KNOW YOUR LAW #3 - REDUCTION IN NUMBER OF MEMBERS – REMOVING THE CORPORATE CLOAK

PROVISION COVERED	Section 3A
CONCEPT COVERED	Reduction of members below the statutory limit prescribed

INTRODUCTION:

Section 3A of the Companies Act, 2013 found its inception vide. Companies (Amendment) Act, 2017 and the same corresponds to Section 45 of the Companies Act, 1956. The section outlines the liability of members in case where the structure of the company is not in line with the provisions laid down under the Companies Act. The said section also serves as a ground for removing the clothing that a company enjoys which is reckoned as corporate veil.

POSITION OF A SHAREHOLDER:

The position of a shareholder can be well attributed to his contribution to the Company in monetary terms. In other words, shareholder is characterised by his interest in the Company by the virtue of his investment in monetary terms. The law expects the members of the company to abide by the notion of welfare of company first rather than placing mark on their personal interest.  The Delhi bench of Income Tax Appellate Tribunal in “H.K. Mittal vs. Assistant Commissioner of Income Tax (1994)” “A shareholder registered and so recognised by a company, obtains a valuable right which he can exercise, because, he becomes one of the several owners of the company. The various powers which a shareholder can exercise for the company or against the company are bundled rights that accompany the shares registered in his favour.”

LEGAL PERSONALITY OF A COMPANY:

A company under the eye of law had always found the character of a natural person and a separate legal status for itself independent of the investors who repose their money in the company. Incorporation of a company adorns the company with an independent status that creates a distinction between itself and the shareholders and the same is recognised as corporate veil. The concept of corporate personality was inducted in the first place to promote the growth of businesses in India and to provide a larger market for sustainable growth of entities. The Delhi High Court in “J.B. Exports Ltd. and Anr. v. BSES Rajdhani Power Ltd. (2006)” opined that “Keeping this historical background in mind we can immediately see that the purpose of the principle of separate corporate personality is to encourage and facilitate industrialization, not to obstruct it.”

Corporate persona is often regarded as a reality rather than a fictitious construction of law. Where there exists a structure to channelize and mobilize business opportunity in monetary terms, there also exists an element of placing personal gains in onus by the people who control such business. This intent prompt misuse, misrepresentation, evasion, fraud and other such conduct to conceive personal gains over business growth. This is the rationale for removing the status of corporate personality in exceptional cases to understand the cause of action and the individuals responsible for the same. The Gujarat High Court in the case of “Mohanlal Ganpatram vs. Shri Sayaji Jubilee Cotton and Jute Mills Limited (1964)” opined that “Shareholders must exercise their rights in the best possible way to cater the interest of the company as a whole.

REDUCTION OF MEMBERS BELOW STATUTORY LIMIT:

Section 3 of the Companies Act, 2013 contemplate the minimum number of members required for formation and operation of companies in India. Section 3A on the other hand stipulates the liability of members per say in case the company operates its business for such period without ensuring the optimal constitution of shareholders as enshrined under Section 3.

INTERPRETATION OF SECTION 3A:

There is an optimal constitutional structure in the first place with respect to shareholders concerning the fact of ideal decision making on behalf of companies, amount of capital involved, business operations and other factors. When such structure is disturbed and the number of members are reduced below the statutory limit of 7 members in case of public company and 2 in case of private company, the business operations of the company are carried on for more than six months from the date of such reduction and the existing member(s) of the company is/are aware of this reduction, then such members are jointly and severally obliged, liable and may be sued for the contracts, agreements, debts, financial and non-financial transactions entered by the such company post six months from the reduction of members. The essential ingredients required to cast such liability on existing members are as outlined below:

·         Reduction of number of members below statutory limit

·         Continuation of business for more than 6 months from the date of such reduction

·         The awareness on the part of members on such reduction

LIFTING OF CORPORATE VEIL:

The Cambridge Dictionary defines corporate veil as “the idea that a company’s managers or shareholders are not legally responsible for the actions of the company.” The notion of lifting of corporate veil connotes disregarding the corporate personality of a company to unearth the people responsible for conducts which tantamount and involve substantial contravention in Companies Act. The Delhi High Court in “Sudhir Gopi v. Indira Gandhi National Open University (2017)” postulated that “A corporate veil can be pierced only in cases where the Court comes to the conclusion that the conduct of the shareholder is abusive and the corporate façade is used for an improper purpose, for perpetuating a fraud, or for circumventing a statute.” Reliance can also be placed on Pennington's Company Law, 5th Edn., at page 49 wherein it is recognised and outlined that “Corporate veil has been lifted where the principal question before the Court was one of Company Law, and in some situations where the corporate personality of the company invoked was really of secondary importance.”

The law grants the blanket for a period of six months to the company and the existing members to ensure that the company maintains the optimum number of shareholders as required under law. Post six months of such reduction, the concept as enshrined under Section 3A serves as a ground to lift the corporate veil and cast appropriate liability on the members.

DISCLAIMER:

This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the blog owner and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated. All content provided on this blog is for informational purposes only. The owner will not be liable for any losses, injuries or damages from the display or use of this information.