Tuesday, March 2, 2010

Novation of Contract

‘P’ Co. Ltd. is a company registered under the Companies Act, 1956. It intends to take over the business of a ‘Partnership Firm’, including its liabilities. The partners of the firm are positive to the idea. The liabilities of the firm also include a loan from Bank.

In this connection, the following Issues arise for consideration:

1. Must the Bank’s consent be obtained to effectuate the transfer of the firm’s business to ‘P’ Co. Ltd.?

2. Whether the Bank is required to enter into a fresh agreement with ‘P’ Co. Ltd.?

3. Is the transfer liable to stamp duty?

“Novation” is defined by the Black’s Law Dictionary, 8th Edn., 2004 as “The act of substituting for an old obligation a new one that either replaces an existing obligation with a new obligation or replaces an original party with a new party.”

In Wharton’s Law Lexicon, 15th Edition, 2009 at p.1174, the meaning of the term ‘Novation’ is stated as “the substitution, with the creditor’s consent, of a new debtor for an old one.”

Section 62 of The Indian Contract Act, 1872 sets out the general parameters for novation. The Section reads in pertinent part as follows:

“Effect of novation, rescission and alteration of contract – If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.

Illustration:- (a) A owes money to B under a contract. It is agreed between A, B and C that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted.”

It is to be noted that Section 62 speaks of substitution of a new debtor, creditor, contract, etc. in place of an old one. The essential feature of novation of contract is that when a contract is substituted the rights under the original contract are relinquished or replaced by the new contract. Illustration (a) to Section 62 indicates that one of the requisites of such novation is the agreement of all the parties to the new contract.

In every novation there are four essential requisites:

“(1) A previous valid obligation;

(2) the agreement of all the parties to the new contract;

(3) the extinguishment of old contract; and

(4) the validity of the new one.

A novation is new contractual relation. It is based upon a new contract by all the parties interested. See Advanced Law Lexicon, P. Ramanatha Aiyar, 3rd Edition, 2005 at pp. 3253-54.

State Bank of India v. T.R. Seethavarma, AIR 1995 Ker 31 at p. 34. is illustrative:

There, on dissolution of a firm its assets and liabilities were taken over by a third person. He paid part of the debt owed by the firm to a Bank and hypothecated assets with the bank. On filing of the suit by the bank against the firm and the third person for recovery of loan, it was held that in the absence of tripartite agreement between the parties, there was no novation of contract. The liability of the firm continued to exist.

In P.S. Atiyah’s An Introduction to the Law of Contract, 3rd Edition, 1981, at p. 283, it is stated as follows:

“The only way in which it is possible to transfer contractual duties to a third party is by the process of novation, which requires the consent of the other party to the contract. In fact novation really amounts to the extinction of the old obligation, and the creation of a new one, rather than to the transfer of the obligation from one person to another. Thus if B owes A $100, and C owes B the same amount, B cannot transfer to C the legal duty of paying his debt to A without A’s consent. But if A agrees to accept C as a debtor in place of B, and if C agrees to accept A as his creditor in place of B, the three parties may make a tripartite agreement to this effect, known as novation. The effect of this is to extinguish B’s liability to A and create a new liability on the part of C.”

The legal maxim that ‘novatio non praesumitur’ enunciates whether a novation needs to be in writing. The maxim means that “A Novation is not presumed”. See Trayner’s Latin Maxims 4th Edition at p. 403.

In Appukuta Panicker v. Anantha Chettiar, AIR 1996 Ker 303, the Kerala High Court held that it is essential for the principle of novation to apply that there must be mutual consent of all parties concerned.

In T.M. & Co. v. H.I. Trust, AIR 1969 Cal 238, the High Court of Calcutta observed that the liability can be transferred only by a tripartite agreement which will amount to novation.

In view of the above legal position, the consent of the Bank as also the execution of a tripartite agreement, between ‘P’ Co. Ltd., the partnership firm(its partners) and the Bank, is sine qua non in order for it to be a novation of contract.

Accordingly, Issue No.1 and Issue No.2 are addressed.

As regards the levy of stamp duty in respect of the aforesaid transfer of liability from partnership firm to ‘P’ Company Ltd., the law on the subject is as follows:

Sub-section (14) of Section 2 of the Indian Stamp Act, 1899, defines the term “Instrument” as under:

“Instrument” includes every document by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded.

A novation arises when a new individual assumes an obligation to pay that was incurred by the original party to the contract. As the same is given effect to by the substitution of a new contract for an old one and the new agreement extinguishes the rights and obligations that were in effect under the old agreement, it falls under the definition of the term “instrument” as defined under the Indian Stamp Act, 1899. A novation agreement is an ‘instrument’ under the Indian Stamp Act, 1899.  Whether such instrument is chargeable to stamp duty needs further analysis.

Section 3 of the Indian Stamp Act, 1899 sets out the instruments chargeable with duty. It provides in relevant part as follows:

“Subject to the provisions of this Act and the exemptions contained in Schedule I, the following instruments shall be chargeable with duty of the amount indicated in that Schedule as the proper duty therefor, respectively, that is to say— (a) every instrument mentioned in that Schedule which, not having been previously executed by any person, is executed in India on or after the first day of July, 1899."

Since in the above case, the novation agreement is being executed for the first time not having been executed previously, it squarely attracts the provisions as contained in Section 3 of the Indian Stamp Act, 1899. Substitution of a new contract is the core of novation. If the new contract suffers from legal flaw such as want of registration, stamps etc., on account of which it becomes unenforceable, the original contract will not be extinguished and there would be no novation. See Vishram Arjun v. Irukulla Shankaraiah, AIR 1957 AP 784 : 1958 (2) An.W.R. 259.

In view of the above stated legal position, it must be said that a novation agreement is an instrument liable to stamp duty under the Indian Stamp Act, 1899.

Accordingly, Issue No. 3 is addressed.
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Alteration of Articles of Association

Whether a company can alter its articles of association in any other way than by a special resolution passed at general meeting?

Sub-section (1) of Section 31 of the Companies Act, 1956 in relevant part reads as follows:

"Subject to the provisions of this Act and to the conditions contained in its memorandum, a company may, by special resolution, alter its articles: ..."

When all the shareholders interested in a company entered into an agreement which modified the articles of association, but was not drafted as a resolution nor passed at a general meeting, the articles could nevertheless be deemed to be effectively modified. This is on the basic principle of company law that all the shareholders of a company acting together can do anything intra vires the company.  Section 31(1) of the Companies Act, 1956 does not undermine that principle but merely lays down the procedure whereby some only of the shareholders can validly alter the aritcles. See: Cane v. Jones, (1981) 1 All E R 533 (Ch D) : [1980] 1 WLR 1451.

In view of the above decision of the Chancery Division, a company can alter its articles even without convening a general meeting and passing a special resolution.
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Minor's Membership in the Company

Alpha Ltd has received an application for transfer of 5,000 equity shares of Rs 10 each fully paid-up in favour of one Mr Rehan. On scrutiny of the application form it was found that Rehan is a minor. Under the circumstances, the following issues are considered:

1. What would be the contractual liability of a minor?

2. Whether shares can be allotted to Rehan by way of transfer?

Section 11 of the Indian Contract Act, 1872 provides as to who are competent to contract and reads as follows:

“Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting by any law to which he is subject.”

