5.

5 Company Law

Limited Company vs. Unlimited Company: Liabilities and Accountability

Submitted By: Abhinav Singh

SM0116057

Vth Semester, IIIrd Year

Faculty in Charge

Mrs. Monmi Gohain

National Law University, Assam

 Index

 Introduction
Overview
Literature Review
Research Question
Research Methodology

 Limited Companies
 Unlimited Companies
 Key Managerial Personnel
 Liabilities and Accountability
 Conclusion
 Bibliography
Introduction

Overview

Industrial has revolution led to the emergence of large-scale business organizations. These
organizations require big investments and the risk involved is very high. Limited resources and
unlimited liability of partners are two important limitations of partnerships of partnerships in
undertaking big business. Joint Stock Company form of business organization has become
extremely popular as it provides a solution to overcome the limitations of partnership business.

A company is a voluntary association of individuals formed to carry on business to earn profits

or for non-profit purposes. These persons contribute towards the capital by buying its shares in
which it is divided. A company is an association of individuals incorporated as a company
possessing a common capital i.e. share capital contributed by the members comprising it for
the purpose of employing it in some business to earn profit.

Literature Review

 Company Law by Avatar Singh

In the book the author has covered the topic of limited and unlimited companies in
regards to their liabilities and how they both differ from each other. In the book the
author has talked about the accountabilities that the companies act had deferred upon
the key managerial personal.
 Company law and Practice by Dr. GK Kapoor
In the book the author has focused on the idea of accountability of the directors a
company. The author has stressed on the point of creating liabilities and
accountabilities for the different position in the company.

Research Question

 What are limited and unlimited companies?

 What are the liabilities of a company and its KMP?
 What are the difference between the liabilities and Accountability of the two types of
company?
Research Methodology

1. Approach to research

In this project, the researchers have adopted Doctrinal type of research. Doctrinal research is
essentially a library-based study, which means that the materials needed by a researcher may
be available in libraries, archives and other databases. Help from various websites were also
taken.

2. Sources of data collection

Data has been collected from secondary sources like books, web sources etc. The researchers
collected no primary sources like survey data or field data.

3. System of Citation and Footnoting:

The researchers have followed the Oxford System of citation and footing throughout the project
to maintain the uniformity
Limited Companies

These are formed under the Companies Act, 2013 or under the Companies Act passed earlier
to this. Such companies come into existence only when they are registered under the Act and a
certificate of incorporation has been issued by the Registrar of Companies. This is the most
popular mode of incorporating a company. Registered companies may further be divided into
three categories of the following.

i) Companies limited by Shares : These types of companies have a share capital and the liability
of each member or the company is limited by the Memorandum to the extent of face value of
share subscribed by him. In other words, during the existence of the company or in the event
of winding up, a member can be called upon to pay the amount remaining unpaid on the shares
subscribed by him. Such a company is called company limited by shares. A company limited
by shares may be a public company or a private company. These are the most popular types of
companies.

ii) Companies Limited by Guarantee : These types of companies may or may not have a share
capital. Each member promises to pay a fixed sum of money specified in the Memorandum in
the event of liquidation of the company for payment of the debts and liabilities of the company1
This amount promised by him is called ‘Guarantee’. The Articles of Association of the
company state the number of member with which the company is to be registered [Sec 27 (2)].
Such a company is called a company limited by guarantee. Such companies depend for their
existence on entrance and subscription fees. They may or may not have a share capital. The
liability of the member is limited to the extent of the guarantee and the face value of the shares
subscribed by them, if the company has a share capital. If it has a share capital, it may be a
public company or a private company. The amount of guarantee of each member is in the nature
of reserve capital. This amount cannot be called upon except in the event of winding up of a
company. Non- trading or non-profit companies formed to promote culture, art, science,
religion, commerce, charity, sports etc. are generally formed as companies limited by
guarantee.

