Company Law - FORMATION AND FLOTATION OF A COMPANY

CHAPTER III : FORMATION AND FLOATATION OF A COMPANY
FORMATION OF A LIMITED COMPANY
Registration of a Company
This is by registration under the Companies Act.
As part of the registration procedure both public and private companies must provide a
constitution which sets out the powers of the company and allocates them to the company’s
organs, usually the general meeting and the board of directors. This constitution historically
consisted of two documents: the memorandum of association and the articles of association.
a. Memorandum of Association: It is addressed to the general public and contains:
 The company’s name
 The company’s share capital
 The address of the company’s registered office
 The objects of the company (stating what the company is empowered by the
state to do)
 Statement that the liability of its members is limited
Two persons in the case of a private company, or seven in a public company, must
subscribe to the memorandum. In essence, they agree to take some shares or share in
the company and become its first shareholders.
b. Articles of Association; It is a set of rules for running the company. They set out the
heart of any company’s organizational structure by allocating power between the
board of directors (the main management organ) and the general meeting (the main
shareholder organ). The articles can be altered if three-quarters of the members (by
special resolution) vote to do so (s. 13 Cap 486)

Both the Memorandum and Articles of Associations must each be signed by seven persons in
the case of a public company or two persons if it is intended to form a private company.
These signatures must be attested by a witness. If the company has a share capital each
subscriber to the share capital must write opposite his name the number of shares he takes
and he must not take less than one share.
c. A list of directors who have agreed to become the first directors of the company and
their written consent to act as directors and to take up qualification shares.
d. Statement of Nominal Capital – this is only required if the company has a share
capital. The share capital in the memorandum is known as the nominal or
authorized share capital. It represents the amount of share capital that could be
issued to investors. Once and amount has been issued to investors, that amount is
called the issued share capital. The memorandum will also state the amount that the
authorized share capital is subdivided into.
Thus, if it states that the company’s nominal capital shall be 100,000 Kenya shillings,
subdivided into shares of 100 Kenya shillings, this will be the value given to each
share and is known as the par or nominal value.
The fees that one pays on registration will be determined by the share capital that the
company has stated. The higher the share capital, the more that the company will pay
in terms of stamp duty.
e. Declaration of Compliance: This is a statutory declaration made either by the
advocates engaged in the formation of the company or by the person named in the
articles as the director or secretary to the effect that all the requirements of the
Companies Act have been complied with. Where it is intended to register a public
company, Section 184 (4) of the Companies Act also requires the registration of a
list of persons who have agreed to become directors and Section 182 (1) requires the
written consents of the Directors.

These are the only documents which must be registered in order to secure the incorporation of
the company. In practice however two other documents which would be filed within a short time
of incorporation are also handed in at the same time. These are:
1. Notice of the Situation of the Registered Office which under Section 108(1)
Cap 486 should be filed within 14 days of incorporation;
2. Particulars of Directors and Secretary which under Section 201 Cap 486
are normally required within 14 days of the appointment of the directors and
secretary.
Certificate of incorporation
When the requisite documents are filled with the Registrar, the Registrar shall satisfy himself
that the statutory requirements regarding registration have been complied with. If the Registrar is
satisfied as to the compliance of statutory requirements, he retains and registers the
Memorandum, the Articles and other documents filed with him and issues a ‘certificate of
incorporation’.
By issuing the certificate of incorporation the Registrar certifies “under his hand that the
company is incorporated and in the case of a limited company, that the company is limited”
Conclusiveness of the certificate of incorporation. A certificate of incorporation given by the
Registrar in respect of a company is conclusive evidence that all the requirements of the
Companies Act in respect of registration have been complied with and nothing can be inquired
into as to the regularity of the prior proceedings and the certificate cannot be disputed on any
grounds whatsoever.
This is known as the Rule in Peel’s Case [Re Peel’s Case, (1867) L.R. 2 Ch. 674]
The following case illustrates the point:
Jubilee Cotton Mills Ltd. v Lewis, (1924) A.C. 958
On the 6th January the necessary documents delivered to the Registrar for registration. Two days
after, he issued the certificate of incorporation but dated it 6th January instead of the 8th, i.e., the
date on which the certificate was issued. On 6th January some shares were allotted to L, i.e.,

before the certificate of incorporation was issued. The question arose whether allotment was
void. Held, the certificate of incorporation is conclusive evidence of all that it contains.
Therefore, in law the company was formed on 6th January, and therefore, the allotment of shares
was valid.
The certificate of incorporation has been held to be conclusive on the following points:
1. That requirement of the Act in respect of registration of matters precedent and incidental
thereto have been complied with. If after the receipt of certificate of incorporation by a
company it is discovered that there were certain irregularities with regard to its
registration, these will not affect the validity of the company.
2. That the association is a company authorized to be registered under the Act, and has duly
been registered.
3. That the date borne by the certificate of incorporation is the date of birth of the company,
i.e., the date on which company comes into existence.
Even though the certificate of incorporation is conclusive for the purpose of incorporation, it
does not make an illegal object a legal one. But the position is firmly established that if a
company is born, the only method to put an end to it is by resorting to the provisions of the Act
which provide for the winding up of the companies.
Test Questions
1. How is a company formed under the Companies Act? Enumerate the various documents
to be filed with the Registrar.
2. Briefly describe the documents to be filled with the Registrar of Companies prior to
incorporation.
3. “A certificate of incorporation is conclusive evidence that all the requirements of the
Companies Act have been complied with.” Explain.
4. From what date is a registered company incorporated? What is the legal effect of the
certificate of incorporation?

MEMORANDUM OF ASSOCIATION
A Memorandum of Association sets the fundamental conditions upon which the company is
allowed to be incorporated. It defines the relationship of the company and creditors the outside
public as well as the shareholders. It also enables creditors and the outside public know the range
of permitted business of the company.
In Ashbury Carriage Company v Riche [1875] LR 7 HL 653 it was noted that “the memorandum
is as it were, the area beyond which the action of the company cannot go outside… that area the
shareholders may make such regulations for their own government as they think fit”.
Importance of memorandum
a) Provides basis of incorporation.
b) It determines the areas of operations of the company.
c) It defines the relationship of the company with the outsiders.
d) It is a charter of the company, which can be altered only under special circumstances.
Purpose of memorandum
There are two purposes of memorandum: -
a) To enable shareholders know where their funds are to be used and risks they are
undertaking in making such investments.
b) To enable outsiders of the company know the objectives of the company and whether the
contracts they intend to make with the company are within the objects of the company.
Preparation of the memorandum
Section 5 provides that memorandum of every company shall be in English and printed.
Section 6 states that memorandum shall be signed by each subscriber (with postal address and
occupation) in the presence of at least one witness who shall effect the signature and shall
likewise add his address and occupation, if any.
Contents of memorandum
Section 5 of the companies Act stipulated the memorandum should compose the following
clauses.
Clause 1: The name

Promoters must enquire from the Registrar as to whether the proposed name of the company is
available for registration and is not considered undesirable; this should be done before filing the
memorandum or even before its preparation.
Section 19 provides that promoters may reserve a name pending registration of the company for
a period of 30 to 60 days.
Section 5(1) requires accompany if limited to use the word "limited" as the word in its name.
Section 21 provides that a company may drop the word "limited" if it obtains a licence to do so
from the Attorney General. Such licence is given if the Attorney General is satisfied that: -
(i) The company to be formed is to promote commerce, art science, religion,
charity or any useful object.
(ii) It intends to apply its profits or other income to promoting its objects.
(iii) It prohibits the payment of any dividends to its members.
Under section 20 a company can charge its name by special resolution and with the approval of
the Registrar signified in writing. A special resolution usually requires 21 days notice to the
members and ¾ majority of the votes at the general meeting.
The above section provides that the company may change its name if it is almost like that of an
existing company, if the Registrar so directs within 6 months of its registration.
The name does not affect any rights or obligations of the company or any legal proceedings by
or against it (section 20 (4)).
Clause 2: Registered office
Every company must have a registered office from the day on which it begins to carry on
business or within 14 days after incorporation whichever is earliest; to which notices and all
communications can be made (section 107) Section 108 states that notice of the address of the
registered office, and of any change therein, must be given to the register within 14 days after
incorporation or of the change.
The registered office is not necessarily the headquarters of the company.
Documents that must be kept at the registered office include: -
(i) Register of members and index of members, unless made up
elsewhere or kept by an agent (section 112&113).