Section 3 of the Majority Act, 1875 sets out the age of majority as eighteen years. The minor lacks the capacity to contract. The reason being that the minors are presumed to be naïve, inexperienced, and easily taken advantage of, hence some protection is required. Contract, which obviously involves obligations on the part of the parties to it, is one such instance.

In Mohori Bibi v. Dharmodas Ghosh (1903) 30 Cal. 539 : 39 IA 114 (PC), it was held that “a minor is wholly incompetent to enter into a contract”. The judicial recognition to the principle that minors should be exempted from contractual obligations can be seen in the aforesaid case. Hence, an agreement by a minor in India to take shares is void and, hence, he cannot be a member of a company.

In Palaniappa Mudaliar v. Official Liquidator, Pasupathi Bank Ltd, Madras, (1942) 12 Comp Cases 89 at 91 it was held that if an application for shares is made by a father as guardian of his minor child and the company registers the shares in the name of the child describing him as a minor, neither the minor nor the guardian can be placed on the list of contributories at the time of winding-up.

In Fazalbhoy Jaffar vs The Credit Bank of India [1914], it was held that if the name of the minor continues on the Register of members and neither party repudiates the allotment, the minor does not incur any liability on the shares during minority.

In view of the above position of law, no contractual liability could be imposed on a minor in case of shares not fully paid up.

Accordingly, Issue No. 1 is addressed.

In case of fully-paid shares, minor's name may be admitted in the Register of members, if he happens to acquire the same by way of transfer or transmission. In Dewan Singh vs Minerva Films Ltd (1959) 29 Comp Cases 263 (P&H), the Punjab High Court held that there is no legal bar to a minor becoming a member of a company by acquiring shares (by way of transfer) provided the shares are fully paid up and no further obligation or liability is attached to them. Similarly, in S. L. Bagree v. Britannia Industries Ltd [1980], CLB upheld transfer in favour of a minor.

The position with respect to a minor becoming a member of a company would be in terms of the following two circulars issued by the Department of Company Affairs in this regard:

i) Circular No. 8/18/(41)/63-PR, dated November 2, 1963: Government of India Publication, Clarifications and Circulars on Company Law, 1977 Edition, page 23; and

ii) Letter No. 8/18(41)/63-PR, dated March 31, 1964: Government of India Publication, Clarifications and Circulars on Company Law, 1977 Edition, page 23).

In view of the above, it can be concluded that there is no objection to a minor being admitted as a member in respect of fully-paid shares provided he happens to acquire the same by way of transfer or transmission. Hence, in the present case, fully paid shares can be transferred to Mr. Rehan without any contractual liability.

Thus, Issue No. 2 is accordingly addressed.
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"Special Notice" under the Companies Act, 1956

What is meant by 'Special Notice'? What resolution is to be passed in case of an item of business to be transacted on Special Notice?

Section 190 of the Companies Act, 1956 reads as follows:

"(1) Where, by any provision contained in this Act or in the articles, special notice is required of any resolution, notice of the intention to move the resolution shall be given to the company not less then fourteen days before the meeting at which it is to be moved, exclusive of the day on which the notice is served or deemed to be served and the day of meeting.

(2) The company shall, immediately after the notice of the intention to move any such resolution has been received by it, give its members notice of the resolution in the same manner as it gives notice of the meeting, or if that is not practicable, shall give them notice thereof, either by advertisement in a newspaper having an appropriate circulation or in any other mode allowed by the articles, not less than seven days before the meeting."

In The Pioneer Motors (Private) Ltd vs The Municipal Council, Nagercoil, the Supreme Court held as follows:

"The words "not being less than one month" do imply that clear one month's notice was necessary to be given, that is, both the first day and the last day of the month had to be excluded.  To put it in the language used by Maxwell on Interpretation of Statutes, 10th Edition, p. 351 :- "..when... not less than so many days are to intervene, both the terminal days are excluded from the computation."

 Special Notice means the 14 clear days’ notice that is required to be given by shareholders to a registered company of an intention to propose certain resolutions at a general meeting of the company. The company must then give notice of the resolution when it calls the relevant meeting (ordinary resolution or special resolution as the case may be). If that is not practicable, notice can be given in newspapers or in any other mode allowed by the articles, not less than 7 days before the meeting.

It is pertinent to note that Special Notice and Special Resolution are not connected. One does not require the other. The object of giving special notice is to invite the special or pointed attention of the members to the particular resolution. Under the Companies Act, 1956, Sections 225, 257 and 284 require special notice and the articles may also require special notice to be given on other matters.
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Signing Authority of Debenture Certificate


Clause (12) of Section 2 of the Companies Act, 1956 defines “debenture” as follows:

“Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.”

In Narendra Kumar Maheshwari v. Union of India, AIR 1989 SC 2138, the Supreme Court of India cited with approval the meaning of the term ‘debenture’ as stated in Palmer’s Company Law, 24th Edition at p. 672 as under:

“A debenture has been defined to mean essentially as an acknowledgement of debt, with a commitment to repay the principal with interest.”

A similar definition was arrived at by the MRTP commission in Director-General of Investigation & Registration v. Deepak Fertilisers & Petrochemicals Corpn. Ltd.[1994] 15 CLA 31 wherein it was held that a ‘debenture' is simply an "acknowledgement of debt by the company whereby it undertakes to repay the amount covered by it and till then it undertakes further to pay interest thereon to the debenture holder".

"Any document which is a debenture in the common acceptance of the term or has the same legal effect" See: Halsbury's Laws of England, Vol. 4(1), Para 655, at p. 302.

Section 54 of the Companies Act, 1956 provides in respect of ‘Authentication of documents and proceedings’ which reads as follows:

“Save as otherwise expressly provided in this Act, a document or proceeding requiring authentication by a company may be signed by a director, the manager, the secretary or other authorised officer of the company, and need not be under its common seal.”

A debenture is generally understood to be a document usually but not necessarily under seal, acknowledging a debt and securing repayment thereof by mortgage or charge on the company’s property or undertaking, and providing that until repayment, interest will be paid thereon at a fixed rate payable usually, either half-yearly or yearly on fixed dates. See: Laxman Bharmaji v. Emperor, (1946) 16 Comp Cases 31; Also See: Edmonds v. Blaina Furnaces Co., (1887) 36 Ch 215. However, in British India Steam Navigation Co. v. Commissioners, (1881) 7 QBD 165, it was considered that a seal is not necessary. There, a debenture certificate which was merely signed by two directors and did not bear the company’s seal was held valid.

Regulation 84 of Table A of Schedule I to the Companies Act, 1956 reads as follows:

(1) The Board shall provide for the safe custody of the seal.

