CA EDGE FOUNDATION TEST SERIES

JUNE 2024 ATTEMPT

SUBJECT: BUSINESS LAWS
Test 1
Test Date: 17.04.2024
TOPIC: COMPANIES ACT 2013
Max Marks: 35 Max Time: 75 Mins

Q1. AK Private Limited has borrowed Rs 36 crore from BK Finance Limited. However, as per memorandum
of AK Private Limited, the maximum borrowing power of the company is Rs 30 crore. Examine
whether AK Private Limited is liable to pay this debt? State the remedy, if any available to BK Finance
Limited. 4 marks
Ans. This case is governed by the ‘Doctrine of Ultra Vires’. According to this doctrine, any act done, or a
contract made by the company which travels beyond the powers of the company conferred upon it
by its Memorandum of Association is wholly void and inoperative in law and is therefore not binding
on the company. This is because the Memorandum of Association of the company is, in fact, its charter;
it defines its constitution and the scope of the powers of the company. Hence, a company cannot depart
from the provisions contained in the memorandum however imperative may be the necessity for the
departure. Hence, any agreement ultra vires the company shall be null and void.
(i) Whether AK Private Limited is liable to pay the debt?
As per the facts given, AK Private Limited borrowed ` 36 crore from BK Finance Limited which is
beyond its borrowing power of` 30 crore.
Hence, contract for borrowing of ` 36 crore, being ultra vires the Memorandum of Association and
thereby is void. AK Private Limited is not, therefore, liable to pay the debt.
(ii) Remedy available to BK Finance Limited:
In light of the legal position explained above, BK Finance Limited cannot enforce the said transaction
and thus has no remedy against the company for recovery of the money lent. BK Finance limited may
take action against the directors of AK Private Limited as it is the personal liability of its directors to
restore the borrowed funds. Besides, BK Finance Limited may take recourse to the remedy by means
of ‘Injunction’, if feasible.

Q2. Mr. Dhruv was appointed as an employee of Sunmoon Timber Private Limited on the condition that
if he were to leave his employment, he will not solicit customers of the company. After some time, he was
fired from company. He set up his own business under proprietorship and undercut Sunmoon Timber
Private Limited’s prices. On the legal advice from his legal consultant and to refrain from the provisions
of breach of contract, he formed a new company under the name Seven Stars Timbers Private Limited.
In this company, his wife and a friend of Mr. Dhruv were the sole shareholders and directors. They
took over Dhruv’s business and continued it. Sunmoon Timber Private Limited filed a suit against Seven
Stars Timbers Private Limited for violation of contract. Seven Stars Timbers Private Limited argued
that the contract was entered into between Mr. Dhruv and Sunmoon Timber Private Limited and as
company has separate legal entity, Seven Stars Timbers Private Limited has not violated the terms of
agreement. Explain with reasons, whether separate legal entity between Mr. Dhruv and Seven Stars
Timbers Private Limited will be disregarded? 4 marks
 Ans. It was decided by the court in the case of Gilford Motor Co. Vs. Horne, if the company is formed
simply as a mere device to evade legal obliga ons, though this is only in limited and discrete
circumstances, courts can pierce the corporate veil. In other words, if the company is mere sham or
cloak, the separate legal en ty can be disregarded.
On considering the decision taken in Gilford Motor Co. Vs. Horne and facts of the problem given, it is
very much clear that Seven Stars Timbers Private Limited was formed just to evade legal obligations of
the agreement between Mr. Dhruv and Sunmoon Timber Private Limited. Hence, Seven Stars Timbers
Private Limited is just a sham or cloak and the separate legal entity between Mr. Dhruv and Seven
Stars Timbers Private Limited should be disregarded.

Q3. Ravi incorporated a “One Person Company” making his sister Rohini as the nominee. Rohini is leaving
India permanently due to her marriage abroad. Due to this fact, she is withdrawing her consent of
nomina on in the said One Person Company. Taking into considera ons the provisions of the Companies
Act, 2013 answer the ques ons given below. 5 marks

(a) If Rohini is leaving India permanently, is it mandatory for her to withdraw her nomination in the said
One Person Company?
(b) If Rohini maintained the status of Resident of India after her marriage, then can she continue her
nomination in the said One Person Company?
Ans. (A ) Yes, it is mandatory for Rohini to withdraw her nomina on in the said OPC as she is leaving
India permanently as only a natural person who is an Indian ci zen and resident in India shall be a
nominee in OPC.

(B) Yes, Rohini can continue her nomination in the said OPC, if she maintained the status of Resident of
India after her marriage by staying in India for a period of not less than 120 days during the immediately
preceding financial year.

