Detailed, Step-by-Step NCERT Solutions for 11 Business Studies Chapter 7 Formation of a Company Questions and Answers were solved by Expert Teachers as per NCERT (CBSE) Book guidelines covering each topic in chapter to ensure complete preparation.
Formation of a Company NCERT Solutions for Class 11 Business Studies Chapter 7
Formation of a Company Questions and Answers Class 11 Business Studies Chapter 7
Tick the followings :
Question 1.
Minimum number of members to form a private company is
(a)’2
(b) 3
(c) 5
(d) 7
Answer:
(a)’2
Question 2.
Minimum number of members to form a public company is
(a) 5
(b) 7
(c) 12
(d) 21
Answer:
(b) 7
Question 3.
Application for approval of name of a company is to be made to
(a) SEBI
(b) Registrar of Companies
(c) Government of India
(d) Government of the state in which company is to be registered
Answer:
(a) SEBI
Question 4.
A proposed name of company is considered undesirable if
(a) It is identical with the name of an existing company
(A) It is resembles closely with the name of an existing company
(c) It is an emblem of Government of India, United Nations etc.
(d) In case of any of the above.
Answer:
(d) In case of any of the above.
Question 5.
A prospectus is issued by
(a) A private company
(b) A public enterprise
(c) A public company seeking
(d) A public company investment from public
Answer:
(c) A public company seeking
Question 6.
Stages in the formation of a public company are in the following order ‘
(a) Promotion, Commencement of Business, Incorporation, Capital Subscription
(b) Incorporation, Capital Subscription, Commencement of Business Promotion.
(c) Promotion, Incorporation, Capital subscription, Commencement of Business
(d) Capital Subscription, Promotion, Incorporation,Commencement of Business
Answer:
(c) Promotion, Incorporation, Capital subscription, Commencement of Business
Question 7.
Preliminary contracts are signed
(a) Before the incorporation
(b) After incorporation but before capital subscription
(c) After incorporation but before commencement of business
(d) After commencement of business
Answer:
(a) Before the incorporation
Question 8.
Preliminary contracts are
(a) Binding on the company
(b) Binding on the company, if ratified after incorporation
(c) Binding on the company, after incorporation
(d) Not binding on the company.
Answer:
(b) Binding on the company, if ratified after incorporation
True-False Answer Questions
- It is necessary to get every company incorporated whether private or public.
- Statement in lieu of prospectus can be filed by a public company going for a public issue.
- A private company can commence business after incorporation.
- Experts who help promoters in the promotion of a company are also called promoters.
- A company can ratify preliminary contracts after incorporation.
- If a company is registered on the basis of fictitious names, its incorporation is invalid.
- Articles of Association’ is the main document of a company.
- Every company must file Articles of Association.
- A provisional contract is signed by promoters before the incorporation of a company.
- If a company suffers heavy losses and its assets are not enough to pay off its liabilities, the balance can be recovered from the private assets of its members.
Answer:
- True
- False
- True
- False
- True
- False
- False
- False
- False
- False
Short Answer Questions
Question 1.
Name the stages in the formation of a company.
Answer:
Formation of a company is a complex activity, involving these stages are as follows:
- Promotion Identification of business opportunities, analysis of its prospects, and initiating steps to form a company is known as promotion of a company.
- Incorporation Registration of a company as a body corporate under Companies Act, 1956 is known as incorporation.
- Subscription of Capital A public company’s raising hinds from the public by means of an issue of shares and debentures is known as a capital subscription.
- Commencement of Business the registrar issues certificate of commencement of business which is conclusive evidence of completion of the formation requirement of a company.
Question 2.
List the documents required for the incorporation of a company.
Answer:
Documents used information of a company – There are some basic documents that are required to be filed with the Registrar of Companies in the formation of a public company. These are :
- Memorandum of Association.
- Articles of Association.
- Prospectus or Statement in lieu of Prospectus.