(2) The seal of the company shall not be affixed to any instrument except by the authority of a resolution of the Board or of a committee of the Board authorized by it in that behalf, and except in the presence of at least two directors and of the secretary or such other person as the Board may appoint for the purpose; and those two directors and the secretary or other person as aforesaid shall sign every instrument to which the seal of the company is so affixed in their presence.

In view of the above legal position, it can be deciphered that the questions as to who shall sign the debenture certificate and whether such certificate needs to have company’s seal would depend on what is provided in the articles of association of a company and further whether the Board or the duly constituted committee of the Board while passing any resolution for signing any Debenture certificate has also approved the affixation of the seal thereunto in terms of the articles of association. Therefore, if the company adopts Table A of Schedule I to the Companies Act, 1956, then Regulation 84 becomes applicable. Similarly, in the event that the company does not adopt Table A or Regulation 84, as the case may be, nor the company addresses the issue relating to the signing and sealing of debenture certificate in its articles, then Section 54 of the Companies Act, 1956 would be applicable.
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Quorum for the Board Meeting When All the Directors are Interested

Can the quorum for the board meeting be achieved for the purpose of passing a resolution when all or all but one of the directors are interested in an item of business to be transacted therein in the event that the board members are not interested to take the matter in general meeting?

Section 287 of the Companies Act, 1956 reads as follows:

(1) In this section- (a) "total strength" means the total strength of the Board of directors of a company as determined in pursuance of this Act, after deducting there from the number of the directors, if any, whose places may be vacant at the time; and (b) "Interested director" means any director whose presence cannot, by reason of section 300, count for the purpose of forming a quorum at a meeting of the Board, at the time of the discussion or vote on any matter.

(2) The quorum for a meeting of the Board of directors of a company shall be one-third of its total strength (any fraction contained in that one-third being rounded off as one), or two directors, whichever is higher :

Provided that where at any time the number of interested directors exceeds or is equal to two-thirds of the total strength, the number of the remaining directors, that is to say, the number of the directors who are not interested present at the meeting being not less than two, shall be the quorum during such time.

As provided in sub-section (2), at least two dis-interested directors or one-third of the total strength, whichever is higher, must be present at the meeting in order to constitute the quoru. If all or all but one of the directors are interested there can be no quorum and, therefore, no meeting.

Quorum means a minimum number of directors required for transacting business. The directors cannot proceed with a meeting unless the required quorum of directors is present. Provision for quorum for meeting of directors is not directory but it is mandatory. Any decision taken by a lesser number than the quorum is void. See: Alma Spinning Co., In re. [(1880) 16 Ch. 681] ; Re, North Eastern Insurance Co. Ltd., [(1919) 1 Ch. 198] . Also see: Needle Industries (India) Ltd. v. Needle Industries Neway (India) Holding Lid., [(1981) 51 Comp. Cases 743 (SC)].

Regulation 75 of Table A of Schedule I to the Companies Act, 1956 reads as follows:

"The continuing directors may act notwithstanding any vacancy in the Board; but, if and so long as their number is reduced below the quorum fixed by the Act for a meeting of the Board, the continuing directors or director may act for the purpose of increasing the number of directors to that fixed for the quorum, or of summoning a general meeting of the company, but for no other purpose."

Where all or all but one of the directors are interested, and there is no quorum, the proper way out of the difficulty will be to have the matter decided by the company in general meeting by an ordinary resolution, or, if the articles so require by a special resolution. This is so because all residual matters are supposed to vest in the general body. Regualtion 75 of Table A, if it is adopted by a company, would authorise the directors to continue to act in such cases for the purpose of increasing the number of directors so as to bring the number upto the quorum requirement or to call a general meeting for the purpose.

The directors cannot act unless the munimum number is first made up. See: Sly, Spink & Co., [Re, (1911) 2 Ch. 430] ; Owen & Ashworth Chaim, [(1901) 1 Ch. 115]. Also that, the Department of Company Affairs has issued a clarification in this regard. The DCA had advised to increase the board strength either by way of co-option or appointment of additional directors, if so authorised by the articles, and to transact the business and if this way out is not possible to call a general meeting. See: Taxmann's Circulars & Clarifications, 1992 Edition at p. 294.

However, in Trayner's Latin Maxims, 4th Edition, 2008 at p. 502, the meaning of the maxim "Quando aliquid prohibetur, prohibetur et omne quod devenitur ad illud" is provided as follows: "When anything is forbidden, everything which amounts to the forbidden thing is forbidden also. This maxim means that when the law has forbidden the doing of anything directly, it equally forbids the doing of it indirectly, and that mere device or colourable evasion will not protect the doer from the consequences of his act."

"... and a transaction will not be upheld which is "a mere device for carrying into effect that which the legislature has said shall not be done." See: Per Martin, B., in Morris v. Blackman, [2 H. & C. 912, at p. 918] ; See also: Minty v. Sylvester, [84 L. J. K. B. 1982] as cited in Broom's Legal Maxims, 10th Edition, 2006 at p. 315. The above clarification is partly erroneous because, the very act of appointment of additional directors is to pass the transaction in which all the existing directors are interested. Thus, as all the directors are even interested in the appointment of additional directors how can they, in the spirit and principle of Section 287, appoint additional directors? Again, even to co-opt a director to make up the quorum there should be at least one disinterested director. It is a well settled legal principle that 'what the law prohibits cannot, in some other way, be legally accomplished'. In view of the above, the directors may, in accordance to the law laid down in the above case laws as also the DCA clarification, first increase the strength of the board and put the item in issue to vote in board meeting if it wants to avoid the item to be put to vote in general meeting. However, it is a moot question whether the transaction would be able to stand against the well laid and followed principle of law, if and when challenged.
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Payment of Sitting Fees to Managing Director

Section 309 of the Companies Act, 1956 in pertinent part, reads as under:

“(1) The remuneration payable to the directors of a company, including any managing or whole-time director, shall be determined, in accordance with and subject to the provisions of section 198 and this section, either by the articles of the company, or by a resolution or, if the articles so required, by a special resolution, passed by the company in general meeting and the remuneration payable to any such director determined as aforesaid shall be inclusive of the remuneration payable to such director for services rendered by him in any other capacity:

Provided that any remuneration for services rendered by any such director in any other capacity shall not be so included if (a) the services rendered are of a professional nature, and (b) in the opinion of the Central Government the director possesses the requisite qualifications for the practice of the profession.

(2) A director may receive remuneration by way of a fee for each meeting of the Board, or a committee thereof, attended by him: Provided that where immediately before the commencement of the Companies (Amendment) Act, 1960 (65 of 1960) fees for meetings of the Board and any committee thereof, attended by a director are paid on a monthly basis, such fees may continue to be paid on that basis for a period of two years after such commencement or for the remainder of the term of office of such director, whichever is less, but no longer.”

Section 198 of the Companies Act in relevant part, reads as follows:

“(1) The total managerial remuneration payable by a public company or a private company which is a subsidiary of a public company, to its directors and its manager in respect of any financial year shall not exceed eleven per cent of the net profits of that company for that financial year computed in the manner laid down in sections 349 and 350, except that the remuneration of the directors shall not be deducted from the gross profits.