Q4. Explain Doctrine of 'Indoor Management' under the Companies Act, 2013. Also state the circumstances
where the outsider cannot claim relief on the ground of 'Indoor Management'. 6 marks
Ans. Doctrine of Indoor Management: The Doctrine of Indoor Management is the excep on to the
doctrine of construc ve no ce. The aforesaid doctrine of construc ve no ce does in no sense mean that
outsiders are deemed to have no ce of the internal affairs of the company. For instance, if an act is
authorised by the ar cles or memorandum, an outsider is en tled to assume that all the detailed
formali es for doing that act have been observed. This can be explained with the help of a landmark
case The Royal Bri sh Bank vs. Turquand. This is the doctrine of indoor management popularly known
as Turquand Rule.
FACTS of The Royal Bri sh Bank vs. Turquand
Mr. Turquand was the official manager (liquidator) of the insolvent Cameron‟s Coalbrook Steam, Coal and
Swansea and Loughor Railway Company. It was incorporated under the Joint Stock Companies Act, 1844.
The company had given a bond for £ 2,000 to the Royal British Bank, which secured the company‟s
drawings on its current account. The bond was under the company‟s seal, signed by two directors and
the secretary. When the company was sued, it alleged that under its registered deed of settlement (the
 articles of association), directors only had power to borrow up to an amount authorized by a company
resolution.
A resolution had been passed but not specifying how much the directors could borrow.
Held, it was decided that the bond was valid, so the Royal British Bank could enforce the terms. He said
the bank was deemed to be aware that the directors could borrow only up to the amount resolutions
allowed. Articles of association were registered with Companies House, so there was constructive notice.
But the bank could not be deemed to know which ordinary resolutions passed, because these were not
registrable. The bond was valid because there was no requirement to look into the company‟s internal
workings. This is the indoor management rule, that the company‟s indoor affairs are the company‟s
problem.
Exceptions to the doctrine of Indoor Management: Thus, you will notice that the aforementioned rule
of Indoor Management is important to persons dealing with a company through its directors or other
persons. They are entitled to assume that the acts of the directors or other officers of the company are
validly performed, if they are within the scope of their apparent authority. So long as an act is valid under
the articles, if done in a particular manner, an outsider dealing with the company is entitled to assume
that it has been done in the manner required.

The above mentioned doctrine of Indoor Management or Turquand Rule has limitations of its own. That
is to say, it is inapplicable to the following cases, namely:

(a) Actual or constructive knowledge of irregularity: The rule does not protect any person when the person
dealing with the company has notice, whether actual or constructive, of the irregularity.
In Howard vs. Patent Ivory Manufacturing Co. where the directors could not defend the issue of
debentures to themselves because they should have known that the extent to which they were lending
money to the company required the assent of the general meeting which they had not obtained.
Likewise, in Morris v Kansseen, a director could not defend an allotment of shares to him as he
participated in the meeting, which made the allotment. His appointment as a director also fell through
because none of the directors appointed him was validly in office.
(b) Suspicion of Irregularity: The doctrine in no way, rewards those who behave negligently. Where the
person dealing with the company is put upon an inquiry, for example, where the transaction is unusual or
not in the ordinary course of business, it is the duty of the outsider to make the necessary enquiry.
The protection of the “Turquand Rule” is also not available where the circumstances surrounding the
contract are suspicious and therefore invite inquiry. Suspicion should arise, for example, from the fact
that an officer is purporting to act in matter, which is apparently outside the scope of his authority. Where,
for example, as in the case of Anand Bihari Lal vs. Dinshaw & Co. the plaintiff accepted a transfer of a
company‟s property from its accountant, the transfer was held void. The plaintiff could not have
supposed, in absence of a power of attorney that the accountant had authority to effect transfer of the
company‟s property.
Similarly, in the case of Haughton & Co. v. Nothard, Lowe & Wills Ltd. where a person holding directorship
in two companies agreed to apply the money of one company in payment of the debt to other, the court
said that it was something so unusual “that the plaintiff were put upon inquiry to ascertain whether the
persons making the contract had any authority in fact to make it.” Any other rule would “place limited
companies without any sufficient reasons for so doing, at the mercy of any servant or agent who should
purport to contract on their behalf.”
(c) Forgery: The doctrine of indoor management applies only to irregularities which might otherwise affect a
transaction but it cannot apply to forgery which must be regarded as nullity.
Forgery may in circumstances exclude the ‘Turquand Rule’. The only clear illustration is found in the
Ruben v Great Fingall Consolidated. In this case the plaintiff was the transferee of a share certificate
issued under the seal of the defendant‟s company. The company‟s secretary, who had a fixed the seal of
the company and forged the signature of the two directors, issued the certificate. The plaintiff contended
that whether the signature were genuine or forged was apart of the internal management, and therefore,
the company should be estopped from denying genuineness of the document. But it was held, that the
rule has never been extended to cover such a complete forgery.