(ii) Minute books of general meetings section 146.
(iii) The register of director's interests in shares or debentures.
(iv) A copy of every instrument creating any charge requiring registration.
(v) The company's register of charges affecting properly of the company.
Clause 3: The objectives of the company
Objects clause defines the sphere of the company's activities, the aims that its formation seeks to
achieve and the kind of activities or business that it proposes to conduct.
Objects give protection to the shareholders and creditors as they are sure where the funds will be
applied. Objects also help outsiders know the powers of the company.
Choice of the company's objects
Subscribers to the memorandum may choose any object for the proposed company. When
drawing the object the subscribers should note the following:
(i) Objects should not include committing an illegality.
(ii) The objects should not contradict the Act.
(iii) Objects should not be against public policy. Objects clause in the memorandum has to
state.
a) The main objects of the company and objects incidental or auxiliary to the
attainment of the main objects
b) Other objects of the company not included in (a) above.
A company cannot continue to peruse subsidiary objects after the main object has come to an
end. In Re Crown Bank (1890) 44 Ch.D. 634, a company objects clause enabled it to act as a
bank and further invest in securities and land and to underwrite issue of securities. Its banking
business was abandoned and it confined itself to financial speculation. It was held that the
company was not entitled to do so.
Incidental acts: -
A company may do anything which is fairly related to its core business. Anything incidental to
the attainment or pursuit of any of the express objects of the company will unless expressly
prohibited to be within the implied powers of the company.
1. Evans vs. Brunner, Mond & Company (1921) 1 Ch. 359, a company engaged in manufacture
of chemicals proposed to devote substantial sum of money to the encouragement of scientific

education. It was proved that this will in the end benefit the company, but a shareholder objected
that this was beyond the powers of the company. It was held that the proposal was fairly
incidental to the company's objects.
2. Foster vs. London, Chatham & Dover Company (1895) 1 QB 711.
A company acquired a piece of land for the purpose of its railway. The railway was erected on
arches. The company left the arches as workshops etc. The neighbors objected of an account of
noise and claimed that the act was ultra vires to the company. It was held that letting of the
arches was valid.
3. Forrest vs. Manchester etc Rly Company (1861) 4 Ltd 666. A railway company had the
authority to keep boats to be supplied for a ferry. It employed the boats for excursion trips to the
sea when they were not wanted for the ferry. It was held that the use of the boats was incidental
to the main purpose and was within the powers of the company. The following activities have
also been held incidental to carrying of business:
a) Appointing agents and hiring servants.
b) Borrowing money and giving security for loans.
c) Paying gratuities to employees.
d) Paying pensions to former officers and employees or their dependants.
In the following cases companies were found to engage in activities beyond their powers.
1. London County Council vs. Attorney General (1902) AC 165 The council had the power to
run tramways. It ran omnibuses to feed the tramways. It was held that this was outside its
powers as the omnibuses business was in no way incidental to the business of working tramways.
2. Stephenes vs. Mysore Reefs (Kangudry Mining Company Ltd) (1902) 1 Ch. 745, the company
object authorized it to acquire gold mines in Mysore and elsewhere and it had other clauses. The
company wanted to work in Ghana. It was held that elsewhere could not be taken to mean any
other place outside India.
Ways a company can engage in a wide variety of business: -
a) Inflated object clause.
Promoters have given a list of several businesses that the company may engage itself.
b) Independent object clause

Courts usually take the first object in the memorandum as the core business and others
subsidiary. To avoid this interpretation, experts drafting the objects may specify;
'Each of the foregoing clause shall in no way unless otherwise provided as forming part of or
being dependent upon or shall in no way be severally formed and object clause of an
independent company.'
c) Subjective objects clause
Here experts can simply say that the company can engage in any business, which in the opinion of
the directors, the company can advantageously engage in.
Clause IV: Liability clause
Promoters must indicate
a) Whether the liability of the company is limited or unlimited.
b) If limited, is it by shares or guarantee.
c) If the company is public promoters have to indicate the liability of directors whether limited or
unlimited.
Liability clause is entirely omitted from the memorandum in an unlimited company.
Clause V: The Capital Clause
States the registered share capital divided into shares of a fixed amount. Registered capital is also
called nominal or authorized capital. The clause is omitted in the companies with unlimited
liability and the companies limited by guarantee having not shown capital.
Clause VI: Association or subscription clause.
This is a declaration by subscribers that they desire to form a company and agree to take shares
stated against their names. The signature of subscribers may be by any of the subscribers. Each
subscriber must indicate his address, description and occupation.
General form of clause
If the several persons whose names and address are subscribed are desirous of being formed into a
company in pursuance of the memorandum of association and they respectively agree to take the
numbers of shares in the company set opposite of our respective names.

After registration no subscriber to the memorandum can with withdraw his subscription on any
ground.
Alteration of the memorandum
Section 7 provides that a company cannot alter the conditions contained in the memorandum
except in the cases provided for, i.e., in the mode and to the extent for which express provision
has been made in the Companies Act.
Section 8 gives seven instances where a company may alter its objects after a special resolution.
i. To enable the company carry its business more economically and
efficiently.
ii. To attain its main purpose by new or more improved means.
iii. To enlarge or change the local area of its operation.
iv. To carry on some business which, may be conveniently combined with its own.
v. To restrict or abandon any of its objects.
vi. To sell or dispose part of or whole of its business.
vii. To amalgamate/merge with another company.
The proposed alteration becomes effective unless within 30 days of the resolution, objection is
made to the courts in which case the alteration will be effective if the court affirms it.
Section 8(2) provides no such application may be made
a) By holders of not less in the aggregate than 15% in nominal value of the company’s issued
share capital or any class thereof or, not less than 15% of the company's members if the
company is not limited by shares.
b) By holders of not less that 15% of the company's debentures entitling the holders to object to
the alteration of its objects.
Section 8(7) after a resolution altering the objects, a printed copy of the memorandum must be
delivered to the Registrar within 14 days after the expiry of the period allowed for objection.
Section 8(2) the fact that an alteration does not come within one of the seven clauses specified
in section 8 does not render the alteration invalid unless objection is submitted within 30 days.
No alteration can be made requiring a member to take up further shares or increasing his
liability unless he agrees in writing (section 24). The courts cannot allow an alteration, which is