- Consent of proposed Directors in Writing and Confirming that they agree to act in that capacity.
- The agreement which the company proposes to enter with an individual for appointment as the Managing Director or a whole-time Director or Manager.
- Statutory Declaration.
- Payment of fees.
Question 3.
What is a prospectus? Is it necessary for every company to file a prospectus?
Answer:
A prospectus is ‘any document described or issued as a prospectus including any notice, circular advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any shares or debentures of, a body corporate’.
In other words, it is an invitation to the public to apply for shares or debentures of the company or to make deposits in the company. It is issued by a public company which is seeking to raise the required funds from the public by means of an issue of shares and debentures.
It is not necessary for every company to file a prospectus. A statement in lieu of prospectus is filed with the Registrar of Companies if the company has adopted Table A of the Companies Act instead of Articles of Association. Private companies are not required to file a prospectus.
Question 4.
Explain the term ‘Minimum Subscription’
Answer:
Minimum Subscription – A public limited company cannot make an allotment of shares unless a minimum subscription is received in cash. The amount of minimum subscription (90 percent of the issued amount) as per SEBI guidelines must be raised within 90 days from the date of the closure of the issue.
In case it is not raised the Company must return to applicants whatever amount it has raised within the next 10 days. The purpose of the minimum subscription is to ensure that no company is allowed to commence its business without raising a sufficient amount of capital. Minimum subscription is required to provide for the following:
- The purchase price of any property bought or agreed to be bought;
- All preliminary expenses, including underwriting commission and brokerage;
- Repayment of any money borrowed for the above purpose;
- Working capital; and
- Any other expenditure.
The company is required to file a declaration that the minimum subscription has been received in cash. This provision is not applicable to private companies.
Question 5.
Explain briefly the term ‘Return of Allotment’.
Answer:
Return of Allotment is a statement submitted to the Registrar which contains the names and addresses of shareholders and the number of shares allotted to each shareholder. Return of allotment, signed by a director or secretary is filed with the Registrar of Companies within 30 days of allotment. Return of allotment shows that the company has received the minimum subscription.
Question 6.
At which stage in the formation of a company does it interact with SEBI.
Answer:
Floatation of Capital Subscription – A private company can commence business immediately after incorporation. But a public company must raise the necessary capital and obtain the certificate of commencement of business before starting its operations. Capital subscription or floatation involves the following steps:
(1) Permission of Capital Issue – A company must ensure that the proposed issue of shares/debentures is in accordance with the guidelines prescribed by the Securities Exchange Board of India (SEBI). These guidelines have been laid down to protect the interests of investors. A draft prospectus containing the required particulars is vatted by SEBI prior to the public issue of shares/debentures. A company inviting funds from the general public must make before SEBI adequate disclosures of all relevant information and must not conceal any material fact.
(2) Appointment of Brokers etc. – The next step is to appoint brokers, bankers, secretaries, auditors, etc. for the company. Such appointments are made in a meeting of the Board of Directors.
(3) Underwriting – The underwriters for the capital issue are appointed. An agreement is made with each underwriter stating the amount underwritten and the underwriting commission. Underwriters undertake to buy the shares of these are not subscribed by the public.
(4) Filling o! Prospectus – A prospectus is drafted, printed and issued. A copy of the prospectus or statement in lieu of prospectus is filed with the Registrar of Companies.
(5) Listing of Shares in Stock Exchange – An application is made to the recognised Stock Exchange for permission for dealings in the shares or debentures. If such permission is not granted before the expiry of ten weeks from the date of closure of subscription list, the allotment shall become void and all money returned to applicants.
(6) Subscription – Application in the prescribed form along with the application money are received by the company’s bankers. The subscription list has to be kept open for a minimum period of three days and then it is closed at the discretion of the Board of Directors.
(7) Allotment of shares – Allotment letters are issued to the successful allotees. Return of allotment, signed by a director or secretary’ is filed with the Registrar of Companies within 30 days of allotment.
