CAN A FIRM BE A SHAREHOLDER IN A COMPANY?

CAN A FIRM BE A SHAREHOLDER IN A COMPANY?

 " 1.   Like many other questions, this question has also been left unanswered by the Indian Partnership Act, 1932. Interestingly, Section 41 of the Companies Act, 1956, which deals with definition of `member' in respect of a company, is also keeping mum on this point.

2.     Under Section 11 of the Indian Contract Act, 1872, read with Sections 2(e) and 3 of the Indian Partnership Act, only such persons as are competent to contract, are of sound mind, major and are not disqualified from contracting by any law in force would be entitled to become partner. Legally speaking, a company or corporation can become a partner in a partnership firm. This is because a company  or corporation is a legal person in eyes of law.

3.     Further, there is no general principle of law, which prevents a corporation or company, from being a partner with another corporation or with ordinary individuals, except the principle that a corporation cannot lawfully employ its funds for purposes not authorised by its constitution. There cannot be any legal objection for companies and individuals forming partnership firms for purposes of trade –            Sri Murugan Oil Industries (P.) Ltd. v. A. V. Suryanarayan Chettiar, (1963) 33 Com Cases 833: AIR [1963] Mad 128. 

4.     However, as regards the question whether a partnership firm can be member or shareholder of a company, the DCA Circular [Circular No. 4/72, dated 9-3-1972] is relevant. As per the clarification issued by the Department of Company Affairs, vide Circular No. 4/72, dated     9-3-1972, a firm of partnership, (not being a legal person) cannot be registered as a member of a company.

5.     However, as an exception, a firm of partnership can become a member of a charitable company. In other words, in case where the company is licensed under Section 25 of the Companies Act, 1956, a firm of partnership can become a member of such a company.

6.     Further, under Section 41(2) of the Companies Act, 1956, any person who has agreed in writing to become a member and whose name is entered in the register of members, shall be treated as a member of the company. Accordingly, only a person can be a member and a person for this purpose may mean any natural person or artificial person or legal person or any corporation. In this context, another question may arise whether a partnership firm, which is not a legal person, can be a member of a company.

7.     In this context, where a firm of partnership was allotted certain shares and its name was registered in the register of members of the company, the Income-tax authorities refused to recognise this as a valid allotment for tax purpose. However, the court overruled the objection raised by the taxmen. The court further held that an allotment in favour of a firm is not inoperative and when shares are registered in name of a firm, such registration in effect would render all partners as joint holders of the shares – Bansidhar Durgadutt v. CIT (1975) Tax LR 900 (Cal.).

8.     According to Palmer's Company Law, (51-04, p. 802, 24th ed. 1987) "A firm can be registered in England under its partnership name although it is not a legal entity. Further, as per the Halsbury's laws of England, 109   (3rd edn., Vol. VI Art. 227) "  if   a   firm  with  the  authority  of the firm, has subscribed to a memorandum, the partners are  joint  holders of  the shares  subscribed for. Neither such registration is void, nor can it be treated as non est."    

9.     However, practically speaking, the articles of association of most of the         companies in India do provide that only individuals, companies and         registered   associations   will be admitted as members.  Further,  a         partnership  firm  as  such  could  not  be  a  member of a company as   decided  in case of Seth Mengraj v. SMES Corporation, (1960) 2 (Mad) LJ 46. Similarly, in case where the debenture is convertible into shares (either automatically or at the option of the holder) it  is  advisable   for  the  issuing  companies  to  restrict the same only to legal entities.          This is because these convertible debentures do involve contract or  option to be a member of the company.    

10.    Further,  the  clarification  of  the  Department of  Companies Affairs is  now  relevant.  Accordingly,  a  firm  (not  being a legal person for this  purpose)  cannot  be  registered  as  a  member  of  a company except  where the company is licensed under Section 25 of the Companies Act,  1956. Further, companies which have firms registered  as shareholders  should  be   advised  to   take  steps  to  rectify  the  position  within  a   specified time.  In  case  the  irregularity  persists,  despite  a  warning necessary   action   can  be  taken  under  section  150(2)   of  the  Act   [Circular  No. 4/72, Dated 9-3-1972]. In other words, the department may launch prosecution against the defaulting company under Section  150  of  the Act for not keeping the register of members in accordance  with the law."             

11. Also, to check the beneficial ownership test, the companies act has introduced amendments in Significant beneficial ownership rules and hence just to capture the carve-out in the provisions, the legislature has ensured people don’t take benefits and hide out the real master behind a partnership firm, but this again also create an ambiguity, MCA on one hand says a partnership firm can become a member in the company and we will check the real SBO behind that also and on one hand way back in time they had issued a specific circular to not to consider partnership firm as a member of the company.