incompatible with the original objects of the company. A case in this point is in Re Cyclists
Touring Club (1970). A company was registered to promote, assist and protect the use of
bicycles, tricycles and similar vehicles on public roads. The company proposed to alter its
powers by admitting all tourists and motorists, it was held by the court that the alteration must
not be allowed as one of the objects was to protect cyclists against motorists.
DOCTRINE OF ULTRA VIRES
Ultra vires is a term given to refer to a situation a company does anything beyond powers given
in the memorandum. A company must not engage in activities which are not expressly or
impliedly authorized by the memorandum, otherwise any act which exceeds the powers of
the company will be ultra vires and void and thus cannot be ratified even by the assent of the
whole body of directors.
An act is intra vires to the company if it is within the company's powers, this is the case when;
(i) The act is within the company's objects as stated in the memorandum of association of the
company.
(ii) The act is reasonably incidental to the company's objects, which are expressly stated in the
memorandum of association and is done in order to effectuate or achieve the stated objectives.
The doctrine of ultra vires is illustrated in Ashbury Rly. Carriage & Iron Co. Ltd. vs. Riche
(1875) L. R. 7 H. L. 653 in this case the memorandum gave the company powers to make and
sell railway carriages. The directors entered in to a contract to lay a railway in Belgium and the
company in a general meeting subsequently purported to ratify the act of the directors by passing
a special resolution to that effect. The company later dishonored (repudiated) the contract and the
other party sued for breach of contract. House of Lords held that there could be no ratification of
a contract made by a company ultra vires even though every single member consented thereto.
The contract to make a railway in a foreign country was a feature not included in the
memorandum. The company was therefore held not liable for the breach of contract.
The doctrine of ultra vires approved but qualified in Attorney General Vs. Great Eastern
Railway (1880) 5 AC 473, by adding that the doctrine ought to be reasonably understood and
applied and whatever may fairly be regarded as incidental to or as consequential upon those
things which the legislature has authorized ought not to be held ultra vires to the company.

In Re Germany Date Coffee Co (1882) 20 Ch. D. 169 it was held that where the substratum of
the company fails, the heart of the company fails and the body cannot function without the heart.
However, in a recent case Re Kitson & Co. [1946] 1 All E.R. 435 (C.A.), it was held that the
company will not be wound up if the carrying on of the general business is still possible.
The main issue in the doctrine of ultra vires is that a company not being a natural person should
not be held responsible for its own acts or agents acts that are beyond its powers and privileges.
But there is nothing to prevent a company from protecting its property.
A case on this point is national National Telephone Co. v. St. Peter's Port Constables [1900]
A.C. 317 (P.C.). A telephone company put wires where it didn't have powers to put them, the
defendant cut them down. It as held the company could sue for damages for the wires. If
transaction is beyond powers of directors but within powers of the company, the shareholders
can ratify it by a resolution in a general meeting provided they have all facts relating to the
transaction to be ratified.
Effects of ultra vires transactions
1. Any member may obtain an injunction of the court to restrain the company from committing
an ultra vires act.
2. Directors may be held personally liable for ultra vires payments. But the directors having
refunded the money could get indemnity as against the person who received the payment
with the knowledge that the payment to him was ultra vires.
3. Directors entering into ultra vires contracts may be liable to the third party for breach of
warranty of authority. Directors will be liable to the losses incurred to third parties provided
the third party does not know that they have no authority to enter in a particular contract.
In Weeks vs. Property a company invited applications for a loan on debentures but the
company had already issued a maximum limit of debentures. Directors were held personally
liable to a plaintiff who offered a loan of £500. In order to make directors personally liable it
must be established that their act amounts to an implied misrepresentation of facts and not of
law.
4. If funds have been spent ultra vires in purchasing some property, its right over the property
will be protected.

5. Ultra vires contracts have no legal effect and are void. A company cannot sue or be sued on
those contracts because they are void. Every person dealing with the company is expected to
know its powers and if he enters into a contract that is inconsistent with them he does so at
his own risk.
Exceptions where a party can sue on an ultra vires contract
i) If the company takes an ultra loan and uses it to pay off the lawful debts of the
company then the second creditor (render) steps to the position of the paid off
creditor and to that extent will have the right to recover his loan from the
company. But he cannot claim any right to securities held by the original
creditor.
ii) If the property handed over to the company exists in specie or if it can be traced,
the party handing it over can reclaim it.
iii) If money is lent by a company that does not have the power to lend it, it can be
recovered because the debtor will be stopped from taking the plea that the
company had no power to lend. 6. A company will be liable for any tort of its
employees if: -
a) The tort is committed in pursuance of its stated objects.
b) It is committed by employees within the course of their employment. A
company will not be liable for ultra vires torts.
Test Questions
1. What is a Memorandum of Association? What are its contents? When may it be altered?
2. What are the compulsory clauses in a Memorandum of Association? In what cases, in
what mode and to what extent can a company alter these clauses?
3. Explain the necessity of setting out clearly the objects in the Memorandum. How may the
objects clause of a company be altered.
4. Write a note on the doctrine of ultra vires.

ARTICLES OF ASSOCIATION
Articles of association are the rules and regulations of a company formed for the purpose of
internal management.
According to the Lord Justice Bowen "the memorandum contains the fundamental conditions
upon which alone the company is allowed to be incorporated. They are conditions introduced for
the benefits of creditors and the outside public. The articles of association are the internal
regulations of the company and are for the benefit of shareholders".
Lord Cairns said "the articles play a part subsidiary to the memorandum of association. They
accept the memorandum as a charter of incorporation of the company and so accepting the
articles proceed to define duties, rights and powers of the governing body as between
themselves and the company at large and the mode and form in which business of the
company is to be carried on and the mode and form in which changes in the internal regulations
of the company may from time to time be made".
Section 2(1) Articles include the regulations contained in Table A Schedule 1 to the Act in so
far as they apply to the company. Articles were to be framed carefully so that they do not go
beyond the powers of the company. They should not violate any provision of the companies
Act as these will make them null and void. In Peveril Gold Mines Ltd, Re [1898] 1 Ch 122
(CA) the articles of a company provided that no petition for a winding up could be presented
unless: -
a) Two directors consented in writing,
b) The petition held is of the issue of the share capital and these conditions were fulfilled.
It was held that the restrictions were invalid and a petition could be presented.
Functions of the Articles of Association
1. Define duties, rights and powers of the governing body.
2. Determine the mode and the form in which the business of the company may from time to
time be made.