Question 7.
Distinguish between ‘Preliminary Contracts’ and ‘Provisional Contracts’.
Answer:
Preliminary contracts:
- Contracts signed by promoters with third parties before the incorporation of the company.
- These are not legally binding on the company and cannot be ratified after incorporation.
- These contracts are the liabilities of promoters.
- Both private and public companies have the right to undertake these contracts.
Provisional Contracts:
- Contracts signed after incorporation but before the commencement of business.
- These become enforceable only after the company gets the certificate of Commencement of Business.
- These contracts are the responsibilities of the company.
- They can only be undertaken by a public company.
Long Answer Questions
Question 1.
What is meant by the term ‘Promotion’. Discuss the legal position of promoters with respect to a company promoted by them.
Answer:
Meaning and Functions of Promoters :
Meaning of Promotion – The term promotion refers to the sum total of activities by which a business enterprise is bring into existence. It consists of the business operations by which a company is established. It is the process of planning and organising the finances and other resources of a business enterprise in the corporate form.
“Promotion is the discovery of business opportunities and the subsequent organisation of funds, property and management ability into business concern for the purpose of making profit therefrom.” — C. W Gensterberg
Definition of Promoter – The person who identify a business idea and initiate to start a company to give a practical shape to the idea are known as promoters. A promoter qonceives the idea of a business enterprise. Thus, apart from conceiving a business opportunity the promoters analyse the prospectus and bring together the men, materials, machinery, managerial abilities and financial resources.
A promoter may be an individual, a firm, association or even a company engaged in the formation of the company. The pioneering promoters in India include Jamshedji N. Tata, Ghanshyam Das Birla, Gujjar Mai Modi, Dhirubhai Ambani.
Role (Functions) of Promoters – The functions or roles of promoters are discussed below :
(1) Discovery of Business Idea It is the promoter who conceives an idea of starting a business for making profit. With his experience, the promoter discovers the field of gainful investment. His knowledge enables him to judge fine soundness of a particular proposal. He also undertakes a preliminary analysis of risk involved, capital required, etc. Such analysis on idea is then analysed to see the technical and economic feasibility.
(2) Detailed Investigation – The promoter undertakes detailed investigation to find out whether the business which he intends to start will be profitable or not. Sometimes an idea may be good but technically not possible to execute. For this purpose, he can take the help of experts like engineers, accountants, cost accountants, market research specialists, etc. This will enable him to know the probable cost of production per unit and the probable demand of the product, etc.
(3) Assembly of Resources – After the promoter is convinced of the feasibility and profitability of the proposition, he takes steps to give the idea a practical shape. Assembling involves making contracts for the purchase of materials, land, machinery, tools, capital, etc. Decisions have to be made regarding the size, location, layout, etc., of the enterprise. Plans are prepared for the procurement of required workforce. Promoters usually take the help of experts while deciding such things.
(4) Preparation of Documents – The promoters prepare the ‘Memorandum of Association’ and ‘Articles of Association”. These documents are essential for the incorporation of the company. After incorporation, they have to prepare prospectus or ‘statement in lieu of prospectus’ to raise capital from the market and obtain certificate for commencement of business and have to select a name for the company and submit application to the registrar of companies of the state in which the registered office of the company is to be situated.
(5) Motivating signatories to Memorandum – To give practical shape to their proposal, the promoters motivate influential businessmen and executives to be the signatories (or founder members) to the Memorandum of Association. In case of a public company, at least seven signatories are required whereas in case of a private company, minimum of two signatories are required. The promoters also find out the first directors of the company. Their written consent to act as directors and to take up the qualification shares in the-company is necessary.
(6) Entering into Preliminary Contracts – The promoters make contracts (preliminary) regarding the purchase of property such as land, buildings, and machinery which require huge sums of money. They also enter into arrangements with the suppliers of materials and buyers of the company’s products.
