flowchart TD
A["<b>Incorporation</b><br>registration with the<br>Registrar of Companies"] --> B["<b>Separate legal person</b>"]
B --> C["<b>Limited liability</b><br>members risk only<br>what they agreed to pay"]
B --> D["<b>Perpetual succession</b><br>the company survives<br>changes in membership"]
B --> E["<b>Own property</b><br>assets belong to the<br>company, not the members"]
B --> F["<b>Capacity to contract</b><br>and to sue and<br>be sued in its own name"]
B -.->|"in defined cases"| G["<b>Veil lifted</b><br>the law looks at<br>the persons behind"]
style A fill:#e3f2fd,stroke:#1976D2
style B fill:#ede7f6,stroke:#7E57C2
style G fill:#ffebee,stroke:#C62828
11 Company Law Basics: Incorporation and Company Types
ImportantLearning Objectives
You will be able to:
- Explain what separate legal personality means and identify the consequences that follow from it.
- Identify the circumstances in which a court or statute will look behind the corporate form.
- Classify companies by liability, by membership and by control, and compare a private company with a limited liability partnership.
- Describe the steps in incorporating a company in India and the documents that constitute it.
- Apply the doctrines of ultra vires, constructive notice and indoor management to determine whether a company is bound by a transaction.
11.1 Introduction
The first ten chapters treated the firm as an actor without asking what kind of thing it is. This chapter asks. A company is not its shareholders, not its directors, and not its business. It is a person the law creates, and almost everything distinctive about corporate life follows from that single legal fact (K. R. Bulchandani, 2021).
The consequences are practical and immediate. A company owns its own assets, so a majority shareholder cannot treat the company’s property as his own. A company owes its own debts, so creditors of a failed business cannot ordinarily reach the members’ personal wealth. A company outlives its founders, contracts in its own name, and sues and is sued as itself. Managers who do not hold this distinction firmly make two opposite errors: they treat a private company as an extension of the family, and they assume the corporate form is an impenetrable shield.
This chapter covers what a company is, what kinds there are, how one comes into existence, and the doctrines that decide when a company is bound by what someone did in its name. The statute throughout is the Companies Act, 2013 (Government of India, 2013).
11.2 Separate Legal Personality
On registration, a company becomes a body corporate capable of exercising all the functions of an incorporated company, with perpetual succession and power to acquire, hold and dispose of property in its own name (Government of India, 2013). Four consequences follow, and they are worth stating separately because managers routinely confuse them.
NoteThe Four Consequences of Incorporation
| Consequence | What it means |
|---|---|
| Separate legal entity | The company is distinct from its members. It can contract with its own shareholders, employ them, and sue them |
| Limited liability | A member’s liability is limited to the amount unpaid on their shares, or to the amount guaranteed. The company’s debts are not the members’ debts |
| Perpetual succession | Membership may change entirely and the company continues unchanged. Death or insolvency of a member does not affect it |
| Property and capacity | Assets belong to the company. A shareholder, however large, has no insurable or proprietary interest in any particular asset |
WarningCommon Misconception: Limited Liability Means the Promoter Is Never Exposed
Limited liability limits a member’s exposure as a member. It says nothing about exposure arising in other capacities, and in a closely held Indian company the same individual usually occupies several.
A promoter who personally guarantees the company’s bank borrowing is liable on the guarantee to its full extent. A director who breaches a statutory duty, or is an officer in default under a provision imposing personal liability, is liable in that capacity. A person who continues to trade while knowing the company cannot pay, or who uses the company to defraud creditors, faces liability the corporate form does not touch. And where the company’s affairs are so entangled with the promoter’s own that the separation is a fiction, a court may disregard it.
The protection is real, but it protects an investment, not a person’s conduct.
