COMPANY AS AN ARTIFICIAL PERSON – A STUDY ON OPPORTUNITIES AND OBSTACLES FACED
1. INTRODUCTION
The word ‘company’ is derived from the Latin word ‘companis’ (com = with or together; panis = bread), and originally referred to an association of persons who took their meals together. Today a company is widely understood as an entity which manufactures, produces and/or provides some type of goods or services to their consumers. Its basic objective is to generate income for its owners and members by the way of profit.
Company as a concept can be understood as an willingful, voluntarily and legally binding agreement between individuals who have come together to achieve a common objective of business profit, among other objectives. The purpose of forming a company is to carry on business for some gain.
Lord Justice Lindley defines company as “A company is an association of many persons who contribute money or monies worth to a common stock and employed in some trade or business and who share the profit and loss arising therefrom. The common stock so contributed is denoted in money and is the capital of the company. The persons who contribute to it or to whom it pertains are members. The proportion of capital to which each member is entitled is his share. The shares are always transferable although the right to transfer is often more or less restricted”. According to Justice Marshall1 “A corporation is an artificial being, invisible, intangible, existing only in contemplation of the law. Being a mere creation of law, it possesses only the properties which the Charter of its creation confers upon it, either expressly or as incidental to its very existence
1 Trustees of Dartmouth College v. Woodward 4 Wheat. 518 [1819]
In Indian Law, Company is defined under section 2(20) of the Companies Act of 2013 in which “Company” means a company incorporated under this Act or under any previous company law. This means that any business which is registered under the Companies Act as a Company, will be given the status of a company and will enjoy all the rights of a company. The incorporation of a company, and its subsequent registration, makes the company an artificial entity2 recognized by the law as a legal person that exists independently with rights and liability. This means that a company is treated not the same as its members, but as an independent legal existence3. It is owned by at least one shareholder and managed by at least one director. This separate legal personality has the consequence that a company has perpetual succession. The life of the company is not affected by the death, disability, insolvency or disagreement of a shareholder. Its existence is ended when it is wound up pursuant to the Companies Acts. The shareholders may come or go the life of the company like an artificial person is least affected by these changes. The liability of the shareholders is limited to the value of the shares held by them, it means if a company fails to pay its obligations, the personal properties of the shareholders cannot be sold for the settlement of business debts.
2. ARTIFICIAL PERSON
The most important decision ever made by the English courts in Relation to company law is Salomon v A Salomon & Co. Ltd (1897). The fact that a company was a legal entity separate from its participants was established in this case. The vital perception to become familiar with when starting a business is the idea that the business has a legal personality in its own right, mostly when it assumes the form of a Limited Liability Company. This means that if someone starts a business as a Limited Liability Company, then the Company is a legal entity with separate legal personality, and would be separate to that of the owners, members, or shareholders. As a separate entity, the company is different from the directors, employees and shareholders. The House of Lords in the Salomon case confirmed the legal principle that, upon incorporation, a company is generally considered to be a new legal entity separate from its shareholders. The court did this in relation to what was essentially a one person Company, which is Mr Salomon. The concept that prevailed in Salomon’s case is nothing else but a company is separate from the shareholder, which means that the company is independent and separate from any other entities that are related to the company.
2 Salomon v. Salomon (1897)
3 Lee v. Lee A.C 12. 1961
When a company is recognized as an artificial person4, i.e, it has a separate legal existence from its members, the company attains many other subset characteristics such as limited liability of shareholders, perpetual succession, separate property5, capacity to sue and to be sued, ability to contract in own name, common seal, among others. The following are described in detail.
A. Limited liability : In a company, the liability of shareholders is upto the unpaid amount of the shares they own. This feature of the company limits the liability of the shareholder, meaning that the shareholders personal property cannot be seized during liquidation or in repayment of any loans. This safeguards the property of the shareholder by proving them immunity from any legal takeover of their property.
B. Perpetual Succession : Since the company is not a natural person and has come into existence after its registration, it cannot cease to exist unless it is liquidated. Thus Board Members, Share holders, debenture holders will come and go, but the firm will always continue to exist.
C. Separate property : The company, being an independent entity, has been provided the legal right to purchase, hold and sell its assets. The company’s property is its own. A member cannot claim to be owner of the company’s property during the existence of the company6. The company can purchase goods and services in its own name and can transact in its own name.
D. Capacity to sue and to be sued : Any business taking place in the company’s name might lead to legal implications. Here, the company being a separate legal entity, can in its own name sue the party which it wants to sue. At the same time, the company is not liable for contempt committed by its officials7. Thus the members of the company, and the company itself, are legally seen as two different entities. All legal proceedings against the company are to be taken in its own name.
