999 CS (Final) CLP-I and CLP-II papers

Corporate laws and practice -- I

THE paper has a fair distribution of questions covering all the areas. However, the winding-up topic continues to remain neglected.

1(iii) Write short notes on: Trust for disposal of odd-lot shares.

To tackle the problems created by the allotment of shares in lots which are not marketable -- especially in the instance of transfer -- the Department of Company Affairs (DCA) has issued Circular No: 11/93 dated October 8, 1993, for the creat ion of the position of an independent trustee to receive the shares from individual investors for being disposed of on their behalf and, after realising the sale proceeds in marketable parcels, make over the sales realisation less brokerage and service charges to the investors. The salient features of the guidelines for the creation of a trust are:

a) the trustee should be a responsible, trustworthy and an unconnected person;

b) the trustee shall only sell the shares of the company in odd lots and not deal with the shares of other companies;

c) the company may provide for the initial funds to start operations, which may later be reimbursed by the trustee from sales realisation;

d) during the period the trustee holds the odd-lot shares on behalf of the investors, the company shall send all the rights and bonus shares to him for and on behalf of the original holders;

e) the trustee shall consolidate the holdings and sell the same;

f) the books of the trustee shall be maintained on a day-to-day basis and shall be open to inspection by the Registrar of Companies (RoC).

3) As a company secretary, how will you advise and act in the following situations:

i) Can the company by passing a single resolution, after it has commenced the main business, obtain the requisite permission to commence business stated under the head ``other objects'' of the company ``which include diverse types of objects'', as and wh en necessary?

Section 149(2A) of the Companies Act, 1956, provides that a company limited by shares shall not commence a business stated in the ``other objects'' clause, unless the company has approved of the commencement of any such business by a special resolution p assed on that behalf by it in a general meeting and a duly verified declaration in Form 20A. It may be reasonably construed that for commencement of every fresh business, a separate special resolution would be required.

If a blanket resolution covering all the businesses stated in the ``other objects'' were permitted, then the provisions of Sec. 149(2A) would be negated. Approval under the section should be given only as and when the need arises, after due consideration by the members as to the viability of the business proposed to be commenced.

ii) Is it necessary to file the letter of offer for renounceable right shares with the RoC?

The issue of further shares by a company to its members with the right to renounce them in favour of third parties does not require the issue/registration of a prospectus, as the same is of a domestic concern of the persons receiving the offer and renoun cing the offer, and is not made by the company with intent to make a public offer (Letter No. 8/81/56-PR, dated November 4, 1957, issued by the Department of Company Law Board Administration).

iii) The shares of ABC Ltd, while inviting subscription from the public, are underwritten by a recognised underwriter. Realising the risk, the underwriter asked ABC Ltd to provide guarantee which it did with arrangement with its sister concerns. But this was not disclosed in the prospectus issued. Does it amount to a misstatement?

The term `misstatement' in relation to a prospectus not only includes the positive act of making false statements, but also the negative act of failing to disclose what is required to be disclosed. The provisions of Schedule II to the Companies Act, 1956 , which provides for the matters to be set out in a prospectus, in Part I, the board of directors should declare in the prospectus that the underwriter has sufficient resources to discharge their obligations. If the fact that the provision of guarantee b y the company in arrangement with its sister concerns has a bearing on their underwriter's capacity to meet his obligation, then the same should be disclosed in the prospectus. If it is not so disclosed, then it would amount to a misstatement.

iv) Will the fixed deposits kept by the employees with the company attract the provisions of the Companies (Acceptance of Deposits) Rules, 1975? Would the position be different if employees, under the terms of employment, have to make a security deposit?

Rule 2(b) of the Companies (Acceptance of Deposits) Rules 1975 defines the term deposit to mean any deposit of money with, and includes any amount borrowed by, the company but not, inter alia, amounts received by way of security deposits from the employe es. Hence the fixed deposits kept by the employees with the company would attract the provisions of the Companies (Acceptance of Deposits) Rules 1975. The same would not be attracted if it were a security deposit.

4(a) Enumerate the circumstances in which the provisions of Sec. 209A are intended to be invoked in relation to the inspection of books of accounts.

