COMPANY LAW - Management of a Company

MANAGEMENT OF A COMPANY

Directors

Minimum/Maximum Number of Directors in a Company

Minimum Number of Directors

The Maximum Number of Directors is 15, which can be increased by passing a special resolution

Appointment of Directors

• As provided in the Companies Act 2013, every Director shall be appointed by the company in a general meeting.
• Director Identification Number (DIN) is compulsory for appointment of a Director.
• Every person proposed to be appointed as a director shall furnish his Director Identification Number (DIN) and a declaration that he is not disqualified to become a director under the Companies Act 2013.
• A person appointed as a director shall on or before the appointment give his consent to hold the office of director in physical form DIR-2 i.e. Consent to act as a director of a company.

Appointment of Directors can be made as follows:

By the Promoters of the Company

By the Subscribers of the Memorandum of Association

By the Shareholders in a General Meeting

By the Board of Directors

By the Central Government

By Proportional Representation

By Third Parties

Role of Directors

• Governing the organization by establishing policies and objectives 
• Selecting,  Appointing, Supporting and Reviewing the performance of the Chief Executive 
• Ensuring the availability of adequate financial resources 
• Approving annual budgets 
• Accounting to the stakeholders for the organization’s performance 
• Setting the salaries and compensation of company management

Duties of directors

• Act in accordance with the articles of the company. 
• Act in good faith in order to promote the objects of the company for the benefit of its members as a whole and in the best interests of the company, its employees, the shareholders, the community, and for the protection of the environment. 
• Exercise his/her duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
• Not involve in a situation in which he/she may have a direct or indirect interest that conflicts or possibly may conflict, with the interest of the company.
• Not achieve or attempt to achieve any undue gain or advantage either to self or to relatives, partners, or associates and if such director is found guilty of making any undue gain, he/she shall be liable to pay an amount equal to that gain to the company. 
• Not assign his/her office to anyone and if any assignment so made shall be void.

Liabilities of directors

Liability to Outsiders 

• If they enter into a contract which is ultra vires the company 
• If they fail to sign a negotiable instrument without mentioning the company’s name 
• If they act in their own name 
• If they have made any mis-statement in the prospectus 
• If they are guilty of committing a fraud 
• If they have made irregular allotment in contradiction of the articles

Liability to Company 

• If they are negligent in the performance of their duties 
• If they commit an act that is ultra vires their powers 
• If they commit any illegal act 
• If they commit any breach of trust

Liability to Shareholders

• The position of directors in respect of the property of the company is that of a trustee. If they commit any breach of trust and if as a result of that, the company suffers a loss, they have to make good that loss. 
• If the directors are negligent and fail to use reasonable care and skill and because of this, the shareholders suffer a loss, they have a right to claim damages from the directors.

Criminal Liability

• Directors may be awarded two years imprisonment and a fine of Rs.5,000 for the filing of a prospectus containing false statements. 
• Criminal proceeding against directors may be instituted: 
• For fraudulently obtaining credit for the company 
• For acting as a director after removal by court 
• For failure to supply information to auditor of the company 
• For improper issue of shares 
• For failure to produce the balance sheet before the annual general meeting

Disqualification of Directors

• Unsound mind and stands so declared by a competent court; 
• An undischarged insolvent; 
• Has applied to be adjudicated as an insolvent and his application is pending; 
• Been convicted by a court of any offense, whether involving moral issues or otherwise and sentenced in respect thereof to imprisonment for not less than six months and a period of five years has not elapsed from the date of expiry of the sentence. If a person has been convicted of any offense and sentenced in respect thereof to imprisonment for a period of seven years or more, he/she shall not be eligible to be appointed as a director in any company;
• An order disqualifying him/her for appointment as a director has been passed by a court or Tribunal and the order is in force; 
• Has not paid any calls in respect of any shares of the company held, whether alone or jointly with others, and six months have elapsed from the last day fixed for the payment of the call; 
• Has not got the DIN - Director Identification Number.

Removal of directors

A director may be removed before the expiry of his term of appointment by: 

1. Removal by Shareholders 
2. Removal by the Central Government 
3. Removal by the Company Law Board

Removal by Shareholders 

• Special notice of 14 days is required to be given to the company to move an ordinary resolution to remove the director and to appoint another director as a replacement 
• On receipt of the notice, the company must inform all the members of the proposed resolution. It must also send a copy of the notice to the director proposed to be removed
• If the director wishes to make a representation he may send it to the company and the company, in turn, sends copies of the representation to the members, together with the notice of a meeting
• If the representation is not received by the company within a reasonable time, the representation may be read out at the meeting. Director can speak at the meeting against his removal.
• At the meeting, two ordinary resolutions will have to be passed. One for removal and another for replacement.

Removal by the Central Government 

The Central Government may order the removal of a director if an adverse finding has been made by the Company Law Board against him/her, after making an inquiry into these cases such as fraud, persistent negligence, default in carrying out his obligations in such a way as to cause damage to the business. 

Removal by the Company Law Board

Company Law Board on receiving an application for prevention of oppression of mismanagement may enquire into the matter and on inquiry, if it finds that relief ought to be granted, it may by order, remove the director.

Types of Directors

Managing Director - A Managing Director is a Director who has substantial powers of management of the affairs of the company subject to the supervisory, control, and direction of the Board. 

Whole Time Director / Executive Director - A Whole-time Director includes a Director who is in the whole-time employment of the company, devotes his whole-time of working hours to the company and has a significant personal interest in the company as his source of income. 

Independent Director - An Independent director (also known as an outside director) is a director (member) of a board of directors who does not have a material or regular relationship with the company or related persons, except sitting fees.

CORPORATE GOVERNANCE

Ideal corporate governance is characterized by a firm commitment to ethical practices by the entire organization in all of its dealings with a wide group of stakeholders encompassing employees, customers, vendors, regulators, and all shareholders.

Corporate governance rests on four pillars: 

• Transparency 
• Full disclosure 
• Independent Monitoring 
• Fairness to all stakeholders

Requirement for Independent Director

As per the Companies Act 2013, all listed public limited companies are mandatorily required to have at least one-third of the total number of directors as independent directors. Unlisted public companies should appoint at least two independent directors in the following situations:

• If the paid up share capital is in excess of Rs.10 crores;
• If the turnover is in excess of Rs.100 crores;
• If the total of all the outstanding loans, debentures, and deposits is in excess of Rs.50 crores.

Independent Director

An independent director is a non-executive director who does not have any kind of relationship with the company that may affect the independence of his/her judgment. 

An independent director should not have been a partner or executive director of the auditors/lawyers/consultants of the company in the preceding three years or should not hold 2% or more of shares of the company. 

Qualities of Independent Director

An independent director should preferably possess appropriate skills, experience and knowledge in one or more domains of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations, or other disciplines that are related to the company’s business. Generally, one who wishes to qualify as an Independent Director has to possess the following qualities:

• Impartiality
• Loyalty
• Decision-making (judgment)
• Professional repute

Role of an independent director

Independent directors primarily provide inputs to all key decisions such as strategies, performance evaluation, and risk evaluation affecting the company 

Independent Directors are also part of Committees and are often Chairmen of Committees, thereby empowering their judgments and decisions

Responsibilities of an Independent Director 

• Thorough preparation for the meeting 
• A free and frank expression of opinions. 
• Being the conscience of the Board 
• Up-to-date information on laws and regulations governing the company 
• Last but not the least, responsibility to act in the larger interest of true growth and development of the company

Letter of Appointment

The selection of independent directors would be formalized by a letter of appointment.