Section 9 stipulates that the articles must be registered before incorporation. Section 11 states a
company limited by shares may adopt all or any part of the regulations of Table A, they may not
be excluded or modified, these regulations shall be the regulations of the company so far as they
are applicable.
Table A in the first schedule to the Act is provided as a model articles of association. Part I may
be adopted in whole/part by public companies and part II may be adopted in whole/part by
private companies where a private company does not adopt part II of Table A and registers its
own articles they must include the restrictions required by section 30.
Section 12 provides that if special articles are registered they must be: -
a) Printed in English
b) Divided into paragraphs
c) Dated
d) Signed by each subscriber and witnessed.
Contents of Articles of Association
As an internal constitution, promoters and later the members can indicate any rules they may
wish to have so long as such rules are permissible. The following are expected to be included in
the articles of association.
a) Share capital, rights of shareholders, and variation, of the rights payments of commissions
share certificates.
b) Lien on shares
c) Calls on shares.
d) Transfer of shares
e) Transmission of shares
f) Forfeiture of shares
g) Conversion of shares into stock
h) Share warrants
i) Alteration of capital

j) General meetings and proceedings there at
k) Voting rights of members voting and poll proxies.
1) Directors their appointments remuneration, qualifications, powers and proceedings of board
of directors.
m) Manager.
n) Secretary.
o) Dividends and reserves
p) Accounts, audit and borrowing powers
q) Capitalization of profits
r) Winding up.
Alteration of articles of association
Section 13 provides that a company can alter or add to its articles by passing a special
resolution. Any alteration made in the articles shall, subject to the provisions of the Act, be as
valid as if originally contained therein.
Limitations to alterations
The following limitations should be observed regarding alteration of articles: -
a) Such alteration should not be inconsistent to the Act.
(i) Restrict the members’ right to petition for winding up under section 221.
(ii) Authorize the company to purchase its own shares.
(iii) Authorize payment of dividends out of capital.
b) It must not contradict the memorandum of association. However articles may be
referred to where there is an ambiguity in the memorandum or where the memorandum
is silent on an issue.
c) Alteration should not sanction anything illegal.
d) Alteration must be made bona fide and for the benefit of the company as a whole.
In Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656, it was observed that the power of
alteration must be exercised subject to those overall principles of law and equity which are
applicable to all powers conferred on majorities and enabling them to bind minorities

In Shuttleworth v Cox Bros and Co (Maidenhead) [1927] 1 Ch 154, the articles of a company
provided that 5 and four others should be permanent directors to the company. They could be
disqualified by any six specific events. S failed to account for the company's money on twenty-
two occasions within twelve months. The articles were accordingly altered and a 7th event
disqualifying a director added. The event added was that if a director was so requested in writing
by all the other directors he should resign. S was so requested to resign, it was held that the
alteration was bona fide for the benefit of the company as a whole and was valid.
Other rulings in support of this point were made in Greenhalgh v Arderne Cinemas Ltd [1951]
Ch 286 and side Sidebottom v Kershaw, Leese & Co Ltd [1920] 1 Ch 154.
e) An alteration to increase the members' liability will only bind those who consent to it.
Section 24 provides that no member is bound by an alteration of the memorandum or articles
which requires him to increase his holding of shares or increase his liability to pay money to the
companies unless:
i) Alteration is made before he became a member.
ii) He agrees in writing to be bound by such alteration.
An alteration of articles subject to restrictions in section 24 may be retrospective in effect, but
this will not enable the company to achieve a lien over shares after they have been transferred for
value by a debtor.
The relationship between the Articles and Memorandum of Association
1. The memorandum is the charter of the company indicating the nature of its business and
it also defines the company’s relationship with the outside world; while the articles are
regulations for the internal management of the company.
2. The memorandum defines the scope of the activities of the company or the area beyond
which the actions of a company cannot go; the articles are the rules for carrying out the
objects of the company as set out in the memorandum.
3. The memorandum must be read in conjunction with articles where it is necessary to;
a) Explain any ambiguity in terms of the memorandum.
b) Supplement the memorandum on matters where it is silent but cannot extend the
scope of the memorandum.
4. The terms of the memorandum cannot be modified or controlled by the articles.

Legal effects of memorandum and articles
1. Section 22 provides that after the articles and memorandum of association have been
signed they bind the members as if they have been signed by each individual member of
the company. The legal implications of the articles and memorandum may be resolved in
four categories.
a) Members to the company.
Each member is bound to the company as if each member has actually signed the memorandum
and the articles. In Borland's Trustee v. Steel Brothers & Co., [1901] 1 Ch. 279, the articles of a
company were altered and provided that the shares of any member who became bankrupt should
be sold to certain persons at a fair price. B a shareholder became bankrupt and his trustee in
bankruptcy claimed that he was not bound by the altered articles. It was held that the articles
were personal contract between B and the rest of the members and B and his trustee were bound.
b) Company to the member.
A company is bound to the members and the company can exercise its rights as against any
member only in accordance with the provisions in the memorandum and articles. A member can
obtain an injunction restraining the company from doing an ultra vires act.
In Wood v Odessa Waterworks Co (1889) 42 Ch. D. 636, the articles of company provided that
the directors may with the sanction of the company at general meeting declare a dividend to be
paid to the members. A resolution was passed to give the shareholders debenture bonds instead
of paying the dividend in cash. It was held that the words "to pay" meant paid in cash; and a
shareholder could restrain the company from acting on the resolution on the ground that it
contravened the articles.
A member can also obtain an injunction restraining the company from committing a breach of
the memorandum and the articles, which would affect his rights as a member.
c) Members to members.
The memorandum and articles constitute a contract between the members and each member is
bound to as against the other or others. Lord Herschel in Welton v Saffery [1897] AC 299,
observed "it is quite true that the articles constitute a contract between each member and the
company and there is no contract in terms of between the individual members of the company
but the articles do not any the less, regulate their rights inter se. such rights can only be enforced

by or against a member through the company or through the liquidators; representing the
company but no member has between himself and other members any right beyond that which
the contract of the company gives". In Ray field v Hands [1960] Ch 1 is a leading case in this
point.
d) Company to outsiders.
The articles do not constitute any binding contract as between a company and an outsider. In
general law a stranger to a contract cannot acquire any rights under such a contract. Cases on
these points are:
i) Browne v. La Trinidad, (1887) 37 Ch. D. 1 (CA)
The articles of a company contained a clause whereby B was to be a director irremovable for a
period of time. He was removed from office before the period; it was held that it could not
restrain the company from removing him as there was no contract between him and the
company.
ii) Eley v Positive Government Securities Life Assurance Co. Ltd (1876) 1 Ex. D. 88
The articles of a company provided that E should be the solicitor of the company for life and
could be removed from office only for misconduct E took office and became a shareholder, after
some time the company dismissed him without alleging misconduct. E sued the company for
damages for breach of contact. It was held that the articles did not constitute any contract
between the company and outsiders and as such no action could lie.
The case in Eley has brought in some problems. The courts have therefore in some cases acted
on the footing that a clause in the articles not dealing with the rights of a member as such but
apparently intended to operate as a contract with him is to be regarded as the basis of a contract.
In Swabey v. Port Darwin Gold Mining Co. (1889) 1 Meg. 385, the articles provided that a
director should receive a specified sum per annum by way of remuneration. In July, the company
passed a special resolution reducing the sum as from the end of the proceeding year. The
plaintiff, who was a director, resigned and sued for the services, it was held that he was entitled
to sue for remuneration up for the date of his resignation.
Constructive notice of memorandum and articles

Each person dealing with the company is assumed to know the contents of the memorandum and
articles of association. It is presumed the individuals dealing with the company have read and
understood the documents. This is called the doctrine of constructive notice.
Memorandum and articles are open and accessible to all, a special resolution becomes a public
document once registered and an outsider is in notice of their contents in the same way as he is
of the articles and memorandum. Lord Hatherly in Mahoney v East Holyford Mining Co. (1875)
LR 7 HL 869 observed. But whether he actually reads them or not it will be presumed that he has
read them.
Every joint stock company has its memorandum and articles of association open to all who
intend to have any dealings whatsoever with the company and those who deal with them must be
affected with notice of all that is contained in these two documents. Anyone dealing with a
company is presumed not only to have read the memorandum and articles but have understood
them properly (Oakbank Oil Co. v. Crum [1882] 8 App Cases 65). The doctrine also prevents
one from alleging that he did not know that the memorandum and articles rendered a particular
act ultra vires to the company (Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd
[1964] 1 All ER 630).
Doctrine of indoor management
This doctrine imposes a limitation on the doctrine of constructive notice. For persons dealing
with the company, once they are satisfied that the company has powers to enter the proposed
transaction, they are not required enquire into the regularity of any internal proceedings; they are
entitled to assume that provisions of the articles have been complied with by the company in its
internal working.
If the proposed contract is within the powers of the company, the company will be bound to the
outsider and claims of the outsider will not be affected in any way by the internal irregularity of
the company. This is the doctrine of indoor management or the Rule in Royal British Bank v.
Turquand.