(2) The percentage aforesaid shall be exclusive of any fees payable to directors under sub-section (2) of section 309.

(3) Within the limits of the maximum remuneration specified in sub-section (1), a company may pay a monthly remuneration to its managing or whole-time director in accordance with the provisions of section 309 or to its manager in accordance with the provisions of section 387.”

The very fact that sub-section (2) of Section 309 very clearly talks of “remuneration by way of a fee for each meeting of the board or a committee thereof attended by him” (by the director) gives rise to a necessary implication that sitting fees would amount to remuneration under provisions of Section 309. Further, in view of sub-section (2) of Section 198, which reads as follows: “The percentage aforesaid shall be exclusive of any fees payable to directors under sub-section (2) of Section 309.” It cannot be said that sitting fee would not amount to remuneration for purposes of Section 309 of the Companies Act, 1956.

In view of this legal position, a Managing Director can be paid sitting fees for attending board meetings of the company.
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Nominee Director - Officer Who Is In Default?

Can a "Nominee Director" nominated to take care of the interests of a public financial institution be treated as an "officer who is in default?

Section 5 of the Companies Act, 1956 provides the meaning of ‘officer who is in default’. It reads as follows:

“For the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any punishment or penalty, whether by way of imprisonment, fine or otherwise, the expression "officer who is in default" means all the following officers of the company, namely:-

(a) the managing director or managing directors;

(b) the whole-time director or whole-time directors;

(c) the manager;

(d) the secretary;

(e) any person in accordance with whose directions or instructions the Board of directors of the company is accustomed to act;

(f) any person charged by the Board with the responsibility of complying with that provision: Provided that the person so charged has given his consent in this behalf to the Board;

(g) where any company does not have any of the officers specified in clauses (a) to (c) any director or directors who may be specified by the Board in this behalf or where no director is so specified, all the directors:

Provided that where the Board exercises any power under clause (f) or clause (g), it shall, within thirty days of the exercise of such powers, file with the Registrar a return in the prescribed form.”

Section 5 of the Companies Act is quite unambiguous on this. Normally, a nominee director will not be an officer who is in default unless the board was remiss in nominating a person for this purpose or remiss in specifying one among themselves for that role in the absence of a whole-time director or a managing director or a manager. Section 5 of the Companies Act, 1956 defines the ‘officer who is in default’ as only those directors and officers of the company who are in charge of the management of the company and not the nominee directors.

However, a nominee director could be proceeded against and they cannot claim wholesale exoneration from the proceeding merely by virtue of being nominee directors unless there is an express provision to that effect under the statute for contravention of which the company and the directors can be proceeded against. Further it is for the prosecution to establish that the nominee director was party to the offence. This principle may be widely disregarded in practice and nominee directors may take themselves to be simply as watchdogs for those who put them on the Board. They are wrong, and before accepting office they should remember that the law expects them to devote their loyalty to the company as a whole. They must be careful. They must not represent only those appointing them. They must look to the interest of ‘the company’s employees in general’, and they, like any other director, must also balance these, where necessary, with those of the membership comprising the company. See LORD DENNING in Meyer v. Scottish C.W.S Ltd., (1959) AC 324 at pp. 366, 367 (HL) cited with approval in Selangar United Rubber Estates Ltd. v. Cradock (No. 3), (1968) 1 WLR 1555 : (1969) 39 Comp Cases 485

Further, in the case of Geetanjali Mills Ltd. v. Thiruvengadathan (1989) 1 Comp. L. J, the liability of the nominee directors in the Income Tax Act, 1961 was discussed and it was held that the Nominee Directors of the creditors, institutions, government, joint venture partners etc., generally, do not enjoy any special immunity. Financial Institutions’ nominee directors, however, get immunity under the State Financial Corporation Act. But it has to be established that the accused person has acted in good faith.

Furthermore, Section 5 (g) of the Companies Act, 1956 may be read very carefully. It reads as follows:

“Where any company does not have any of the officers specified in clauses (a) to (c) any director or directors who may be specified by the Board in this behalf or where no director is so specified, “all the directors”.”

Sub-section (13) of Section 2 of the Companies Act, 1956 defines a “director” as ‘director includes any person occupying the position of director, by whatever name called’.

In view of the above and the law evolving on the subject vide various other decisions, it appears that nominee directors are in the same position and they owe same duties to the companies as any other director.
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Are Indian Companies bound by Decrees of US Courts?

‘A’ Company Ltd. is a company registered under the Companies Act, 1956.  Mr. X holds jointly with his wife, 1000 shares in ‘A’ Company Ltd.  Mr. X is resident in USA and has taken a divorce decree from a US Court.  As per the decree, the property in India is granted to the husband.  Based on the said decree, the husband has applied for removal of the name of his ex-wife as a joint shareholder from the register of members of ‘A’ Company Ltd.

Issues:

1. Is the decree issued by a US Court valid in India?

2. Can ‘A’ Company Ltd., relying on such foreign decree, remove the name of ex-wife of Mr. X as the joint shareholder from its register of members?

Code of Civil Procedure, 1908 sets the general parameters in relation to foreign courts and their judgments. That statute reads in pertinent parts as under:

Clause (5) of Section 2 of the Code of Civil Procedure, 1908 defines 'foreign court' as follows:

“"foreign Court" means a Court situate outside India and not established or continued by the authority of the Central Government.”

Clause (6) of Section 2 of the Code of Civil Procedure, 1908 defines 'foreign judgment' as follows:

“"foreign judgment" means the judgment of a foreign Court.”

“A foreign judgment would mean adjudication by a foreign court upon the matter before it” and not merely a statement of reasons for the order. [Brijlal v. Govind AIR 1947 PC 192]  A suit on a foreign judgment is governed by Section 13 of the Code of Civil Procedure, 1908.  Section 13 provides as to when a foreign judgment is not conclusive. It reads as follows:

“A foreign judgment shall be conclusive as to any matter thereby directly adjudicated upon between the same parties or between parties under whom they or any of them claim litigating under the same title except –

(a) where it has not been pronounced by a Court of competent jurisdiction;

(b) where it has not been given on the merits of the case;

(c) where it appears on the face of the proceedings to be founded on an incorrect view of international law or a refusal to recognize the law of India in cases in which such law is applicable;

(d) where the proceedings in which the judgment was obtained are opposed to natural justice;

(e) where it has been obtained by fraud;

(f) where it sustains a claim founded on a breach of any law in force in India.

Section 14 of the Code of Civil Procedure, 1908 provides for the Presumption as to foreign judgments. It reads as follows:

“The Court shall presume upon the production of any document purporting to be a certified copy of a foreign judgment that such judgment was pronounced by a Court of competent jurisdiction, unless the contrary appears on the record; but such presumption may be displaced by proving want of jurisdiction.”

Thus, Sections 13 and 14 of the Code of Civil Procedure, 1908 enact a rule of res judicata in case of foreign judgments. These provisions embody the principle of private international law that a judgment delivered by a foreign court of competent jurisdiction can be enforced by an Indian court and will operate as res judicata between the parties thereto except in the cases mentioned in Section 13 herein above. As such the decree issued by the United States of America is valid in India.