The terms and conditions of the selection of independent directors should be open for inspection at the registered office of the company by any member during normal business hours. 

The terms & conditions of appointment of independent directors should also be posted on the company’s website.

The components of a letter of appointment is as follows:

• The term of appointment.
• The board-level committee in which the director is expected to serve his/her tasks.
• Directors and Officers insurance.
• The code of Occupational Ethics that the company expects from its directors and employee to follow.
• Enumerated actions that a director should follow while working in a company
• The remuneration, mentioning the periodic fee, compensation of expenses for contribution in the Boards and other meetings, and profit-related commission.

Re-appointment, Resignation, or Removal

The independent directors are subject to evaluation of their performance by other directors. Their re-appointment would be considered based on their performance appraisal report.

The independent director could resign or could be removed just like any other director. Upon resignation or removal, the vacancy is to be filled in by the Board within a period of 180 days from the date of either resignation or removal. 

The vacancy caused by resignation or removal is different from intermittent vacancy. In case of an intermittent vacancy, it must be occupied by the Board of Directors within a maximum period of 3 months or at the next Board meeting, whichever is earlier.

Duties of an independent director

The key role and functions of an Independent Director as listed under Schedule IV of the Companies Act, 2013 are described as follows:

Aid in bringing an independent judgment to bear on the Board’s deliberations particularly on issues of strategy, performance, risk management, resources, key appointments and standards of conduct;

Enable an objective view in the evaluation of the performance related to board and management;

Examine the performance of management in meeting the decided goals and objectives and examine the reporting of performance;

Satisfy themselves on the reliability of financial information and that financial controls and the systems of risk management are considered robust and defensible;

Protect the interests of all stakeholders, mainly the minority shareholders;

Balance the conflict of interest of the stakeholders;

Decide suitable levels of remuneration of executive directors, key managerial personnel and senior management and have a major role in appointing and where essential recommend removal of executive directors, important managerial personnel and senior management;

Moderate and adjudicate in the interest of the company as a whole, in the situations of conflict between the management as well as shareholder’s interest.

COMMITTEES MANDATORILY TO BE CONSTITUTED UNDER THE COMPANIES ACT, 2013

Audit Committee - Minimum 3 directors with independent directors forming a majority.

Nomination And Remuneration Committee - 3 or more Non-Executive Directors out of which not less than ½ shall be Independent Directors.

Stakeholders Relationship Committee - Chairperson who shall be a Non-Executive Director and such other members as may be decided by the Board.

CSR Committee – depends on the type of the company

Liabilities

The question of whether independent directors are held liable rose with the Bhopal Union Carbide case in which Mr. Keshub Mahindra, ex-chairman, Union Carbide India, guilty and was sentenced to two years of imprisonment in June 2010. (Since appealed)

A Chairman without any knowledge of the company activities, how can (he) preside over the meetings of the shareholders and higher officials? 

The judgment seemed to impute that the chairman of a company ‐ in this case, a nonexecutive chairman ‐ ought to be omnipresent, omnipotent, and omniscient.

SMS PHARMACEUTICALS Vs NEETA BALLA(2005): (Dishonor of cheque/bouncing of the cheque.) Any offense has been committed by a company and it is proved that the offense has been committed with the consent of, or is attributable to, any neglect on the part of, any director, manager, secretary or any other officer of the company, such director, manager, secretary or other officers shall also be deemed to be guilty of that offense and shall be liable to be proceeded against and punished accordingly.

SATYAM CASE The promoters inflated the revenue and profit figures of Satyam. the company had a huge hole in its balance sheet, consisting of non-existent assets and cash reserves that have been recorded and liabilities that are unrecorded. Mangalam Srinivasan, Vinod K Dham, Krishna who were the independent directors of Satyam were arrested.

The Circular from the ministry of corporate affairs says that penal action can only be initiated against the non‐executive directors when the ROC, after taking due care, has come to the conclusion that such directors are the officers in default and have not acted diligently in the Board process. 

The non‐executive directors cannot be prosecuted if the violation of the law or any omission is on the part of the company or by any other officers of the company and which have occurred without his knowledge and consent.

The directors who can be held liable are: 

• Independent Directors in listed companies. 
• Government nominees in PSUs. 
• Nominee directors of public sector financial institutions.
• Government director. 

The Circular adopts a principles‐based approach by avoiding the rigidity involved in complete immunity.

MEETINGS

Statutory Meeting

A public company limited by shares or a guarantee is required to hold a statutory meeting. The statutory meeting is held only once in the lifetime of the company. Such a meeting must be held within a period of not less than one month or within a period not more than six months from the date on which it is entitled to commence business i.e. it obtains a certificate of commencement of business.

Purpose: 

The purpose of the meeting is to enable members to know all important matters pertaining to the formation of the company and its initial life history.

Notice Period: 

A notice of at least 21 days before the meeting must be given to members unless consent is accorded to a shorter notice by members.

Contents: 

The Board of Directors must prepare and send to every member a report called the "Statutory Report" at least 21 days before the day on which the meeting is to be held. The report should be certified as correct by at least two directors, one of whom must be the managing director, where there is one, and must also be certified as correct by the auditors of the company. A certified copy of the report must be sent to the Registrar for registration immediately after copies have been sent to the members of the company.

Breach: 

If the default is made in complying with the above provisions, every director or other officer of the company who is in default shall be punishable with a fine. The Registrar or a contributory may file a petition for the winding-up of the company if the default is made in delivering the statutory report to the Registrar or in holding the statutory meeting on or after 14 days after the last date on which the statutory meeting ought to have been held.

Annual general meeting

Annual General Meeting must be held by every type of company, public or private, limited by shares or by guarantee, with or without share capital or unlimited company, once a year. Every company must in each year hold an annual general meeting. 

Not more than 15 months must elapse between two annual general meetings. 

However, a company may hold its first annual general meeting within 18 months from the date of its incorporation.

Notice: 

A notice of at least 21 days before the meeting must be given to members. The notice must state that the meeting is an annual general meeting. The time, date, and place of the meeting must be mentioned in the notice. 

The notice of the meeting must be accompanied by a copy of the annual accounts of the company, the director’s report on the position of the company for the year, and the auditor’s report on the accounts. 

Companies having share capital should also state in the notice that a member is entitled to attend and vote at the meeting and is also entitled to appoint proxies in his absence. 

A proxy need not be a member of that company. 

A proxy form should be enclosed with the notice. 

The AGM must be held on a working day during business hours at the registered office of the company or at some other place within the city, town or village in which the registered office of the company is situated. 

The Central Government may, however, exempt any class of companies from the above provisions. 

If any day is declared by the Central government to be a public holiday after the issue of the notice convening such meeting, such a day will be treated as a working day.

Each AGM takes up ordinary business and special business regarding the company.

Ordinary business covers the following issues:

1. Accounts, Balance Sheet, and Report of the Board of Directors and Auditors.
2. A decision on declaration of dividend.
3. Appointment of Directors in the place of retiring directors.
4. Appointments of Auditors and their remuneration.

In case of default in holding an annual general meeting, the following are the consequences :

• Any member of the company may apply to the Company Law Board.
• The Company Law Board may call or direct the calling of the meeting. 
• Fines may be levied and for continuing default, a further fine per day during which the default continues may be levied.

Every general meeting (i.e. meeting of members of the company) other than the statutory meeting and the annual general meeting or any adjournment thereof, is an extraordinary general meeting.

