CBSE NCERT Class XI (11th) | Business Studies

Chapter 7 - Formation of a Company


Multiple choice questions : Solutions of Questions on Page Number : 178
Q1 :  
Minimum number of members to form a private company is
(a) 2
(b) 3
(c) 5
(d) 7

Answer :
As per the law, a minimum of two members are required to form a private company.
Hence, the correct answer is option (a).
Q2 :  
Minimum number of members to form a public company is
(a) 5
(b) 7
(c) 12
(d) 21

Answer :
According to the law, a minimum of seven members are required to form a public company.
Hence, the correct answer is option (b).
Q3 :  
Application of 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 :
For approval of the name of a company, the promoters need to submit an application to the registrar of companies concerned.
Hence, the correct answer is option (b).
Q4 :  
A proposed name of Company is 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
(d) in case of any of the above.

Answer :
The name proposed for a company is considered 'undesirable' if it is identical to the name of an existing company, or if the proposed name closely resembles the name of an existing company, or if it is an emblem of a government organisation. In all these cases, the name proposed is considered 'undesirable'.
Hence, the correct answer is option (d).
Q5 :  
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 :
A prospectus is issued by a public company if it decides to raise funds through public investment. A private company need not issue a prospectus as it is prohibited from raising funds from the public.
Hence, the correct answer is option (d).
Q6 :  
Stages in the formation of a public company are in the following manner
(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 :
In case of a public company, its formation follows the stages given below.
(a) Promotion
(b) Incorporation
(c) Capital Subscription
(d) Commencement of business
Hence, the correct answer is option (c).
Q7 :  
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 :
Preliminary contracts are signed between the promoters and the third party during the promotion of a company. As they are signed during the first stage of a company's promotion, they are said to be signed before the incorporation of a company.
Hence, the correct answer is option (a).

Short answersmultiple choice questionstrue or fals : Solutions of Questions on Page Number : 179
Q1 :  
Name the stages in the formation of a company.

Answer :
The formation of a company is a complex process which involves various stages. The following are the sequential stages.
(a) Promotion: This involves taking the initiative to form a company and promoting it.
(bIncorporation: This step involves the formation of the company as a separate legal entity.
(c) Subscription of capital: In this stage, funds are raised in the form of shares and debentures.
(d) Commencement of business: This stage implies the completion of the formalities and the commencement of business by the company.
Q2 :  
It is necessary to get every company incorporated, whether private or public.

Answer :
The statement is TRUE.
It is necessary for every company to be incorporated, because a company can legally commence its business only after its incorporation with the registrar of companies.
Q3 :  
List the documents required for the incorporation of a company

Answer :
An entrepreneur needs to submit the following documents for the incorporation of a company.
(a) Memorandum of association.
(b) Articles of association.
(c) Written approval of the proposed directors to function as directors and an undertaking to buy the qualification shares.
(d) An agreement naming the proposed managing director or a manager or a full-time director, if any.
(e) A copy of the letter obtained from the registrar concerned approving the company name proposed.
(f) A legal confirmation by the law stating the submission of all documents and requirements for registration.
(g) The exact address of the registered office.
(h) Documentary evidence of payment of the registration fee.
Q4 :  
Statement in lieu of prospectus can be filed by a public company going for a public issue.

Answer :
The statement is False.
A public limited company inviting applications from the general public to subscribe to its shares or debentures is mandatorily required to file a prospectus with the Registrar of Companies. However, if a company is confident that it can raise funds through private sources i.e. through friends, relatives or some private arrangements as done by a private company, then it may file a statement in lieu of prospectus with the Registrar of Companies atleast three days before making the allotment.

Q5 :  
What is a prospectus? Is it necessary for every company to file a prospectus?

Answer :
A prospectus is an advertisement or an invitation from a company to the general public to subscribe or purchase shares or debentures issued by the company. This invitation to purchase shares is also known as the initial public offering (IPO), through which a public company can raise the funds it requires. However, in the case of a private company, it is not necessary to file a prospectus as it is prohibited from raising funds from the public. Only a company that needs to raise funds from the general public by issuing shares or debentures is required to file a prospectus.
Q6 :  
A private company can commence business after incorporation.