11.2.1 Lifting the Corporate Veil
Courts and statutes look behind the corporate form only in defined situations, because the value of the form depends on its being respected in ordinary cases.
| Ground | Illustration |
|---|---|
| Fraud or improper conduct | The form is used to evade an existing obligation or to defraud creditors |
| Sham or facade | The company exists only as a device, with no genuine business of its own |
| Agency or alter ego | The company acts wholly as the agent or instrument of another person or company |
| Evasion of a legal obligation | A company is formed to escape a contractual restraint or a tax liability arising from a specific transaction |
| Determination of character | Wartime and similar cases where the enemy character of controllers matters |
| Statutory lifting | Provisions of the Act and other statutes that impose personal liability on officers in default, or on those who conduct business fraudulently |
The point to hold is that lifting the veil is a remedy directed at conduct, not a general licence to ignore corporate structure. A creditor who simply cannot recover from a company has no claim against its shareholders.
11.3 The Kinds of Company
The Act classifies companies along three axes at once, so any given company carries a description from each.
NoteClassification
| Basis | Categories | Notes |
|---|---|---|
| Liability of members | Limited by shares; limited by guarantee; unlimited | Limited by shares is the ordinary commercial form. Guarantee companies are used where there is no share capital, often for clubs and not-for-profit bodies |
| Number of members and public access | One Person Company; private company; public company | A private company restricts transfer of its shares and prohibits invitation to the public. A public company may invite public subscription and faces heavier governance obligations |
| Control | Holding, subsidiary, associate | Determined by control of composition of the board or of voting power, and by significant influence for associates |
Several further descriptions sit on top of these.
- A small company is a private company below the capital and turnover thresholds prescribed by the rules, which are revised from time to time. It receives relaxations in filings, board meetings and audit-related requirements.
- A Section 8 company is formed to promote commerce, art, science, education, research, social welfare, religion, charity or environmental protection, applies its profits to those objects, and pays no dividend to members.
- A government company is one in which the central or a state government holds not less than the prescribed proportion of the paid-up share capital.
- A foreign company is one incorporated outside India that has a place of business in India, and is subject to specified provisions of the Act.
- A dormant company is one with no significant accounting transaction, which may obtain that status to hold an asset or a name.
- A listed company is one whose securities are listed on a recognised stock exchange, which brings SEBI’s listing obligations on top of the Act. Module IV takes that layer.
11.3.1 The Company Compared with the Limited Liability Partnership
The LLP is governed by its own statute (Government of India, 2008) and is the form most often weighed against a private company by professional firms and small businesses.
| Private company | Limited liability partnership | |
|---|---|---|
| Governing statute | Companies Act, 2013 | Limited Liability Partnership Act, 2008 |
| Separate legal personality | Yes | Yes |
| Liability of owners | Limited to unpaid amount on shares | Limited, except for a partner’s own wrongful act |
| Internal governance | Board of directors, memorandum and articles, statutory meetings | LLP agreement between partners, considerable freedom |
| Compliance burden | Heavier: board and general meetings, statutory registers, wider filing | Lighter, with audit required only above prescribed thresholds |
| Raising equity | Can issue shares, take institutional investment, convert to public and list | Cannot issue shares, which makes external equity difficult |
| Suitability | A business intending to raise outside capital or scale | A professional practice or closely held business prioritising simplicity |
TipPractitioner Insight: Choose the Form for the Funding Path, Not the Filing Burden
Founders commonly select an LLP because the compliance is lighter, and then discover the constraint when the business needs money. Venture and private equity investment is built around shares, preference rights, and instruments an LLP cannot issue. Converting later is possible but costs time and tax analysis at exactly the moment the business is trying to close a round.
The question to ask at formation is not which form is easier this year. It is whether external equity is plausible within three to five years. If it is, the private limited company is the form the funding market is built for, and the extra compliance is the price of being fundable.
11.4 Incorporating a Company
Incorporation in India is now largely an online process through the Ministry of Corporate Affairs, using an integrated form that combines several applications that were once separate.
NoteThe Steps
| Step | What happens |
|---|---|
| Digital signature and director identification | Proposed directors obtain a digital signature certificate, and a Director Identification Number is allotted through the incorporation form |
| Name reservation | A proposed name is applied for and must not be identical to an existing company or registered trade mark, nor undesirable in the opinion of the central government |
| Drafting the constitutional documents | The memorandum of association and articles of association are prepared and subscribed |
| Filing the integrated application | A single web form carries incorporation, allotment of identification numbers, and registrations including permanent account number and tax deduction account number |
| Certificate of incorporation | The Registrar registers the company and issues the certificate, which carries the Corporate Identity Number and is conclusive evidence of incorporation |
| Declaration before commencement | A company with share capital files a declaration that subscribers have paid the value of shares agreed and verifies its registered office, before it may commence business or exercise borrowing powers |
11.4.1 The Memorandum and the Articles
These two documents are the company’s constitution, and the division of labour between them is precise.