(7) Appointment of Professionals – The promoters appoint the bankers of the company. They may also appoint merchant bankers, underwriters, solicitors, etc. to manage the issue of new capital.
8. Obtaining Licence – The promoters also take steps to obtain license from the government if the product to be manufactured by the company is covered by the licensing policy of the government.
Legal Status of a Promoter -During the preliminary stage, a company does not come into existence. Therefore, a cannot be called an agent or trustee of the company. However, a promoter stands in a fiduciary relationship with the company he is promoting, i.e. a relationship involving confidence or trust. The relationship of good faith requires the promoter to act honestly and sincerely and in the best interests of the company.
He should not misuse his position for personal gain. Promoters can make a profit only if it is disclosed but must not make any secret profits. In the event of non-disclosure, the company can rescind the contract and recover the purchase price paid to the promoters. It can claim damages for the loss suffered due to the non disclosure of material information. Given below are the liabilities of a promoter:
- To disclose full details of the nature and extent of money taken by him in the process of promotion;
- To deposit all money received on behalf of the company in the company’s bank account;
- To refrain from selling his own property to the company at unreasonably high prices;
- To exercise due to care and intelligence in the work of promotion;
- To act without deceit, misfeasance or breach of trust towards the company;
- To surrender any secret profits made during promotion of the company;
- To be personally liable for preliminary contracts till they are approved by the company;
- To pay compensation to those who have invested money in the company on the basis of untrue statements or misrepresentation in the prospectus;
- To be liable for failure to comply with the legal formalities; and
- To make good any loss caused to the company on account of negligence or breach of trust.
Question 2.
Explain the steps taken by promoters in the promotion of a company.
Answer:
(i) Identification of business opportunity:
The first and foremost activity of a promoter is to identify a business opportunity. The opportunity may be in respect of producing a new product or service or making some product available through a different channel or any other opportunity having investment potential. Such opportunity is then analysed to see its technical and economic feasibility.
(ii) Feasibility studies:
It may not be feasible or profitable to convert all identified business opportunities into real projects. The promoters, therefore, undertake detailed feasibility studies to investigate all aspects of the business they intend to start. Depending upon the nature of the project, the following feasibility studies were maybe undertaken, with the help of the specialists like engineers, chartered accountants etc., to examine whether the perceived business opportunity can be profitably exploited.
(a) Technical feasibility:
Sometimes an idea may be good but technically not possible to execute. It may be so because the required raw material or technology is not easily available. For example, in our earlier story suppose Avtar needs a particular metal to produce the carburettor.
If that metal is not produced in the country and because of poor political relations, it can not be imported from the country which produces it, the project would be technically unfeasible until arrangements are made to make the metal available from alternative sources.
(b) Financial feasibility:
Every business activity requires funds. The promoters have to estimate the fund requirements for the identified business opportunity. If the required outlay for the project is so large that it cannot easily be arranged within the available means, the project has to be given up. For example, one may think that developing townships is very lucrative.
It may turn out that the required funds are in several crores of rupees, which cannot be arranged by floating a company by the promoters. The idea may be abandoned because of the lack of financial feasibility of the project.
(c) Economic feasibility:
Sometimes it so happens that a project is technically viable and financially feasible but the chance of it being profitable is very little. In such cases as well, the idea may have to be abandoned. Promoters usually take the help of experts to conduct these studies.
It maybe noted that these experts do not become promoters just because they are assisting the promoters in these studies. Only when these investigations throw up positive results, the promoters may decide to actually launch a company.
(iii) Name approval:
Having decided to launch a company, the promoters have to select a name for it and submit, an application to the registrar of companies of the state in which the registered office of the company is to be situated, for its approval. The proposed name may be approved if it is not considered undesirable.
It may happen that another company exists with the same name or a very similar name or the preferred name is misleading, say, to suggest that the company is in a particular business when it is not true. In such cases the proposed name is not accepted but some alternate name may be approved.