Q5. ABC Limited was registered as a public company. There were 245 members in the company. Their
details are as follows :
Directors and their relatives 190
Employees 15
Ex - employees
(shares were allotted when they were employees) 20
20
Others (Including 10 joint holders holding shares jointly in
the name of father and son)

The Board of directors of the company propose to convert it into a private company. Advice whether
reduction in the number of members is necessary for conversion. 5 marks

Ans. According to section 2(68) of the Companies Act, 2013, "Private company" means a company having
a minimum paid-up share capital as may be prescribed, and which by its articles, except in case of One
Person Company, limits the number of its members to two hundred.
However, where two or more persons hold one or more shares in a company jointly, they shall, for the
purposes of this clause, be treated as a single member.
It is further provided that -
(A) Persons who are in the employment of the company; and
(B) persons who, having been formerly in the employment of the company, were members
of the company while in that employment and have continued to be members after the
employment ceased,
Shall not be included in the number of members.
In the instant case, Total No. of Members of ABC Ltd. will be counted as follow:
1. Directors & their relatives - 190
2. Others (10 Couple) (10x1) - 10
200
Since No. of member do not exceed 200. Therefore, there is no need for reduction in the number
of members.

Q6. Explain the concept of 'Corporate Veil'. Briefly state the circumstances when thecorporate veil can be lifted as
per the provisions of the Companies Act, 2013.
6 marks
Ans. Corporate Veil: Corporate Veil refers to a legal concept whereby the company is iden fied separately from the members
of the company. Due to this, members of a company are shielded from liability connected to the company’s ac ons.
 Lifting of Corporate Veil: The following are the cases where company law disregardsthe principle of corporate personality
or the principle that the company is a legal entity distinct and separate from its shareholders or members:
(1) To determine the character of the company i.e. to find out whether co-enemyor friend: It is true that, unlike a natural
person, a company does not have mind or conscience; therefore, it cannot be a friend or foe. It may, however, be
characterised as an enemy company, if its affairs are under the control of people of an enemy country. For this purpose, the
Court may examine the character of the persons who are really at the helm of affairs of the company.
(2) To protect revenue/tax: In certain matters concerning the law of taxes, duties and stamps particularly where question of
the controlling interest is in issue. Where corporate entity is used to evade or circumvent tax, the Court can disregard the
corporate identity.
(3) To avoid a legal obligation: Where it was found that the sole purpose for the formation of the company was to use it as a
device to reduce the amount to be paid by way of bonus to workmen, the Supreme Court upheld the piercing of the veil to
look at the real transaction.
(4) Formation of subsidiaries to act as agents: A company may sometimes be regarded as an agent or trustee of its members,
or of another company, and may therefore be deemed to have lost its individuality in favour of its principal. Here the
principal will be held liable for the acts of that company.
(5) Company formed for fraud/improper conduct or to defeat law: Where the deviceof incorporation is adopted for some
illegal or improper purpose, e.g., to defeat or circumvent law, to defraud creditors or to avoid legal obligations.

Q7. BC Private Limited and its subsidiary KL Private Limited are holding 90,000 and 70,000 shares respectively in PQ Private
Limited. The paid-up share capital of PQ Private Limited is ` 30 Lakhs (3 Lakhs equity shares of ` 10 each fully paid).
Analyse with reference to provisions of the Companies Act, 2013 whether PQ Private Limited is a subsidiary of BC Private
Limited. What would be your answer if KL Private Limited is holding 1,60,000 shares in PQ Private Limited and no shares are
held by BC Private Limited in PQ Private Limited? 5 marks

Ans. Sec on 2(87) defines “subsidiary company” in rela on to any other company (that is to say the holding company),
means a company in which the holding company—
 controls the composition of the Board of Directors; or
 exercises or controls more than one-half of the total voting power either at its ownor together with one or
more of its subsidiary companies:
For the purposes of this section —
 a company shall be deemed to be a subsidiary company of the holding company even if the control referred
to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
 “layer” in relation to a holding company means its subsidiary or subsidiaries.
(i) In the instant case, BC Private Limited together with its subsidiary KL Private Limited is holding 1,60,000 shares
(90,000+70,000 respectively) which is more than one half in nominal value of the Equity Share Capital of PQ Private Limited.
Hence, PQ Private Limited is subsidiary of BC Private Limited.
(ii) In the second case, the answer will remain the same. KL Private Limited is a holding 1,60,000 shares i.e., more than
one half in nominal value of the EquityShare Capital of PQ Private Limited (i.e., holding more than one half of voting
power). Hence, KL Private Limited is holding company of PQ Private Company and BC Private Limited is a holding company
of KL Private Limited. Hence, by virtue of Chain relationship, BC Private Limited becomes the holding company of PQ Private
Limited.