NCERT Solutions for Class 11th Business Studies Chapter 7 – Formation of a Company
Multiple Choice Questions
1. Minimum number of members to form a private company is
(a) 2
(b) 3
(c) 5
(d) 7
Answer (a) To form a private company the memorandum of association is needed to be signed by at least two members.
2. Minimum number of members to form a public company is
(a) 5
(b) 7
(c) 12
(d) 21
Answer (b) To form a public company, at least seven members must sign the memorandum of association.
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 (b) The promoters have to select a name for the company and submit an application to Ihe registrar 0′ companies of the slate in which the registered office of the company is to be situated for its approval
4. A proposed name of company is considered undesirable if
(a) it is identical with the name of an existing company
(b) it 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) According to name clause the name of a company should not be identical or resembling the name of an existing company and should not violate the provrsions of ‘The Emblem and Names (Prevention of Improper Use) Act 1950.
5. A prospectus is issued by
(a) a private company
(b) a public company seeking investment from public
(c) a public enterprise
(d) a public company
Answer (b) for raising the required funds from the public by means of issue of shares and debentures, a public company has to Issue a prospectus which is an invitation to the public to subscribe to the capital of the company and undergo various other formalities
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) The formalIlles of formation of a company can be divided into four distinct stages, which are
(i) Promotion
(ii) Incorporation
(ii’) Subscription of capital
(iv) Commencement of business
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) Preliminary contracts ars pre-incorporation contracts.
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 (d) Preliminary Contracts are not legally binding on the company. A company cannot ratify a preliminary contract.
True/False Type Questions
1. It is necessary to get every company incorporated, whether private or public.
Answer True
Promotion and incorporation stages have to be fulfilled by both private and public companies.
2. Statement in lieu of prospectus can be filed by a public company going for a public issue.
Answer True
A copy of the prospectus or statement In lieu of prospectus is filed with the Registrar of companies in case of going for a public issue.
3. A private company can commence business after incorporation.
Answer True
A private company can start its business immediately after obtaining the certificate of Incorporation. As it is prohibited to raise funds from public, It does not need to ssue a prospectus and complete the formality of minimum subscription
4. Experts who help promoters in the promotion of a company are also called promoters.
Answer False
Experts do not become promoters just because they are assisting the promoters in the various feasibility studies.
5. A company can ratify preliminary contracts after incorporation.
Answer False
Preliminary contracts or pre-Incorporation contracts are not legally binding on the comp ny A company cannot ratify a preliminary contract.
6. If a company is registered on the basis of fictitious names, its incorporation is invalid.
Answer False
The Certificate of incorporation once issued, is a conclusive evidence of the existence of the company even if there were deficiencies in the formalities. Even when a company gets registered With illegal objects using fictitious names, the birth of the company cannot be questioned The only remedy available is to wind it up.
7. ‘Articles of Association’ is the main document of a company.
Answer False
Memorandum of Associauon’ is the main document of the company and is subordinate to the Companies Act.
8. Every company must file ‘Articles of Association’.
Answer False
Every company has to file a ‘Memorandum of Association’. It is not compulsory for a company to file ‘Articles of Association’. It may adopt Table A of the Companies Act.9.
9. A provisional contract is signed by promoters before the incorporation of the company.
Answer False
Provisional contracts are signed after incorporation but before the commencement of business. These become enforceable only after the company gets the Certificate of Commencement of Business.
10. If a company suffers heavy issues and its assets are not enough to pay off its liabilities, the balance can be recovered from the private assets of its members.
Answer False
The shareholdersof a company are liable to the extent of the amount unpaid on the shares held by them. Also. only the assets of the company can be used to settle the debts, leaving the members’ personal property free from any charge.
Short Answer Type Questions
Question 1. Name the stages in the formation of a company.
Answer Formation of a company is a complex activity, involving these stages which 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 company as body corporate under Companies Act, 1956 is known as incorporation.
- Subscription of Capital A public company’s raising funds from the public by means of issue of shares and debentures is known as capital subscription.
- Commencement of Business The registrar issues certificate of commencement of business which is a conclusive evidence of completion of formation requirement of a company.
Question 2. List the documents required for the incorporation of a company.
Answer The documents required for the incorporation of a company are
- The Memorandum of Association duly stamped, signed and witnessed.
- The Articles of Association duly stamped and witnessed as in case of the Memorandum. If company adopts Table A, statement In lieu of the prospectus is submitted, instead of Articles of Association
- Written consent of the proposed directors to act as directors and an undertaking to purchase qualification shares
- The agreement, if any, with the proposed Managing Director, Manager or whole-time director.