Therefore, three names, in order of their priority are given in the application to the Registrar of Companies. (Performa Application for the availability of names (Form 1 A) is given at the end of the chapter.)
(iv) Fixing up Signatories to the Memorandum of Association:
Promoters have to decide about the members who will be signing the Memorandum of Association of the proposed company. Usually, the people signing the memorandum are also the first Directors of the Company. Their written consent to act as Directors and to take up the qualification shares in the company is necessary.
(v) Appointment of professionals:
Certain professionals such as mercantile bankers, auditors etc., are appointed by the promoters to assist them in the preparation of necessary documents which are required to be with the Registrar of Companies. The names and addresses of shareholders and the number of shares allotted to each is submitted to the Registrar in a statement called the return of allotment.
(vi) Preparation of necessary documents:
The promoter takes up steps to prepare certain legal documents, which have to be submitted under the law, to the Registrar of the Companies for getting the company registered. These documents are Memorandum of Association, Articles of Association and Consent of Directors.
Question 3.
What is a ‘Memorandum of Association’? Briefly explain its clauses.
Answer:
Memorandum of Association is the most important document as it defines the objectives of the company. No company can legally undertake activities that are not contained, in ns Memorandum of Association. As per section 2(56) of The companies Act, 2013 “memorandum” means the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous company law or of this Act.
The Memorandum of Association contains different clauses, which are given as follows:
(i) The name clause:
This clause contains the name of the company with which the company will be known, which has already been approved by the Registrar of Companies.
(ii) Registered office clause:
This clause contains the name of the state, in which the registered office of the company is proposed to be situated. The exact address of the registered office is not required at this stage but the same must be notified to the Registrar within thirty days of the incorporation of the company.
(iii) Objects clause:
This is probably the most important clause of the memorandum. It defines the purpose for which the company is formed. A company is not legally entitled to undertake an activity, which is beyond the objects stated in this clause. The object clause is divided into two subclauses, which are:
- The main objects: The main objects for which the company is formed are listed in this sub-clause. It must be observed that an act which is either essential or incidental for the attainment of the main objects of the company is deemed to be valid, although it may not have been stated explicitly in the sub-clause.
- Other objects: Objects not included in the main objects could be stated in this sub-clause. However, if a company wishes to undertake a business included in this subclause, it has to either pass a special resolution or pass an ordinary resolution and get centred government’s approval for the same.
(iv) Liability clause:
This clause limits the liability of the members to the amount unpaid on the shares owned by them. For example, if a shareholder has purchased 1000 shares of Rs. 10 each and has already paid Rs. 6 per share, his/her liability is limited to Rs. 4 per share. Thus, even in the worst case, he/she may be called upon to pay Rs. 4,000 only.
(v) Capital clause:
This clause specifies the maximum capital which the company will be authorised to raise through the issue of shares. The authorised share capital of the proposed company along with its division into the number of shares haying a fixed face value is specified in this clause.
For example, the authorised share capital of the company may be Rs. 25 with divided into 2.5 lakh shares of Rs. 10 each. The said company cannot issue share capital in excess of the amount mentioned in this clause.
Question 4.
Distinguish between ‘Memorandum of Association’ and ‘Articles of Association’.