The memorandum of association faces outward. It states the name, the state in which the registered office is situated, the objects for which the company is proposed to be incorporated, the liability of members, and the share capital, together with the subscription by the first members.
The articles of association face inward. They contain the regulations for management: how shares are issued and transferred, how meetings are called and conducted, how directors are appointed and removed, how dividends are declared. A company may adopt the model articles in the schedules to the Act or register its own.
Where the two conflict, the memorandum prevails. Both are filed with the Registrar and are public documents, which is what makes the next set of doctrines work.
11.5 Three Doctrines That Decide Whether the Company Is Bound
A manager dealing with another company needs to know when that company is committed by what its people do. Three doctrines answer the question, and they interlock.
Ultra vires. An act beyond the objects in the memorandum is beyond the company’s capacity. Such an act is void and cannot be ratified even by unanimous shareholder agreement, since the members cannot enlarge a capacity the constitution does not confer. The 2013 Act permits objects to be framed broadly, so the doctrine bites less often than it once did, but it has not disappeared, and it remains sharpest where a company has deliberately narrow objects, as many joint venture and special purpose vehicles do.
Constructive notice. Because the memorandum and articles are registered and open to public inspection, every person dealing with the company is deemed to have notice of their contents. A party cannot say it did not know of a restriction that the articles plainly contained.
Indoor management. Constructive notice alone would make commerce impossible, because an outsider can read the articles but cannot see whether the internal steps they require were actually taken. The rule in Royal British Bank v Turquand supplies the balance: a person dealing in good faith with a company is entitled to assume that the internal procedures have been complied with. If the articles permit borrowing subject to a board resolution, an outsider may assume the resolution was passed.
NoteWhen Indoor Management Does Not Protect
| Exception | Why |
|---|---|
| Knowledge of the irregularity | A party who knew the internal step was not taken cannot assume it was |
| Suspicion that should have prompted inquiry | The rule protects good faith, not indifference to obvious warning signs |
| Forgery | A forged document is a nullity, and no assumption can validate it |
| Acts outside apparent authority | The rule assumes proper performance of an authority that appears to exist, not the creation of one that does not |
| No reliance on the articles | A person who never consulted the articles cannot claim to have relied on the appearance they create |
TipPractitioner Insight: Ask for the Resolution Anyway
Indoor management is a defence to fall back on, not a procedure to rely on. It protects good faith, and the moment a counterparty has anything that should have raised a question, the protection weakens. Obtaining a certified copy of the board resolution authorising the transaction, together with the signatory’s authority, costs one e-mail and removes the argument entirely.
The habit matters most in exactly the transactions where it is most often skipped: an urgent order from a familiar customer, a guarantee signed by a director of a group company, an amendment agreed informally with a long-standing supplier.
11.6 Case Studies
11.6.1 Case Study 1: The Company and Its Owner Are Different Persons
In Salomon v A Salomon and Company Limited, a sole trader transferred his boot business to a company he formed, taking shares and secured debentures in payment. The company failed, and its unsecured creditors argued that the company was a mere sham, effectively the same person as Salomon, and that he should be made to pay its debts.
The House of Lords rejected the argument. Once the company had been duly registered in compliance with the statute, it was a distinct person in law, and the motives of those forming it were irrelevant. Salomon’s security ranked ahead of the unsecured creditors. The decision has been treated as foundational in India as well, and it is why the separate entity principle is stated as strongly as it is.
Discussion questions
- The creditors dealt with a business that looked exactly as it had before incorporation. Why should the change of legal form defeat them?
- What protection does a trade creditor of a small private company actually have, given this decision?
- What would the creditors have had to prove to succeed?
11.6.2 Case Study 2: The Veil Lifted to Reach the Assets
In Delhi Development Authority v Skipper Construction Company Private Limited, a builder collected money from many purchasers for a property it was not entitled to sell, and the funds were dispersed among companies and family members while the promoters resisted enforcement.
