Chapter 7: Joint Stock Company
A trading firm run by two partners can raise only as much money as the partners own or can borrow. When a business needs land, plant, machinery and working capital running into crores of rupees, that limit becomes a serious obstacle. Unlimited liability adds to the difficulty, because a person investing in a partnership risks personal assets far beyond the amount actually put into the business. The joint stock company form of organisation was developed to remove both obstacles. Its capital is divided into shares of small value, so savings can be collected from a very large number of investors. The liability of each investor is limited to the amount unpaid on the shares held. The law treats the company as a person separate from its members, which gives it a continuous existence and the ability to own property, enter into contracts and sue in its own name. This chapter explains what a joint stock company is, its essential features, how it differs from partnership, its merits and demerits, and the types of companies classified on the basis of ownership.
Figure
Fig. 7.0-1 — The Corporate Form Of Business Photograph of the head office building of a large listed Indian company, with the company signage visible.
7.1 Meaning And Definitions Of A Joint Stock Company
Sole proprietorship and partnership both run into the same three walls once a business grows: capital is limited to what a few owners can bring in, liability is unlimited, and the firm’s existence depends on the lives of its owners. Large-scale industry and trade cannot be organised on those terms. The joint stock company developed as the form of organisation that removes all three limitations at once.
In ordinary language, a company is an association of persons who come together for a common business object and contribute money towards it. That contribution is not made in a lump sum by two or three people. The total capital is divided into units of small value called shares, and a person who buys one or more of these units becomes a shareholder, also called a member of the company. Because each unit is small, savings can be drawn from a very large number of people, including those with modest means.
Three further points complete the meaning. The liability of a member is generally limited to the amount unpaid on the shares held, so personal assets are not at risk. A member of a public company can transfer shares to another person without needing the consent of the other members. And the company is brought into existence by a process of registration under the law, after which it is treated as a person distinct from the persons who own it. Companies in India are incorporated under the Companies Act, 2013, and were earlier incorporated under the Companies Acts of 1913 and 1956.
How The Definitions Are Grouped
The definitions of a company fall into three groups, and each group emphasises a different aspect. Writers on business describe what the company is like; jurists describe how the law views it; and the Act itself supplies the working legal test.
Among writers, L.H. Haney’s description is the one most often quoted, because it packs four features into a single line — the company is created by law, it has an identity of its own, it continues irrespective of changes in membership, and it has a common seal.
Jurists approach the company from the side of legal status rather than business function. Chief Justice Marshall described a corporation as an artificial person that is invisible and intangible and exists only in the contemplation of law. The phrase is worth pausing on: the company cannot be seen or touched, and yet it can own a factory, sign a contract and be taken to court, because the law chooses to treat it as a person.
The Companies Act, 2013 does not attempt a descriptive definition at all. It states simply that a company means a company incorporated under that Act or under any previous company law. The test is therefore procedural — an association becomes a company by being registered, and not by resembling one.
Taken together, the three groups point to the same conclusion. A joint stock company is a voluntary, registered association of persons, with capital divided into transferable shares, having a separate legal identity, perpetual succession, a common seal and, usually, limited liability.
7.2 Essential Characteristics Of A Joint Stock Company
Every feature of a company follows from one legal act — incorporation. The moment the Registrar of Companies issues the certificate of incorporation, the law stops treating the group of investors as a set of individuals and begins treating the company as a person in its own right. Once that step is understood, the features listed below are not eleven separate facts to be memorised but consequences of a single idea.
The features that flow from incorporation are summarised in FC 7.1.
Flowchart
FC 7.1 — Essential Characteristics Of A Joint Stock Company Incorporation → Artificial person, Separate legal entity, Perpetual succession, Limited liability, Common seal, Limitation of action, Voluntary association for profit, Representative management, Right to sue and be sued, Transferability of shares, Winding up by legal process
- Artificial person created by law — the company is not born and does not breathe, but the law grants it rights close to those of a natural person. It can buy and sell property, employ people and enter into contracts in its own name, because a business owned by thousands of changing investors could not otherwise hold assets or make binding promises.
