Class 11-commerce NCERT Solutions Business Studies Chapter 7: Formation of a Company

The statement is True. It is necessary to get every company incorporated, whether private or public. This is because it gives them a legal identity for business operation. According to Companies Act, 1956, a company can come into existence only when it receives the certificate of incorporation.

The statement is True. A prospectus refers to a document which invites the public to purchase shares or debentures of a company. Therefore, a public company is entitled to file a prospectus or statement in lieu of prospectus to raise funds from the public.  

The statement is True. A private company can commence business after incorporation because it can raise funds from friends and relatives to start the business. 

The statement is False. The term promoter refers to an individual/set of people who identify, explore and reveal an idea crucial for the formation of business. Experts only provide assistance to promoters in the promotion of a company.

The statement is False. The company cannot ratify preliminary contracts after incorporation. This is because the contract is not made between the company and the third party. It is only between the promoters and the third party before incorporation. Thus, a company cannot be forced to honour this contract. 

The statement is False. If a company is registered on the basis of fictitious names, its incorporation is not considered invalid. This is because the issue of the certificate of incorporation will become conclusive evidence of the existence of the company.  

The statement is False. The main document of a company is the 'Memorandum of Association' rather than the 'Articles of Association'. This is because Articles of Association rules are subsidiary to Memorandum of Association rules. Rules of Articles of Association should not disagree with those of Memorandum of Association.

The statement is False. It is not necessary for every company to file Articles of Association. However, a company may adopt Table A of the Companies Act which contains the rules and regulations for internal operation of the company. 

This statement is False. The private assets of the members cannot be used to repay the debt of the company because liabilities have to be cleared only by using company's assets.

Stages in the formation of a public company are Promotion, Incorporation, Capital subscription, Commencement of business. 

1. Promotion: It includes people (promoters) with similar ideas who come together and decide to form a company. They examine the available business opportunities and take necessary steps for the formation of business.
2. Incorporation: Promoters apply to the Registrar of Companies with the necessary documents and fees to receive the certificate of incorporation.
3. Capital subscription: After incorporation, a public company raises funds from the public through the issue of shares and debentures. This process involves various steps to raise funds such as obtaining SEBI approval and filing a copy of prospectus with the Registrar of Companies.
4. Commencement of business: This is the final stage in the formation of a company. A public company applies to the Registrar of Companies for the certificate of commencement of business. 

Documents required for the incorporation of a company:

1. Memorandum of Association duly signed, stamped and witnessed. This document must be signed by seven members for a public company and two members for a private company.
2. Articles of Association duly stamped and witnessed.  A public company may adopt Table A of the Companies Act, and hence, the statement in lieu of prospectus needs to be submitted.
3. A document which states the proposed directors will act as directors and undertake to acquire qualification shares.
4. An agreement with the proposed Managing Director and managers if any.
5. A copy of a letter certifying the name assigned to the company from the Registrar.
6. Details of the address of the registered office. A statutory declaration confirms that all the necessary legal documents for registration are adhered to. 

A prospectus refers to a document which invites the public to purchase the shares or debentures of the company.

No, it is not necessary for every company to file a prospectus. This document is filed only by a public company which raises funds from the public. A private company need not file a prospectus as it raises funds from friends and relatives.

'Return of Allotment' refers to a document which contains the  shareholders' details along with the number of shares allotted to them, the nominal value of each share, the amount payable or paid on each share and shares issued at discount. This document is signed by the director or the secretary and submitted to the Registrar within 30 days of allotment.  

SEBI represents Securities and Exchange Board of India. Promoters interact with SEBI in the third stage of formation of company, i.e. capital subscription.

During this stage, if a company raises funds from the public through the issue of shares and debentures, then they need SEBI's approval. This approval certifies that the company has disclosed all the relevant information to potential buyers. This is required for a company to protect the interests of investors.

Promotion refers to the entire process which brings a company into existence. This includes conceiving business opportunities, organisation of funds and properties to form a company. Thus, the initial process of exploiting the available business opportunities occurs. A person or group of people engaged to discover business opportunities to form a company are called promoters. It is the preliminary stage in the formation of a company. Legal position of promoters with respect to a company promoted by them:  

1. Before a company obtains its certificate of incorporation, it does not have a legal identity. Thus, the promoters are not considered trustees or agents of the company.
2. Promoters enjoy a fiduciary position with the company. They are forbidden to make any secret profits. However, they can make profit only after disclosure to the company.
3. Any untrue statements in the prospectus of the company will become a promoter's liability and legally held responsible for the same.
4. Expenses incurred by promoters during the promotion of the company cannot be claimed by them as they are not legally entitled to claim it.
5. Shares or debentures can be allotted to promoters by the company or  can be given an option to buy them in the future. 

A promoter is a person who introduces a practical idea to set up a company and initiates necessary steps. He/she can analyse and forecast the situation of the company, hire human resources and purchase materials, machinery and financial resources.