The Supreme Court was prepared to look behind the corporate structure to reach assets held in the names of the promoters and their relatives. Where the corporate form has been used as a device to defraud, the Court held, it may be disregarded so that the persons who actually control the enterprise are made answerable.
Discussion questions
- What distinguishes this case from Salomon, where the corporate form was also being used to the owner’s advantage?
- Why is the remedy directed at conduct rather than at the size or closeness of the company?
- What warning signs should a purchaser have looked for before paying money to this structure?
11.6.3 Case Study 3: The Guarantee Nobody Approved (illustrative)
The following situation is constructed rather than reported, in order to test the three doctrines together.
A bank lends to a manufacturing company against a corporate guarantee from an affiliated company. The affiliate’s articles permit it to guarantee the obligations of group companies, subject to a resolution of its board. The guarantee is signed by the affiliate’s managing director, who tells the bank the board approved it. No resolution was ever passed. The bank does not ask for a copy. Separately, one signature on the guarantee turns out to have been forged by an employee of the affiliate. When the borrower defaults, the affiliate denies liability.
The analysis separates the two defects. On the missing resolution, the bank would ordinarily be protected by indoor management, since the articles permitted the guarantee and the bank was entitled to assume that the internal step required had been taken. On the forged signature, the position reverses entirely, because a forgery is a nullity and no assumption of regularity can breathe life into it. Whether the bank keeps its protection on the first point may also depend on whether anything in the dealings should have prompted inquiry.
Discussion questions
- Why does the law protect the bank on the unpassed resolution but not on the forgery?
- If the bank’s relationship manager had been told by a junior officer that the board was unlikely to approve, what happens to the protection?
- What is the one document the bank should have obtained, and what would it have cost?
11.7 Applying the Chapter
ImportantExercise: Choosing and Constituting the Vehicle
Three siblings run a profitable food processing business in Guntur as a partnership. Revenue is growing, a regional private equity fund has shown interest, and one sibling wants to start a separate organic snacks brand. They have been advised variously to incorporate a private company, to form an LLP, and to leave things as they are. The eldest sibling has personally guaranteed the firm’s bank limit and has been told that incorporating will end that exposure.
Working in a group, advise them.
- Recommend a form for the main business, and justify it against the two alternatives. Give explicit weight to the private equity interest and say what would change your recommendation.
- Correct the misconception. Explain to the eldest sibling exactly what incorporation does and does not do to the personal guarantee, and identify two other routes by which personal liability could still arise after incorporation.
- Draft the constitutional questions. List the five decisions the siblings must make before the memorandum and articles can be drafted, and explain what turns on each.
- Handle the new venture. Recommend whether the organic snacks brand should be a separate company, a division, or a subsidiary. State the consequence of your choice for liability, for the investor’s diligence, and for a future sale of one business but not the other.
- Assess veil risk. Identify three habits common in family businesses that would make a court more willing to disregard the corporate form, and recommend a control for each.
Present the advice as a one-page note to the three siblings, with a table comparing the forms and a short annexure listing the incorporation steps in order.
11.8 Summary
NoteChapter Summary
A company is a legal person distinct from the people who own and run it (Government of India, 2013). From that follow four consequences: it is a separate entity that may contract with its own members, its members enjoy limited liability, it has perpetual succession, and it owns its property in its own name so that no shareholder has a proprietary interest in any particular asset (K. R. Bulchandani, 2021).
Limited liability protects an investment rather than a person’s conduct. A promoter remains liable on a personal guarantee, a director remains liable for statutory breaches and as an officer in default, and courts will lift the veil where the form is used for fraud, as a sham, as the alter ego of a controller, or to evade an existing obligation, alongside instances where a statute itself imposes personal liability.
Companies are classified by liability, by membership and by control at once, with further descriptions for small, Section 8, government, foreign, dormant and listed companies. The limited liability partnership (Government of India, 2008) offers separate personality and limited liability with a lighter compliance load, but it cannot issue shares, which is why the funding path rather than the filing burden should decide the choice at formation.