E. Ability to contract : A company has the ability to independently enter into contacts, in its own name, to conduct its own business. A shareholder cannot enforce a contract made by his company; nor can he be
4 Union Bank of India v. Khader International Construction & Ors 2001 42 CL 296 SC
5 Macaura v. Northern Assurance Co., Ltd., 1925 A.C. 619.
6 R F Perumal v. H John Deavin AIR 1960 Mad 43.
7 Lalit Surajmal Kanodia v. Office Tiger Database Systems India (P) Ltd (2006)
a party to the contract and gain any benefit from it. A company enters into a contract in its own name for
conducting its own business.
F. Common Seal : A seal of a company is basically its signature. Since the company is an independent entity, it requires its own signature to affirm all its transactions. A common seal is applied on the documents of the company which are not only of importance to the company, but which shows that it is the company which has dealt in the transaction and not some member.
Even though a company is an artificial person, a company is not a citizen of the country in which it has registered itself in8. However, a company does enjoy nationality and has a domicile and residence. The domicile of a company is the place of its registration, and this domicile clings on to it throughout its existence9. A company does enjoy certain fundamental rights enshrined in the Constitution of India, such as for the protection of the person, a company enjoys Article 14, i.e, Right to Equality.
3. DIFFERENCE BETWEEN A PARTNERSHIP AND A COMPANY
PARTNERSHIP
Indian Partnership Act, 1932 defines Partnership as “Partnership is a relationship between two or more persons who have agreed to share the profits of a business carried on by all partners or any one partner acting for all”. The members of the Partnership firm are called Partners. There are different types of partners such as Active partner, Sleeping partner, Nominal partner, Minor partner, Etc. Partnership Firm is created by agreement between two or more people by registering the partnership firm with the Registrar of Firms according to Indian Partnership Act, 1936. Registration of a partnership firm is a very simple process and Application for registration of a firm must contain the following details
1. Name of the firm,
2. Names of the partners and their addresses,
3. location where the business is carried on,
4. Partnership tenure between the partners,
5. The main office of the firm, etc.
8 State Trading Corporation of India Ltd v. C.T.O AIR 1963 S.C. 1811
9 Macnaghten. J. 2 KB 88 (1940)
COMPANY
Indian Companies Act, 2013 defines Company as ” A Company formed and registered under this Companies Act or under any previous company law”20. A company is defined easily as an association of two or more persons which is formed for doing business collectively and registered with the Registrar of Companies according to Indian Companies Act, 2013. There are different types of companies like One Person Company, Private company and Public Company, etc. To get registered with the Registrar of Companies, the promoters are required to submit the copies of Articles of Association and Memorandum of Association which consists of various information relating to internal management and external management of the company. The company exhibits certain special characteristics, such as
1. It have a Separate Legal Entity,
2. It contains Common Seal under its name,
3. It has limited liability,
4. It acts as an artificial person.
4. MODERN OPPORTUNITIES OF BEING AN ARTIFICIAL PERSON
A company is an artificial person. Being an artificial person, a company enjoys a lot of rights, liberties, but then it also has certain duties and has to abide by certain rules. When an organization is an artificial person, it means that in the eyes of law the organization is a separate entity which has its own rights, responsibilities and functions. Since a company is the creation of law, it is an artificial juridical person
Being the creation of law, it possesses only the powers conferred upon it by its Memorandum of Association which is the charter of the company. Within the limits of powers conferred by the charter, it can do all acts as a natural person may do11.
Many opportunities present itself when an organization is an artificial person. Some opportunities have been mentioned previously, but opportunities such as incorporated association, transferability of shares, independent loans, separation of ownership and management, Juristic Person, Trustee, Financial autonomy etc, which are discussed as follows –
10 Section 2(20)
11 Ishita Ramani – Tax Guru
1. Incorporated Association : The fundamental attribute of an incorporated company from which all the other attributes emanate is that it enjoys a separate legal personality from its members. Therefore, it is capable of enjoying rights and being subject to duties that are not the same as those being enjoyed or borne by its members. By being an artificial entity, the company stands in complete contradistinction to the members constituting. In Rajendra Nath Dutta v. Shibendra Nath Mukherjee12, it was held that if the company contends that a wrong has been committed against it, legal proceedings for redressing the same should be instituted by the company in its own name. In this case, a lease deed had been executed by the Directors of a company but without its seal. Later, they filed a suit on the grounds that the defendants had fraudulently added certain terms to the lease deed. The court held that the Directors shall not be competent to file the suit, until and unless they are doing so on behalf of the company itself.