- Separate legal entity — the company is distinct in law from the members who own it. Its property is its own and not the joint property of the shareholders, and a shareholder may even enter into a contract with the company as an outsider would. This separation is the source of every other feature in this list.
- Perpetual succession — the life of the company does not depend on the lives of its members. Death, insolvency, retirement or the sale of shares by a member only changes who the members are; it does not touch the existence of the company, which ends only when it is wound up by legal process.
- Limited liability — a member is liable only up to the amount still unpaid on the shares held. If the company’s own assets fall short of its debts, the personal property of the members cannot be attached, and this assurance is what persuades ordinary savers to invest in a business they will never manage.
- Common seal — since an artificial person cannot sign, a metal seal carrying the company’s name traditionally acted as its official signature on documents. The law has since made the common seal optional, and a company that does not adopt one authenticates documents through the signatures of authorised directors or officers instead.
- Limitation of action — a company may carry on only those activities that fall within the objects stated in its Memorandum of Association. It cannot switch to an unrelated line of business at will, as a sole trader can, and an alteration of the objects requires the legal formalities laid down for the purpose.
- Voluntary association for profit — no one can be compelled to become a member, and membership is acquired by buying shares. The company is formed to earn profit, and the profit that is distributed to members is paid as dividend in proportion to shareholding.
- Representative management — shareholders are too numerous and too scattered to run the business, so they elect representatives called directors. Ownership therefore rests with the shareholders while management is entrusted to the Board of Directors, which is answerable to the members for the conduct of the company.
- Right to sue and be sued — being a person in law, the company litigates in its own name. Its members are not made parties to a suit against the company, which again follows from its separate legal identity.
- Transferability of shares — a member of a public company may sell shares to another person without the consent of the other members, which makes the investment liquid. A private company restricts this right by its articles, so transferability is not equally free in every company.
- Winding up by legal process — a company does not come to a natural end. It is dissolved only through the procedure prescribed by law, either voluntarily or by an order of the Tribunal, so that creditors and members are dealt with in a settled order.
Two of these features are often stated loosely and need care. Limited liability does not mean that a member owes nothing; it means the liability stops at the unpaid amount on the shares. Similarly, separate legal entity does not mean the members have no interest in the company’s property; it means their interest is in the shares they hold, not directly in the assets.
7.3 Difference Between Partnership And Joint Stock Company
Partnership and the company form both allow several persons to pool capital and run a business together, which is why the choice between them is a real decision for a growing firm. The difference lies in how far the law is willing to separate the business from the persons behind it. In a partnership the firm is not distinct from the partners; in a company it is. Almost every point of distinction in Table 7.1 is a working out of that single divergence.
The practical effect of the table is a matter of scale and risk. A partnership is quicker to form, cheaper to run and keeps its affairs private, which suits a firm whose capital needs are moderate and whose partners intend to manage the business themselves. A company costs more to form and must disclose its accounts, but it can raise capital from investors who will never enter the office, and it survives the people who founded it. As the capital required rises and the founders’ willingness to risk personal assets falls, the balance tips towards the company form.
7.4 Evaluation Of A Joint Stock Company
The company form is not superior to every other form in every situation; it is superior for a particular kind of business. It suits an undertaking that needs large capital, expects to live longer than its founders, and can bear the cost of disclosure and regulation. Its merits and demerits are best read as two sides of the same characteristics: the very separation of ownership from management that brings in professional managers is also what allows a small group to dominate the company, and the disclosure that builds public confidence is what destroys secrecy.
7.4.1 Merits Of A Joint Stock Company
- Large financial resources — capital is divided into shares of small value and offered to the public, so funds can be collected from a very large number of investors. Debentures and deposits add to what shares raise, which is why almost every large-scale enterprise in the country is organised as a company.
- Limited liability — a member risks only the amount unpaid on the shares held. Investors who have no say in day-to-day management will part with their savings only on that assurance, so limited liability is the condition on which large public capital becomes available at all.