The circumstances in which, and the objects of, inspection of books of accounts under Sec. 209A of the Companies Act can be summed up follows:

i) the inspection is intended to be a routine feature and not a special affair;ii) to keep a watch on the performance of the company;

iii) to enable the Government to ascertain the quantum of profits accrued but not accounted for;

iv) to detect misuse of fiduciary responsibilities by the company's management;

v) to enable the Government to take effective remedial measures to avoid the company going into liquidation and to save the industry and prevent distress to employees;

vi) to ensure that transactions have been validly entered into in accordance with the relevant rules and procedures; and

vii) to ascertain how far statutory auditors have discharged their functions and duties in certifying the true and fair view of a company's accounts and their proper maintenance.

b) An Indian public company has an overseas subsidiary company. Explain the application of the requirements of Sec. 212 of the Companies Act as regards attachment of documents in respect of this subsidiary.

This is an interesting question based on Sec. 212. It calls for sound knowledge of the provisions and application of the same. This question may be rated as one of the toughest in the paper.

Sec. 212 provides that there shall be attached to the balance-sheet of a holding company having a subsidiary or subsidiaries at the end of the financial year as at which the holding company's balance-sheet is made out, the following documents in respect of such subsidiary or each such subsidiary, as the case may be: a) a copy of the balance-sheet of the subsidiary; b) a copy of its profit and loss (P&L) account; c) a copy of the report of its board of directors; d) a copy of the report of its auditors; e) a statement of the holding company's interest in the subsidiary; f) the statement referred to in Sec. 212(5), if any; and g) the report referred to in Sec. 212(6), if any.

Under this section, an Indian company having an overseas subsidiary would also be required to attach the documents specified therein. On a `literal construction', Sec. 212 applies to all subsidiaries, whether incorporated in India or not.

Further, the section provides that the financial year of the holding company and the subsidiary should coincide. Where however they do not, the financial year of the subsidiary shall not end on a day, which precedes the day, which the holding company's f inancial year ends by more than six months.

Sec. 212(8) provides that the Central Government may, on application or with the consent of the board of directors of the company, direct that in relation to any subsidiary, the provisions of Sec. 212 shall not apply or shall apply only to such extent as may be specified in that direction.

5) ``Doctrines of `constructive notice' and of `indoor management' are conflicting doctrines.'' Examine this statement and state what matters would not be covered by the respective doctrines.

This question is based on the basics of company law. This has been well dealt with at the intermediate level itself and could have been avoided at the final level.

The company is an artificial legal person. Its objects and powers are set out in the memorandum and articles of association as amended from time to time. The memorandum and articles, when registered, become public documents and can be inspected by any me mber of the public at the office of the RoC under Sec. 610 of the Companies Act on payment of a nominal fee.

Thus, every person who contemplates entering into a contract with a company, has the means of ascertaining and consequently presumed to know, not only the exact powers of the company but also to the extent to which these powers have been delegated to the directors and of any limitation placed upon the exercise of these powers. Every person dealing with the company is deemed to have a constructive notice of the contents of its memorandum and AoA. Hence, if a person enters into a contract which is beyond the powers of the company, as defined in the memorandum, he cannot acquire any rights under the contract against the company.

This rule proved to be too inconvenient for business transactions and hindered the smooth flow of business. The rigour of the rule was, therefore, lightened by the judicial pronouncement in Royal British Bank vs Turquand (1856), and the doctrine of `indo or management' serving as a partial exception to the doctrine of `constructive notice'.

While the doctrine of constructive notice seeks to protect the company against the outsiders, the principal of indoor management operates to protect the outsiders while dealing with the company. According to this doctrine, as laid down in the Royal Briti sh Bank case, persons dealing with a company are not bound to inquire into the regularity of any internal proceedings. In other words, while persons contract with a company they are entitled to assume that the provisions of the Articles have been observe d by the officers of the company. It is no part of the duty of an outsider to see that the company carries out its own internal regulations. It is sufficient if the act is not ultra vires.

The doctrine of constructive notice operates against the person who has failed to inquire. But the doctrine of indoor management can be invoked by the person dealing with the company and cannot be invoked by the company.

Exceptions to the doctrine of indoor management: It is subject to the following limitations:

A where the violation of the articles is known;

A where the person is put to inquiry by suspicious circumstances;

A when the contract is illegal; and

A forged documents.

6(c) The legal representative of a deceased member of a company alleged oppression and mismanagement. He made a complaint to the Company Law Board (CLB) for relief. The management of the company is of the opinion that the petitioner has no locus standi s ince he is not a member. The register of members still shows the name of the deceased as member. Will the representation be entertained by the CLB?

In the present case, the CLB would entertain the application even though the name of the deceased member is still placed in the register of members and the legal representative's name is not entered in the register. In Worldwide Agencies vs Margaret T. D esor (1990), the Supreme Court held that where a member dies and his name being still in the register of members, his legal representatives are entitled to proceed under Sec.s 397 and 398 even if their names are not yet entered in the register of members and that it could not be a just construction to deny the legal representative of the deceased member the right to maintain a petition under Sec.s 397 and 398.