1
Sec 13(3)Companies Act, 2013
Limited Liability Company

Limited Liability Company is another category of company registered under the Indian New
Companies Act, 2013. There are numbers of companies are available in India including private
limited and public limited ones but Limited Liability Company is a brand new one in the line.
It's often called as a Limited Liability Corporation and its nature of business is quite similar
with partnership firm and sole trade business. Company is an association of persons or an
artificial person formed under the Indian Companies act in order to carry out a certain business.
Under the Limited Liability Company Act, liability is limited among members or partners and
no one is responsible for other's misconduct and responsibilities in any case. Limited liability
company registration has been extensively growing due to its many advantages over other form
of business enterprises. As the name itself defines a limited liability company is the company
where the shareholders liability towards the loss or deficit is limited by shares. Here the only
investment a shareholder does is by investing to buy the shares distributed. And in any case the
company collapses or goes bust then the shareholders do not have to use their personal property
or balance to cover the loss. Shareholders have limited and determined risk in the company.
The main idea behind this is that the legal behaviour and the performance of a company are
different from that of its members or partners. The main aim of this system is to give the
investors minimum insurance in the business over their own personal lives. Therefore only the
amount paid for the shares and the value of the investment are at risk without taking into
consideration of his personal wealth and belongings. In a company which is incorporated with
limited liability status where ownership is divided into shares that were paid fully at once by
its shareholders will not be liable for any debts of that company. Incorporation by registration
was introduced in 1844 and the doctrine of limited liability followed in 1855.Subsequently in
1897 in Solomon v. Solomon & Company the House of Lords effected these enactments and
cemented into English law the twin concepts of corporate entity and limited liability. In that
case the apex court simply laid down that a company is a distinct legal person entirely different
from the members of that company. What this means is that the company has life of its own,
can own property, can sue and be sued in its own name, has perpetual life and existence to
name a few of the benefits of incorporation. It is a trite law that a rather hefty veil is drawn
between these two that can be lifted only in a limited number of circumstances that seem to be
fluctuating according to current judicial thinking. However the courts have not always applied
the principal lay down in Solomon v. Solomon & Co. In a number of circumstances, the court
will pierce the corporate veil or will ignore the corporate veil to reach the person behind the
veil or reveal the true form and character of the concerned company. The rationale behind this
is probably that the law will not allow the corporate form to be misused or for the purposes
which is set out in the statute. In those circumstances in which the court feels that the corporate
form is being misused it will rip through the corporate veil and expose its true character and
nature disregarding the Solomon principal as laid down by the House of Lords.
Unlimited Companies

As per Section 2(92) of the Companies Act 2013, (corresponding Section 12(2)(c) of the
Companies Act, 1956) Unlimited Company means a company not having any limit on the
liability of its Members.

As per Section 2(92) of the Companies Act 2013,(“Act”) (corresponding Section 12(2)(c) of
the Companies Act, 1956) “Unlimited Company” (UC) means a company not having any limit
on the liability of its Members.

Members and Shareholders are fully liable to cover its debts. In the case of UC the liability of
each member extends to the whole amount of the company’s debts and liabilities, but he will
entitled to claim the contribution from other members.

In the case of a UC, the liability is similar to that of partner although the creditors cannot
directly institute legal proceeding against the individual member. Creditors have to institute
proceeding for winding up but OL can call upon the member to discharge the debts and
liabilities without limit. Under Section 32 of the Companies Act, 2013 an ULC can get itself
re-registered as limited liability Company but such conversion will not affect prior debts,
liabilities and obligations.

An UC is not the same as an un-incorporated company, though in both case, the liability of the
member is unlimited. The difference between two is that while UC registered under the
Companies Act is a legal person with perpetual succession and common seal, capable of
borrowing, suing, sued, and holding property in its own name in the case of un-incorporated
association the individual member alone have right & duties, and association as such no
existence as legal entity.

As per the provisions of Section 65 of the Act, an unlimited company may convert itself into a
limited company. The procedure for incorporation of such companies is similar to that of
companies with limited liability.

In relation to a holding company which is either a company limited by guarantee or an UC, the
reference in this section to shares shall, whether or not the company has a share capital, be
construed as including a reference to the interest of its members as such, whatever the form of
that interest.
Key Managerial Personnel

The definition of the term Key Managerial Personnel is contained in Section 2(51) of the
Companies Act, 2013. The said Section states as under:

“key managerial personnel”, in relation to a company, means—

(i) the Chief Executive Officer or the managing director or the manager;

(ii) the company secretary;

(iii) the whole-time director;

(iv) the Chief Financial Officer; and

(v) such other officer as may be prescribed

The liability of the company is generally not transferred onto the directors. However, directors
can be held personally liable for their acts under the Companies Act 2013, if there is a breach
of fiduciary duty or instance of fraud. In this article, we look at instances where the directors
can be held personally liable under the Companies Act, 2013.
Liabilities & Accountability

Breach in Fiduciary Duty

A director must comply with certain fiduciary duties, and any lapse on this part will make the
directors personally liable in an action for tort. Some of these cases include fraud, breach of
trust, fraudulent misrepresentation etc.