Such a meeting is usually called by the Board of Directors for some urgent business which cannot wait to be decided till the next AGM. Every business transacted at such a meeting is a special business. An explanatory statement of the special business must also accompany the notice calling the meeting.

Extraordinary General Meeting

The Articles of Association of a Company may contain provisions for convening an extraordinary general meeting. 

Eg. It may provide that "the board may, whenever it thinks fit, call an extraordinary general meeting" or it may provide that "if at any time there are not within India, directors capable of acting who are sufficient in number to form a quorum, any director or any two members of the company may call an extraordinary general meeting".

A meeting cannot be held unless proper notice has been given to all persons entitled to attend the meeting at the proper time, containing the necessary information. A notice convening a general meeting must be given at least 21 clear days prior to the date of meeting.

Requisites of a Valid Meeting

It must be properly convened. The persons calling the meeting must be authorized to do so. Proper and adequate notice must have been given to all those entitled to attend. The meeting must be legally constituted. There must be a chairperson. 

The rules of quorum must be maintained and the provisions of the Companies Act, 2013 and the articles must be complied with. 

The business at the meeting must be validly transacted. The meeting must be conducted in accordance with the regulations governing the meetings.

The chairman is the head of the meeting. Generally, the chairman of the Board of Directors is the Chairman of the meeting. Unless the articles otherwise provide, the members present in person at the meeting elect one of themselves to be the chairman thereof on a show of the hands. 

If there is no Chairman or he is not present within 15 minutes after the appointed time of the meeting or is unwilling to act as chairman of the meeting, the directors present may elect one among themselves to be the chairman of the meeting.

Without a chairman, a meeting is incomplete. The chairman is the regulator of the meeting. His duties include the following :

He must ensure that the meeting is properly convened and constituted i.e. that proper notice has been given, that the required quorum is present, etc. 

He must ensure that the provisions of the act and the articles in regard to the meeting and its procedures are observed.

He must ensure that business is taken in the order set out in agenda and no business which is not mentioned in the agenda is taken up unless agreed to by the members. 

Without a chairman, a meeting is incomplete. The chairman is the regulator of the meeting. His duties include the following :

He must impartially regulate the proceedings of the meeting and maintain discipline at the meeting.

He may exercise his powers of adjournment of the meeting, should he in good faith feel that such a step is necessary. 

The chairman has the power to adjourn the meeting in case of indiscipline at the meeting. 

Without a chairman, a meeting is incomplete. The chairman is the regulator of the meeting. His duties include the following :

Note:  A chairman however does not have the power to stop or adjourn the meeting at his own will and pleasure. If he adjourns the meeting prematurely, the members present may decide to continue the meeting and elect another chairman and proceed with the business for which it was convened.

Quorum

Quorum is the presence of a requisite number of members when a meeting can validly commence its business. It is the minimum number of members of a company whose presence is necessary for the transaction of business. In the case of a company, the quorum is usually fixed by the articles.

The Act provides that unless the articles of a company provide for a larger number, five members personally present in the case of the public company and two members personally present in the case of a private company shall be a quorum for a general meeting of a company.

Unless the articles otherwise provide, if within half an hour from the time appointed for holding a meeting of a company, a quorum is not present, the meeting, if called upon the requisition of members, shall stand dissolved. 

In any other case, the meeting shall stand adjourned to the same day in the next week, at the same time and place, or to such other day and at such other time and place as the Board may determine.

If at the adjourned meeting also, the quorum is not present within half an hour from the time appointed for holding the meeting, the members present shall constitute a quorum.

Resolution

A decision in a meeting is taken by a resolution of the members. 

A proposition for a decision at a meeting is called a motion.

It can be introduced by any member. 

A motion is always in writing and its notice is given in advance. 

When a motion is passed by the meeting by voting, it is called a resolution.

Special Resolution

Companies are required to pass a special resolution in various matters. Special resolution should be passed either under the Companies Act, 2013 or if duly authorized by the Articles of Association of the company. 

A special resolution is required for changing a foundational aspect of the company. 

Procedures

Convene a General Meeting – To propose a resolution as a special resolution call a general meeting or otherwise intimate the same to members complying with all requirements of notice for General Meeting.

Send notice – Notice should be sent to all members at least 21days before constituting the General Meeting. Along with the notice, an Explanatory Statement should be sent to members.

Pass the Resolution – In meeting for a resolution to be “special resolution” votes cast in favor of resolution whether by raising hands or on a poll by members, or proxies where allowed, by proxy, are not less than three times the number of votes cast against the resolution.

Matters requiring Special Resolution

Alteration of Memorandum

Change of registered office or Object clause

Change of name of the Company

Alteration of Articles

Issue of further shares without pre –emptive rights

Creation of Reserve Capital

Reduction of share capital

Removal of registered office outside the local limits

Commencement of new business

Keeping Register of members at a place other than registered office.

Payment of interest out of capital.

Investigation of affairs of the company

Authorizing a director to hold any office or place of profit

Making the liability of any director or manager unlimited where so authorized by the articles

Loans to other bodies corporate.

Winding up by the Court

Voluntary winding up

Authorizing Liquidator to accept shares etc.

Approval of arrangement with creditors.

Exercise of certain powers by liquidator in voluntary winding up.

Disposal of books and papers upon winding up.

Ordinary Resolution

Any matter for which a special resolution is not required can be accomplished through an ordinary resolution.

An ordinary resolution requires a simple majority of above 50% of the votes.

Some of the issues that require ordinary resolutions:

Alteration of the authorized capital of the company.

Declaration of dividend.

Appointment of Auditors.

Election of Directors.

AN INTRODUCTION TO COMPANY LAW - Characteristics & Formation of a Company

AN INTRODUCTION TO COMPANY LAW

Importance of Choice of Business Organisation

• The ability of the entity to raise capital
• The Manner in which risk is shared between owners and creditors 
• The Extent of control exercisable by the owners 
• The Nature of the regularity framework applicable to the entity 
•  The Tax burden for the entity and the owners 

CHARACTERISTICS

SEPARATE LEGAL ENTITY: An Entity separate from its members

LIMITED LIABILITY: Either limited by shares or limited by guarantee.

PERPETUAL SUCCESSION: A Company outlasts its members. Since Law has created it, only Law can end it… 

COMMON SEAL: It is the official signature of the company. The purpose of the seal is to furnish evidence regarding the authenticity of a document.

TRANSFERABILITY OF SHARES: Transfer of the ownership of shares either in the form of a transfer or by transmission

SEPARATE PROPERTY: Since it is a legal person distinct from its members, it is capable of owning, enjoying & disposing of property in its own name.

CAPACITY TO SUE: A company can sue and can be sued

MANAGEMENT  Management of a company is vested in the hands of directors who are elected by shareholders

Salomon v Salomon Ltd (1895-9)

Case of a profitable leather & shoe manufacturing business being converted into a company – Salomon, his wife & five children subscribe to one share each – authorized capital £ 40000 – business valued at £39,000 & sold to a company which pays £9,000 in cash & allots shares worth £ 20,000, Salomon loaned the remaining £ 10,000 through secured debentures – Company took an unsecured loan of £ 10,000 from Mr Broderip – thereafter company falls on hard times – had to be liquidated to meet demands of the creditors – total assets were not sufficient – Should Salomon, a secured creditor be paid first? 

Though a company is a legal person, it is not a citizen either under the Constitution of India or the Citizenship Act 1955. But a company has a nationality & a residence.

NUMBER OF MEMBERS

PRIVATE COMPANY:

MINIMUM 2* MAXIMUM 200

PUBLIC COMPANY:

MINIMUM 7 MAXIMUM - Not specified 

ONE PERSON COMPANY

What is One Person Company (OPC)?

