Class 11 Business Studies Notes Chapter 7 (Formation of a Company) – Business Studies Book

Alright class, let's delve into Chapter 7: Formation of a Company. This is a crucial topic, not just for your Class 11 understanding but also frequently tested in various government examinations due to its procedural and legal importance. Pay close attention to the stages and the key documents involved.

A company, as we know, is an artificial person created by law with a separate legal entity, perpetual succession, and a common seal. Its formation is a systematic process involving several distinct stages.

Stages in the Formation of a Company

The formation process can be broadly divided into four stages:

1. Promotion Stage
2. Incorporation or Registration Stage
3. Capital Subscription Stage
4. Commencement of Business Stage

(Note: A private company only needs to go through the first two stages. Stages 3 and 4 are relevant primarily for public companies wishing to raise funds from the public).

1. Promotion Stage

This is the first stage, involving the conception of the business idea and taking initiatives to form a company.

• Meaning: Promotion refers to the entire process from the discovery of a business idea to starting the company and commencing its business.
• Promoter: The person or group of persons who undertake the process of promotion are called promoters.
  • They identify a business opportunity.
  • Conduct feasibility studies (technical, financial, economic viability).
  • Assemble the necessary resources (finance, assets, managerial personnel).
  • Decide on the name, location, and structure of the company.
  • Prepare the necessary documents for registration.
• Functions of a Promoter:
  • Identification of business opportunity.
  • Feasibility studies.
  • Name approval (from Registrar of Companies - RoC).
  • Fixing up signatories to the Memorandum of Association (MoA).
  • Appointment of professionals (bankers, brokers, underwriters, solicitors).
  • Preparation of necessary documents (MoA, AoA).
• Legal Position of Promoters:
  • They are neither agents nor trustees of the company before its incorporation.
  • They stand in a fiduciary position (position of trust and confidence) towards the company they promote.
  • They cannot make secret profits.
  • They are entitled to receive legitimate pre-incorporation expenses incurred by them.
  • They can be held liable for misstatements in the prospectus.

2. Incorporation or Registration Stage

This stage involves the formal registration of the company with the Registrar of Companies (RoC) of the state where the registered office is to be located.

• Application to RoC: Promoters file an application along with several documents.
• Key Documents to be Filed:
  • Memorandum of Association (MoA):
    • This is the principal document or charter of the company.
    • It defines the company's objectives, scope of activities, and relationship with the outside world.
    • It must contain the following clauses:
      • Name Clause: The approved name of the company (ending with 'Limited' for public companies and 'Private Limited' for private companies).
      • Registered Office Clause/Situation Clause: State where the registered office is situated.
      • Objects Clause: Defines the purpose for which the company is formed (Main objects and other objects). Acts beyond this are 'ultra vires' (beyond powers) and void.
      • Liability Clause: States the liability of members (usually limited by shares or guarantee).
      • Capital Clause: States the maximum capital the company is authorized to raise (Authorised Share Capital).
      • Association or Subscription Clause: Declaration by subscribers (minimum 7 for public, 2 for private) stating their desire to form a company and agreeing to take shares.
    • Must be signed by the required number of subscribers.
  • Articles of Association (AoA):
    • Contains the rules and regulations for the internal management of the company.
    • Defines the rights, duties, and powers of officers and the board of directors.
    • Covers aspects like share allotment, calls on shares, transfer of shares, forfeiture, meetings, voting rights, appointment of directors, accounts, audit, etc.
    • It is subordinate to the MoA and the Companies Act.
    • Must be duly signed by the subscribers of the MoA.
  • Consent of Proposed Directors: Written consent from individuals agreeing to act as directors and confirmation they have taken qualification shares (if any, as per AoA).
  • Agreement: Any agreement made with individuals for appointment as Managing Director, Whole-time Director, or Manager.
  • Statutory Declaration: A declaration stating that all legal requirements for registration have been complied with. This must be signed by an Advocate, Chartered Accountant, Cost Accountant, or Company Secretary in practice, or by a director named in the Articles.
  • Payment of Fees: Prescribed registration fees must be paid.
• Scrutiny by RoC: The Registrar scrutinizes the documents. If satisfied, the RoC registers the company.
• Certificate of Incorporation:
  • Upon registration, the RoC issues a Certificate of Incorporation.
  • This certificate is the 'birth certificate' of the company.
  • It brings the company into legal existence as a separate legal entity from the date mentioned on it.
  • It is conclusive evidence that all requirements for registration have been duly complied with. Any procedural irregularity discovered later does not invalidate the incorporation.
• Corporate Identity Number (CIN): The RoC also allocates a unique CIN to the company upon incorporation.

Effect: A private company can commence its business immediately after receiving the Certificate of Incorporation. A public company cannot start its business yet; it needs to proceed to the next stages if it intends to raise funds from the public.

3. Capital Subscription Stage

This stage is required only for public companies that want to raise capital from the public by issuing shares or debentures. Private companies are prohibited from inviting the public to subscribe to their securities.