- Liquidity of investment — shares of a public company can be transferred freely, and shares listed on a stock exchange can be sold quickly for cash. An investor who may need money back is therefore willing to invest in the first place.
- Professional management — a company can afford to employ specialists in production, finance, marketing and personnel, and its directors are chosen for the expertise they bring. Division of managerial work of this kind is not open to a sole trader or to most partnership firms.
- Diffusion of risk — the loss of a company is spread over a very large body of shareholders, so no single investor is ruined by it. This makes it possible to undertake ventures that no individual would finance alone.
- Economies of large-scale operation — because it can command large funds, a company can buy in bulk, install modern plant, spend on research and market over a wide area. Cost per unit falls, and the benefit reaches consumers as better goods at lower prices.
- Stability and continuity — perpetual succession gives the business an assured life, which allows long-term projects with long gestation periods to be planned and financed with confidence.
- Public confidence and credit — the company works under statutory regulation and must publish audited accounts. Lenders and suppliers can assess it from published information, so a company generally finds it easier than an unincorporated firm to obtain credit.
- Mobilisation of small savings — small sums lying idle with a large number of households are drawn into shares and channelled into productive industry, which strengthens capital formation in the economy.
- Scope for expansion — large resources, professional management and continuous existence together give the company far greater room to grow than any other form of organisation.
7.4.2 Demerits Of A Joint Stock Company
- Difficulty and cost of formation — incorporation requires several documents to be drafted and filed and several legal formalities to be completed. The process takes time and money, and a delay in formation can cost the business the advantage of an early start.
- Excessive legal regulation — meetings, audits, filings and disclosures continue for as long as the company exists, and default attracts penalties. Compliance therefore adds a permanent cost and an administrative burden that a partnership does not carry.
- Lack of secrecy — accounts and several other documents filed with the Registrar are open to public inspection, and a large number of officers know the company’s affairs. Business information that a proprietor could have kept private becomes available to competitors.
- Delay in decision-making — proposals move through managers, committees and board meetings before approval. The procedure protects the members’ money, but in a fast-changing market the slowness can mean a lost opportunity.
- Oligarchic management — in theory the members control the company; in practice most of them are scattered, take little interest and do not attend meetings, so a small group of directors and dominant shareholders effectively rules. Control passes to a few in a body that is democratic on paper.
- Conflict of interest — the interests of equity shareholders, preference shareholders, debenture holders, directors and managers do not always coincide. Because managers handle money that is not their own, decisions may be taken that suit the management rather than the owners.
- Risk of fraud at the promotion stage — the promoters control all the information at the time of formation. Assets may be overvalued or unfavourable facts left out of the documents offered to investors, and the loss is borne by members who invested on that information.
- Lack of personal initiative — day-to-day work is done by salaried employees who have no ownership stake in the firm. The direct link between effort and reward that drives a sole trader is missing, and initiative can suffer.
- Danger of concentration of economic power — the size a company can reach may allow it to dominate a market, restrict competition and raise prices, which is why company activity is watched by regulators.
- Speculation in shares — free transferability, which is a merit for the genuine investor, also invites trading purely in the hope of price movements, and the resulting fluctuations can hurt the company’s standing.
7.5 Types Of Companies On The Basis Of Ownership
Not every company needs to collect money from the general public, and the law does not impose the same obligations on a company that does and a company that does not. Where savings of ordinary investors are involved, disclosure and regulation must be strict; where a business is owned by a small closed group, lighter rules will do. On this basis the Companies Act, 2013 recognises the three types shown in FC 7.2.
Flowchart
FC 7.2 — Types Of Companies On The Basis Of Ownership Company → Public Company, Private Company, One Person Company
7.5.1 Public Company
A public company is defined in the negative: it is a company which is not a private company. Its distinguishing feature is that it may invite the general public to subscribe to its shares and debentures, and its securities may be listed on a recognised stock exchange.
Because outside investors put money into it, the law fixes a minimum of seven members and places no upper limit on membership. Shares are freely transferable, so a member who wants to withdraw sells the shares rather than asking the company to return the money. A public company must have at least three directors, must issue a prospectus or a statement in lieu of it before offering securities, and must place its audited accounts before the public. A subsidiary of a public company is treated as a public company even if its own articles are those of a private company, so that the lighter rules are not obtained indirectly.