The concept of One Person Company [OPC] is a new vehicle/form of business, introduced by The Companies Act, 2013 [No.18 of 2013], thereby enabling Entrepreneur(s) carrying on the business in the Sole-Proprietor form of business to enter a Corporate Framework.

One Person Company is a hybrid of Sole-Proprietor and Company form of business and has been provided with concessional/relaxed requirements under the Act.

Features of One Person Company (OPC)

Only One Shareholder:

Only a natural person, who is an Indian citizen and resident in India shall be eligible to incorporate a One Person Company. Explanation: The term "Resident in India" means a person who has stayed in India for a period of not less than 182 days during the immediately preceding one calendar year.

Nominee for the Shareholder:

The Shareholder shall nominate another person who shall become the shareholders in case of death/incapacity of the original shareholder.  Such nominee shall give his/her consent and such consent for being appointed as the Nominee for the sole Shareholder.   Only a natural person, who is an Indian citizen and resident in India shall be a nominee for the sole member of a One Person Company.

Director: 

Must have a minimum of One Director, the Sole Shareholder can himself be the Sole Director. The Company may have a maximum number of 15 directors.

Terms and Restrictions of OPC

A person shall not be eligible to incorporate more than a One Person Company or become nominee in more than one such company.

Minor cannot become a member or nominee of the One Person Company or can hold share with beneficial interest.

An OPC cannot be incorporated or converted into a company under Section 8 of the Act. [Company not for Profit].

An OPC cannot carry out Non-Banking Financial Investment activities including investment in securities of any body corporate. 

An OPC cannot convert voluntarily into any kind of company unless two years have expired from the date of incorporation of One Person Company, except threshold limit (paid-up share capital) is increased beyond Rs.50 Lakhs or its average annual turnover during the relevant period exceeds Rs.2 Crores i.e., if the Paid-up capital of the Company crosses Rs.50 Lakhs or the average annual turnover during the relevant period exceeds Rs.2 Crores, then the OPC has to invariably file forms with the ROC for conversion into a Private or Public Company, within a period of Six Months on breaching the above threshold limits.

PIERCING  THE CORPORATE VEIL

WHEN THE COMPANY IS A SHAM/CLOAK FOR FRAUD OR FOR IMPROPER CONDUCT,  COURTS PIERCE THE CORPORATE VEIL & LOOK AT THE PERSONS WHO ARE THE REAL BENEFICIARIES OF THE CORPORATE FICTION.

CIRCUMSTANCES

(A few examples Under Judicial Interpretations) 

PROTECTION OF REVENUE: Company has been formed for tax evasion or to circumvent tax obligation 

PREVENTION OF FRAUD OR IMPROPER CONDUCT: Company has been formed to default creditors or circumvent any law.

WHERE THE COMPANY IS USED FOR SOME ILLEGAL OR IMPROPER PURPOSE: Courts have shown themselves willing to lift the veil where the device of incorporation is used for some illegal or improper purpose. 

DETERMINATION OF THE CHARACTER OF A COMPANY: When persons in actual control are residents of an enemy country, the court may lift the veil and declare the company to be an enemy.

FORMATION OF SUBSIDIARIES TO ACT AS AN AGENT: When the parent & the subsidiary company are one commercial unit, & the subsidiary is formed to circumvent some obligation. 

WHERE COMPANY IS USED TO AVOID WELFARE LEGISLATION: Where it was found that the sole purpose for the formation of the new company was to use it as a device to reduce the amount to be paid by way of bonus to workmen.

TO PUNISH FOR CONTEMPT OF COURT 

FOR DETERMINATION OF TECHNICAL COMPETENCE OF THE COMPANY

WHERE THE COMPANY IS A MERE SHAM OR CLOAK

(Under Statutory Provisions) 

• Reduction of membership 
• Misrepresentation in Prospectus
• Failure to return application money
• Misdescription of name
• For investigation of the company by investigators appointed by Central Govt. 
• Fraudulent conduct (at time of winding up)
• Liability for Ultra Vires Act

FORMATION OF A COMPANY

• PROMOTERS
• MEMORANDUM OF ASSOCIATION
• ARTICLES OF ASSOCIATION
• LIST OF FIRST DIRECTORS
• DECLARATION OF COMPLETION OF FORMALITIES
• FILING FEES
• APPLICATION TO THE REGISTRAR OF COMPANIES.
• PROMOTERS

Who is a Promoter? The term promoter is “a term not of law but of business”, usefully summing up, in a single word— promotion, “a number of business operations familiar to the commercial world by which a company is brought into existence”. 

However, the persons assisting the promoters by acting in a professional capacity do not thereby become promoters themselves.

PROMOTERS

Legal Position of a Promoter: The promoter stands in a fiduciary position towards the company. The following are some of the fiduciary duties that the Courts will insist that a Company promoter has to observe:

• Top of the list is not to make a secret profit at the expense of the company
• A duty to account to the company for the benefit for any property he might purchase with the intent of selling the property to the Company for a profit later.
• A duty not to defraud the Company by active concealment of any affairs relating to the company
• A duty not to disclose confidential information to outsiders.
• A duty not to hide his personal interests through a nominee.

Pre-incorporation contracts are Void-ab-initio: 

• However, pre-incorporation contracts shall be valid if: 
• The contract is made for the purpose of the company and the contract is warranted by the terms of incorporation. 
• The company adopts the transactions after incorporation.

MEMORANDUM OF ASSOCIATION (MA)

Fundamental conditions upon which alone the company is allowed to be incorporated. 

Regulates external affairs of the Company with outsiders.

Enable those who deal with it to know the permitted range of its enterprise.

CONTENTS OF THE MA:

NAME CLAUSE

REGISTERED OFFICE CLAUSE

OBJECTS CLAUSE: a) Main objects and objects ancillary to main objects b) Other objects

CAPITAL CLAUSE: the amount of share capital the company is permitted to raise.

LIABILITY CLAUSE: limited by shares or by guarantee

ASSOCIATION CLAUSE: declaration by the subscribers that they are desirous of forming a company. 

ARTICLES OF ASSOCIATION (AA)

The articles of association are the rules, regulations and bylaws for the internal management of the affairs of the company. They are formed with the object of carrying out the aims and objects as set out in the memorandum of association. 

CONTENTS OF AA:

The articles of association usually contain provisions relating to:

• Share capital & rights of shareholders, 
• Lien on shares
• Calls on shares
• Transfer of shares 
• Transmission of shares
• Forfeiture of shares
• Conversion of shares into stock
• Share warrants
• General meetings and procedures there at
• Voting rights of members, voting & poll proxies
• Directors, their appointments, remuneration, qualifications, powers and proceedings of the board of directors
• Manager & secretary 
• Dividends and reserves
• Accounts, audit and borrowing powers
• Capitalisation of profits
• Winding up procedures

IMPORTANT NOTE ON AA

The AA should not go beyond the powers of the company itself as contemplated in the MA. Also, they should not violate the provisions of the Companies Act.

DOCTRINE OF ULTRA VIRES

ULTRA VIRES = BEYOND THE POWERS

The company has the power to do all acts & things that are:

• Authorised by the Act
• Essential to attain the objects specified in the MA
• Fairly incidental to the objects

EVERYTHING ELSE IS ULTRA VIRES

The Ashbury Railway Carriage & Iron Company v Riche (1875) 

Case of ARC&IC contracts to provide finance to Riche for the construction of a railway in Belgium -objects of a company (a) To make and sell or lend on hire, railway carriages and wagons, and all kinds of railway plant, fittings, machinery and rolling stock (b) to carry on the business of mechanical engineers and general contractors (c) to purchase, lease, work and sell mines, minerals, land and buildings (d) to purchase and sell as merchants, timber, coal, metals, or other materials, and to buy any such materials on commission or as agents – evident that financing was not an object of the company. 