In Royal British Bank v Turquand (1856) 6 E&B 327, the articles empowered the directors to
borrow money provided they were authorized by a resolution passed at a general meeting of the
company. The directors borrowed money from T and issued a bond to him without the authority of
resolution passed at the general meeting. It was held that the company was liable for the money to
T because once the articles authorized directors to borrow subject to a resolution of the general
meeting of the company T, was entitled to assume that the directors were borrowing on the
authority of the resolution passed at a general meeting of the company, T was not required to
enquire into the regularity of the company's internal proceedings.
In Premier Industrial Bank Ltd. v. Carlton Manufacturing Co., Ltd. & Crabtree, (1909) 1 KB
106, it was stated that "if the directors have power and authority to bind the company, but certain
preliminaries are required to be gone through on the part of the company before that power can be
duly exercised, then the person contracting with the directors is not bound to the section, that all
these preliminaries have been observed he is entitled to presume that the directors are acting
lawfully in what they do".
The rule is also held in Fountain v. Carmarthen Rail Co. (1868) L.R. 5 Esq. 316. The general
rule here is that persons dealing with limited liability are not bound to inquire into the regularity of
the internal proceedings and will not be affected by irregularities of which they had no notice.
Exceptions to the Doctrine of indoor management
The doctrine of indoor management will not apply in the following instances:
(i) Where the outsider has notice (actual or constructive) that the prescribed procedure
has not been complied with by the company.
In Howard v Patent Ivory Manufacture Co (1888) 38 Ch. D. 156, the directors were empowered
to borrow up to 1000 and such further sums as the company in the general meeting might
authorize without such consent they issued to themselves debentures for sums in excess of £1000.
it was held they had knowledge of irregularity in the internal proceedings of the company, the
company would be liable for £1000 only. Sums borrowed in excess of this were held invalid.
(ii) A company cannot be held liable for forgeries committed by its officers.

In Ruben v Great Fingall Consolidated Co. Ltd. [1906] AC 439 (HL), the company secretary
issued a share certificate by forging the signatures of the two directors under the seal of the
company. The plaintiff contended that it was not his duty to verify the signatures. Whether
signatures were genuine or not was part of internal management. It was held that the certificate
was not binding on the company as the rule in Turquand's case does not protect forgery. Lord
Loreburn observed in the case "it is quite true that persons dealing with limited liability
companies are not bound to inquire into their indoor management and will not be affected by
irregularities of which they have no notice. But this doctrine applies only to irregularities that
otherwise might affect a genuine transaction, it cannot apply to forgery".
(iii) When the outsider is negligent.
Any person entering into a contract with the company ought to make proper inquires, and in the
absence of this he cannot claim benefit under the Turquand case.
In Underwood (A.L.) v. Bank of Liverpool & Martins [1924] 1 K.B. 775, the sole director paid
cheques drawn in the name of the company in his account. It was held that the bank was put
upon inquiry before crediting the cheques drawn in favour of the company in the account of the
director. The bank was not entitled to rely upon the unstable authority of the director.
In Anand Bihari Lal vs. Dinshaw & Co., A.I.R. (1942) Oudh 417, the plaintiff accepted transfer
on the company's property from its accountant. The transfer was held to be void because such a
transaction is apparently beyond the scope of the accountant's powers. It puts the person dealing
with the company under inquiry; the plaintiff should have insisted on seeing the Power of
Attorney executed in favour of the accountant by the company. Even a delegation clause is not
enough to make the transaction valid unless the accountant is in fact authorized.
(iv) When an outsider does not have any knowledge of the articles.
A person who did not consult the company's memorandum and articles and
consequently did not act in reliance on those documents, cannot be protected under the rule in
Turquand.
(v) .Where an act is ordinarily beyond the apparent authority.

An outsider will not be protected by the rule in Turquand's case if the act of the agent is one
which would not ordinarily be within his powers simply because under the articles the power of
making such a contract might have been entrusted to him. The outsider can only hold the
company liable if only the power had infact been delegated. The facts of Anand Bihari Lal vs.
Dinshaw & Co. [(1942), A.I.R. Oudh. 417] illustrate this point.
Test Questions
1. What are the Articles of association? How can they be altered? Discuss the limits upon
the powers of a company to alter the Articles of Association.
2. Discuss the relationship between the Articles and the memorandum.
3. What is the legal effect of the Articles of a company between (a0 members and the
company, (b) members inter se, (c) company and outsiders?
4. Discuss the scope of the doctrine of indoor management. To what extent has the doctrine
been incorporated in the Companies Act.
5. Outline the rule in Royal British Bank v Turquand. What are the exceptions of this rule?
Statutory declaration of compliance
This is a document required by section 17(2) and it contains a declaration made to the
Registrar of companies telling him that the persons who have formed the company have
complied with all the requirements of the Companies Act as regards formation of a company.
The declaration should be prepared and signed by an advocate of the high court or by a
person who was named in the articles as a director or secretary of the company. The declaration
must be in the prescribed format usually on Form 203 A.
The Act requires the promoters to prepare: -
a) Written consent of every director of public companies stating that each has agreed to act as
a director.
b) A return of the first directors i.e. particulars of the first directors.
c) A statement on the authorized share capital of the company. This is required by the Stamp
Duty Act Section 39.
d) A document indicating notice of the company’s registered office (sec.108).

Effects of Registration
The documents are then lodged with the Registrar of Companies and if they are in order they
are then registered and the Registrar thereupon grants a Certificate of Incorporation and the
company is thereby formed. Section 16(2) Cap 486 provides that from the date mentioned in a
Certificate of Incorporation the subscribers to the Memorandum of Association become a body
corporate by the name mentioned in the Memorandum, capable of exercising all the functions of
an incorporated company. It should be noted that the registered company is the most important
corporation.
ADVANTAGES OF INCORPORATION
1. Limited Liability – since a corporation is a separate person from the members, its
members are not liable for its debts. Limited liability is therefore the logical consequence
of a separate personality. In the absence of any provisions to the contrary the members
are completely free from any personal liability. In a company limited by shares the
members’ liability is limited to the amount unpaid on the shares whereas in a company
limited by guarantee the members’ liability is limited to the amount they guaranteed to
pay. The relevant statutory provision is Section 213 of the Companies Act.
2. Holding Property: Corporate personality enables the property of the association to be
distinguishable from that of the members. In an incorporated association, the property of
the association is the joint property of all the members although their rights therein may
differ from their rights to separate property because the joint property must be dealt with
according to the rules of the society and no individual member can claim any particular
asset to that property.
3. Suing and Being Sued: As a legal person, a company can take action in its own
name to enforce its legal rights. Conversely it may be sued for breach of its legal duties.
The only restriction on a company’s right to sue is that it must always be represented by a
lawyer in all its actions.

