NCERT Solutions for Class 11 Business Studies Chapter 7: Formation of a Company

Chapter at a glance

Exercises – Short Answer Questions

Question SA – Q1

Name the stages in the formation of a company.

Answer

1. Promotion
2. Incorporation (registration)
3. Capital subscription (for a public company raising money from the public)
4. Commencement of business

A private company needs only the first two stages to start business; under the Companies Act, 2013 every company must also file a declaration before commencing business.

Question SA – Q2

List the documents required for the incorporation of a company.

Answer

1. Memorandum of Association, duly signed by subscribers.
2. Articles of Association, duly signed by subscribers.
3. Consent of proposed directors in writing to act as directors and to take qualification shares.
4. Agreement with the proposed managing director/manager/whole-time director, if any.
5. Copy of the Registrar’s letter approving the name of the company.
6. Statutory declaration by a professional (advocate, CA, CS) or director that all requirements of registration have been complied with.
7. Notice of the exact address of the registered office.
8. Documentary evidence of payment of registration fees.

(Under the 2013 Act these are filed electronically through the SPICe form on the MCA portal.)

Question SA – Q3

What is a prospectus? Is it necessary for every company to file a prospectus?

Answer

A prospectus is a document issued by a public company inviting the public to subscribe to its shares or debentures. It contains details about the company, its promoters and directors, objects of the issue, terms of issue, risks and financial information, so that investors can make informed decisions.

Not every company has to file a prospectus:

1. A private company cannot invite the public and so does not issue a prospectus.
2. A public company that raises funds privately (through friends, relatives or private placement) need not issue a prospectus; instead it files a statement in lieu of prospectus with the Registrar.

Question SA – Q4

Briefly explain the term ‘Return of Allotment’.

Answer

After a public company allots shares to applicants, it must file a ‘Return of Allotment’ with the Registrar of Companies within 30 days of allotment. It contains details of the shares allotted — names and addresses of allottees, number of shares, amount paid on them, and shares allotted for consideration other than cash. It informs the Registrar and the public about the allotment made.

Question SA – Q5

At which stage in the formation of a company does it interact with SEBI.

Answer

At the capital subscription stage. A public company that wants to raise funds from the public must obtain SEBI’s approval before issuing a prospectus. It files the draft offer document with SEBI and must comply with SEBI guidelines regarding disclosures, pricing, allotment and listing, to protect the interests of investors.

Exercises – Long Answer Questions

Question LA – Q1

What is meant by the term ‘Promotion’. Discuss the legal position of promoters with respect to a company promoted by them.

Answer

Promotion is the first stage in the formation of a company. It involves conceiving a business opportunity and taking the initiative to form a company to exploit it, by undertaking feasibility studies, getting the name approved, arranging finance and completing the preliminaries. The persons who do this are called promoters.

Legal position of promoters

1. Neither agents nor trustees — promoters are neither agents nor trustees of the company because the company does not exist when they act.
2. Fiduciary position — they stand in a position of trust and confidence towards the company. They must not make secret profits and must disclose all relevant facts, including any profit made on property sold to the company.
3. Personal liability for pre-incorporation contracts — contracts made by promoters before incorporation are not binding on the company; promoters are personally liable on them unless the company adopts them after incorporation.
4. No automatic right to reimbursement — the company is not legally bound to reimburse pre-incorporation expenses, though it usually does so voluntarily.
5. Liability for misstatements in the prospectus.

Question LA – Q2

Explain the steps taken by promoters in the promotion of a company.

Answer

1. Identification of business opportunity — a new product, service or idea with commercial potential.
2. Feasibility studies — to check whether the idea can be implemented and is profitable:
   • Technical feasibility — availability of technology and raw materials.
   • Financial feasibility — whether required funds can be arranged.
   • Economic feasibility — whether the business will be profitable.
3. Name approval — choosing a name and applying to the Registrar of Companies; the name must not be identical or too similar to an existing company.
4. Fixing up signatories to the Memorandum of Association — deciding the members who will sign the MoA and the first directors, and obtaining their consent.
5. Appointment of professionals — such as merchant bankers, auditors, legal advisers to prepare documents.
6. Preparation of necessary documents — Memorandum of Association, Articles of Association, consent of directors, agreement with managing director, statutory declaration, for submission to the Registrar.

Question LA – Q3

What is a ‘Memorandum of Association’? Briefly explain its clauses.

Answer

The Memorandum of Association (MoA) is the most important document of a company. It is its charter, defining its objectives, scope of activities and relationship with the outside world. The company cannot do anything beyond what is stated in its MoA (doctrine of ultra vires).

Clauses

1. Name clause — the name of the company, ending with “Limited” (public) or “Private Limited” (private); it must not be identical to an existing company.
2. Registered office clause — the state in which the registered office is situated; the exact address is notified to the Registrar within 30 days of incorporation.
3. Objects clause — the main objects for which the company is formed and matters necessary for furtherance of the main objects.
4. Liability clause — that the liability of members is limited to the unpaid amount on shares held by them (or by guarantee).
5. Capital clause — the maximum (authorised) capital and its division into shares of fixed amount.
6. Association (subscription) clause — the signatories declare their desire to form a company and agree to take the shares stated against their names.

Question LA – Q4

Distinguish between ‘Memorandum of Association’ and ‘Articles of Association.’

Answer

Question LA – Q5

What is the meaning of ‘Certificate of Incorporation’?

Answer

The Certificate of Incorporation is the document issued by the Registrar of Companies after verifying that all documents for registration are in order and the fees are paid. It certifies that the company has been incorporated and, in the case of a limited company, that it is limited. It bears a Corporate Identity Number (CIN).

Effect

1. The company comes into legal existence as a separate legal entity from the date mentioned in the certificate.
2. It is conclusive evidence of the regularity of incorporation; even if there were defects in registration, its existence cannot be challenged.
3. The company acquires perpetual succession and can enter into contracts, own property, sue and be sued in its own name.

Question LA – Q6

Discuss the stages of formation of a company?

Answer

1. Promotion: Identifying an opportunity, conducting feasibility studies, getting name approval, fixing signatories to the MoA, appointing professionals and preparing documents (MoA, AoA, consents, declarations).

2. Incorporation: Filing an application with the Registrar of Companies with all documents and fees. After scrutiny, the Registrar issues the Certificate of Incorporation, and the company comes into existence.

3. Capital subscription (public company)

• Obtain SEBI approval and file the prospectus (or statement in lieu of prospectus) with the Registrar.
• Appoint bankers, brokers and underwriters.
• Receive applications; ensure minimum subscription (90% of issue) is received.
• Apply to stock exchanges for listing.
• Allotment of shares and filing of return of allotment within 30 days.

4. Commencement of business: A company must file with the Registrar a declaration by a director that every subscriber has paid the value of shares agreed to be taken, and verify its registered office. After this, it can commence business and exercise borrowing powers.

Topic checklist

• Stages in the formation of a company
• Promotion: steps and legal position of promoters
• Incorporation: documents, Certificate of Incorporation
• Memorandum vs Articles of Association
• Capital subscription: SEBI, prospectus, minimum subscription, allotment
• Commencement of business

Total questions answered: 11 of 11