PURPOSE OF THE DOCTRINE

The purpose of this doctrine is:

• To protect the investors in the company so that they may know the objects in which their money is to be employed.
• To protect creditors by ensuring that the company’s funds to which they must look for payment, are not wasted in unauthorised activities.

DOCTRINE OF CONSTRUCTIVE NOTICE

Every outsider dealing with a company is deemed to have notice of the contents of the memorandum & articles of association; which on registration with the registrar of companies assume the character of public documents. This is known as constructive notice of the MA & AA.

EFFECT OF THE DOCTRINE

The doctrine is not a positive one but a negative one. It is like the doctrine of estoppel. I.e. a person dealing with the company is stopped from taking the plea that he had not read the memorandum & articles of association.

DOCTRINE OF INDOOR MANAGEMENT

The doctrine of indoor management is a limitation to the doctrine of constructive notice. The outsiders dealing with the company are entitled to assume that as far as the internal proceedings of the company are concerned, everything has been regularly done. They are not bound to do more than read the MA & AA. They need not inquire into the regularity of the internal proceedings.

Royal British Bank v Turquant (1843-60)

The directors of a coal mining and railway company borrowed money from the Royal British Bank, on a bond of £ 2,000. The bond was given under the seal of the company and was signed by two directors and a secretary. The company, however, claimed that under its clauses of incorporation, the directors had the power to borrow only such sums as had been authorised by a general resolution of the company. Further, in this case, no sufficiently specific resolution had been passed. 

EXCEPTIONS - DOCTRINE OF INDOOR MANAGEMENT

• Where the outsider had knowledge of irregularity
• Where the outsider had no knowledge of Articles
• Forgery
• The doctrine, in no way, rewards those who behave negligently

CERTIFICATE OF INCORPORATION

Effect of Certificate of Incorporation 

On incorporation, the association of persons becomes a body corporate by the name contained in the memorandum, capable forthwith of exercising all the functions of an incorporated company and having perpetual succession and a common seal but with such liability on the part of the members to contribute to the assets of the company in the event of its being wound-up as is mentioned in the Act.

Conclusiveness of Certificate of Incorporation 

Conclusive to the effect that all requirements of law relating to registration and matters precedent and incidental thereto have been duly complied with. 

A private limited company can commence business on receipt of a certificate of incorporation. 

A public company has, however, to wait to commence business till a certificate of commencement of business is received from the registrar of the joint-stock companies. 

CERTIFICATE OF COMMENCEMENT OF BUSINESS

The certificate of commencement of business is granted on fulfilling some requirements:

Where prospectus has been issued inviting the public to subscribe for shares:

• Shares payable in cash have been allotted to the amount of minimum subscription.
• Every director of the company has paid the full amount of the shares payable in cash.
• There is no money liable to be paid to applicants for shares that have been offered for subscription.
• A statutory declaration by the chief executive or one of the directors and the secretary that the aforesaid conditions have been complied with.

The registrar on being fully satisfied that:

• The verified declaration has been filed,
• All other requirements of the ordinance have been complied with, 

will issue a certificate called ‘certificate to commence business'. On receipt of this certificate, a company is entitled to commence business. 

A company that has not issued a prospectus shall have to file a statement in lieu of a prospectus in order to get a certificate of commencement of business to be issued. 

Provisional Contracts 

Contracts entered into by a company after incorporation but before getting the certificate to commence business are called ‘provisional contracts’. 

Provisional contracts are, therefore, relevant to public companies only. 

Such contracts become void if a company fails to obtain a certificate to commence business and automatically become valid, and binding if the company obtains the certificate.

LIMITED LIABILITY PARTNERSHIP (LLP) - An Overview

 

Limited Liability Partnership (LLP)

Nature of Limited Liability Partnership 

• LLP is a body corporate formed & incorporated under LLP Act
• LLP is a legal entity separate from its partners 
• LLP has perpetual succession 
• Existence, Rights & Liabilities of LLP not affected by a change in partners 
• Indian Partnership Act, 1932 does not apply to LLPs 
• Partners
• Individuals / Body Corporate can be partners 
• Minimum two partners 
• Maximum unlimited partners

• If no. of partners fall below 2 for more than 6 months &
• The remaining partner has knowledge of such no. of partners falling below two for period more than 6 months
• Then remaining partner will be personally liable for liabilities incurred by LLP

Designated Partners (DP) 

• At least two DPs
• Only Individuals can be DPs – Can be nominees of Body corporate partner/s
• At least one resident in India 
• Every DP to obtain a Designated Partner Identification No. (DPIN)

Responsibilities  & Liabilities of DPs 

• Responsible for doing all acts, matters & things required to be done by LLP w.r.t compliance of LLP Act including the filing of any document, return, statement & like report under LLP Act & as specified in LLP Agreement
• Liable to all penalties imposed on LLP for any contravention of above

Changes in DPs 

• LLP to appoint DP within 30 days of vacancy
• If no DP is appointed or if, at any time, there is only 1 DP, each partner shall be deemed to be a DP

Disqualifications of DPs

No person can be DP of LLP, if-

• He is adjudged as insolvent within the preceding 5 years
• He has suspended payment to his creditors & not made any composition with them within the preceding 5 years
• He is convicted by Court for any offence including moral turpitude & sentenced to imprisonment not less than 6 months
• He is convicted by Court  for the offence under Section 30 of LLP Act (Defrauding creditors or any other person)

Incorporation

Incorporation Document 

• Is among Prime Documents of LLP
• Must be submitted to the registrar in ‘Form-2’ 
• Requires particular information to be contained in Incorporation Document-
• Name of LLP
• Proposed Business of LLP
• Address of Registered Office (RO) (RO shall be place of all correspondence for LLP)
• Names & Addresses of Partners
• Names & Addresses of DPs
• Other Information as may be prescribed

Effect of Registration

LLP will be able to, in its own name-

• Sue & be sued
• Acquire, hold & develop or dispose of any property
• Have common seal
• Do & suffer  such other acts & things as bodies corporate may lawfully do or suffer
• Name of LLP must end with words ‘Limited Liability Partnership’ or acronym ‘LLP’ 

Procedure for formation of LLP

• Check availability of name on-site ‘llp.gov.in’
• Acquire Digital Signature Certificate (DSC)
• Acquire DPIN by applying in prescribed ‘Form-7’
• Apply for Reservation of Name in prescribed ‘Form-1’ 
• Apply for Incorporation Document in prescribed ‘Form-2’
• Along with the Incorporation Document, submit: 
• Information regarding LLP Agreement in ‘Form-3’
• Appointment of Persons and their consent as such to act as Partners / DPs in ‘Form-4’ & ‘Form-9’, respectively
• Receive Form-2 duly signed by Registrar & certificate from registrar regarding incorporation, within 14 days of filing such documents
• LLP is ready to function

Partners & their Relations 

Eligibility to be partner

• Persons who subscribe to Incorporation Document
• By LLP Agreement

Relationship of partners 

• Rights & duties of partners with other partners & with LLP governed by LLP Agreement
• In absence of any agreement, principles set out in First Schedule will apply