Accordingly, Issue No.1 is addressed.

Section 44A of the Code of Civil Procedure, 1908 deals with the Execution of decrees passed by Courts in reciprocating territory.

“44A. Execution of decrees passed by Courts in reciprocating territory.

(1) Where a certified copy of decree of any of the superior Courts of any reciprocating territory has been filed in a District Court, the decree may be executed in India as if it had been passed by the District Court.

(2) Together with the certified copy of the decree shall be filed a certificate from such superior Court stating the extent, if any, to which the decree has been satisfied or adjusted and such certificate shall, for the purposes of proceedings under this section, be conclusive proof of the extent of such satisfaction or adjustment.

(3) The provisions of section 47 shall as from the filing of the certified copy of the decree apply to the proceedings of a District Court executing a decree under this section, and the District Court shall refuse execution of any such decree, if it is shown to the satisfaction of the Court that the decree falls within any of the exceptions specified in clauses (a) to (f) of section 13.

Explanation 1- "Reciprocating territory" means any country or territory outside India which the Central Government may, by notification in the Official Gazette, declare to be a reciprocating territory for the purposes of this section; and "superior Courts", with reference to any such territory, means such Courts as may be specified in the said notification.

Explanation 2.- "Decree" with reference to a superior Court means any decree or judgment of such Court under which a sum of money is payable, not being a sum payable in respect of taxes or other charges of a like nature or in respect to a fine or other penalty, but shall in no case include an arbitration award, even if such an award is enforceable as a decree or judgment.”

Therefore, it follows from the above that a foreign judgment can be enforced in India in one of the two ways: 1) Judgments from Courts in "reciprocating territories" can be enforced directly by filing before an Indian Court an Execution Decree. A "reciprocating territory" is defined in explanation 1 to Section 44A of Code of Civil Procedure, 1908 as: "Any country or territory outside India which the Central Government may, by notification in the Official Gazette, declare as a reciprocating territory." Presently, the United States of America is not declared as a "reciprocating territory" by the Government of India. 2) Judgments from "non-reciprocating territories," such as the United States, can be enforced only by filing a law suit in an Indian Court for a Judgment based on the foreign judgment. The foreign judgment is considered evidentiary.

In view of the above legal position, Mr. X has to file a suit in the Indian Court of competent jurisdiction based on the foreign decree which will have evidentiary value and obtain a decree whereupon he should file an execution petition and obtain execution decree. Based upon such execution decree, Mr. X can then approach ‘A’ Company Ltd. to give effect the orders contained therein. Therefore, ‘A’ Company Ltd. cannot remove the name of ex-wife of Mr. X as the joint shareholder from its register of members merely based on the decree of US Court.

Accordingly, Issue No. 2 stands addressed.
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Annual General Meeting and Due Date

As per Section 166 of the Companies Act, 1956 not more than 15 months shall elapse between the date of one annual general meeting of a company and that of the next. Further the same can be extended for a further period of 3 months with the approval of the Registrar of Companies. A Co. Ltd. has convened an Annual General Meeting. The said meeting is adjourned for some reason.  Now, the Queries are:

1. For the purpose of calculating the 'due date' for the next AGM, whether the period of 15 months shall begin from the date of original AGM or from the date of the adjourned AGM?

2. Which date shall be treated as the AGM date --- (a) the date on which 'notice' is sent; or (b) the date on which AGM was held... for the purposes of Form 23AC...?

Sub-Section (1) of Section 166 of the Companies Act, 1956 reads as follows:

“Every company shall in each year hold in addition to any other meetings a general meeting as its annual general meeting and shall specify the meeting as such in the notices calling it; and not more than fifteen months shall elapse between the date of one annual general meeting of a company and that of the next:

Provided that a company may hold its first annual general meeting within a period of not more than eighteen months from the date of its incorporation; and if such general meeting is held within that period, it shall not be necessary for the company to hold any annual general meeting in the year of its incorporation or in the following year;

Provided further that the Registrar may, for any special reason, extend the time within which any annual general meeting (not being the first annual general meeting) shall be held, by a period not exceeding three months.”

In T.V. Mathew v. Nandukkara Agro Processing Co. Ltd., [2002] 108 Comp Cas 130 (Ker), it was held that “It is a statutory requirement that every company should hold an annual general meeting in every year… There is no provision in the Act for deferring the annual general meeting and an AGM has to be held within the time and manner prescribed in the Act.”

In M.D. Mundra v. Asst. Registrar of Companies, [1980] 50 Comp Cas 346, the Calcutta High Court, with reference to annual general meeting, has held that the adjourned annual general meeting was nothing but a continuance of its earlier meeting.”

It is pertinent to note that Section 166 of the Companies Act, 1956 speaks about holding an AGM but not about its conclusion or otherwise for the purpose of calculation of due date of the next AGM. Since, an adjournment of a meeting is nothing but continuing the same meeting on a different day, the period of 15 months for the next annual general meeting shall begin from the date on which the original annual general meeting was held.

Accordingly, Query No. 1 is answered.

The relevant portion of the Sub-Section (1) of Section 220 of the Companies Act, 1956 reads as follows:

“After the balance sheet and the profit and loss account have been laid before a company at an annual general meeting as aforesaid, there shall be filed with the Registrar within thirty days from the date on which the balance sheet and the profit and loss account were so laid, or where the annual general meeting of a company for any year has not been held, there shall be filed with the Registrar within thirty days from the latest day on or before which that meeting should have been held in accordance with the provisions of this Act, –"

It is abundantly clear from a cursory reading of the provision that for the purpose of filing Form 23AC with the Registrar of Companies, the count of 30 days shall begin from the date of AGM on which the balance sheet and profit and loss account were laid. In the above case, if the annual financial statements were laid before the company at original AGM, then the count of 30 days for filing Form 23AC shall begin from the date of original AGM. If the annual accounts were laid before the company at the adjourned AGM, then the count of 30 days for filing the Form 23AC with the Registrar shall begin from the date of such adjourned AGM.

Accordingly, Query No. 2 is answered.
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Alternate Director and Form No. 32

'A' Company Ltd. has its Registered Office in Hyderabad. 12 board meetings of the Company are held in a year. Out of the total meetings held, 4 are held at Hyderabad, 4 are held at Delhi, and 4 are held at Pune. One of the directors of 'A' Company Ltd. has been abroad. The board of directors of 'A' Co. Ltd. appointed Mr. 'X' as alternate director in his place whereupon, Form No. 32 was filed. Now, the original director is back to India and is to attend a week-long business conference at Hyderabad. Meanwhile, a board meeting is scheduled to be held at Delhi. In such backdrop, 'A' Company Ltd. seeks legal view on the following Queries:

(1) Since the original director is back to Hyderabad, can Mr. 'X' participate in the board meeting of 'A' Company Ltd.?

(2) Should Form No. 32 be filed for cessation of office of the Alternate Director?