Issue of Prospectus with Intent to Defraud

If a director issues a prospectus with intent to defraud the applicants or other persons for any
purpose, he/she will be personally held liable, without any limitation of liability, for the
damages incurred by any person who has subscribed to the securities on the basis of such
prospectus.

Acceptance of Deposits with the Intent to Defraud

If a company fails to repay the deposit or interest within the stipulated time, and it is established
that the deposits were accepted for a fraudulent purpose, the concerned officer who was
responsible for the acceptance of such deposit will be held personally accountable, without any
limitation of liability, for all or any of the losses/damages incurred by the depositors.

Undue Advantage by Directors on Account of Fraud

An inspector may report on the occurrence of any fraudulent activity in a company. If any
director, key managerial personnel, other officer of the company or any other person belonging
to the company utilize this scenario in an inappropriate manner, whether in the form of asset
property, cash or any other manner, the Central Government may file an application before the
National Company Law Tribunal seeking appropriate orders with regard to discharge of such
asset, property or cash, and holding the concerned director, key managerial personnel, officer
or other person personally liable, without any limitation of liability.

Liability for Fraudulent Conduct of Business

While dissolving a company, if it is evident that any business of the entity has been pursued
with intent to defraud the creditors of the company or any other persons, the National Company
Law Tribunal, on the application of the Official Liquidator/Company
Liquidator/Creditor/Contributor of the company, is entitled to declare that any person who
is/has been a director, manager or officer of the company, or has been a part of it with the
complete awareness of the events, shall be personally held liable, without any limitation of
liability, for all or any of the debts or other liabilities of the company as directed by the
Tribunal.

Sec 322 - Directors, etc., with unlimited liability in limited company.

(1) In a limited company, the liability of the directors or of any director or manager may, if so
provided by the memorandum, be unlimited.

(2) In a limited company in which the liability of a director or manager is unlimited, the
directors and the manager of the company, and the member who proposes a person for
appointment to the office of director or manager, shall add to that proposal a statement that the
liability of the person holding that office will be unlimited; and before the person accepts the
office or acts therein, notice in writing that his liability will be unlimited, shall be given to him
by the following or one of the following persons, namely, the promoters of the company, its
directors, or manager, if any, and its officers.

(3) If any director, manager or proposer makes default in adding such a statement, or if any
promoter, director, manager or officer of the company makes default in giving such a notice,
he shall be punishable with fine which may extend to ten thousand rupees and shall also be
liable for any damage which the person so appointed may sustain from the default; but the
liability of the person appointed shall not be affected by the default.

What is a Derivative Action?

Derivative action is defined as an action by one or more shareholders of a company where the
cause of action is vested in the company and relief is accordingly sought on its behalf. Since
the company has a distinct legal personality with its own rights and liabilities which are
different from those personal rights of individual shareholders, this action is brought by a
shareholder not to enforce his or her own personal rights but, rather, the rights and liabilities
of the company on its behalf and for the benefit of the company; which the company cannot
itself do, as it is controlled by the ‘wrong doers’.

In order to be classified as a derivative action, the following aspects must be satisfied:

  It must be brought in a representative form, even though it is the company, rather than
the other shareholders, whom the person initiating the legal action / proceedings seeks
to represent. Thus, by implication, all the other shareholders are bound by the result of
the action.
 Although the action is brought on behalf of the company, the company appears as a
defendant, so that the action takes the form of a representative action by the initiating
shareholder on behalf of himself and all the other shareholders (other than the alleged
‘wrong doers’), against the alleged ‘wrong doers’ (who are, in fact, in control of the
company) and the company.

Indemnifying Directors

Indemnification: The Companies Act restricts the ability of a company to indemnify its
Directors and officers against losses. Any provision contained in the Articles or any other
agreement, to provide indemnity on account of their negligence, default, misfeasance and
breach of duty or trust is void. However, such indemnity will be enforceable if it is against any
liability incurred by such Director or officer in defending any proceedings in which judgment
is given in his favour or in which he is acquitted or discharged or where it is determined that,
although liable, he acted honestly and reasonably and should be excused. The Companies Act,
however, does not prevent a company from taking an insurance policy for its own protection
against loss caused to it by its Directors. Further, the Director can take out a policy to
recompensate the loss he suffers because of his liability to the company. The premium for such
policy may be paid by the company itself.