Cessation of Partnership Interest

• In accordance with LLP Agreement 
• By  resignation notice in writing of 30 days 
• On death, dissolution of LLP, or if he is of unsound mind or insolvent as declared by a court

Liability of Outgoing Partner – he still  remains liable to the extent of obligations he incurred while he was a partner 

First Schedule 

• Relates to mutual rights & duties between partners & LLP & its partners' absence of Agreement on such matters
• Partners of LLP entitled to share equally in capital & profits/losses
• Partners shall be indemnified by LLP in respect of payments made & liabilities incurred by him-
• In ordinary & proper conduct of the business of LLP
• In anything necessarily done for Preservation of business or property of LLP
• LLP shall be indemnified by Partners for any loss caused by his fraud in the conduct of the business of LLP
• Partners may participate in the management of LLP
• Partners shall not be entitled to any remuneration for acting in business or management of LLP
• No partner may be introduced without the consent of all other partners
• Any ordinary matter regarding LLP may be decided by resolution passed by the majority of partners
• However, change in nature of the business may be decided only by consent of all partners
• Every decision taken by LLP be recorded in minutes within 30 days of such decision
• Minute Book be maintained & kept at RO of LLP
• Partners must render true accounts & full information of all things affecting LLP to any partner or his legal representative
• Partners to account for & pay overall profits earned from the business of similar nature & competing with LLP, to LLP if there is no consent from LLP in that respect
• Partners to account to LLP for any benefit derived by him without LLP’s consent, from any transaction concerning LLP or from use of name, property or business connection of LLP
• No partner may be expelled by a majority unless there is an express power conferred by LLP Agreement to do so
• All disputes which cannot be resolved by LLP Agreement can be referred to for arbitration as per Arbitration and Conciliation Act, 1996

Liability of LLP & Partners 

• Just like a partnership, every partner is an agent; not of other partners but of LLP. 

• LLP not bound by unauthorized acts of partners in dealing with a person if that person knows that the partner had no authority or did not know him to be a partner of LLP 

• LLP liable in respect of wrongful acts or omissions of partners in course of its business or with its authority 

• Obligation of LLP is solely an obligation of LLP & shall be met out of the property of LLP 

• Partners not personally liable for wrongful act or omissions of another partner

• Liability of partner(s) committing wrongful acts or omissions will be unlimited 

• Partnership by Holding out  (LLP liable only if it has taken benefits of the act)

• Unlimited Liability in case of fraud 

• If fraud done with knowledge/authority of LLP, LLP’s & partner’s liability will be unlimited. LLP’s liability = Partner’s liability
• Otherwise, LLP will not be liable
• Imprisonment for 2 years & fine up to Rs. 5 Lacs

Assignment & Transfer of Partnership Rights 

• Right of partner to share profits is transferable/assignable (in whole or in part)
• Transfer does not imply that transferor/assignor has ceased to be a partner 
• Likewise, transferee/assignee does not have the right to participate in management 
• Transferee / assignee has no right to obtain any information of transactions of LLP

Investigation

• Central Government (CG) may appoint one or more inspector(s) to investigate into affairs of LLP & report thereon, if-
• Not less than 1/5 th of partners apply for investigation on payment of prescribed security to Central Government
• LLP applies for investigation
• CG is of opinion that-

• Business of LLP is with intent  to defraud its Creditors, Partners or any other Person
• Affairs of LLP are not being conducted in accordance with provisions of this Act
• On receipt of Report of Registrar or any other Regulatory Agency, there exist sufficient reasons that affairs of LLP ought to be investigated

• Inspector cannot be partnership firm, body corporate or other association 
• Investigator has the power to investigate in matters of any entity which has been associated, or is associated, to LLP unless it is irrelevant to do so 
• Investigator must obtain prior approval of CG
• It shall be the duty of DPs & Partners to-

• Preserve & produce before investigator all documents relating to LLP or, as case may be, any other entity
• Give assistance to an investigator in connection to the investigation
• Investigator has the power to keep such documents in custody up to 30 days

• Investigator has the power to seize documents relating to LLP, if he believes that such documents may be-
• Destroyed
• Mutilated
• Altered
• Falsified or 
• Secreted

• Investigator shall make reports (Interim & Final) to CG & such report such act as evidence in any legal proceeding 
• Application by CG for Winding-up of LLP pursuant to an investigation 
• Expenses of Investigation (by guilty party)

Conversion of Firm to LLP 

• All partners of LLP must be partners of the original firm & no one else.

• On such conversion-
• All assets & liabilities of firm would get vested in LLP
• Firm stands dissolved
• Will be removed from records of Registrar of Firms
• Every partner will continue to be personally liable jointly & severally with LLP, for liabilities prior to conversion / arising out of a contract entered prior to conversion 
• Partner to be indemnified by LLP in respect of such liability subject to anything contrary in LLP Agreement 

• Every official correspondence of LLP for 1 year, must bear a statement that it was, from the date of registration converted from a firm into an LLP along with the name & registration, if applicable, of the firm from which it was converted
• Partnership Firm proposing to convert to LLP must apply to ROC in the prescribed form along with Statement of Partners.
• ROC must issue certificate of registration.
• Upon receipt of application LLP must apply, within 15 days of registration, to Registrar of Firms to strike-out name of Firm in prescribed.

Conversion of Companies to LLP

• Company can be converted into LLP provided-
• All partners of LLP must be shareholders of that company & no one else
• There is no security interest in its assets
• Upon conversion, all assets & liabilities get vested in LLP and principally all other provisions are similar as that for firms

• Listed Public Company cannot be converted into LLP

Winding-up

The winding-up of a limited liability partnership may be either voluntary or by the Tribunal and limited liability partnership, so wound up may be dissolved.

• A limited liability partnership may be wound up by the Tribunal,-

1. If the limited liability partnership decides that limited liability partnership be wound up by the Tribunal;
2. If, for a period of more than six months, the number of partners of the limited liability partnership is reduced below two;
3. If the limited liability partnership is unable to pay its debts;
4. If the limited liability partnership has acted against the interests of the sovereignty and integrity of India, the security of the State or public order;
5. If the limited liability partnership has made a default in filing with the Registrar, the Statement of Account and Solvency or annual return for any five consecutive financial years; or
6. If the Tribunal is of the opinion that it is just and equitable that the limited liability partnership be wound up.

Comparison with Companies

Comparison with Partnership Firms 

BANKING - Bank Guarantee (BG) & Letters of Credit (LC)

 BANK GUARANTEE

With the development of trade and commerce, the guarantor, who earlier typically was a friend or an associate, became a professional. Banks in the business of transferring funds & lending were the natural ones to take up the role.

Being a neutral party, they were considered trade worthy and would not default when called upon to pay. 

The bank could guarantee a valued customer who has accounts with them on requiring a deposit, at least for a part of the sum for a commission. 

A surety provided by the bank came to be called bank guarantee.

• As Earnest Money Deposit 
• As security against performance of the contract
• As security against initial (advance) & stage payments
• Towards liquidated damages
• Towards specified operational parameters of the equipment…. 
• Towards meeting warranty claims in respect of the equipment.
• Towards performance of maintenance during a specified period (usually one year) in respect of civil works contracts

Bank guarantees lead to invoking and payment only if there is a default by the supplier/contractor. 

Bank guarantees figure, therefore, as a contingent liability in the accounts of the bank.

Notwithstanding clause in BG (Example)

Notwithstanding anything contained herein:

• The bank’s liability under the bank guarantee shall not exceed Rs. 10,00,000 (Rupees ten lakh only)
• This bank guarantee is valid up to 30th September 2020

The bank is liable to pay the guaranteed amount or any part thereof under this bank guarantee only and only if the beneficiary serves upon the bank a written claim or demand on or before 15th October 2020.