7.5.2 Private Company
A private company is one that keeps its membership closed, and its articles must contain three restrictions to that effect. It restricts the right of members to transfer their shares, it limits the number of its members to 200, and it prohibits any invitation to the public to subscribe to its securities. Present employees who are members, and former employees who became members while in employment and continue as members, are not counted in the limit of 200. Where two or more persons hold shares jointly, they are counted as a single member.
The minimum number of members is two and the minimum number of directors is two. A private company must add the words ‘Private Limited’ at the end of its name, so that anyone dealing with it knows both that liability is limited and that the company cannot approach the public for funds.
7.5.3 One Person Company
The One Person Company, introduced by the Companies Act, 2013, closes an old gap. A single entrepreneur who wanted limited liability and a separate legal identity previously had to find a second person to satisfy the minimum membership requirement. The One Person Company allows one person to obtain the benefits of incorporation alone.
The features that follow from this are:
- It has only one member at any point of time, and is incorporated as a private limited company.
- Only a natural person who is an Indian citizen and a resident in India is eligible to incorporate it, since the form is meant for individual entrepreneurs and not for corporate bodies.
- The member must name a nominee in the memorandum, who becomes the member if the sole member dies or becomes incapable of contracting. Without a nominee, perpetual succession would be meaningless in a company of one.
- It may have a minimum of one and a maximum of fifteen directors, and the sole member may be the sole director.
- No person may incorporate more than one such company or be a nominee in more than one, which prevents the form from being used to split a single business into several.
- The words ‘One Person Company’ must be mentioned in brackets below the name wherever the name is printed or engraved, so that outsiders know they are dealing with a single-member company.
- It may be converted into a private or a public company, and conversion becomes necessary once the company crosses the limits prescribed for the purpose under the rules.
7.6 Private And Public Companies — A Comparative Study
A private company and a public company are both incorporated bodies with a separate legal identity, perpetual succession and limited liability. They differ in one thing only: whether the company may go to the general public for its capital. Every advantage and disadvantage set out below can be traced back to that permission and to the regulation that comes with it.
Evaluation Of A Private Company
- Ease of formation — only two members are needed and the company need not issue a prospectus or arrange for a public offer, so the company can be brought into existence and begin business quickly.
- Secrecy — a private company is subject to lighter disclosure, and its affairs are known to a small group. Business plans, margins and customer arrangements can be kept away from competitors.
- Unity of management — membership is small and the owners are usually the managers, so decisions can be taken quickly and there is little distance between ownership and control.
- Fewer legal formalities — several requirements that bind a public company do not apply, which saves both money and management time.
- Limited liability with continuity — the owners obtain the protection of limited liability and an existence independent of their own lives, which a partnership firm cannot give them.
- Limited membership — with a ceiling of 200 members and no access to public subscription, the capital that can be raised is restricted, and this is the main obstacle when the business wants to expand.
- Restricted transfer of shares — a member who wishes to leave cannot simply sell in the market, since the articles restrict transfer. The investment is therefore illiquid.
- Weaker protection for members — several safeguards designed for public investors do not extend to private companies, so a minority member has less protection against the dominant group.
Evaluation Of A Public Company
- Large resources — the company may invite the public to subscribe to shares and debentures, so the capital it can raise is limited only by what investors are willing to put in.
- Liquidity for the investor — shares are freely transferable and may be listed, so an investor can convert the holding into cash and is therefore readier to invest.
- Protection of investors — strict regulation, compulsory audit and published accounts safeguard the persons who have supplied money without taking part in management, and this is also what earns the company public confidence.
- Economies of scale and professional management — the size that large capital makes possible allows specialist managers to be employed and unit costs to be brought down.
- Heavy legal formalities — the same regulation that protects investors imposes a continuous burden of meetings, filings, audits and disclosures, at both the formation stage and afterwards.