Answer :
The statement is TRUE.
A private company becomes a legal entity as soon as it is incorporated. Thus, it can immediately commence its business after incorporation.
Q7 :  
Explain the term 'Minimum Subscription'.

Answer :
When shares are issued to the general public, the minimum amount that must be subscribed by the public so that the company can allot shares to the applicants is termed 'minimum subscription'. As per the Companies Act of 1956, the minimum subscription of shares cannot be less than 90 per cent of the issued amount. If the minimum subscription is not received, the company cannot allot shares to its applicants, and it shall immediately refund the entire application amount received from the applicants.
Q8 :  
Expert who help promoters in the promotion of a company are also called promoters.

Answer :
The statement is FALSE.
A promoter is an individual who discovers the idea of formation of a company and takes steps to achieve this purpose. On the other hand, experts who help promoters in promoting a company are not considered as promoters. They only assist the promoters.
Q9 :  
Briefly explain the term 'Return of Allotment'.

Answer :
In the promotion stage of a company, the promoters are required to submit the name and addresses of the shareholders along with the number of shares allotted to them. The statement that contains this information is known as 'return of allotment'.
Q10 :  
A company can ratify preliminary contracts after incorporation.

Answer :
The statement is FALSE.
This is because a preliminary contract are signed before the incorporation of a company. These are contracts which the promoter undertakes with the third party during the company's promotion. Thus, the company cannot ratify preliminary contracts after incorporation and cannot also be forced to honour these contracts.
Q11 :  
At which stage in the formation of a company does it interact with SEBI?

Answer :
A company interacts with the Securities and Exchange Board of India (SEBI) at the stage of capital subscription. This is because, at this stage of formation, the company is required to raise its funds from the general public through the medium of issue of shares and debentures. To do so, the company is required to follow the rules and guidelines prescribed by SEBI in order to protect the investors' interests. Thus, it is necessary for the company to get SEBI's approval before proceeding with capital subscription.
Q12 :  
If a company is registered on the basis of fictitious names, its incorporation is invalid.

Answer :
The statement is FALSE.
This is because once the certificate of incorporation is issued, its existence cannot be questioned. Thus, as the certificate of incorporation provides definite evidence of the incorporation of a company, its incorporation will not be regarded as invalid even if it is registered on the basis of fictitious names.
Q13 :  
Distinguish between 'preliminary contracts' and 'provisional contracts'.

Answer :
Preliminary contracts: These contracts are signed by the promoters of a company with the third parties during the promotion of the company. These contracts are also called pre-incorporation contracts as they are created before the company is incorporated. Preliminary contracts are non-binding, as the company cannot ratify them. Therefore, these contracts are not enforceable unless fresh contracts are created on the same terms and conditions after the company comes into existence.
Provisional contracts: These contracts are signed after the incorporation of a company and before the commencement of business. They are different from preliminary contracts as they are enforceable automatically once the company obtains the certificate of commencement of business.
Q14 :  
'Articles of association' is the main document of a company.

Answer :
The statement is FALSE.
'Articles of association' is not the main document of the company. Rather, the most important document of a company is the memorandum of association.
Q15 :  
Preliminary Contracts are
(a) binding the company
(b) binding on the company, if ratified after incorporation
(c) binding on the company after the incorporation
(d) not binding on the company

Answer :
Preliminary contracts are signed between the promoters and the third party during the promotion of a company. As they are signed before the incorporation of a company, they are not regarded as binding on the company. The company cannot ratify these contracts and are not forced to honour them.
Hence, the correct answer is option (d).
Q16 :  
Every company must file Articles of Association

Answer :
The statement is FALSE.
It is not compulsory for every company to file articles of association (AoA). Instead of AoA, the company may adopt Table A of the Companies Act.
Q17 :  
A provisional contract is signed by promoters before the incorporation of the company.

Answer :
The statement is FALSE.
This is because the provisional contract is signed after the incorporation of a company and before the commencement of business.
Q18 :  
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 :
The statement is FALSE.
In view of the limited liability of the members and shareholders of a company, they are not liable to pay any amount from their private assets if the company suffers any loss or is liquidated.

Long answers : Solutions of Questions on Page Number : 180

Q1 :  
What is meant by the term 'promotion'? Discuss the legal position of promoters with respect to a company promoted by them.