Bank Guarantee - Features

Bank Guarantees should be unconditional guarantees by the bank to the beneficiary, undertaking to pay the sum specified in the guarantees on demand. 

When a bank guarantee is given by a bank to the beneficiary, a direct relationship gets established, and a contract comes into being between the bank and the beneficiary, independent of the main contract between the buyer/employer & the supplier/contractor. 

The beneficiary's right under a bank guarantee is governed by the bank guarantee itself and not by the terms and conditions of the original contract. 

 The bank's liability under the guarantee is absolute, and courts would not generally interfere with the contractual obligation of the banker by issuing an injunction against the payment when the guarantee is validly invoked. (The only exception is when there is a clear case of fraud or misrepresentation) 

Through a series of judgments of the supreme court, it is well established that the party seeking an injunction against enforcement of a bank guarantee must show a prima facie case of established fraud and irretrievable injury to it.

 Enforcement of a guarantee cannot be made the subject matter of any arbitration.

NOTE: When there is a pending arbitration under which the liability of all the parties had to be ascertained, the court upheld the decision of the bank to withhold payment against a bank guarantee. 

Safeguards by the Bank

Important

Banks must honour the guarantee issued by them and pay the amount claimed when they are invoked except where fraud by the beneficiary is established, or there is misrepresentation or deliberate suppression of material facts.

• It would be for the banks to safeguard themselves by other means and generally not for the courts to come to their rescue with injunctions unless there is established fraud.

Limits

Maximum monetary limits are fixed based on the financial standing, the extent to which the account has been maintained by the customer satisfactorily, the volume of transactions, past track record of the client in respect of guarantees etc. 

Limits are reviewed and re-fixed periodically.

Margins

Clients requesting the issue of guarantees are required to place, in an interest-bearing fixed deposit with the bank, a margin (amount) expressed as a percentage of the value of the bank guarantee. 

The percentage of margin money could range from 10% to 100% of the value of the guarantee. 

In the case of foreign BG, the margin could even be 110% of the value to cover fluctuations in foreign exchange rates. 

Counter Guarantee

Banks obtain counter-guarantees on non-judicial stamp paper from the clients for equal value before furnishing bank guarantees on their behalf. 

This document is an undertaking by the client on whose behalf the bank guarantee is issued that he will reimburse the amount paid by the bank when the guarantee is invoked by the beneficiary.

Safeguards by the Beneficiary

If the bank guarantee is obtained from a supplier’s/contractor’s bank in another country, the beneficiary runs the risk of not getting paid when it invokes the bank guarantee, as the judiciary may be liberal in granting injunctions against the bank, preventing it from honouring the bank guarantee. 

Bank guarantees are valuable documents and must be kept in safe custody.

Bank Guarantee - Extension

A Bank guarantee is an independent contract between the bank & the buyer/employer.

• To safeguard his interest, the buyer/employer should address the bank for extending the bank guarantee with a copy to the supplier/contractor.

• While asking for an extension, the buyer/employer should also intimate the supplier/contractor that if the bank guarantee is, for any reason, not extended, the letter should be treated as a notice invoking the bank guarantee, and the bank should pay the amount covered by the bank guarantee on the due date. 

• This will ensure that the supplier gives a direction to the bank to extend the bank guarantee as the only option is to pay the amount if it is not extended. 

Bank Guarantee - Discharge

If the particular aspect of the transaction between its client and the beneficiary covered by the guarantee has been completed satisfactorily, Banks insist on the bank guarantee being returned to them duly discharged to confirm the non-existence of liability against such guarantees. 

Discharge & Notwithstanding clause in BG

A BG with a notwithstanding clause & validity having expired and no written notice for a claim having been served by the beneficiary, the bank is no longer authorised to entertain any claim against an expired bank guarantee.

• Upon serving the issuing bank a written notice to close the expired BG and refund the margin money, the bank is required to send a written notice to the beneficiary asking them to return the expired original guarantee. If the original guarantee is not returned by the beneficiary after a lapse of 30 days, the issuing bank is required to cancel the BG and return the margin money without further delay as per RBI guidelines. 

LETTERS OF CREDIT

Meaning

LCs are guarantees issued by a buyer’s bank in favour of the supplier, guaranteeing that payments will be made against documents listed in the LC, inter alia evidencing completion of supplies/services/stages of progress of work before the delivery dates specified in the LC & subject to the conditions specified therein. 

The documents are also required to be presented for payment to the advising bank before the last date for negotiation of documents mentioned in the LC.

There are thus two dates – one the last date for shipment/completion of work, and the other is the last date for negotiation of documents.

The gap between the two dates enables the beneficiary to collect and assemble the documents specified before presenting them to the advising bank for payment.

Two banks are involved in an LC. The buyer has/opens an account in a bank (issuing bank) in his country, which guarantees payment.

This bank opens a credit with a bank in the supplier’s country in favour of the supplier. This bank is known as the advising bank (normally the supplier nominates the advising bank)

The advising bank advises the supplier:

1. the last date for delivery of goods, 
2. the documents which the supplier must deliver to the bank and the time within which he must do so, 
3. and any other conditions stipulated in the LC. 

All LCs are irrevocable.

Documents

• Bill of lading

Adherence to the delivery date for goods is evidenced by a bill of lading, an airway bill, a railway receipt or a lorry waybill, showing the date the consignment is made over to the carrier. 

• Supplier’s invoice

• Certificate of quality or acceptance

If the buyer, under the contract, conducts an inspection for quality and other parameters and accepts the items.

• Certificate of Origin

           Issued normally for imports.

Last date for Negotiation…

• A reasonable time is allowed (10 -15 days) from the completion of supplies/service to enable the supplier to assemble the stipulated documents. 

• This is fixed as the last date for negotiation, and the supplier must present documents to the advising bank before this date to receive payments against the letter of credit.

Payment

On presentation of such documents, the payment under the LC is released by the advising bank to the supplier, after scrutinizing the documents for completeness and fulfilment of conditions (particularly w.r.t. the delivery date and the date for negotiation)

This system is also known as documentary credit.  

Liability

An LC is a contingent liability both to the bank and the buyer who has established the LC till it is operated and till the expiry of the validity (or extended validity) of the LC. 

Once it is operated by the supplier in accordance with the conditions, it ceases to be a contingent liability but gets converted to a definite liability.

Charges

Opening charges (one-time charge)

Maintaining charges (recurring charges, mostly every quarter, as a percentage of the value of the credit, established)

Confirmation charges (one-time charge – in International trade, it is common practice for suppliers to demand a confirmed letter of credit as opposed to an unconfirmed letter of credit)

Margins (Issuing Bank)

Clients requesting an issue of LC are required to place, in an interest-bearing fixed deposit with the bank, a margin (amount) expressed as a percentage of the value of the LC. 

The percentage of margin money could range from 10% to 100% of the value of the LC. 

In the case of foreign LC, the margin could even be 110% of the value to cover fluctuations in foreign exchange rates. 

Counter Guarantee (Issuing Bank)

Issuing Bank obtains counter-guarantees on non-judicial stamp paper from the client undertaking to reimburse the amount paid by the bank against the LC and also authorizing the issuing bank to debit his account when payment is made against the LC.