In East Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86 here the Plaintiff a limited
liability company filed a suit against the defendant claiming certain sums of money. The
defendant entered appearance and filed a defence admitting liability but praying for
payment by instalments. The company secretary set down the date on the suit for hearing
ex parte and without notice to the defendant. This was contrary to the rules because a
defence had been filed. On the hearing day the suit was called in court but no appearance
was made by either party and the court therefore ordered the action to be dismissed. The
company thereafter applied to have the dismissal set aside. At the hearing of that
application, it was duly represented by an advocate. The only ground on which the
company relied was that it had intended all along to be represented at the hearing by its
manager and that the manager in fact went to the law courts but ended in the wrong court.
It was held that a corporation such as a limited liability company cannot appear in person
as a legal entity without any visible person and having no physical existence it cannot at
common law appear by its agent but only by its lawyer. The Kenya Companies Act does
not change this common law rule so as to enable a limited company to appear in court by
any of its officers.
4. PERPETUAL SUCCESSION As an artificial person, the company has neither
body mind nor soul. It has been said that a company is therefore invisible immortal and
thus exists only intendment consideration of the law. It can only cease to exist by the
same process of law which brought it into existence otherwise; it is not subject to the
death of the natural body. Even though the members may come and go, the company
continues to exist.
5. TRANSFERABILITY OF SHARES Section 75 of the Companies Act states as follows
“The Shares or any other interests of a member in a company shall be moveable property
transferable in the manner provided by the Articles of Association of the Company.” In a
company therefore shares are really transferable and upon a transfer the assignee steps
into the shoes of the assignor as a member of the company with full rights as a member.

Note however that this transferability only relates to public companies and not private
companies.
6. BORROWING FACILITIES: in practice companies can raise their capital by
borrowing much more easily than the sole trader or partnership. This is enabled by the
device of the ‘floating charge’ a floating charge has been defined as a charge which floats
like a cloud over all the assets from time to time falling within a certain description but
without preventing the company from disposing of these assets in the ordinary course of
its business until something happens to cause the charge to become crystallized or fixed.
The ease with which this is done is facilitated by the Chattels Transfer Act which
exempts companies from compiling an inventory on the particulars of such charges and
also by the bankruptcy Act which exempts companies from the application of the reputed
ownership clause. As far as companies are concerned the goods in the possession of the
company do not fall within the reputed ownership clause.
The only disadvantages are three
(i) Too many formalities required in the formation of the company
(ii) There is maximum publicity of the company’s affairs;
(iii) There is expense incurred in the formation and in the management of a
company.
In order to form a company, certain documents must be prepared whereas no such documents
need to be prepared to establish business as a sole proprietor or partnership and throughout its
life a company is required to file such documents as balance sheets and profits and loss accounts
on dissolution of the company it is required to follow a certain stipulated procedure which does
not apply to sole traders and partnerships.

ALLOTMENT OF SHARES AND COMMENCEMENT OF BUSINESS
PRIVATE AND PUBLIC COMPANIES
Restriction on private companies
Companies can be either private or public. A key distinction between the two types of registered
company is that in terms of equity or capital raising the law presumes that in private companies
the investment is largely provided by the founding members, either through their personal
savings or from bank loans, and that in public companies the intention is to raise large amounts
of money from the general public.
Private companies usually also restrict the ability of their shareholders to transfer their shares.
Crucially, private companies are prohibited from raising capital from the general public. Public
companies have no such prohibition and may freely raise capital from the general public.
Sometimes where extremely large amounts of capital are needed, a public company will choose
to raise capital through listing on the stock exchange. The Listing Rules of the Nairobi Stock
Exchange (NSE) require that a company be a public company.
Public companies are designed to secure investment from the general public. As such they can
advertise the fact that they are offering shares to the public. In doing so the company must issue
a prospectus giving a detailed and accurate description of the company’s plans (see below).
Public companies and the public interest
Public companies have a much greater potential to affect the general public than private
companies because of their capital-raising activities. As a result the state has taken a greater
interest in investor protection where public companies are concerned.
Public companies are not necessarily listed on the stock exchange, but as we noted above, some
public companies may decide to raise capital on the NSE. This involves applying to the NSE and
fulfilling a very strict set of criteria to ensure the business is a sound one.
A listing on the stock exchange is essentially a private contractual arrangement between a public
company and the NSE (itself a listed public company) to gain access to a very sophisticated
market for its shares. The public company, once it gains access to the stock market, is then
generally known as a listed company and its shares as listed shares or securities.
a) The NSE offers the facility of a secondary market, that is, a place where shares can be
traded after they have been issued to shareholders.
b) It also functions as a capital market for companies to sell new shares to the general public
who can then trade them on the stock exchange.
c) A listing also has the advantage that investors will have greater confidence in the
business if it is within the regulatory ambit of the NSE and investors will be able to sell
their shares easily through the LSE.

Prospectus
In order to finance its activities, a company needs to have capital. This is raised by a public
company1 by the issue of a prospectus inviting deposits or offers for shares and debentures from
the public. The central theme of the prospectus, from the money raising point of view, is that it
sets out the prospects of the company and the purpose for which the capital is required. The
prospectus is the basis on which the prospective investors form their opinion and take decisions
as to the worth and prospects of the company.
Definition of a prospectus:
Sec.2 of Companies Act: -
"A prospectus means any prospectus, notice, circular advertisement or other invitation; offering to
the public or for subscription or purchase any shares or debentures of a company".
Any document inviting deposits from the public or inviting offers from the public for subscription
of shares or debentures of a company is a prospectus. A prospectus must be in writing; an oral
invitation or an advertisement in television or film is not treated as a prospectus.
Subscription:
The word when used in relation to a prospectus means to take shares for cash. In Government
Stocks and Other Securities Investment Co Limited v Christopher [1956] 1 All ER 490, an offer
was made by company A to the members of company B and C to acquire all their shares in
exchange for allotment in the company. The offer cannot be held to be an offer made to the public
because it does not invite subscription for share since subscription means taking shares for cash.
Also this can not be said to be an offer to the public.
Invitation to the public:
Section 57 defines "public" as including any section of the public, whether selected as members
or debenture holders of the company concerned or as clients of the person issuing the prospectus
or in any other manner. The section also provides that a public offer: -
a) Must be calculated to result in the shares or debentures becoming available to persons
other than those receiving the offer.
b) Should not be a domestic concern of those making and receiving the offer or invitation.
In Nash v. Lynde, (1929) A.C. 158, the managing director of a company prepared a document that
was marked strictly private and confidential and it did not contain particulars required to be
1 A private company is prohibited from making any invitation to the public to subscribe for shares in, or debentures
of, the company. Hence it need not issue a prospectus.