2. Transferability of Shares : The shares of a public limited company are freely transferable. It is laid down that the shares/debentures and other interest of a member in a company shall be freely transferable, being moveable property capable of being transferred in the manner as contained in the articles, the only requirements being those contained in the articles13. In the absence of any restrictions being imposed, a shareholder has a right under the statute itself to transfer his shares to anybody, without taking anybody’s consent for this. The transaction should be a bona fide transaction, and the shareholder should afterwards retain no interest in the shares transferred. This shows that the statutes do not intend to regulate the composition of members of a company, since doing so shall restrict the member’s right to free transferability of his interest. This right is enjoyed not just by shareholders, but also by debenture holders, and by all those possessing an interest in the company. Free transferability results in the members being free to transfer their interest at any point of time subject to certain broad restrictions, and in the process enjoying the resultant economic gains in the form of profits on the sale of their interest in the company. This undoubtedly operates as a major incentive for people to become members of companies and trade their interest for gains. The restrictions that apply to the transfers of shares are as follows:
The Board of Directors may refuse to permit a transfer on the grounds of protecting the interests of the company, but their refusal has to proceed from an honest desire to benefit the company, and should not be mala fide.
12 Calcutta High Court
13 Section 82 of the Companies Act
3. Independent Loans : Being an Artificial person, companies generally acquire a lot of assets in their name, and since loan providing agencies, before providing any loan perform a valuation check up, companies usually get huge sums of money as loan to conduct their business. Any person can abscond and cause many other problems for an institution which provides loans to entities, but a company is transparent due to the statutory involvement of auditors, making it very simple to value the company and its assets. The fact that a company is an artificial entity grants the opportunity and easy access to attain huge sums of money as a loan.
4. Separation of ownership and management : A company is owned (de facto) by a number of shareholders which is too large a body to manage the affairs of the company. Shareholders set the objectives of the company and appoint their representatives or agents (known as directors) to manage the affairs of the company on their behalf to pursue their objectives.
The directors, in turn, hire professional managers (executives) to run the day-to-day operations of the company under their supervision and control. This striking feature of separation of ownership and management has raised many issues which give rise to evolution of corporate governance as the focal point of modern corporations. In a particular case14, a company had been incorporated under the Companies Act, and was running a business in one of the industries appearing in the First Schedule, Industries (Development and Regulation) Act. For this, it had obtained loans from a public financial institution that had placed a Director on the company’s board of management. The court held that this did not result in the company becoming an instrumentality or agency of the government within the meaning of Article 12.
Companies that are performing governmental but commercial functions do not become government departments. In the absence of any statutory provisions to the contrary, a commercial corporation acting independently, even if controlled partially or wholly by a government department, shall be presumed not to be an agent of the state . This ensures autonomy in managerial functioning. This also enables companies to attract the best of managerial talent, because the management executives are assured freedom in forming and implementing their managerial ideas, so long as the same do not conflict with the settled norms of the company.
14 Madras Labor Union v. Buckingham and Carnatic Mills and Others
5. Juristic Person15 : Under the Companies Act, the term person includes not only natural persons but also other juridical people. A company is a juristic person that a person can represent it before a Court of Law or any other place by a person competent to represent it. The power to institute a suit in the case of a company vests with the Board of Directors of the Company and an individual Director can institute a suit only if specifically empowered. However, a company cannot take an oath or make an affirmation. Hence, a company cannot become a witness.
6. Trustee : A company can be a trustee if it has a permit from the objects clause in the Memorandum of Association of the Company. It may also act as an fiduciary.
7. Financial Autonomy : The company is the only form of business organization that can raise finances from the general public by inviting the general public to subscribe to its shares, debentures, and other securities. Banks and financial institutions lend their resources more willingly to companies because of the facility of floating charge, this being an exclusive characteristic of companies. Easy availability of capital ensures that the business operations of the company are not impeded for want of capital. Unincorporated associations face the disadvantage of not being able to raise finances from the general public. A company also can take its own autonomous decision as to how, when and where it decides to use its finance.
5. OBSTACLES FACED
One of the biggest obstacles and obstructions faced is the Doctrine of Lifting the Corporate Veil, which essentially allows the court to disregard the company as an artificial person and punishes the actual members involved in the event.
The doctrine of lifting the corporate veil means ignoring the corporate nature of the body of individuals incorporated as a company. A company is a juristic person, but in reality it is a group of people who are the beneficial owners of the property of the corporate body. Being an artificial person, it (company) cannot act on its own, it can act only by natural persons. The doctrine of lifting the veil can be understood
as the identification of the company with its members.
