Section 3 of the Companies Act 2013 – Formation of a Company

Section 3 of The Companies Act, 2013 reads as –

Formation of company.—

1) A company may be formed for any lawful purpose by—

1. a) seven or more persons, where the company to be formed is to be a public company;
2. b) two or more persons, where the company to be formed is to be a private company; or
3. c) one person, where the company to be formed is to be One Person Company that is to say, a private company, by subscribing their names or his name to a memorandum and complying with the requirements of this Act in respect of registration:

Provided that the memorandum of One Person Company shall indicate the name of the other person, with his prior written consent in the prescribed form, who shall, in the event of the subscriber’s death or his incapacity to contract become the member of the company and the written consent of such person shall also be filed with the Registrar at the time of incorporation of the One Person Company along with its memorandum and articles:

Provided further that such other person may withdraw his consent in such manner as may be prescribed:

Provided also that the member of One Person Company may at any time change the name of such other person by giving notice in such manner as may be prescribed:

Provided also that it shall be the duty of the member of One Person Company to intimate the company the change, if any, in the name of the other person nominated by him by indicating in the memorandum or otherwise within such time and in such manner as may be prescribed, and the company shall intimate the Registrar any such change within such time and in such manner as may be prescribed:

Provided also that any such change in the name of the person shall not be deemed to be an alteration of the memorandum.

2) A company formed under sub-section (1) may be either— 

a) a company limited by shares; or

b) a company limited by guarantee; or 

c) an unlimited company.

The incorporation of a company is governed by legal provisions that establish the minimum requirements for its formation. According to the relevant statutes, a public company must be formed by at least seven individuals, a private company requires a minimum of two, and a One Person Company (OPC) can be constituted by a single individual. However, the formation must always align with lawful objectives.

Defining a ‘Person’

The term ‘person’ is not explicitly defined in the Companies Act. Therefore, reference must be made to the General Clauses Act, 1897, which includes companies, associations, and bodies of individuals—whether incorporated or not—within its definition. While the Income Tax Act, 1961, also provides a definition, it cannot be relied upon for interpreting the term under the Companies Act due to the principle that terms in different statutes cannot be interpreted interchangeably unless they are pari materia.

Exclusion of Partnership Firms and Hindu Undivided Families

A partnership firm is considered an association of individuals rather than a distinct legal entity and thus cannot be a member of a company. Only individual partners can hold membership. This stance was affirmed by the Department of Company Affairs through an official circular. Similarly, a Hindu Undivided Family (HUF) lacks separate legal status, preventing it from becoming a member, although the Karta or co-parceners may individually do so. Conversely, a company, being a separate legal entity, can subscribe to the memorandum through an authorized signatory.

Competency of Subscribers to the Memorandum

Individuals subscribing to the memorandum must have the legal capacity to enter into contracts. Minors, individuals of unsound mind, and undischarged insolvents are disqualified from being subscribers, as they lack contractual competency. If a minor’s name appears as a subscriber, the Registrar of Companies has the authority to reject the registration application. If a guardian subscribes on behalf of a minor, the commitment is considered personal rather than on behalf of the minor.

Subscription Clause and Requirements

The Companies Act mandates that a minimum of seven subscribers for a public company and two for a private company must sign the memorandum. These subscribers can be natural or legal persons, and there is no restriction on foreign participation, provided compliance with the Foreign Exchange Management Act, 1999, is ensured. For an OPC, the subscriber must be a resident Indian, and a nominee must be appointed in case of incapacity. If a company is a subscriber, the authorized signatory must be duly empowered to act on its behalf.

Each subscriber must sign the memorandum in the presence of a witness, who must attest to the authenticity of the signature. In cases where an illiterate person is a subscriber, a thumb impression may be affixed, with an endorsement stating that the document was read and explained.

Payment Obligations for Subscribed Shares

Under the previous Companies Act, no specific timeframe was prescribed for payment against shares subscribed in the memorandum. However, the Companies Act, 2013, stipulates that such payment must be made within two months of incorporation. This provision ensures timely compliance with financial commitments and discourages undue delays.

Lawful Purposes of a Company

The incorporation of a company must be for legal purposes, ensuring compliance with public policy and statutory provisions. If any proposed objective is unlawful, the company’s formation may be invalidated. The Registrar of Companies has the authority to deny registration if any objectives contravene legal principles. Even after incorporation, if a company engages in prohibited activities, it may face regulatory action, including deregistration.

Registrar’s Role in Incorporation

The Registrar of Companies must register an entity if all procedural and legal requirements are met. However, if an application is incomplete or the intended activities are not lawful, registration may be refused. Courts have upheld the principle that the issuance of a certificate of incorporation does not validate unlawful objectives.

Separate Legal Entity and Nationality

Upon incorporation, a company attains a distinct legal personality, separate from its members. This doctrine has been reaffirmed through various judicial precedents. Additionally, the nationality of a company is determined by the jurisdiction in which it is incorporated, regardless of the nationality of its members.

Liability of Members

A company may be structured as limited by shares, limited by guarantee, or as an unlimited company. The liability of members in a company limited by shares is restricted to the unpaid amount on their subscribed shares. Any alteration in liability terms requires member consent.

Conclusion

The formation of a company involves adherence to various legal requirements to ensure compliance with corporate governance principles. By understanding these aspects, businesses can establish entities that operate within the legal framework while achieving their commercial objectives.

 

This article is presented by CA B K Goyal & Co LLP Chartered Accountants, your trusted partner in audit and compliance solutions. For expert assistance, feel free to contact us.