Answer :
Promotion refers to the process of innovating or discovering the idea of formation of a company and developing it into a concrete form. It is the very first stage in the process of formation of a company. It starts when an individual or a group of individuals discovers an idea about a business that has the potential to be converted into a successful business opportunity. If they proceed further to form a company, then they are said to be the promoters of the company. Thus, in simpler terms, a promoter is one who takes the initiative to form a company with reference to a given idea or project and takes the steps necessary to fulfil this purpose. Besides discovering the business opportunity, the promoter is responsible for analysing the future prospects of the company and acquires the inputs necessary to establish the company, such as labour, capital and machinery. In this regard, the following are the legal liabilities of the promoters towards the company, which highlight their legal position with respect to the company.
(i) The promoters are neither the trustees nor the agents of the company that they are forming. This is because the company does not exist as a legal entity before its incorporation.
(ii) They cannot make any secret profits by making deals on behalf of the company.
(iii) They are legally liable for any untrue statement filed in the prospectus of the company.
(iv) The promoters cannot claim the expenses incurred by them during the promotion of the company.
(v) The company may or may not indemnify the promoters for the payments made before its incorporation. The company may choose to allot shares to them in order to compensate for their services.
Q2 :  
Explain the steps taken by promoters in the promotion of a company.

Answer :
A promoter is a person who takes the initiative to form a company with reference to a given idea or a project and also takes the steps necessary to fulfil this purpose. Besides discovering the business opportunity, the promoter is also responsible for analysing the future prospects of the company and acquiring the inputs necessary, such as labour, capital and machinery, to run the company successfully.
The following steps are taken by the promoters for the promotion of the company.
(i) Conceiving a business idea: First, a promoter discovers the idea for the formation of a company. If this idea is good enough to be considered and worth investing in, then its profitability or economic feasibility is analysed.
(ii) Checking the feasibility of the idea: As the idea may or may not be feasible enough to be converted into a successful business, it has to be studied in detail depending on its nature. In this regard, the following studies are made with the help of charted accountants, engineers, accountant, etc.
(aTechnical feasibility: In some cases, the idea may be good enough but technically unfeasible. This may happen if the technology or raw material required to execute the project is not easily accessible. Therefore, the technical feasibility of the idea has to be considered before proceeding further.
(b) Financial feasibility: Every organisation requires capital to start functioning and sustain itself. The promoters have to assess the cost of implementing the idea. Thus, in case the cost of the project is huge and the project cannot be financed within the funds available, then the idea may have to be dropped.
(c) Economic feasibility: In some cases, the project may be technically and financially feasible but the probability of its success may be very low. In such cases, too, the idea will have to be given up.
(iii) Selecting the company's name: Once the decision to establish a company is made, the promoters need to select a name for it. For securing approval for the proposed name, an application has to be submitted to the registrar of companies of the state concerned. This application must contain at least three names in the order of their preference. This is because, in some cases, it may happen that the name most preferred may not be approved if another company by the same name already exists. Thus, in such cases, an alternative name that is proposed is approved.
(iv) Selecting the members to sign the memorandum of association (MoA): The promoters are required to select the members for signing the MoA. In this regard, the members who generally sign the MoA become the first directors of the company.
(v) Appointing professionals: The promoters are required to appoint professionals—bankers, brokers, solicitors and underwriters—for preparing the documents necessary for the company. The details of the number of shares allotted to each shareholder, along with his or her addresses for correspondence, are submitted to the registrar.
(vi) Preparing all the documents necessary: After the appointment of professionals, the promoters are required to submit the legal documents necessary (such as the MoA, articles of association and consent of directors) to the registrar of companies.
Q3 :  
What is 'Memorandum of Association'? Briefly explain its clauses.