Steps taken by promoters in the promotion of a company:

1. Identifying business opportunity: This is the first step taken by the promoter in the promotion of the company. The promoter generates/introduces an idea/business opportunity which can be used to start a company or produce a new product or service or provide products in a different manner or any other opportunity.
2. Feasibility studies: Although all the identified ideas may appear feasible, a full depth analysis is necessary to have a successful profit-making business. Based on the nature of the project, the following feasibility studies are undertaken by professionals.
1. Technical: Promoter's may identify good ideas, but it may be difficult to execute as the raw materials or technology are not available. Thus, it is essential to check the availability of sources before execution of the project.
2. Financial: Finance is necessary for any kind of business activity. The promoters need to estimate the funds required for the business. If the cost exceeds the funds available for the identified business, then the project has to be changed according to the available sources.
3. Economic: Sometimes, a project can be both technically and financially feasible but may not yield the required result or may not be economically viable. Then again, the identified project will be discarded.

Only when all these three factors give positive results, the promoters will go ahead to invest in the idea.

3. Company's name approval: After the decision to invest in a business, a name must be selected. Hence, they apply to the registrar of the companies in the state where the registered office is situated. So, the registrar verifies whether the name is similar to some existing company; if not, the name is approved.
4. Selecting signatories for the MOA and preparing the AOA: The promoters are required to decide the members to sign the MOA and prepare the AOA. So, the members signing the MOA would be considered Directors of the Company and need to give consent to act as Directors and buy the qualification shares.
5. Appointment of professionals: After the basic formation of the company is the need for appointment of professionals such as bankers, auditors and lawyers. Expertise is required for the preparation of documents to be submitted to the Registrar of Companies.
6. Preparation of necessary documents: After the selection of professionals, the necessary documents are prepared by professionals and submitted to the Registrar of Companies for registration. 

Memorandum of Association is a fundamental legal document of the company. It is prepared during the registration and formation process of the company. This document construes the main intention of the company and includes the working pattern, goal and identity of the company, names of shareholders and distribution of shares. It is also called the Constitution of the company. Moreover, a company cannot legally undertake activities not mentioned in the MOA; it needs to stick to activities mentioned in the document.

Clauses mentioned in the MOA:

1. Name clause: This clause states the name of the company with which it will be recognised and have an identity. The name however needs to be approved by the registrar of the company provided there are no similarities with the name of any other existing company and it should neither mislead nor give an impression that the company has government favour.
2. Registered office clause: This clause states the name of the state where the Company's registered office is proposed to be located. The exact location needs to be submitted to the Registrar within 30 days of the incorporation of the company.
3. Objects clause: This is the most important clause of all. It includes the purpose, scope and limits of the company. It states that the company does not have the right to undertake activities not indicated in the memorandum. It has two sub-clauses:
1. Main objects: It includes the main aim of the establishment of the company. Also, the essential and incidental acts which assist the progress of the company's main aim should be included in the sub-clause.
2. Other objects: Rest of the clauses not stated in the main object will be included in this clause. If the company hopes to take up an activity under this sub-clause, there is a need for special resolution or passing of an ordinary resolution.
4. Liability clause: This states the liability of the members of the company which may be limited by shares or by guarantee.
5. Capital clause: This states the maximum capital which the company needs to raise. It cannot secure capital more than that specified in the clause.
6. Association clause: This includes the names, addresses and signatures of the first subscribers who agree to associate with the company. They also need to provide consent for purchase of qualification shares.

The MOA needs to be signed by at least seven members in a public company and by at least two members in a private company.

A company is established with an objective to fulfil economic and social goals. However, it does not have the authority to do so until it is legally recognised. This legal recognition can be obtained by the company under the Companies Act, 1956.  According to this Act, a company can have legal identity only after obtaining the certificate of incorporation. However, the company's business cannot be initiated unless the certificate of commencement of business is obtained from the registrar. Thus, both certificates are required for the company to start its operation in full fledge.

Effect of the 'Certificates of Incorporation':

• A company is legally born on the date the certificate of incorporation is issued, i.e. it becomes a legal entity with perpetual succession on such date.
• Obtain the authority to enter into valid contracts.
• If any error is found in its registration, it still continues to be legal business irrespective of its flaw.

Thus, this certificate is a conclusive evidence of the legal existence of the company.

Effect of commencement of business:

• Submission of all the acceptable relevant legal documents to the registrar helps in procuring certificate of commencement of business.
• This certificate is the proof which entitles to start its business legally.
• Formation of company is completed after obtaining the certificate of commencement of business.

Thus, this certificate is conclusive evidence that the company is entitled to do business.

There are two stages in the formation of a private company, promotion and incorporation. A public company has to undergo capital subscription stage to begin operations.

1. Promotion: It begins with a potential business idea. Certain feasibility studies e.g., technical, financial and economic, are conducted to determine whether the idea can be profitably exploited. In case, the investigations yield favourable results, promoters may decide to form the company. Persons who conceive the business idea, decide to form a company, take necessary steps for the same, and assume associated risks, are called promoters.
Steps in Promotion
i. Approval of company’s name is taken from the Registrar of Companies
ii. Signatories to the Memorandum of Association are fixed
iii. Certain professionals are appropriated to assist the promoters
iv. Documents necessary for registration are prepared

2. Incorporation: An application is made by promoters to the Registrar of Companies alongwith necessary documents and registration fee. The Registrar, after due scrutiny, issues certificate of incorporation. The certificate of incorporation is a conclusive evidence of the legal existence of the company.