Incorporation proceeds through digital signatures and director identification, name reservation, the memorandum and articles, an integrated filing, the certificate of incorporation carrying the Corporate Identity Number, and a declaration before commencement of business. The memorandum faces outward and states name, registered office, objects, liability and capital; the articles face inward and govern management; and the memorandum prevails on conflict.
Three doctrines decide whether a company is bound. Ultra vires makes an act beyond the objects void and incapable of ratification. Constructive notice deems everyone to know the registered documents. Indoor management then protects a person dealing in good faith, who may assume internal procedures were followed, subject to exceptions for knowledge, suspicion, forgery, acts outside apparent authority, and absence of reliance.
TipKey Terms
Body corporate · Separate legal entity · Limited liability · Perpetual succession · Lifting the corporate veil · Sham or facade · Alter ego · Officer in default · Company limited by shares · Company limited by guarantee · Private company · Public company · One Person Company · Holding and subsidiary · Associate company · Small company · Section 8 company · Foreign company · Listed company · Limited liability partnership · Certificate of incorporation · Corporate Identity Number · Memorandum of association · Articles of association · Objects clause · Ultra vires · Constructive notice · Indoor management
Summary
| Concept | Description |
|---|---|
| Separate Personality | |
| Separate legal entity | The principle that the company is a person distinct from its members, able to contract with and sue them |
| Limited liability | A member's exposure confined to the amount unpaid on shares or the sum guaranteed |
| Perpetual succession | The company's continuity through complete changes of membership, unaffected by a member's death |
| Company property | Assets vested in the company, in which no shareholder holds a proprietary or insurable interest |
| Personal guarantee | The commonest route by which a promoter remains personally liable despite incorporation |
| Officer in default | The capacity in which a director or officer bears personal liability for statutory breaches |
| Piercing the Veil | |
| Lifting the corporate veil | The court's disregard of the corporate form, directed at conduct rather than at closeness of ownership |
| Sham or facade | A company existing only as a device, with no genuine business of its own |
| Alter ego | A company acting wholly as the instrument of another person or company |
| Statutory lifting | Provisions of the Act and other statutes imposing personal liability directly on officers |
| Kinds of Company | |
| Company limited by shares | The ordinary commercial form, in which liability attaches to the unpaid amount on shares |
| Company limited by guarantee | A form used where there is no share capital, with members guaranteeing a sum on winding up |
| Private company | A company restricting share transfer and prohibiting invitation to the public |
| Public company | A company that may invite public subscription and carries heavier governance obligations |
| One Person Company | A company with a single member, introduced by the Companies Act, 2013 |
| Holding and subsidiary | The relationship established by control of board composition or of voting power |
| Small company | A private company below prescribed capital and turnover thresholds, receiving compliance relaxations |
| Section 8 company | A company formed for charitable or similar objects, applying profits to them and paying no dividend |
| Listed company | A company whose securities are listed, adding SEBI listing obligations on top of the Act |
| The LLP Alternative | |
| Limited liability partnership | A separate legal person with limited liability and lighter compliance, unable to issue shares |
| Choosing for the funding path | The formation decision that asks whether external equity is plausible, not which form files less |
| Incorporation | |
| Name reservation | The step at which a proposed name is tested against existing companies and registered trade marks |
| Certificate of incorporation | The Registrar's certificate, which is conclusive evidence that the company is incorporated |
| Corporate Identity Number | The unique identifier assigned to the company on registration |
| Declaration before commencement | The filing confirming subscribers have paid and the registered office is verified, before business may begin |
| Memorandum of association | The outward-facing constitution stating name, registered office, objects, liability and capital |
| Articles of association | The inward-facing regulations governing shares, meetings, directors and dividends |
| Objects clause | The statement of purposes, which still constrains capacity in narrowly drafted vehicles |
| Is the Company Bound | |
| Ultra vires | An act beyond the company's objects, which is void and cannot be ratified even unanimously |
| Constructive notice | The deemed knowledge of registered documents held by everyone dealing with the company |
| Indoor management | The good faith outsider's entitlement to assume that required internal procedures were followed |
| Exceptions to indoor management | Knowledge, suspicion, forgery, acts outside apparent authority, and absence of reliance on the articles |