Answer :
A memorandum of association (MoA) is the most essential document in the formation of a company as it highlights the company's main objectives and goals. The MoA regulates the activities of the incorporated company in such a manner that the company can legally undertake only those activities that are mentioned in the MoA. This document must be signed by at least seven members in the case of a public company and by two persons in the case of a private company. The following are the main clauses of the MoA.
(aThe name clause: This includes the name of the company which has already been approved by the registrar of companies. It is the name by which the company will be known.
(b) Registered-office clause: This clause mentions the name of the state where the registered office of the company is situated. It is not mandatory to submit the exact address of the registered office at this stage. However, the address needs to be submitted within 30 days of incorporation of the company.
(c) Objects clause: This is the most important clause in the MoA as it defines the main objective of the company for which it was formed. The company cannot undertake activities that are not stated in the objects clause. The objects clause is divided into the following two sub-clauses.
(i) The main objects: This sub-clause lists the main objects for which the company is formed. Any clause that is essential for the achievement of the main objectives is considered valid even if it is not contained in the sub-clause.
(iiOther objects: Objects that are not included in the main-objects clause can be included in this sub-clause. If a company wants to initiate a business activity that is mentioned in this clause, it is required to pass either an ordinary resolution or a special resolution to get the consent of the central government.
(d) Liability clause: This clause states the liability of each shareholder according to the amount unpaid by them for the shares they own.
(e) Capital clause: This clause defines the authorised capital of the company which it can raise through the issue of shares. It also states the division of the number of shares.
(f) Association clause: This clause contains the statement by the signatories to the MoA giving their approval to be a part of the company. They also give their consent to buy the qualification shares of the company.
Q4 :  
Distinguish between 'Memorandum of Association' and 'Articles of Association.'

Answer :
Basis of difference
Memorandum of Association (MoA)
Articles of Association (AoA)
Objective
The MoA defines the character of a company and the scope of its activities.
The AoA defines the rules and regulation of the company.
Position
It is the main document of a company which is subordinate to the Companies Act.
It is the subsidiary document of a company which is subordinate to both MoA and the Companies Act.
Relationship
The MoA establishes the relation between the company and outsiders.
The AoA defines the relation of the company with its members.
Alteration
Altering the MoA requires the approval of a statutory authority.
The AOA can be easily altered by passing a resolution.
Ratification
Acts beyond MoA cannot be ratified.
Acts beyond the AoA can be ratified by the members if they do not violate the MoA.
Necessity
It is a necessary document.
It is a secondary document.
Q5 :  
What is the effect of conclusiveness of the 'Certificates of Incorporation' and 'Commencement of Business'?

Answer :
When we say that the 'certificates of incorporation and commencement of business' is conclusive, we mean that once the certificate is issued, the existence of the company is considered valid despite any flaw in its registration process or formation. The following are the effects of the conclusiveness of the certificates of incorporation and commencement of business.
Effect of Conclusiveness of Certificate of Incorporation
(a) A company legally comes into existence or becomes a separate legal entity on the date stated in its certificate of incorporation. For instance, if the certificate is issued on September 30 and the date mentioned on the certificate is September 27, then the company is said to exist since September 27 only.
(b) The certificate of incorporation acts as compelling confirmation of the regularity of the incorporation of the company even if there is any flaw in its registration process.
(c) A company can immediately commence its business once its certificate of incorporation is issued. Thus, the certificate of incorporation is conclusive evidence of the existence of a company. As a result, the birth of the company cannot be questioned if it has the certificate of incorporation.
Effect of Certificate of Commencement of Business
(a) The certificate of commencement of business is issued by the registrar of companies when all the documents submitted by the company are found satisfactory.
(b) The commencement of business certificate acts as definite proof for the company that it has the legal right to do business.
(c) The formation of a public company is completed once it is granted the certificate of commencement of business. Thus, the business activities of the company cannot be questioned as it is legally allowed to start its business after getting the certificate.
Q6 :  
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 for a stock exchange for permission to deal in its securities or fails to get such permission?

Answer :
Yes, it is mandatory for every public company to be listed on a stock exchange. To be listed on a stock exchange, a public company is required to send an application to at least one stock exchange. Once it is listed, the company is allowed to offer its shares in order to become public. However, initially the company may offer only a small percentage of its shares to the public. This act of going public gives the company the following advantages.
(a) It gives the company a wider access to the debt markets along with the capability of selling equity stakes in the future, if any.
(b) It helps the company to ensure the safety of its investors by providing complete acknowledgment of markets and traders.
(c) It enables the company to acquire funds for its future growth.
(d) It helps calculate the value of the company. The value of the company can be calculated only after it is listed on a stock exchange.

In case, a company fails to apply for permission to go public or fails to get permission within 10 weeks from the date of closure of the subscription list, the allotment of shares has to be abandoned. The funds raised from the applicants have to be returned to them within eight days from the date of cancellation of the applications.

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