Section 313 of the Companies Act, 1956 provides for the appointment and term of office of alternate directors. The Section reads as follows:

"(1) The Board of directors of a company may, if so authorised by its articles or by a resolution passed by the company in general meeting, appoint an alternate director to act for a director (hereinafter in this section called "the original director") during his absence for a period of not less than three months from the State in which meetings of the Board are ordinarily held.

(2) An alternate director appointed under sub-section (1) shall not hold office as such for a period longer than that permissible to the original director in whose place he has been appointed and shall vacate office if and when the original director returns to the State in which meetings of the Board are ordinarily held.

(3) If the term of office of the original director is determined before he so returns to the State aforesaid, any provision for the automatic re-appointment of retiring directors in default of another appointment shall apply to the original, and not to the alternate director."

Alternate director is a person who can act temporarily to fill the position, carry out the duties, etc., of a regular or original director of a company in his absence for more than 3 months from the State where the Board Meetings are ordinarily held.  It is important to note that the power to appoint an alternate director lies exclusively with the board and that neither the original director nor the shareholders have any say in his appointment.  An alternate director vacates his office if and when the original director returns to the State in which the Board meetings are ordinarily held irrespective of the fact whether the original director attends a Board meeting or not. [Circular No. 6/16(313) /63-PR dated 5.2.1963]. The expression "State in which meetings of the Board are ordinarily held" does not necessarily mean the State in which the registered office of the company is situated.  However, such a State must be one in which the meetings of the Board are ordinarily held. A query was made to the department, wherein 12 meetings of the board of a company are held in a year… 4 each in 3 different states.  In such a case where, according to the department, the board meetings of the company can be said to be ordinarily held?  In such a case the State in which the registered office is situated would have to be taken as the State in which meetings of the company can be said to be ordinarily held. [Minutes of meeting of Company Law Sub-Committee of BCCI with Secretary DCA held on 20-06-1972.]

In view of the above, since equal numbers of meetings were held at 3 different states, Hyderabad, where the registered office is situated has to be taken as the state where meetings are ordinarily held. As the original director has returned to Hyderabad, albeit the meeting is scheduled in pune, the office of Mr. X, the alternate director is vacated. Therefore, he could not attend the board meeting in scheduled in Pune.

Accordingly, Query No. 1 is answered.

Sub-section (13) of Section 2 of the Companies Act, 1956 defines a “director” as ‘director includes any person occupying the position of director, by whatever name called’.  Since an alternate director occupies the position of director and performs same duties and is subject to same liabilities as of any director, he shall be treated for all intents and purposes of the Companies Act, 1956 and articles of the company, as a 'director' of the company like any other director.  The provisions of Sections 264, 271 and 303 of the Companies Act, 1956 are to be complied with by, and in respect of, an alternate director. [Circular No. 8/9 (313)/61 – PR, dated 07-08-1961.]  DCA has expressed a view that appointment of an employee as an alternate director will be governed by the provisions of sections 314, 269, 198 and 309 of the Companies Act. [Department of Company Affairs' Circular No. 219/63-PR dated 29 June 1964].

In view of the above, the Registrar of Companies should be notified of the appointment or cessation, as the case may be, vide Form No. 32 along with the requisite filing fees, giving particulars about the cessation from the directorship (including alternate) of the company on the return of the original director, within 30 days of the such cessation. Where an individual’s Form No. 32 for cessation is not filed, and the same individual is subsequently (some months or years later) re-appointed as a director or as an alternate, the electronic system will not permit the filing of the said Form for the fresh appointment, which, in turn, will be construed as a statutory violation.
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Charge on Assets - Effect of Non-Registration

The term “Charge” is not defined in the Companies Act, 1956 save and to the extent that it includes a mortgage. So, its meaning must be construed in the ordinary sense. Section 100 of the Transfer of Property Act, 1882 defines that where immovable property of one person is by act of parties or operation of law made security for the payment of money to another, and the transaction does not amount a mortgage, the latter person is said to have a charge on the property, and that all the provisions which apply to a simple mortgage shall, so far as may be, apply to such charge.

In Fisher and Lightwood’s Law of Mortgage, 8th Ed., p.156, ‘Charge’ has been defined thus, ---

“A charge is a security whereby real or personal property is apportioned for the discharge of a debt or other obligation, but which does not pass either an absolute of a special property in the subject of the security to the creditor, nor any of right to possession, but only a right of realization by judicial process in case of non-payment of the debt.”

Thus charge means a security created on the property of the company in favour of its creditor to secure payment of a loan or debt or any other obligation. In order to create a charge it is not necessary to employ any technical or particular form of expression. All that is required is that there should be clear intention to make a particular property a security for the payment of money. Creation of enforceable security is of the essence of a charge either in respect of immovable property or in respect of moveables.

Under Section 124 of the Companies Act, 1956, a charge includes a mortgage and every mortgage or a charge created by a company is required to be lodged with a copy of the instrument creating the encumbrance and got registered with the Registrar of Companies of the State concerned under Section 125 of the said Act, failing which the charge would be void against the liquidator and any creditor of the company. The provision for registration of such charge amounts to a notice of the charge as from the date of registration to all concerned who are likely to deal with the said company. The object of registration of charges is Public Notice to prospective creditors of the company and those who deal with a company of certain matters which vitally affect the company’s credit i.e., the degree of credit-worthiness of the company in so far as their position might be affected by the existence of certain debts entitled to be paid in priority. The idea is to prevent people to deal with the specified assets in oblivion. It is provided, therefore, that the register shall ‘be open to inspection by any person’. Also that, the registration serves the purpose of preventing fraudulent and belated claims on charge in the event of liquidation of a company. Only those charges that are specified in the Companies Act, 1956 requires compulsory registration.

Under Section 125(4) of the Companies Act, 1956, the following are the assets of a company, if any charge or mortgage created, must be registered with the Registrar of Companies:

1. a charge for the purpose of securing any issue of debentures;

2. a charge on uncalled share capital of the company;

3. a charge on any immovable property, wherever situate or any interest therein;

4. a charge on any book debts of the company;

5. a charge, not being a pledge, on any moveable property of the company;

6. a floating charge on the undertaking or any property of the company including stock in trade;

7. a charge on calls made, but not paid;

8. a charge on a ship or any share in a ship;

9. a charge on goodwill, or a patent or a licence under a patent, on a trademark, or on a copyright or a licence under a copyright.

A charge which is not created by a company does not require registration. Instances being that of a charge created by operation of law, a charge created by a decree based upon award made on an agreement out of court or otherwise, vendor’s charge for unpaid purchase money under Section 55(4) of the Transfer of Property Act, 1882 etcetera. A charge by operation of law results not by volition of parties, but as the result of a legal obligation.

Under Section 127(1) of the Companies Act, 1956, where a company acquires any property which is subject to a charge of any such kind as would, if it had been created by the company after the acquisition of the property, have been required to be registered under Part V of the said Act, the company shall cause the prescribed particulars of the charge, together with a certified copy of the instrument by which the charge was created, to be delivered to the Registrar for Registration within 30 days after the date on which the acquisition is completed, failing which the company and every officer of the company who is in default, shall be punishable with fine which may extend to five thousand rupees. However, the Registrar may extend the time up to the next thirty days, if he is convinced of the sufficiency of the cause for the default.