- Delay in decisions — a large body of members and a formal board procedure slow down decision-making, so the company is less suited to a business needing quick commitments.
- Loss of secrecy — accounts are published and documents filed with the Registrar are open to inspection, so confidential information reaches competitors.
- Oppression of the minority and speculation — control rests with those holding the majority of shares, leaving small shareholders with little say, while free transferability tempts outsiders to trade in the shares for price gain rather than to invest.
The two forms are compared point by point in Table 7.2.
The choice therefore turns on the source of capital. So long as the promoters can finance the business themselves, the private company gives them limited liability, speed and privacy. Once the business needs money from investors who will never manage it, the public company is the only route, and the price of that access is regulation, disclosure and slower decisions.
7.7 Summary
- A joint stock company is a voluntary, registered association of persons whose capital is divided into transferable shares, having a separate legal identity, perpetual succession and, usually, limited liability.
- The definitions of a company fall into three groups — those given by writers, those given by jurists, and the definition in the Companies Act, 2013, which treats registration as the test of whether an association is a company.
- Every essential characteristic of a company follows from incorporation:
- It is an artificial person created by law and a separate legal entity from its members.
- It has perpetual succession, so changes in membership do not affect its existence.
- The liability of a member is limited to the amount unpaid on the shares held.
- It may authenticate documents under a common seal, which the law now leaves optional.
- Its activities are confined to the objects stated in its Memorandum of Association.
- It is a voluntary association for profit, and distributed profit is paid as dividend.
- Ownership rests with the shareholders while management is entrusted to the Board of Directors.
- It can sue and be sued in its own name, its shares are transferable, and it is wound up only by legal process.
- A partnership arises from agreement and is not distinct from the partners, while a company arises from registration and is distinct from its members. The two forms therefore differ in legal status, liability, membership limits, transfer of interest, management, continuity, disclosure and dissolution.
- The merits of the company form are large financial resources, limited liability, liquidity of investment, professional management, diffusion of risk, economies of large-scale operation, stability, public confidence, mobilisation of small savings and scope for expansion.
- Its demerits are difficulty and cost of formation, heavy legal regulation, lack of secrecy, delay in decisions, oligarchic management, conflict of interest, risk of fraud at the promotion stage, lack of personal initiative, concentration of economic power and speculation in shares.
- On the basis of ownership, the Companies Act, 2013 recognises three types of companies:
- A public company, which may invite the public to subscribe to its securities, needs at least seven members and at least three directors.
- A private company, which by its articles restricts transfer of shares, limits members to 200 and prohibits public subscription.
- A One Person Company, incorporated as a private company by a single natural person who is an Indian citizen and resident in India, with a nominee named in the memorandum.
- A private company offers ease of formation, secrecy, unity of management and fewer formalities, but is limited in the capital it can raise and in the transferability of its shares.
- A public company can raise large capital and offers liquidity and investor protection, but carries heavy legal formalities, slower decisions, loss of secrecy and the risk of the minority being overruled.
- The choice between the two turns on the source of capital: a business financed by its own promoters suits the private form, while a business needing money from outside investors must accept the regulation that the public form brings.
Flowchart
FC 7.3 — The Company Form At A Glance Registration → Incorporation → Separate legal entity → Perpetual succession, Limited liability, Transferable shares, Management by Board of Directors → Public Company, Private Company, One Person Company
7.8 Key Terms
- Artificial Person A body that is not a human being but is treated by law as a person, able to own property, enter into contracts and sue or be sued in its own name.
- Board Of Directors The body of representatives elected by the shareholders to manage the company and answerable to the members for its conduct.
- Common Seal The official seal bearing the company’s name, traditionally used to authenticate documents on behalf of the company; the law now leaves its adoption optional.
- Joint Stock Company An artificial person created by law, having a separate entity, with perpetual succession and a common seal, and with capital divided into transferable shares.
- Limited Liability The liability of a member confined to the amount still unpaid on the shares held, beyond which personal assets cannot be claimed for the company’s debts.
- One Person Company A company incorporated as a private limited company with a single member, who must be a natural person, an Indian citizen and a resident in India, and who names a nominee in the memorandum.
