CA Inter Corp Laws

Feasibility of the Proposal – Section 8 Company under the Companies Act, 2013

Formation of Section 8 Company: The proposal to form 'Budding Pilots Flying Club' as a Section 8 company is partially feasible. Under Section 8(1) of the Companies Act, 2013, the Central Government may issue a licence to register a company with charitable objects such as promotion of education, sports, science, arts, research, or any other useful object, provided that the profits or income of the company are applied only for promoting such objects, and no dividend is declared or paid to its members. Since the club intends to impart classroom teaching and aircraft flight training to trainee pilots, this constitutes a legitimate educational and training purpose, and the formation as a Section 8 company is permissible.

Prohibition on Distribution of Surplus to Members: However, the proposal to dissolve the company after ten years and distribute the surplus assets to members is NOT feasible and is contrary to the express provisions of the Companies Act, 2013. This aspect of the proposal is fundamentally flawed for the following reasons:

Section 8(4) mandates that a Section 8 company shall not alter its Memorandum of Association or Articles of Association except with the prior approval of the Central Government, and shall not pursue any object other than those specified at the time of registration. More critically, the entire structure of a Section 8 company is premised on the principle that members derive no economic benefit from the company.

Section 8(9) of the Companies Act, 2013 explicitly provides that if a licence granted to a Section 8 company is revoked or the company is wound up or dissolved, the surplus assets remaining after satisfaction of its debts and liabilities shall NOT be distributed among the members. Instead, such surplus shall be transferred to another Section 8 company having similar objects, as may be determined by the Tribunal, or shall be disposed of as directed by the Tribunal.

This provision is non-negotiable and cannot be contracted out of by the promoters in the Memorandum or Articles of Association. The distribution of surplus amongst members, as proposed, is therefore ultra vires the Act.

Advice to the Promoters: The promoters are advised that:

1. The formation of 'Budding Pilots Flying Club' as a Section 8 company for educational/training purposes is valid and permissible.
2. The intention to distribute surplus to members upon dissolution is legally impermissible under Section 8(9) of the Companies Act, 2013 and cannot be treated as a 'usual procedure' under the Act.
3. If the promoters wish to eventually recover their contributions and share in profits, they should consider incorporating a private limited company or LLP instead of a Section 8 company, as those structures permit distribution of surplus/profits to members.
4. Any attempt to distribute surplus to members by the Section 8 company upon dissolution would expose the members and officers to penal consequences under Section 8(11) of the Companies Act, 2013.

Conclusion: The proposal is feasible only with respect to the formation of the Section 8 company. The plan to distribute surplus assets to members upon dissolution is not permissible under Section 8(9) of the Companies Act, 2013 and must be abandoned.

Relevant Provision: Section 130 of the Companies Act, 2013 — Re-opening of Accounts

Section 130(1) lays down that a company shall not re-open its books of account and shall not recast its financial statements, UNLESS an application is made by an eligible authority AND an order is passed by a Court of competent jurisdiction or the National Company Law Tribunal (NCLT) on the ground that:
(i) the relevant earlier accounts were prepared in a fraudulent manner, OR
(ii) the affairs of the company were mismanaged during the relevant period, causing loss or undue gains to the company or others.

Eligible Applicants: The Income Tax Authorities are specifically listed among the authorities competent to make such an application under Section 130(1) of the Companies Act, 2013. Hence, the Income Tax Authorities are entitled to approach the NCLT — this part of the application is valid.

Restriction on the Period for Re-opening: The critical issue here is the time limit. The proviso to Section 130(1) provides that no order shall be made in respect of re-opening of books of account relating to a period earlier than eight financial years immediately preceding the current financial year.

An exception exists: where a direction has been issued by the Central Government in public interest (after consultation with the concerned regulatory authority), or where fraud has come to light, the Tribunal may direct re-opening of books for a period even earlier than eight financial years.

Application of Law to the Given Facts:

The current financial year is 2019-20. The eight financial years immediately preceding 2019-20 are: 2018-19, 2017-18, 2016-17, 2015-16, 2014-15, 2013-14, 2012-13, and 2011-12 (the earliest permissible year under the normal rule).

The Income Tax Authorities have sought re-opening of accounts for FY 2008-09, which is approximately 11 financial years prior to the current year 2019-20. This falls well outside the 8-year limit prescribed under Section 130.

Conclusion: The application filed by the Income Tax Authorities before the NCLT for re-opening the accounts of Chetan Ltd. for FY 2008-09 is NOT VALID, as the said year is beyond the eight-year restriction prescribed under the proviso to Section 130(1) of the Companies Act, 2013. The NCLT does not have the power to order re-opening for such a period in the absence of any Central Government direction in public interest or a specific finding of fraud. Accordingly, the application is liable to be rejected by the NCLT.

Answer: No, Y cannot avoid payment of the bill to M.

Although X drew the bill in the fictitious name of Z, Y (the acceptor) remains liable to M (the holder in due course) and cannot avoid payment.

Applicability of Section 129 of the NI Act 1881:

Section 129 of the Negotiable Instruments Act, 1881 provides that an acceptor of a bill is bound by his acceptance and cannot deny: (1) the existence of the drawer, (2) the genuineness of the signature of the drawer, or (3) the capacity and authority of the drawer to draw the bill.

In the given scenario, Y accepted the bill as drawn by X (even though X signed in the fictitious name Z). By accepting the bill, Y is now bound and cannot subsequently deny these three facts. The critical distinction is that the drawer (X) is a real, existing person—X merely signed the bill under a fictitious name. The drawer is not non-existent; rather, the drawer used a false identity.

Why Y Cannot Escape Liability:

1. Existence of Drawer: X, the actual drawer, is a real person. Although X signed as "Z," this does not make the drawer non-existent. Section 129(1) requires only that the drawer exist—it does not require that the name used be real or genuine.

2. Genuineness of Signature: X's signature on the bill is genuine because X actually signed it. Even though the name under which X signed is fictitious, the physical act of signing was performed by a real person (X). Section 129(2) is therefore satisfied.

3. Capacity and Authority: X, as the drawer, had the authority and capacity to draw the bill on Y.

Application of Estoppel Doctrine:

Y, by accepting the bill, is estopped from later challenging facts that were apparent or that Y accepted. Once Y accepted the bill as presented, Y cannot subsequently deny the drawer's identity or the signature's authenticity.

Position of M as Holder in Due Course:

M is a holder in due course because M obtained the bill from X in good faith, for value, before it became overdue, and without notice of any defect. A holder in due course is protected from personal defenses that the acceptor might otherwise raise. Y cannot resist payment to M even if Y had legitimate defenses against X.

Conclusion:

Y is absolutely liable to pay M. The use of a fictitious name by the drawer does not relieve the acceptor from liability, particularly when the actual drawer exists and the signature is genuine. Section 129 of the Negotiable Instruments Act, 1881 ensures that the acceptor's liability to a holder in due course is complete and cannot be defeated by raising issues about the drawer's name.