Understandably, the stipulation of a time limit within which registration must be effected (or otherwise the consequence of invalidation of the security) is meant to ensure that such information be provided promptly on the register, so that inspection by a person about to become a creditor of the company might induce him to extend credit to the company on the grounds that such inspection might show that no charge or encumbrance had been given.

The effect of non-registration of a charge created on the property of a company requiring registration is that it is void and as such affects the security against the liquidator and creditor(s) of the company. It damages the interest of creditor in whose favour the charge is created. The effect being that, if a subsequent charge is created on the same property and the earlier charge has not been registered, the earlier charge would become void and the latter charge, if registered, would enjoy priority in case the latter charge-holder intervenes to get the charge enforced and have the property sold so as to enable him to satisfy his debt. Also that, it becomes unenforceable against the liquidator in the event of winding-up of the company or any other company’s creditor(s) in case the company is a going concern.

However, failure to register a charge avoids only the security but not the debt concerned. The charge is not at all void against the company as the company may not repudiate the charge failed to have registered, provided it is a going concern.
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'Trust' and 'Body Corporate'


Can a 'Trust' under the Indian Trusts Act, 1882 be a 'Body Corporate' under the Companies Act, 1956?

Sub-section (7) of Section 2 of the Companies Act, 1956 defines a Body Corporate or Corporation as follows:-

“Body Corporate” or “Corporation” includes a company incorporated outside India but does not include---

(a) a corporation sole;

(b) a co-operative society registered under any law relating to co-operative societies; and

(c) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification in the Official Gazette, specify in this behalf.

Institution or body which can be regarded body corporate---- Department’s Circular:---  The question whether a particular institution or body other than that specified in sub-clauses (a), (b) and (c) of clause (7) of section 2 is a “body corporate” under the Companies Act, 1956 has to be decided with reference, among other things, to the status, mode of incorporation, constitution, etc., of the institution. It is not possible for the Department to lay down any general definition other than that given in the Act or to furnish a list of bodies which are deemed to be “bodies corporate” under section 2(7). Generally speaking, the Department would consider that any corporate body, i.e., a body which has been or is incorporated under some statute and which has a perpetual succession, a common seal and is a legal entity apart from the members constituting it, will come within the definition of the term "body corporate".  The term will not, however, include a society registered under the Societies Registration Act, 1860, or any of the bodies which have been specifically excluded by sub-clauses (a), (b) and (c) of clause (7) of section 2. (Circular No. 8(26)/2(7)/63-PR, dated 13-03-1963)

The Supreme Court of India in Ashoka Marketing Ltd v Punjab National Bank, (1990) 4 SCC 406 held that “The expression ‘body corporate’ is used in legal parlance to mean a public or private corporation.”

Further, the Supreme Court of India, in Board of Trustees, Ayurvedic and Unani Tibia College v. State of Delhi, AIR 1962 SC 458 while posing the question as to what is a corporation, the court answered it with the statements contained in HALSBURY 4th Edn., Vol.9, para 1201 as:- “A Corporation may be defined as a body of persons (in the case of a corporation aggregate) or an office (in case of a corporation sole) which is recognized by the law as having a personality which is distinct from the separate personalities of the members of the body or the personality of the individual holder for the time being of the office, in question.”

The Supreme Court of India again in S. P. Mittal v. Union of India, AIR 1983 SC 1, summed up the essential elements in the legal concept of a corporation, which are: “(1) a continuous identity, i.e., the original member or members or his or their successors are one; (2) the persons to be incorporated, (3) the name by which the persons are incorporated, (4) a place, and (5) words sufficient in law to show incorporation. A corporation aggregate can express its will by deed under a common seal.”

Corporation also means any body corporate established by or under Central, Provincial or State Act. It can be brought into existence by a statute.

In legal parlance, a legal person is any subject-matter other than a human being to which the law attributes personality. The law, in creating legal persons, always does so by personifying some real thing. The thing personified may be termed the corpus of the legal person so created; it is the body into which the law infuses the animus of a fictitious personality. Thus a Corporation, being the creation of law is undoubtedly a legal person. It comes into existence by the lawful authority of incorporation. A corporation, having neither soul nor body, cannot act save through the agency of some representative in the world of real men. Whatever a corporation is reputed to do in law is done in fact by the directors or the shareholders as its agents and representatives.

Trust literally means a confidence which one reposes in another. Creation of a Trust is regulated by the Indian Trusts Act, 1882. According to Section 3 of the Act, a Trust is an obligation annexed to the ownership of property and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner. A trust is a curious instance of duplicate ownership which allows for the separation of the powers of management and the rights of enjoyment. Trust property is that which is owned by two persons at the same time, the relation between the two owners being such that one of them is under an obligation to use his ownership for the benefit of the other. The former is called the trustee, and his ownership is trust-ownership; the latter is called the beneficiary, and his is beneficial ownership.

The trustee is destitute of any right of beneficial enjoyment of the trust property. His ownership, therefore, is a matter of form rather than substance, nominal rather than real. If we have regard to the essence of the matter rather than to the form of it, a trustee is not an owner at all, but a mere agent, upon whom the law has conferred the power and imposed the duty of administering the property of another person. In legal theory, however, he is not a mere agent but an owner. He is a person to whom the property of some one else is fictitiously attributed by the law, to the extent that the rights and powers thus vested in a nominal owner shall be used by him for the benefit of the real owner. As between trustee and beneficiary, the law recognizes the truth of the matter; as between two, the property belongs to the latter and not to the former. But as between the trustee and third persons, the fiction prevails. The trustee is clothed with the rights of his beneficiary, and is so enabled to personate or represent him in dealings with the world at large.

The purpose of trusteeship is to protect the rights and interests of persons who for any reason are unable effectively to protect them for themselves. The law vests those rights and interests for safe custody, as it were, in some other person who is capable of guarding them and dealing with them, and who is placed under a legal obligation to use them for the benefit of him to whom they in truth belong.

In a celebrated case, Sir Edward Coke C.J enunciated that the first essential for a valid corporation is a “lawful authority of incorporation”.

The courts in India in various decisions held that the instrument of registration does not by itself lend legal entity to a trust. The Supreme Court of India in AIR 1957 SC 887 (891) held that “A trustee is legal owner of trust property and the property vests in him. He holds trust property for the benefit of beneficiaries but does not hold it on their behalf.

In Duli Chand v Mahabir Prasad etc. Trust AIR 1984 Del 145 (DB) the court observed that a trust is “not like a corporation which has a legal existence of its own and therefore, can appoint an agent. A trust in not in this sense a legal entity. It is possible for some of the trustees to authorize the others to file a suit but this could only be done by the execution of a power of attorney.”