Difference

Liability should be a critical concern for any small business owner, as it refers to how much
personal responsibility a business owner has for any debts racked up by the business. If you
have unlimited liability, then your personal assets -- your home, your bank accounts, etc. -- are
at risk.
Debt Danger

People don't start a business thinking that the businesses will fail, but according to the Small
Business Administration, about half of small businesses fail within five years, and two-thirds
are out of business within 10 years. When a business goes down, it often leaves debt behind.
The question is whether that debt will become a personal burden for the owners of the business,
possibly wiping them out. Protecting yourself from that liability isn't expecting failure; it's
prudence -- hoping (and working) for the best while preparing for the worst.

Unlimited Liability

Sole proprietorships, or unincorporated businesses owned by a single person, are the most
common kind of enterprise, accounting for about three-quarters of small businesses. A sole
proprietorship is an unlimited liability company. Legally, the business and the owner are one
and the same, so the debts of the business are automatically those of the owner. General
partnerships are also unlimited liability companies. Each partner is personally liable for all the
debts of the business -- even those taken on by other partners. A "limited partnership" has two
kinds of partners: general and limited. The general partners have unlimited liability; they're
also the ones who run the company. The limited partners are shielded from personal liability
for business debts, but they usually don't get a say in running the company.

Limited Liability

At one time, the only way to guarantee limited liability for all the owners of a company was to
incorporate. The shareholders of a corporation can lose the money that they have invested in
the company -- the price they paid for their shares, essentially -- but that's it. Any debts belong
to the corporation, not them. Their liability is therefore limited to whatever they put into the
company. Starting in the 1970s, states revised their commercial codes to allow businesses to
operate as "limited liability companies," or LLCs. An LLC is effectively a partnership without
any general partners. Its owners enjoy the limited liability protections of a corporation, but
without all the corporate trappings, such as issuing stock, having a board of directors and so
on.

Exceptions

Even for companies with limited liability, courts can hold owners or shareholders personally
liable for business debts. Legal scholars refer to this as "piercing the veil" of liability protection.
Nolo lists three conditions for piercing the veil: owners not treating the business like a separate
legal entity, perhaps mingling personal and business funds or ignoring corporate rules; owners
knowingly acted in a negligent, reckless or criminal manner; and the company's creditors show
that these actions caused them "unjust" losses -- losses beyond those associated with typical
business risk

Limited Liability Advantages

For a business owner or investor, the advantages of limited liability are significant. No one
goes into business wanting to lose money, but it's always a possibility. With limited liability,
though, the most you can lose is the amount of your investment. If you buy, say, $10,000 worth
of stock in a company, you can lose that $10,000 -- but the company's creditors can't come
knocking on your door demanding that you cough up more to settle the company's debts. If
you're going to invest money in any company, you're probably going to expect and insist upon
limited liability protection.

Unlimited Liability Disadvantages

The disadvantages of unlimited liability are just as clear as the advantages of limited liability.
There's no cap on how much you can lose. When you have unlimited liability, the failure of
your business can cost you everything you own, pushing you into personal bankruptcy. The
concept of limited liability is a cornerstone of the modern entrepreneurial system. Innovation
comes from entrepreneurs willing to take risks -- but unlimited liability makes many risks
unacceptable because the penalties for failure can be so high.
Conclusion

Limited and unlimited companies are both types of companies with different characteristic and
nature. The Companies Act, 2013 has conferred different type of liabilities and accountabilities
to both of them, though they share some common liabilities and accountabilities. The
companies act has tried to merge some of their difference by including sections such as Section
13, which provide for unlimited liability for the directors of the company.

Depending on the way a business is organized and structured, the owners may be liable for the
entire debts and obligations of the business or liable for a certain percentage of the
organization’s debts and obligations. The owners of certain types of business organizations,
such as sole proprietorships and general partnerships, are subject to unlimited liability. The
shareholders in corporations and the members of businesses organized as limited liability
entities are only liable for the debts and obligations of the organization to the extent of
their investments, and enjoy protection of personal assets.
Bibliography

 Books
Company Law and practice By Dr. GK Kapoor
Company Law by Avatar Singh
 Websites
http://www.legalservicesindia.com/articles/dl.htm