15 Section 09 of the Companies Act, 2013.
The company is equal in law to a natural person. It allows a company to perform juristic acts in its own name, as well as to sue and to be sued. Members and Directors enjoy protection against personal liability. Although this fundamental rule has considerable influence in Company Law across the globe, including India, it cannot be absolute and must allow some exceptions, where the court may disregard the legal personality of the company. Such exceptions as there are represent haphazard refusals by the legislature or the courts to apply logic where it is to flagrantly opposed to justice, convenience or the interest of the revenue. The veil of incorporation never means that the internal affairs of the company are completely concealed from view.
Lifting the corporate veil means disregarding the corporate personality and looking behind the real person who is in control of the company. In other words, where a fraudulent and dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate personality. In this regard the court will break through the corporate veil.
Justice O. Chinnappa Reddy16 had stressed that the corporate veil should be lifted where the associated companies are inextricably connected as to be in reality, part of one concern. After the Bhopal Gas leak disaster case, the lifting of corporate veil has been escalated. A corporation will be looked upon as a legal entity, as a general rule, and until sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons17.
In the following situations, the corporate veil can be lifted –
1) Statutory Provisions
The Companies Act, 2013 has been integrated with various provisions which tend to point out the person who’s liable for any such improper/illegal activity. These persons are more often referred as “officers who are in default” under Section 2(60) of the Act, which includes people such as directors or key-managerial positions. Few Instances of such frameworks are as following:-
16 LIC of India v. Escorts Ltd.
17 United States v. Milwaukee Refrigerator Transit Company
A. Misstatement in Prospectus:-
Under Section 26 (9), Section 34 and Section 35 of the Act, it is made punishable to furnish untrue or false statements in the prospectus of the company. Through issuing prospectus, companies offer securities for sale. Prospectus issued18 contains key notes of the company such as details of shares and debentures, names of directors, main objects and present business of the company. If any person attempts to furnish false or untrue statements in prospectus, he is subject to penalty or imprisonment or both prescribed under the aforesaid sections, depending upon the case. Each of these sections create a distinct aspect, that which type of incorrect information furnishing would make such a person liable for what amount or serving term.
B. Failure to return application money19:-
Against allotment of securities, if the stated minimum amount has not been subscribed and the sum payable on application is not received within a period of thirty days from the date of issue of the prospectus, then such officers in default are to be fined with an amount of one thousand rupees for each day during which such default continues or one lakh rupees, whichever is less.
C. Mis-description of Company’s name:-
The name of the company is most important. Usage of approved names entitles the company to enter into contracts and make them legally binding. This name should be prior approved under Section 4 and printed under Section 12 of the Act. Thus, if any representative of the company collect bills or sign on behalf of the company, and enters incorrect particulars of the company, then such persons are to be held personally liable.
18 under Section 26 of the Companies Act, 2013
19 under Section 39 (3) of the Companies Act, 2013
D. For investigation of ownership of company:-
Under Section 216 of the Act, the Central Government is authorized to appoint inspectors to investigate and report on matters relating to the company, and its membership for the purpose of determining the true persons who are financially interested in the success or failure of the company; or who are able to control or to materially influence the policies of the company.
E. Fraudulent conduct:-
Under Section 339 of the Act, wherever in case of winding up of the company, it is found that company’s name was being used for carrying out a fraudulent activity, the Court is empowered to hold any such person be liable for such unlawful activities, be it director, manager, or any other officer of the company. In the case Delhi Development Authority vs. Skipper Construction Company (P) [7] it was stated that “where, therefore, the corporate character is employed for the purpose of committing illegality or for defrauding others, the court would ignore the corporate character and will look at the reality behind the corporate veil so as to enable it to pass appropriate orders to do justice between the parties concerned.
6. CONCLUSION
Any association of persons to be called a company is to be registered under the procedure prescribed by the Law. An incorporated organization is queued with a bundle of advantages, which a partnership firm or any other business organization does not have. Therefore indulging in business with an incorporated organization is the safest way. A company has many striking features, one of them being that it is an artificial person, which gives itself and its members a lot of advantages and opportunities to further their goal. Being recognized as an artificial person, a company can indulge into a lot of transactions like a natural person, but is not considered a citizen of the country from which it has been registered. A company, however, has a domicile of the country from which it has been registered. Since a company is an artificial person, opportunities such as perpetual succession, limited liability, separate legal entity, ability to sue and get sued, financial autonomy, separation of ownership and management etc present themselves.
The biggest obstacle faced by a company would be the practice of lifting the corporate veil wherein the members can be targeted and harassed. This is a very case sensitive doctrine which has to be practiced with utmost caution and perseverance.
By – Ritabh Singh, Government Law College, Mumbai
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