Answer:
The relationship between Memorandum and Articles may be viewed from the opinion of Lord Cairns that articles play a part subsidiary to a Memorandum of Association. Memorandum is the area beyond which the actions of the company cannot go, but Articles are subordinate to the Memorandum. The main points of distinction between Memorandum and Articles are given below in the table :
| Basis | Memorandum of Association | Articles of Association |
| 1. Purpose | To lay down the charter or the constitution of the company. | To provide rules and regulations for smooth internal management of the company. |
| 2. Scope | It defines objects and powers of the company beyond which the company cannot go. Besides, it contains name, place, capital, liability clauses. | It lays down ways and means to achieve objects laid down in the Memorandum. It contains rules and regulations for management of internal affairs of the company. |
| 3. Status | It is the fundamental document of the company | It is a supplementary’ document and is subordinate to the Memorandum. |
| 4. Relationship | It governs external relations between the company and outsiders. | It controls internal relations between the company and its members. |
| 5. Filing with Registrar | It is a compulsory document. It must be filed with the Registrar of Companies before incorporation. | Filling of Articles is not compulsory. A company may adopt the model articles given under table ‘A’. |
| 6. Legal Effect | Acts done beyond the Memorandum are void and are not legally binding on the company. | Acts done beyond the Articles can be ratified by the shareholders. |
| 7. Alteration | It is very difficult to alter this document. It can be altered only under certain circumstances and sometimes with the permission of the Central Government or Company Law Board. | It is not very difficult to amend the articles. Generally, articles can be altered by a special resolution passed in the general meeting of the company. |
Question 5.
What is the effect of conclusiveness of the ‘Certificate of Incorporation’ and ‘Commencement of Business’.
Answer:
Effect of the Certificate of Incorporation:
A company is legally born on the date printed on the Certificate of Incorporation It becomes a legal entity with perpetual succession on such date. It becomes entitled to enter into valid contracts. The Certificate of Incorporation is conclusive evidence of the regularity of the incorporation of a company.
Imagine, what would happen to an unsuspecting party with which the company enters into a contract, if it is later found that the incorporation of the company was improper and hence invalid. Therefore, the legal situation is that once a Certificate of incorporation has been issued, the company has become a legal business entity irrespective of any flaw in its registration.
The Certificate of Incorporation is thus conclusive evidence of the legal existence of the company. Some interesting examples showing the impact of the conclusiveness of the Certificate of Incorporation are as under:
- Documents for registration were filed on 6th January. Certificate of Incorporation was issued on 8th January. But the date mentioned on the Certificate was 6th January. It was decided that the company was in existence and the contracts signed on 6th January were considered valid.
- A person forged the signatures of others on the Memorandum. The Incorporation was still considered valid.
Thus, whatever be the deficiency in the formalities, the Certificate of Incorporation once issued, is conclusive evidence of the existence of the company. Even when a company gets registered with illegal objects, the birth of the company cannot be questioned. The only remedy available is to wind it up.
Because the Certificate of Incorporation is so crucial, the Registrar has to go very carefully before issuing it. On the issue of Certificate of Incorporation, a private company can immediately commence its business. It can raise necessary funds from friends, relatives or through private arrangements and proceed to start a business. A public company, however, has to undergo two more stages in its formation.
Question 6.
Is it necessary for a public company to get its share listed on a stock exchange? What happens if a public company going for a public issue fails to apply to a stock exchange for permission to deal in its securities or fails to get such permission?
Answer:
Applying with a stock exchange for permission to deal in shares before the issue – Every company intending to offer shares or debentures to the public by the issue of the prospectus shall make an application before the issue, to one or more recognised stock exchanges for permission for the shares or debentures to be dealt with at the exchange (Section 73C) of Companies Act 1956.
Stating the name of Exchanged in the Prospectus – Where a prospectus states that an application has been made for permission for shares or debentures to be dealt at one or more recognised stock exchanges, such prospectus shall state the name of stock exchange(s).
Allotment Void if Permission not Granted – Any allotment made shall be void if the permission has not been granted by the stock exchange before the expiry of ten weeks from the date of the closing of the subscription lists.
Repayment of Money on Refusal of Permission – Where the permission has not been granted by the stock exchange(s), the company shall forthwith repay without interest all moneys received from applicants. If any such money is not repaid within 7 days after the company becomes liable to repay it, the company and every director of the company who is an officer in default shall, on and from the expiry of the seventh day, be jointly and severally liable to repay that money with prescribed rate of 15 percent. If default is made in repayment of the amount, the company and every officer of the company, who is in default, shall be punishable with fine which may extend to Rs. Fifty thousand.