- A copy of the Registrar’s letter approving the name of the company.
- A statutory declaration affirming that all legal requirements for registration have been complied with
- A notice about the exact address of the registered office (can be submitted within 30 days of Incorporation)
- Documentary evidence of payment of registration 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 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 Campanies 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 refers to the minimum amount required by the company for Its preliminary functions. It has been provided by the Companies Act, that the company must receive apphcations for a certain minimum number of shares before gOing ahead with the allotment of shares in order to prevent companies from commenCing business with inadequate resources thus is called the minimum subscription. The limit of minimum subscription is 90% of the size of the issue.
Question 5. Briefly explain 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 adirector 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 A company interacts with SEBI (Securities and Exchange Board of India) in the third stage of formation that is, in the stage of capital subscription. SEBI is the regulatory authority of capital markets in our country which has issued guidelines for the disclosure of information and investor protection. A company inviting funds from the general public must make adequate disclosure of all relevant information and must not conceal
any material information from the potential investors as per SEBI guidelines.
Prior approval from SEBI is, therefore, required before going ahead with raising funds from public. SEBI ensures that the proposed issue of securities follows all the guidelines laid down by it, no over subscription of any issue can be retained, full underwriting of issue is important, promoters contribution must be 25% in an issue of less than ₹ 100 crore.
Question 7. Distinguish between ‘preliminary contracts’ and ‘provisional contracts’.
| S.N. |
Preliminary Contracts |
Provisional Contracts |
| 1 |
Contracts signed by promoters WIth third parties before the incorporation of company. |
Contracts signed atter in corporation but before commencement of business. |
| 2 |
These are nollegally btnding on the company and cannot be ratified after Incorporation. |
These become enforoeable only after the company gets the Certificate of Commencement of Business. |
| 3 |
These contracts are the liabilities of Promoters. |
These contracts are the responsibilitiesof the company |
| 4 |
Both private and public company have right to undertake these contracts |
They can only be undertaken by public Company. |
Long Answer Type 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 Promotion is the first stage in the formation of a company. It involves conceiving a business opportunity and taking an initiative to form a
company so that the available business opportunity can be turned into a real business project. A promoter is said to be the one who undertakes to form a company with reference to a given project and to set It going and who takes the necessary steps to accomplish that purpose It is the function
of promoters to analyse the prospects and bring together the men, materials, machinery managerial abilities, financial resources and commence the business.
Promoters undertake various activities to get a company registered and get it to the position of commencement of business. But they are neither the agents nor the trustees of the company Legally they cannot be the agent of non existing companies. It means that he IS personally liable for the contracts, not legally. Also promoters are not the trustees they supposed to observe good faith in the promotion and must not making secret gains out of the dealings. If there ISgain then it must be disclosed.
Promoters are not legally entitled to claim the expenses incurred in the promotion of the company but the pre-incorporation expenses may be reimbursed. The company may also remunerate the promoters for their efforts by paying a lump sum amount or a commission on the purchase price of property purchased through them or on the shares sold. Shares or debentures may also be allotted to the promoters or they may be given an option to purchase the securities at a future date.
Question 2. Explain the steps taken by promoters in the promotion of a company.
Answer The Important steps taken by promoters in the promotion of a company are as follows
- Identification of Business Opportunity The first step to be taken by 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 using a different process or any other opportunity having an investment potential.
- Feasibility Studies All the identified business opportunities may not be feasible or profitable as real projects. The promoters, therefore, undertake detailed feasibility studies to invesllgate all aspects of the business they intend to start Various types of feasibility have to be assessed which Include
(i) Technical Feasibility
(ii) Financial Feasibility
(iii) Economic Feasibility
These feasibility studies are undertaken with the help of the specialists like engineers, chartered accountants etc and only when these Investigations throw up positive results, the promoters may decide to actually launch a company.
(iii) Name Approval The promoters have to select a name for the company 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 it it is not considered undesirable. According to the name clause the name of a company should not be identical or resembling the name of an existing company and should not violate the provisions of ‘The Emblem and Names (Prevention of Improper Use) Act, 1950. Three names, In order of their priority are given in the application to the Registrar of Companies so that alternative name may be allotted in case the first preference does not fulfil the name clause.
(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 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 submitted with the Registrar of Companies. The names and addresses of shareholders ard the number of shares allotted to each is submitted In a statement called return of allotment to the Registrar with the help of these professionals.