- Perpetual Succession The continued existence of a company irrespective of the death, insolvency, retirement or change of its members, the company being dissolved only by the process of law.
- Private Company A company which by its articles restricts the transfer of its shares, limits its members to 200 and prohibits any invitation to the public to subscribe to its securities.
- Public Company A company which is not a private company; it may invite the public to subscribe to its securities and must have at least seven members and at least three directors.
- Separate Legal Entity The status of a company as a person in law distinct from its members, owning its own property and carrying its own liabilities.
- Share A unit of small value into which the total capital of a company is divided, and which a person buys to become a member of the company.
- Shareholder A person who holds one or more shares in a company and is thereby a member and part owner of it.
- Transferability Of Shares The right of a member to pass shares to another person, free in a public company and restricted by the articles in a private company.
7.9 Points To Ponder
- Limited liability protects the investor, but it also means that creditors of a failed company may recover only from the company’s assets. Is that a fair distribution of risk between shareholders and creditors?
- A company is described as democratic because its directors are elected by the members, and yet the same form is criticised as oligarchic. Can both descriptions be true at once, and what would have to change for the first to be more accurate than the second?
- Disclosure protects investors and simultaneously hands information to competitors. How much secrecy should a company be allowed to keep, and who should decide where the line falls?
- The One Person Company gives a single entrepreneur limited liability that a sole proprietor does not have. If incorporation is available to one person, is there any remaining reason to start a business as a sole proprietorship?
- Perpetual succession lets a company outlive everyone who built it. Does an existence independent of its founders make a business more responsible in its decisions, or less?
- A private company gains speed and privacy by giving up access to public capital. At what point in a business’s growth does that trade become too costly to continue with?
7.10 Objective Questions
- A company is treated as a person distinct from its members. This characteristic is known as: [1]
- Perpetual succession
- Separate legal entity
- Limited liability
- Representative management
- There are two statements given below, marked as Assertion (A) and Reason (R). Read the statements and choose the correct option. [1] Assertion (A): A joint stock company is able to raise capital from a very large number of small investors. Reason (R): The capital of a company is divided into shares of small value and the liability of a member is limited to the unpaid amount on the shares held.
- Both (A) and (R) are true, and (R) is the correct explanation of (A).
- Both (A) and (R) are true, but (R) is not the correct explanation of (A).
- is true, but (R) is false.
- is false, but (R) is true.
- Fill in the blank: A private company must restrict, by its articles, the transfer of its shares and must limit the number of its members to __________. [1]
- State whether the following statement is true or false: A One Person Company may be incorporated by a company as well as by an individual. [1]
- Match the feature in Column A with the consequence it produces in Column B. [1]
| Column A | Column B |
|---|---|
| a. Perpetual succession | i. Ownership is separated from control |
| b. Transferability of shares | ii. The investor can convert the holding into cash |
| c. Representative management | iii. Personal assets are not available to the company’s creditors |
| d. Limited liability | iv. Death or insolvency of a member does not end the business |
7.11 Check Your Concepts
- Define a joint stock company. [2]
- Why is a company described as an artificial person? State one right it enjoys as a consequence. [3]
- Distinguish between a partnership firm and a joint stock company on any three bases. [3]
- ‘The separation of ownership from management is both a merit and a demerit of the company form.’ Explain this claim with one point on each side. [4]
- Explain any three merits and any three demerits of the joint stock company form of organisation, giving in each case the reason why the merit or the demerit arises. [6]
7.12 Case-Based Questions
- Ardhika runs a design studio on her own and wants the protection of limited liability without taking in a partner. She incorporates a company in which she is the only member and names her sister in the memorandum as the person who will take her place if she is no longer able to hold the shares. Two years later the studio wins large corporate contracts, and Ardhika considers raising capital from outside investors by offering shares to the public.
- Name the type of company Ardhika has incorporated and state the purpose served by naming her sister in the memorandum. [2]
- State the form of company Ardhika must adopt if she wishes to offer shares to the public, and explain any two obligations that this form will bring with it. [2]