7(b) In the context of court rulings in the matter of merger, answer the following: (This question has three problems all of which are based on the judgment given by the Supreme Court in the Hindustan Lever Ltd and TOMCO merger case in 1995.)

i) Whether exchange ratio approved by shareholders of merging companies can be questioned by a small group of dissenting shareholders?

Once the majority of shareholders prescribed under Sec. 391 approve the exchange ratio, it would be binding on the minority shareholders. However, the court may interfere on the application on minority shareholders if it is proved that the minority has b een coerced or there is lack of good faith on the part of the majority (Indo Continental Hotels and Resorts Ltd (1990), and HLL-TOMCO merger case (1994)).

ii) Whether transferor company is justified in excluding assets held on lease and licence arrangement, from those transferred to the transferee company?

The Supreme Court, in HLL Employees Union vs HLL (1995), held that it did not attach importance to the fact that certain lease-hold assets and property held under licence were excluded from valuation. Such assets, the court said, were neither transferabl e nor heritable and they are in the nature of a personal privilege. Hence, it is not legally wrong for the transferor company to exclude certain assets, which are held on lease and license arrangement, from those transferred to the transferee company.

iii) Whether there was contravention of Sec. 393(1)(a), inasmuch as the fact that the chartered accountant entrusted with the valuation of the shares was also a director of the amalgamating company had not been disclosed?

Sec. 393(1)(a) of the Companies Act requires particulars to be given of any material interests of certain persons connected with the company, including the director and managing directors. The interest contemplated is interest that is material for the co nsideration of the scheme by the shareholders. In the HLL-TOMCO merger case, the Supreme Court held that the non-disclosure of the fact that a director of a company, who possesses requisite qualification, has been appointed as the valuer would not amount to suppression of any material interest of a director in the scheme under Sec. 393.

8(a) X, a duly qualified cost auditor, consented to the company for his appointment as cost auditor, and accordingly, government approval was obtained. The cost auditor, later on did not accept the offer. Advise the company how to proceed in the matter.

Under Sec. 233B of the Companies Act, the cost auditor is required to be appointed by the board of directors of the company with the previous approval of the Central Government. In the present case, a cost auditor had consented to be appointed as cost au ditor of the company and, accordingly, the Central Government's approval was obtained, but the cost auditor later did not accept the offer. The Act does not specifically provide for the procedure to be followed in such a case. However, it would be the du ty of the company to restart the process of appointing the cost auditor by following the procedure prescribed under Sec. 233B. The board should approve the appointment of the cost auditor being considered for appointment and the approval of the Central G overnment should be obtained for the appointment.

CLP-II

ALMOST all the questions on the Companies Act were confined to Sections 252 to 314. The key to success in this paper is a sound knowledge of these provisions relating to directors.

1(iii) Draft the board resolution for ``constitution of audit committee''.

``RESOLVED THAT an audit committee is be and is hereby formed with the Directors Mr. X and Mr. Y as the members of the committee, to review and supervise the functioning of the internal audit department of the company and report to the board at its meeti ng every month.''

``RESOLVED FURTHER THAT the committee shall have the power to regulate its proceedings and affairs as it may deem fit.''

3(b) X, a sales tax officer, has to recover outstanding dues from a company. Can the Companies Act recover outstanding dues from the director without first trying to recover the dues from the company?

To answer this question, the student must know the relevant provisions of the I-T and the CST Acts, otherwise he/she would be misled.

The general rule of corporate veil is pierced by common law in certain cases. However, certain fiscal legislation, such as the I-T Act and the Central Sales Tax Act, provide for the recovery of dues from the director of a company when the same is not rec overable from the company. It may be noted that these provisions are applicable only in the case of private limited companies. Even in this case, the amount can be recovered from the directors only if the same is not recoverable from the company. Hence, the sales tax officer cannot recover the amounts from the directors without first trying to recover the same from the company.

c) The RoC has launched a prosecution against all the three directors of the company for the offences under Sec. 159/220 read with Sec. 162 of the Companies Act for failure to submit the statutory return required under the Act. One of the directors took a stand that he had resigned and, therefore, was not liable for non-filing of the statutory return. Advise the director.

The director in the present case should be advised that his contention is not tenable. Recently, the Delhi High Court had considered in Anitha Chada vs Registrar of Companies (1998-31 CLA 60) whether a director who had resigned would fall within the mean ing of the expression ``officer in default'' under Sec. 5 of the Companies Act. The court concluded that the argument that a director who had resigned from his office would no longer come within the meaning of the expression ``officer in default'' was un tenable.