(vi) Preparation of Necessary Documents The promoter takes up steps to prepare certain legal documents which include Memorandum of Association, Articles of Association and Consent of Directors These documents have to be submitted under the law, to the Registrar of the Companies for getting the company registered.
Question 3. What is a ‘Memorandum of Association’? Briefly explain its clauses.
Answer Memorandum of Association is the most important document. It defines the objectives of the company and determines the boundary line, with In which the company has to perform tasks. No company can legally undertake activities that are not contained In its Memorandum of Association. 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. According to name clause the name of a company should not be identical or resembling the name of an existing company and should not violate the provisions of ‘The Emblem and Names (Prevention of Improper Use) Act 1950.
(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 clause is the most Important one as 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 objects
- The Main Objects The main objects for which the company is formed are listed in this sub-clause.
- Other Objects Objects not included in the main objects could be stated in this sub-clause. A company can undertake a business included in this subclause, either by passing a special resolution or passing an ordinary resolution and get central government’s approval for the same.
(iv) Liability Clause This clause limits tile liability of the members to the amount unpaid on the shares owned by them.
(v) Capital Clause This clause specifies the maximum capital which the company wil be authorised to raise through the Issue of shares. The authorised share capital of the proposed company along with its divtsion into the number of shares having a fixed face value is specified in this clause
(vi) Association Clause In this clause. the signatories to the Memorandum of Association state their intention to be associated With the company and also give their consent to purchase qualification shares. The Memorandum of Association must be signed by at least seven persons n case of a public company and by two persons In case of a private company
Question 4. Distinguish between ‘Memorandum of Association’ and ‘Articles of Association’.
Answer Difference between Memorandum of Association and Article of Association
| Basis |
Memorandum of Association |
Articles of Association |
| Objectives |
Memorandum of association defines the objects for which the company is formed |
ArtIcles of assccianon are rules of Internal management of the company They Indicate how the objectives of the company are to be achieved. |
| Position |
This is the man document of the company and is subordinate to the companies act. |
Trus is a subsldtary document and is subordinate to both the Memorandum of Association and the Companies Act |
| Relationship |
Memorandum of association defines the relationship of the company with outsiders. |
Articles define the relationship of the members and the company |
| Validity |
Acts beyond the memorandum of Iassociation are invalid and cannot be ratified even by a unanimous vote of the members |
Acts which are beyond articles can be ratified by the members, provided they do not violate the memorandum. |
| Necessity |
Everycompany has to file a Memorandum of Association |
It is not compulsory for a public limited company to file articles of association. It may adopt table A of the Companies Act. |
| Alteration |
Alteration of memorandum of t association is quite difficult and in many cases, approval of certain statutory authority is required |
Articles can be altered by passing a special resolution by the members. |
Question 5. What is the effect of conclusiveness of the ‘Certificates of Incorporation’ and ‘Commencement of Business’?
Answer Effect of Certificates of Incorporation A company becomes a legal entity with perpetual succession on the date printed on the Certificate of Incorporation. After conclusiveness of the certificate of incorporation, the company becomes entitled to enter into valid contracts. The Certificate of Incorporation is a conclusive evidence of the regularity of the incorporation and legal existence of a company.
Once a Certificate of Incorporation has been issued, the company has become a legal business entity irrespective of any flaw in its registration.
Thus, whatever be the deficiency in the formalities, the Certificate of Incorporation once issued, is a 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.
On the issue 01 Certificate of Incorporation, a private company can immediately commence its business. It can raise necessary funds from friends, relatives or through private arrangement and proceed to start business. A public company, however, has to undergo two more stages in its formation.
Effect of Certificate of Commencement of Business The Registrar, after examining the required documents like memorandum of association, articles of association and consent of Directors, etc. issues a ‘Certificate of Commencement of Business’ if these documents are found satisfactory.
This certificate is conclusive evidence that the company is entitled to do business. With the grant of this certificate the formation of a public Company is complete and the company can legally start doing business.
Quetions 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 faits to apply to a stock exchange for permission to deal in its securities or faits to get such permission?
Answer A public company can raise the required funds from the public by means of Issue of shares and debentures For doing the same. It has to issue a prospectus which is an invitation to the public to subscribe to the capital of the company and undergo various other formalities. It is necessary for the company to make an application to at least one stock exchange for perrnlssron to deal in Its shares or debentures by getting its shares listed on the stock exchange
If a public company going for a public issue falls to apply to a stock exchange for permission to deal In its securities or fails to get such permission before the expiry of ten weeks from the date of closure of subscription list, the allotment of shares done by the company shall become void and all money received from the applicants will have to be returned to them within eight days.
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