disclosed in a prospectus, a copy of the document along with application forms were sent to
solicitor who in turn sent it to the plaintiff. The document was held to be a prospectus and as
such the claim of the plaintiff for compensation was dismissed.
In another case distribution of 3000 copies of a prospectus among members of a certain company
was held to be a public offer because persons other than those receiving the offer could also
accept it. The main issue is that an offer or invitation to any section of the public, whether
selected as members or debenture holders of the company or as clients of the person making the
invitation, will be deemed to be an invitation to the public.
Form and contents of a prospectus
A prospectus gives a picture of the company's intended activities and position. It provides all the
necessary and material particulars about a given company. The following provisions of the Act
must be observed in the preparation of the prospectus.
a) Section 43. A copy of the prospectus must be delivered to the Registrar of
companies and must be signed by every person named therein as a director or
proposed director.
b) Section 39. Every prospectus must be dated; and the date unless the contrary
is proved, is taken to be the date of publication of the prospectus. It is
advisable to insert a date two or three days later than actual date.
c) Section 40(1). Every prospectus issued must include the matters specified in
Part 1 of the third schedule to the Act and set out the reports specified in Part
11 of that schedule.
As per the third schedule to the Act the prospectus must contain the following:
1. The number of founders or management or deferred shares if any and the nature and
extent of the interest of the holders in the property and the profits of the company.
2. The minimum shares a director can have and the remuneration of directors.
3. Names, occupation and postal addresses of the directors.
4. Where shares are offered to the public for subscription, particulars as to;

a) Minimum amount that must be raised by the issue of those shares to provide funds
for the following:
b) The purchase price of property purchased or to be purchased, which is to be defrayed
in whole of the issue.
c) Preliminary expenses payable by the company and any commission so payable to
any person in consideration of his agreeing to procure subscription for any
shares in the company.
d) Repayment of any moneys borrowed by the company without use, the issue proceeds
and sources out of which amounts are to be provided.
5. The time of opening the subscription list.
6. The amount payable on applications and allotment on each share. In the case of second or
subsequent offer, the amount offered for subscription on each previous allotment made
within the two proceeding years, the amount paid for the allotted shares.
7. The number, description and amount of any shares in or debentures of the company which
any person has, or is entitled to be given, an option to subscribe for; together with the
following particulars of the option:
a) The period during which it is exercisable.
b) The prices to be paid for shares or debentures subscribed for under it.
c) Consideration (if any) given or to be given for it for the right to it.
d) The names and postal address of the persons to whom it or the right to it was given.
8. The number and amount of shares and debentures issued or agreed to be issued within the
two preceding years as fully or partly paid otherwise than in cash and the extent to which
they are paid up.
9. (i) In respect of any property to which this paragraph applies;
a) The names and postal addresses of the renders.
b) The amounts payable in cash, shares or debentures to the vendor and where
there are many vendors amount payable to each vendor.
c) Short particulars of any transaction relating to the property completed within
the two preceding years in which any vendor of the property to the company

was at the time of the transaction, a promoter or a director or proposed director
of the company had any interest direct or indirect.
(ii) The property to which this paragraph applies is property purchased or by the company
or proposed so to be purchased, which is to be paid for wholly or partly out of the
proceeds of the issue offered for subscription by the prospectus or the purchase of which
has not been completed at the date of the issue of the prospectus, other than property:
a) The contract for the purchase whereof was entered in to the ordinary course of
the company's business, the contract not being made in contemplation of the
issue nor the issue in consequence of the contract.
b) As respects which the amount of the purchase money is not material.
10. The amounts, if any, payable as purchase money in cash, shares or debentures for any
property referred to in (9) above specifically the amount of goodwill.
11. The amount, if any, payable or paid within the two preceding years as commission for
subscribing or agreeing to subscribe on procuring or agreeing to procure subscriptions for
any shares in or debentures of the company or the rate of any such commission.
12. The amount or estimated amount of preliminary expenses and the persons by whom any of
those expenses have been paid or are payable and the amount of he expenses of the issue
and the persons by whom any of those expenses have been paid or are payable.
13. Any amount or benefit paid within two proceeding years or intended to be paid to any
promoter and the consideration for the payment or benefit.
14. General nature of any material contract not being a contract entered in the ordinary course
of the business carried on or intended to be carried on by the company or a contract entered
into more than two years before date of issue of prospectus. The dates of the contract and
parties to such contract should also be disclosed.
15. The names and postal address of the auditors if any by the company.
16. Full particulars of the nature and extent and interest, if any of every director in the
promotion of or in the property proposed to be acquired by the company or where the
interest of such a director consists in being partner in a firm, the nature and extent of the
interest of the firm, with a statement of all sums paid or agreed to be paid to him or to the

firm in cash or shares or otherwise by any person either to induce him to become or to
qualify him as a director, or otherwise for services rendered by him or by the firm in
connection with the promotion or formation of the company.
17. If the prospectus invites the public to subscribe for shares in the company and the share
capital of the company is divided into different classes of shares, the right of voting at
meetings of the company conferred thereby, and the rights in respect of capital and
dividends attached to the several classes of shares respectively.
18. In the case of a company which has been carrying on business or of a business which has
been carried on for less than three years, the length of time during which the business of
the company or the business to be acquired, as the case may be, has been carried on.
Reports to be set out in prospectus
Part II of the third schedule stipulates reports to be included in the prospectus. These reports are
prepared by the company's auditors and state:
a) The profits or losses of the company in each of the five preceding years.
b) The rate of dividends paid by the company in each in respect of each class of shares in
each of those years.
c) The assets and liabilities at the last date to which the accounts of the company were
made up.
d) If the proceeds or parts of the proceeds are to be used directly or indirectly to purchase
a business the report must be made up of the profits or losses of the business for the last
five years.
Where the company has subsidiaries the performance of such subsidiaries has to be reported or
the consolidated accounts have to be prepared.
Raising money from the public
Issuing shares to the public is done by public companies wishing to raise capital through:
 The company could offer its shares for subscription on its own. This is done by issuing a
prospectus and advertising in the trade or general press.
 An offer for sale. This is where the company has an agreement with an issuing house (a
merchant bank) whereby it will allot its entire issue of shares to the issuing house. The
issuing house will then try to sell the shares to its clients and the general public. The

advantage of this type of sale is that the issuing house takes the risk that the shares will
not sell.
 A placing. Here the shares may not be offered to the general public at all, but are ‘placed’
with the clients of a merchant bank or group of merchant banks.
 The company could raise money through a rights issue. This is where new shares are
offered to the existing shareholders in proportion to their existing shareholding. Once a
company is listed, further capital raising is more straightforward without the complication
of the initial listing process.
Prospectus and duty of disclosure:
Apart from requirements set out under section 40 any other information may be volunteered. The
intending purchaser of shares is entitled to all true disclosure in the prospectus.
In New Brunswick and Canada Railway Co v Muggeridge (1860) 1 Dr & Sm 381, VC
Kindersley said.
"Those who issue prospectus holding out to the public the great advantages which will accrue to
persons who will take shares in a proposed undertaking and inviting them to take shares on faith
of the representations therein contained are bound to state everything with strict and scrupulous
accuracy and not only to abstain from stating as fact that which is not so but to omit no one fact
within their knowledge the existence of which might in any degree affect the nature or extent and
quality of the privileges and advantages which the prospectus holds as inducement to take
shares".
Effects of disclosure
Misstatement and non-disclosure are both fatal to the validity of the contract and a subscriber for
shares or debentures may rescind the contract within a reasonable time before the company goes
into liquidation. The contract can be rescinded if the following conditions are satisfied: -
a) The statement must be a material misrepresentation of fact.
In Greenwood v. Leather Shod Wheel Co. [1900] 1 Ch. 421 (C.A)., as company formed to
manufacture leather tyre wheels for trolleys issued a prospectus stating in large type "orders
have already been received from the house of commons to be followed by large orders later".
Infact all orders received were trial orders and no customers had yet expressed any intention to
buy in large scale. It was held that the prospectus was misleading. Statements of the fact can
lead to the rescission of a contract but opinions in prospectus cannot nullify a contract.