It was also held in H. N. Bhiwandiwala v Zoroastrian Co-op. Bank AIR 2001 Bom 267 that, a suit against a trust is not maintainable as it is not a legal entity. Observed, “all the trustees must be made a party.”

It was further held in N. T. P. C. v Canara Bank (1999) 97 Comp. Cas. 930 at Pages 937-38 that “Trusts created under Indian Trusts Act, 1882 are not legal entities as public trusts registered under the Societies Registration Act are.

It would be pertinent to speak about the section 10 of the Indian Trusts Act, 1882 which provides that every person capable of holding property may be a trustee, but where the trust involves the exercise of discretion, a trustee must be a person competent to contract. Thus there is no statutory prohibition upon the appointment of any person as a trustee, who should be a person capable of taking and holding legal estate, possessed of natural capacity and legal ability to execute the trust, and domiciled within the jurisdiction of the court.

In view of the above discussion as well as the decisions that a Trust is an obligation annexed to the ownership of property and a trustee is a person who accepts a confidence which gives rise to obligation annexed to the ownership of property. But a trust is not a legal entity in the eye of law as it has no lawful authority of incorporation. Generally, the assumption that an entity will behave substantially as expected. Trust may apply only for a specific function. As such a Trust under the Indian Trusts Act, 1882 cannot be a ‘Body Corporate’ under the Companies Act, 1956.

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Monday, March 1, 2010

Whether Company's lien extends to dividends?

Whether Company’s "Lien" can be extended to the "Dividends" payable on such Shares?

Clause (46) of Section 2 of the Companies Act, 1956 defines the word share as follows:

"“SHARE” means share in the share capital of a company, and includes stock except where a distinction between stock and shares is expressed or implied."

In Lindley on Companies, 6th edition, page 1, Shares have been defined as follows:

“The common stock’ (contributed by the members) is denoted in money, and is the capital. The persons who contribute it or to whom it belongs are members. The proportion of capital to which each member is entitled is his share."

A Share in a company does not denote rights only, but denote obligations as well. A share is not a sum of money, but is an interest of a shareholder in the company measured by a sum of money for the purpose of liability and made up of various rights. When a member transfers his share, he transfers all his rights and obligations as a shareholder as from the date of the transfer. The rights attached to ordinary shares (equities) may be stated in brevity. Except so far as the memorandum, articles or terms of issue provide otherwise, an equity shareholder is entitled to receive dividends when declared, to have his appropriate proportion of the company’s assets after payment of creditors paid or transferred to him on a winding up and to exercise one vote for each share that he holds at the general meetings of the company.

Clause (14A) of Section 2 of the Companies Act, 1956 defines 'dividend' as follows:

“’Dividend’ includes any interim dividend”.

The Supreme Court of India, in Cf. CIT v Girdhardas & Co. (Private) Ltd., AIR 1967 SC 795 held as follows:

"The expression ‘dividend’ has two meanings. As applied to a company which is a going concern, it ordinarily means the portion of the profits of the company which is allocated to the holders of shares in the company. In the case of a winding up, it means a division of the realized assets among the creditors and contributories according to their respective rights.”

Black’s Law Dictionary, 6th Edition defines the term “Lien” as a claim, encumbrance or charge on property for payment of some debt, obligation or duty. The word ‘lien’ originally means “binding” from the Latin ligamen. Its lexical meaning is “right to retain”. Meaning of the term 'lien' has been explained by the Supreme Court in Triveni Shankar Saxena v. State of U.P., (1992) Suppl 1 SCC 524. In different contexts the word 'lien' can refer to 'contractual lien, equitable lien, specific lien, general lien etc.'. In legal sense 'lien' means 'right of a man to retain it rightfully and continuously in his possession belonging to another until the present and accrued claims are satisfied. (Refer, Halsbury's Law as quoted in the said judgment). Lien implies that there is something in existence to which it attaches. It includes right of retention. Lien was defined in Paresh Chandra Nandi v. Controller of Stores, AIR 1971 SC 359, with reference to Railway Fundamental Rules as title of a railway employee to hold substantively a permanent post to which he has been permanently appointed. In principle, a lien is no more than the right to retain the shares until the debt is satisfied. A lien on shares is a security and makes the company a secured creditor in the bankruptcy of a shareholder. Indeed, the word ‘Lien’ has not succeeded in attaining any fixed application as a technical term of both Indian as well as English Law. Its use appears to be capricious and uncertain. Apparently, this being the reason, its meaning, nature, effect of exercise and enforcement are all to be construed through the wide foray of case law and judicial decisions that has developed on this aspect of the company law.

Though the Companies Act, 1956 does not directly deal with the right of lien of a company on its shares held by members, Regulations 9 to 12 of Table A, Schedule I contain detailed provisions which a company may adopt to exercise lien as follows:

9. (1) The company shall have a first and paramount lien :-

(a) on every share (not being a fully-paid share), for all moneys (whether presently payable or not) called, or payable at a fixed time, in respect of that share ; and

(b) on all shares (not being fully-paid shares) standing registered in the name of a single person, for all moneys presently payable by him or his estate to the company : Provided that the Board of directors may at any time declare any share to be wholly or in part exempt from the provisions of this clause.

(2) The company's lien, if any, on a share shall extend to all dividends payable thereon.

10. The company may sell, in such manner as the Board thinks fit, any shares on which the company has a lien : Provided that no sale shall be made :- 

 (a) unless a sum in respect of which the lien exists is presently payable; or 

 (b) until the expiration of fourteen days after a notice in writing stating and demanding payment of such part of the amount in respect of which the lien exists as is presently payable, has been given to the registered holder for the time being of the share or the person entitled thereto by reason of his death or insolvency.

11. (1) To give effect to any such sale, the Board may authorise some person to transfer the shares sold to the purchaser thereof.

(2) The purchaser shall be registered as the holder of the shares comprised in any such transfer.

(3) The purchaser shall not be bound to see to the application of the purchase money, nor shall his title to the shares be affected by any irregularity or invalidity in the proceedings in reference to the sale.

12. (1) The proceeds of the sale shall be received by the company and applied in payment of such part of the amount in respect of which the lien exists as is presently payable.

(2) The residue, if any, shall, subject to a like lien for sums not presently payable as existed upon the shares before the sale, be paid to the person entitled to the shares at the date of the sale.

These regulations are not mandatory and a company may make its own regulations to govern its Lien on shares. Unless the Articles of the company provide for Lien, a company primarily has no Lien on members’ shares. A lien, if appropriate words are used in the articles, extends to all liabilities, not only to those in respect of shares, it also may authorize retention of any dividends due to the shareholder. A lien clause may be adopted by special resolution. The effect of Lien on shares is that, on exercise of the right of lien, the member ceases to be a member of the company. It was held in Hague v Dandeson (1848) 2 Exch 741 that, a lien imposed by the Articles of a company attaches not only to the shares in question but also to dividends payable in respect of them. In view of the above, it may be concluded that the company’s lien on share extends to the dividend payable. Accordingly, the holder of the shares, whose shares are in lien by virtue of his default in payment of the called up and un-paid share capital, can not have the benefit of the company’s dividend.
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