A reading of Sec. 5 showed that even after the retirement as director of the company, he would come under the definition of the expression ``officer in default''. Were it not so, any managing director, manager or secretary would escape the rigour of thes e provisions by simply tendering their resignation as officer bearer of the company and, thus, defeating the intention of these provisions.

4(a) A public limited company borrowed in excess of the limit laid down by the Companies Act. The money was utilised for the genuine purpose in respect of the company. Is it possible for the company to repudiate the liability being ultra vires the board?

Sec. 293(1)(d) of the Companies Act provides that the board shall not borrow monies in excess of the paid-up share capital and free reserves without the approval of the members of the company by way of an ordinary resolution at a general meeting. Sec. 29 3(5) provides that no debt incurred by the company in excess of the limit imposed by the above provisions shall be valid and effectual, unless the lender proves that he advanced the loan in good faith and without knowledge that the limit imposed by that clause had been exceeded. Hence, the directors may repudiate the liability only if the lender had advanced the money knowing that the borrowings were in excess of the limits laid down by Sec. 293.

4(b) The AoA of a company fixed three as quorum for meeting of the board. At a meeting of the board, all the five directors were present. They allotted shares of the company to three directors. Is the allotment valid? Would the position be different if t he company were a private limited company?

In the present case, there are only two disinterested directors and there is no quorum present. By virtue of the provisions of Sec. 287, quorum for a board meeting should be a disinterested one. In Transvaal Lands Co vs New Belgium Co, it was held that w here the board of directors approved of a contract by a resolution in which one of the director was interested and he participated and voted in the meeting and the resolution would not have been without a quorum if his vote was not counted, the decision was a nullity. Hence, the allotment is invalid as the votes cast by the three interested directors are void under Sec. 300 of the Companies Act.If the company were a private company, then the allotment would be valid since Sec. 300 does not apply to a pr ivate company, which is not a subsidiary or a holding company of a public company. Consequently, there would be a quorum under Sec. 287 and a validly constituted board meeting. The interested directors are not prohibited from voting on the resolution all otting shares.

This question was asked in the June 1997 exam as well.

4(c) In the Companies Act, the son of a director, who is the managing director of XY Ltd, is to lease out his flat to the company. The paid-up capital of XY Ltd is Rs. 5 crores. Advise the managing director.

Sec. 297, dealing with contracts for goods or services, does not apply to this case as it is a contract relating to an immovable property. However, Sec.s 299 and 300 would apply and, hence, the managing director should be advised to disclose the interest in the contract at a meeting of the board. It would also suffice if he had already given a general notice of interest under Sec. 299 in Form 24AA.

The managing director should also not participate in the discussions of the board when the business leasing out the flat is considered by the board and he should not vote. If he votes, his vote shall be void. His presence shall not be counted for the pur pose of quorum under Sec. 287 of the Companies Act.

4(d) R, a director of the company, sends his director friend to inspect the accounts of the company with an authorisation letter. Can Y carry out inspection?

This question is relatively a difficult one, and requires a reading of the recommended texts.

In the present case, the director can carry out the inspection on behalf of the director R. In Vakharia vs Supreme General Film Exchange Co Ltd (1948), it was held that a director is entitled to take inspection of accounts personally or through an agent provided that there is no reasonable objection to the person chosen and the agent undertakes not to utilise the information obtained by him for any purpose other than the purpose of his principal.

5(a) `A' was appointed director of the company at an AGM of the company. Subsequently, it was found that there were some irregularities in the voting and the appointment of `A' was declared invalid. Would the acts done by `A, while in the office as a dir ector, be binding upon the company?

Sec. 290 of the Companies Act provides that acts done by a person as a director shall be valid, notwithstanding that it may afterwards be discovered that the appointment was invalid by reason of any defect. Provided however that this provision shall not be deemed to give validity to the acts done by a director after his appointment has been shown to the company to be invalid. Hence, in the present case, the acts done by A would be valid until his appointment was shown to be invalid to the company.

5(b) X, an employee of XYZ Ltd, was appointed an alternate director in the place of Y who went abroad. In the meantime, Y returned and wanted to attend the board meeting. Advise.

Sec. 313(2) of the Companies Act provides that an alternate director appointed under Sec. 313(1) shall not hold office as such for a period longer than that permissible to the original director in whose place he has been appointed and shall vacate office if and when the original director returns to the state in which meetings of the board are ordinarily held. Hence, X ceases to be the alternate director the moment Y returns. Hence, only Y has the right to attend the board meeting.