Section 3: Formation of A Company

Introduction

Section 3 of Companies Act, 2013, part of chapter II primarily lays down and discusses the nitty gritties of formation of a company. A company under this section can be formed for only lawful purpose and includes companies of three types: (1) a company limited by shares (2) a company limited by guarantee and (3) an unlimited company (having no limit to the liabilities of its members). Section 2(21) of the act, 2013 defines a company limited by guarantee as one in which the liability of the members is limited to the amount, they undertake to contribute to the assets of the company in event of it being wound up. Section 2(22) of the act, 2013 defines a company limited by shares as one in which the liability of the members is limited to the amount unpaid if any of the shares are held by them. This section forms the backbone of companies act and lays down initial requirements of forming a company, which is a first step towards incorporation of a company and thus this analysis will give a thorough description and applicability of this section.

Purpose of Section 3

First, this section lays down that a company could only be formed under this act for lawful purposes. Thus, no company shall be formed for carrying on any unlawful objects. Every company formed under this section has to be a limited or unlimited company. This section lays down requirements for three types of companies as follows:

• A public company can be formed by seven or more persons subscribing to its memorandum.
• A private company can be formed by two or more persons subscribing to its memorandum.
• One Person Company (OPC) can be formed by any one person. It is a private company having only one member.  It is a new concept introduced by the 2013 act.

They have to also as per this section follow all the registration requirements under the act.

For the purposes of OPC this section also provides that the member of OPC shall also give name of one other person (nominate), with prior consent of such person registered with the registrar, who will be liable to become a member of the company in the event of death or incapacity of the previous subscriber. The name of the nominated person has to be mentioned in the memo of the company and has to be filed in form no. INC-3 with the registrar at the time of incorporation of the company along with its memorandum and articles. Such nominated person may withdraw his consent at any time as per procedure given under Company (Incorporation) rules, 2014. Further this section lastly makes it a duty of the member of OPC to intimate the company and registrar of any change in name of nominated person in manner as per prescribed rules.

Situation Before Enactment of Section 3

There have been few acts which contained similar provisions, before the 2013 Companies act came in force in India. Under 1882 act, which was followed in British India the requirement for formation of both public and private companies were seven persons. Under both 1913 and 1956 Companies act, the provisions for requirement for formation of a public and private company were same, provided under section 5 and section 12 of respective acts. Only OPC is a new addition under 2013 act. The requirement of minimum seven and two persons for public and private company has been the same, to create stability in any corporate entity formed and for its smooth functioning. The requirement for a private company is only two people since long before because firstly it is an independent private entity and secondly to make the procedure smooth and easy and to encourage business. This is in contrast with the requirement for a public company, because more stakeholders ensure better governance for a company, which impacts the public at large.

Application of Section 3

This section lays down the first requirement of forming and incorporating a company under the act. If for example ‘A’ wants to incorporate a private corporation for his business in India, then ‘A’ would have to have at least two members (including himself) who have subscribed to its memorandum and would have to fulfil the requirements of section 3 before moving towards registration. The requirements of section 3 are fundamental which every corporation in India have to fulfil for their incorporation.

Amendments

This section has been quite constant since its incorporation and lays down a basic requirement. There haven’t been amendments in this fundamental rule since 1913 act but there have been additions, which are as follows:

• Companies act, 2013, brought in a new concept in form of One Person Companies (OPC). This was notified on 26th March 2014 and the same has been effective from 01st April 2014. It is a hybrid of a sole proprietor and a company form of business, with relaxed requirements under the act and enabling smooth functioning. Section 3(1)c of Companies act is to be supplemented by Company (Incorporation) Rules, 2013. According to the rules, only a natural person who is an Indian citizen and ‘resident of India’, and not a minor can be a member of an OPC. Further OPC cannot be incorporated or converted into a company under section 8 of the Act. An OPC cannot carry out Non-Banking Financial Investment activities including investment in securities of anybody corporates. The sole member of an OPC may, by writing to the company, change the nominee at any time for any reason including reason of death or incapacity to contract of nominee with another person after obtaining the prior consent of such another person in Form No INC 3. The company shall within thirty days of receipt of the notice of withdrawal of consent may change the name, file with the Registrar, in Form No INC 4 along with the written consent of such another person so nominated in Form No. INC 3. Another important thing to note about the 2013 amendment is that if paid up share capital of a company, exceeds rupees fifty lakhs or its average annual turnover during the relevant period exceeds rupees two cores or if during financial year the balance sheet of an OPC total exceeds one crore rupees, it would cease to continue as an OPC and would have 6 months to mandatorily convert into public or private company.
• Ministry of corporate affairs by notification dated 4th January 2017, have exempted specified Indian Financial System Code public and private companies under section 3(2) of the 2013 act, restricting them to be formed only as a company limited by shares.

Cases at a Glance

• M/s. Aptean Software Private Limited v. Shri R. Mohan Kumar, Advocate: In this case the applicant filed an application for compounding violation of section 3 (1) b of the act, 2013. At the time of inception of the company, there were two shareholders -‘Pivotal corporation’ and ‘British Columbia LTD.’ Thereafter there was a restructuring of the company, due to which one shareholder got merged into another and thus only one shareholder remained. The applicant contested that there should be no penalty as firstly that it was an honest mistake and it did not adversely affect the company or the interest of the shareholders. Secondly, the 2013 act provides no penalty for violation of this section. Companies act, 1956 provided by way of section 45 the consequence for repayment of debt when the number of shareholders go below statutory limit, which provides only for civil liability. The court held that the penalty under section 629A of 1956 act would be applicable, which provides penalty when there is no specific punishment under the act, as the act provides specific requirement of two people to form a private company and thus section 420 of companies act 2013  (corresponding section of 629A section of 1956 act), was applied and the applicant punished.
• Dalco Engg. (P) LTD. V. Satish Prabhakar Padhye: inthis case the court looked at the question- “what is a corporation established by or under … Act?” for the purpose of looking at connection with some other act. The court examined whether a company owes its existence to acts or not. Here the court examined in detail section 12 of 1956 act, which is similar to section 3 of 2013 act and this case is important because after examining section 12, the court concluded that a company is not established pursuant to section 12 of the companies act, neither owes its existence to companies act but is only incorporated and registered under the companies act.

Concluding Summary

The first step for benefiting in business through formation of a corporate personality, is forming a company, be it public, private or an OPC.  Section 3 of companies act 2013, thus is a very important section, which lays down the basic requirements of forming a company. The minimum requirement of a person is itself as given under section 3 has been constant since the inception of companies act, and provides a safeguard for the interest of the company and shareholders. The Companies act, 2013 had led to advent of OPC, which is a very welcome business model. It helps sole proprietor business to enjoy the benefits of corporate personality. It helps boost business and thus helps in the economy of the country.

The companies (Incorporation) Rules, 2014 gives a better incite on the regulation and procedure of formation and incorporation of an OPC. Further there aren’t many cases as of now, but the few that are there on formation of company, brings more clarity, firstly with respect to liability of violation of section 3 and secondly on the nature of company formed under the companies act. The case on section 3 discussed above, which is a recent 2017 judgement, clarifies the penal liability for violation of section 3, rather than only conferring civil liability, thereby reflecting upon the status of following the requirements of section 3 and thus this helps one understand the mandatory nature of section 3 of the act, 2013.