Sequence

• The supplier delivers goods to the carrier obtains a bill of lading, airway bill, railway receipt etc.
• Prepares the invoice.
•  Presents invoice and all documents specified in LC to advising bank for payment.
• Advising bank scrutinizes document:
• Completeness.
• Evidence of delivery with a scheduled delivery date.
• Documents presented before the date set as the last date of negotiation.
• If documents are in order & conditions of LC are met, the advising bank credits the supplier’s account with the amount due & advises the issuing bank and the buyer of having debited its account with the amount paid. 
• The advising bank forwards the documents to the issuing bank.
• The issuing bank advises the buyer of having debited his account, with the amount paid & bank charges, and forwards the documents to the buyer to enable the latter to clear the consignment when it arrives at the destination.
• The issuing bank releases the fixed deposit held as security in favour of the buyer. 

BANKING - Bouncing of Cheque and related matters

BANKING

Negotiable Instruments

Bill of Exchange

Where a creditor directed the debtor to pay the money to a named person or bearer.

[To A. Pay to C a sum of Rs. 1000. B (Signed)]

Promissory Note

Where a person promised to pay another or the bearer a certain sum of money.

[1.10.2014. Rs. 20,000. I promise to pay A or order at Calicut, three months after date the sum of Rs. 20,000. B(Signed)]

Cheque

A bill of exchange directing a bank to pay to a party.

As bank branches have got networked, a cheque drawn on any branch can be encashed from any location within a day. In this context, no person would agree to take a negotiated cheque. Thus, the negotiability of cheques has lost significance.

It is pertinent to note that a negotiable instrument is given as a part of another contract. 

With electronic banking, direct electronic transfer by the customer is reducing the significance of cheques.

However, cheques as a payment mechanism will continue to be of some significance.

To give sanctity to the payment mechanism, the dishonour of a cheque, if certain conditions are met, has been made a punishable offence.

As the punishment prescribed is imprisonment, there has been much litigation to avoid imprisonment. 

(40 lakh cheque-bounce cases choke the justice delivery system in the country – Data 07.02.2020)

BANKER 

One who, in the ordinary course of his business, honours cheques drawn upon him by persons from whom and for whom he receives money on current accounts.

CUSTOMER

Customer is not defined. 

A person who opens some sort of an account with a banker is called a customer. 

Mere casual acts of service do not create the relationship of banker & customer.

BANKING COMPANY

A company that transacts the business of banking.

BANKING 

Accepting for the purpose of lending or investment, of deposits of money from the public repayable on demand or otherwise, and withdrawable by cheque, draft order or otherwise.

BANKER CUSTOMER RELATIONSHIP

The relationship between a banker and a customer is essentially contractual and is that of a debtor (banker) and creditor (the customer). This relationship is sometimes reversed. This happens when the banker lends money to the customer. The relationship also partakes many aspects of the relationship of agent and principal.

OBLIGATIONS OF A BANKER

• Honour cheques
• Keep proper record of transactions
• Abide by the instructions given by the customer
• Not to disclose the state of his customers' account or affairs

RIGHTS OF A BANKER

• General lien of banker
• Incidental charges and interest 
• Set off (debit balance against credit balance)

WHEN BANKER MUST REFUSE PAYMENT ON HIS CUSTOMER’S CHEQUES

• When customer countermands payment. (issuing instructions to a banker not to honour a particular cheque) 
• When the customer has died, or become insane or insolvent.
• When a garnishee order (prohibiting a banker from paying money from a customer’s account) has been received by the banker.
• When the customer has given notice of assigning the money in his account…..

WHEN BANKER MUST REFUSE PAYMENT ON HIS CUSTOMER’S CHEQUES

• When the banker has knowledge that the title of the holder of the cheque is defective. (eg. A thief)
• When the customer informs the banker that the cheque is lost.
• When the cheque is irregular. (Material alteration on the cheque or signature of the drawer does not tally with the specimen signature)
• When the customer closes his account.

WHEN BANKER MAY REFUSE PAYMENT ON HIS CUSTOMER’S CHEQUES

• When the cheque is post dated.
• When the cheque is out dated.
• When the funds in the customer’s account are insufficient. (& the customer has no overdraft arrangement with the bank)……..

BOUNCING OF A CHEQUE

A cheque is said to bounce or dishonoured by non-payment, when a banker defaults in its payment, even when he is required to pay. 

Section 138 of the Negotiable Instruments Act of 1881 (as amended from time to time) applies.

TO CONSTITUTE THE OFFENCE OF BOUNCING OF CHEQUE……

• The cheque should have been issued by the drawer to the payee in the discharge of, in whole or in part, any legally enforceable debt or other liability……..(it shall be presumed, unless the contrary is proved, that the holder of the cheque received the cheque, for the discharge, in whole or in part, of any debt, or other liability)

• The cheque should have been presented by the payee to the banker within the period of validity…. (The Reserve Bank of India has fixed three months to be the validity period for a cheque)

• The cheque should have been returned by the bank unpaid, because the amount of money standing to the credit of the account is insufficient or it exceeds the amount arranged to be paid from that account….

• The cheque has been returned unpaid by the bankers of the drawer on account of stop payment instructions having been issued by the drawer…..

• The cheque has been returned unpaid by the bankers of the drawer on the ground that the account of the drawer has been closed…..

• The payee (or any other holder) of the cheque should have demanded the payment of the amount of the cheque from the drawer, within 30 days of getting the information of dishonour by the banker…..

Once the bank has returned the cheque, i.e. the cheque has bounced, the payee (or any other holder) is required to send a letter (demand notice) within 30 days of such bouncing to the party who wrote the cheque (the drawer) threatening to initiate proceedings under the Negotiable Instruments Act in case the amount is not paid within 15 days.

• The drawer of the said cheque should have failed to make payment within 15 days of the receipt of the said notice given by the payee (or any other holder).

Note 
Section 138 can get attracted for dishonour due to any reason, including mismatch of signatures & stop payment of a post-dated cheque.

PROCEDURE……..

• The complaint has to be filed in the court by the holder of the cheque within 30 days from the date when the cause of action has arisen.

Jurisdiction of Court

• If cheque delivered for collection through an account

• If the cheque is delivered for collection through an account, the case will be tried by the court not inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the first class within whose local jurisdiction the branch of the bank where the payee or holder in due course, as the case may be, maintains the account is situated.

• If cheque presented for payment by payee or holder in due course otherwise through an account

• In such a situation, the case will be tried by the court not inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the first class within whose local jurisdiction the branch of the drawee bank where the drawer of the cheque maintains the account is situated.

PUNISHMENT & PENALTY

• The court, after receiving the complaint along with relevant documents, will start the case. If the drawer is found guilty, he/she will have to, as per Section 138 of the Negotiable Instruments Act, 1881, spend time in jail for up to two years and/or pay a penalty of amount twice the cheque amount. 

• In addition, the banks also have the right to close the guilty person’s account (on repeated bounce cheque offence) or stop their cheque book facility. The bank may also charge a penalty to both the drawer and the payee for the inconvenience, extra paperwork and wasting the bank’s time.

• The Negotiable Instruments (Amendment) Act, 2018 which came into effect from September 1, 2018, allows the Court trying an offence related to cheque bouncing, to direct the drawer to pay interim compensation not exceeding 20% of the cheque amount to the complainant within 60 days of the trial court's order to pay such compensation. 

• This interim compensation may be paid either in a summary trial or a summons case where the drawer pleads not guilty to the accusation made in the complaint or upon framing of charge in any other case. 

• Furthermore, the Amendment also empowers the Appellate Court, hearing appeals against conviction under s. 138, to direct the appellant to deposit a minimum of 20 % of the fine/compensation awarded, in addition to interim compensation.