• SEBI Approval: Securities and Exchange Board of India (SEBI), the regulatory authority, must approve the proposal. Companies must comply with SEBI's disclosure and investor protection guidelines.
• Filing of Prospectus:
  • A Prospectus (or a statement in lieu of prospectus) must be filed with the RoC.
  • A prospectus is any document described or issued as a prospectus, including any notice, circular, advertisement, or other document inviting offers from the public for the subscription or purchase of any securities of a body corporate.
  • It contains detailed information about the company, its finances, promoters, projects, risks, etc., to help investors make informed decisions.
  • If a company does not want to raise funds from the public immediately, it can file a Statement in Lieu of Prospectus with the RoC at least three days before the allotment of shares.
• Appointment of Bankers, Brokers, Underwriters: To facilitate the issue process. Underwriters guarantee the subscription of shares if the issue is undersubscribed, for a commission.
• Minimum Subscription:
  • This is the minimum amount stated in the prospectus that must be subscribed by the public before the company can proceed with the allotment of shares.
  • As per SEBI guidelines (and reflected in the Companies Act provisions), this is generally 90% of the size of the issue.
  • If minimum subscription is not received within a specified period (usually 120 days from the issue opening, though SEBI norms might specify shorter periods like 30 days for application money refund), the application money must be returned to the applicants within the prescribed time.
• Application to Stock Exchange: The company must apply to at least one recognised stock exchange for permission to deal in its shares or debentures.
• Receipt of Application Money: Investors apply for shares along with application money.
• Allotment of Shares: If minimum subscription is received and other formalities are met, the company can allot shares to the applicants. Allotment letters are sent to successful applicants, and regret letters (with refunds) to unsuccessful ones. A 'Return of Allotment' signed by a director or secretary must be filed with the RoC within 30 days of allotment.

4. Commencement of Business Stage

This stage is applicable only to public companies that have issued a prospectus to raise funds from the public. Such companies cannot commence business activities or exercise borrowing powers until they obtain a Certificate of Commencement of Business.

• Documents to be Filed with RoC:
  • A declaration that shares payable in cash up to the amount of minimum subscription have been subscribed and allotted.
  • A declaration that every director has paid the application and allotment money on their shares.
  • A declaration that no money is pending for refund to applicants.
  • A statutory declaration confirming the above requirements have been met, signed by a director or the company secretary (or a CS in practice).
• Scrutiny by RoC: The Registrar verifies these documents.
• Certificate of Commencement of Business:
  • If satisfied, the RoC issues this certificate.
  • This certificate is conclusive evidence that the company is entitled to commence its business.
  • Only after receiving this certificate can a public company that raised funds via prospectus start its operations and borrow money.

Summary:

• Private Company: Promotion -> Incorporation -> Can commence business.
• Public Company (not raising funds from public): Promotion -> Incorporation -> Can commence business (after filing certain declarations, though Certificate of Commencement is not required in the same way as for companies issuing prospectus).
• Public Company (raising funds from public): Promotion -> Incorporation -> Capital Subscription -> Commencement of Business -> Can commence business only after getting the Certificate of Commencement.

Understanding these stages, the roles of promoters and the RoC, and the significance of key documents like the MoA, AoA, Prospectus, Certificate of Incorporation, and Certificate of Commencement is vital for your exams.

Multiple Choice Questions (MCQs)

Here are 10 MCQs based on the chapter:

1. The stage in the formation of a company which involves conceiving the business idea and taking steps to form the company is called:
   a) Incorporation Stage
   b) Capital Subscription Stage
   c) Promotion Stage
   d) Commencement Stage

2. The principal document defining the objectives and powers of a company is the:
   a) Articles of Association
   b) Prospectus
   c) Statement in Lieu of Prospectus
   d) Memorandum of Association

3. Which of the following clauses is NOT typically part of the Memorandum of Association?
   a) Name Clause
   b) Objects Clause
   c) Rules for Internal Management Clause
   d) Liability Clause

4. The authority responsible for the registration of companies in India is:
   a) SEBI (Securities and Exchange Board of India)
   b) RBI (Reserve Bank of India)
   c) RoC (Registrar of Companies)
   d) Ministry of Corporate Affairs

5. The 'birth certificate' of a company, signifying its legal existence, is the:
   a) Certificate of Commencement of Business
   b) Letter of Intent
   c) Certificate of Incorporation
   d) Prospectus

6. A private company can commence its business operations immediately after obtaining:
   a) Approval from SEBI
   b) Certificate of Incorporation
   c) Certificate of Commencement of Business
   d) Minimum Subscription

7. Minimum Subscription, generally 90% of the issue size, must be received before a public company can proceed with:
   a) Filing the Memorandum of Association
   b) Appointing promoters
   c) Allotment of Shares
   d) Applying for name approval

8. A document issued to invite the public to subscribe to the shares or debentures of a company is known as a:
   a) Article of Association
   b) Memorandum of Association
   c) Prospectus
   d) Certificate of Incorporation

9. Which of the following companies MUST obtain a Certificate of Commencement of Business before starting operations, if it has raised funds through a public issue?
   a) Private Limited Company
   b) Public Limited Company
   c) One Person Company (OPC)
   d) Government Company (if private limited)

10. Promoters of a company stand in a ________ position towards the company they help form.
    a) Competitive
    b) Fiduciary
    c) Subordinate
    d) Agency (in the legal sense before incorporation)

Answer Key:

1. c) Promotion Stage
2. d) Memorandum of Association
3. c) Rules for Internal Management Clause (This is part of AoA)
4. c) RoC (Registrar of Companies)
5. c) Certificate of Incorporation
6. b) Certificate of Incorporation
7. c) Allotment of Shares
8. c) Prospectus
9. b) Public Limited Company
10. b) Fiduciary

Study these notes thoroughly. Focus on the sequence, the documents, and the legal implications at each stage. Good luck with your preparation!