In Edgington v Fitzmaurice (1885) 29 Ch D 459, a company issued a prospectus inviting
subscriptions for debentures. The object of the issue was stated to be that the money would be
used for effecting certain alterations in the company's buildings and for developing the business
of the company. The money however was needed to pay off pressing liabilities. The plaintiff
applied for debentures in reliance on the statements in the prospectus. It was held that the
plaintiff could rescind the contract and directors were liable.
b) The statement must have induced the shareholder to take shares
In Jennings v. Broughlon, (1854) 23 L. J. Ch. 999 A subscriber for shares in a mining company
offered by a prospectus which inaccurately described the capacity of the company's mine. He
inspected the mine himself. It was held that he was not entitled to rescind the contract to take
shares as he had inspected the mine himself. It was held that he was not entitled to rescind the
contract to take the shares as he had inspected the mine himself and must have therefore, relied
on his own observation and not on the content of the prospectus.
c) The statement must be untrue.
A statement is untrue if it is misleading in the form and context in which it is included or where
the omission from a prospectus of any matter is calculated to mislead. A mere non-disclosure
does not amount to misrepresentation unless the concealment has prevented an adequate
appreciation of what was stated.
A statement can be false because of what it has said, concealed, omitted or implied.
In Rex v Kylsant (Lord) ([1932] 1 KB 442) a prospectus was issued by a company stating that the
company had paid a dividend every year between 1921 and 1927 (years of depression) thus
giving the impression that the company was stable. However, the company had infact incurred
considerable trading losses and was able to pay dividends only out of realized capital profits.
This fact was not disclosed. It was held that the prospectus was false in material particular in that
it conveyed a false impression.
e) The deceived shareholder is an allotee and he must have relied on the statement in
the prospectus

If a person purchases shares in the open market he has no right against the company.
In Peek v Gurney (1873) LR 6 HL 377, a company issued a prospectus with a misstatement. A
relying on the misstatement applied and was allotted shares, which he later sold to P. The
company was wound up and P had to pay £100 and as a contributory. P sought an indemnity for
his loss from the directors; it was held that the directors were not liable to P.
Lord Chelmsford observed "the office of a prospectus is to invite persons to become allotees, and
the allotment having been completed, such office is exhausted and the liability to allotees does
not follow the shares into the hands of the subsequent transferees. Directors cannot be made
liable uad infinitum" for all the subsequent dealings which may take place with regard to those
shares up on the stock exchange.
f) The omission of material fact must be misleading before recission is granted
If a person relies as aground for the rescission of a contract on the omission of a statement, he
must show that the omission of the statement makes what is stated misleading. An omission must
be of such a nature to make a statement actually misleading.
In Coles v White City (Manchester) Greyhound Association Ltd (1929) 45 TLR 230, a prospectus
described land as eminently suitable for Greyhound racing, local authority refused approval, it
was held that he description of land was misleading and rescission was granted.
g) The proceedings of rescission must be started as soon as the allotee comes to know
of a misleading statement and before the company goes into liquidation
Where an allotee decides to rescind a contract on grounds of fraudulent misrepresentation, a
mere notice to the company is not enough. He must make effective steps for the rectification of
register of members and removal of his name there from
Damages for deceit
Anyone induced by fraudulent statement to take share is entitled to sue the company for
damages. He cannot both retain the shares and get damages against the company.
Liability for false statement in prospectus

Section 46 where a prospectus has any untrue statement any person who authorized its issue is
liable for convictions, to a term of two years imprisonment or fine up to ten thousand unless he
proves:
a) That the statement was immaterial.
b) That he had reasonable ground for believing and did believe up to the time the issue of
prospectus that the statement was true.
In Derry v. Peek (1889) 14 AC 337 the court held that the directors might not be liable on a
statement contained in a prospectus, which in their honest opinion was true and not made
carelessly.
Section 45 also provides that civil liability to pay damages may be incurred by:
(i) Directors of the company
(ii) Persons who have agreed to become directors at a later date.
(iii) Promoters
(iv) Other persons who have authorized the issue of the prospectus.
Defenses for directors or promoters
Section 45(2) provides the following defenses, which the directors have to establish to avoid
liability: -
a) That one had withdrawn his consent to become a director before the issue of prospectus
and it was issued without his consent.
b) That the issue was made without his knowledge or consent and that on becoming aware
of the issue, he forthwith gave reasonable public notice of the fact.
c) That he withdrew his consent after the issue of the prospectus and gave reasonable
public notice before allotment.
d) He had reasonable ground to believe that the statements were true and believed them to
be true.
e) That the statement was correct and fair summary of an experts report or a statement
made by official or in an official documents.
STATEMENT IN LIEU PROSPECTUS
A statement in lieu of prospectus is to be filled with the Registrar on two occasions:

1) Under section 50 a public company having privately arranged for its capital subscription
need not issue a prospectus, but in that event a statement in lieu of prospectus must be
filled with the Registrar, 3 days before any allotment of any shares or debentures can be
made.
2) Under section 32, if a company alters its articles such that provisions of section 30 are
excluded, the company will cease to be a private company and must within 14 days after
the said date file with the Registrar a statement in lieu of prospectus.
For a public company a statement in lieu of prospectus has to be in the form of the Schedule IV
while in the case of a private company it has to be in the form of the Schedule II.
Form of statement:
The statement must be signed by every person named therein as a director or proposed director
or his agent authorized in writing. The statement must contain same information as a
prospectus complying with the Schedule III. Section 50 provides that if a statement in lieu of
prospectus includes any untrue statement, the directors and others who authorized its
delivery for registration are liable to imprisonment up to 2 years or a fine up to ten thousand
shillings or both, unless it is established by the person liable that:
i) The untrue statement was immaterial.
ii) He had reasonable ground to believe that such a statement was true.
Contents of statement in lieu of prospectus
Contents of this statement depend on whether that statement is delivered under section 32 (1)
or section 11 (2).
A statement delivered under section 32(1) must contain the following particulars:
a) The nominal share capital of the company, and shares into which it is divided,
b) The amount (if any) of the capital constituted by redeemable preference shares,
c) The earliest date in which the company has power to redeem the redeemable preference
shares, if any,
d) Names, occupation and postal address of directors or proposed directors,

e) Amount of issued shares and commission or discount allowed therewith,
f) Amount of preliminary expenses and by whom they have to be paid or are payable,
g) Amount given or any other benefit given to any promoter and the consideration for the
payment of the benefit
h) Voting, capital and dividend attached to the different classes of shares
i) Shares and debentures issued in the preceding two years as fully paid up otherwise than
for cash and consideration for the issue
j) Number description and amount of any shares which any person has or is entitled to be
given an option to subscribe for and the period the option is exercisable.
k) Name and postal address of vendors of the property of the company the amount payable
for any such property to each separate vendor
l) Dates, parties to and general nature of material contracts, and the time and place at
which the contract or copies there of may be
m) Names and address of auditors
n) Full particulars of the nature and extent of the interest of every director in any of the
interests of every director in any property of the company purchased or acquired by the
company within the preceding two years
o) Rates of dividend (if any) paid by the company in respect of each class of shares in the
company in each of the five financial years immediately preceding the issue of the
statement or financial years immediately preceding the issue of the statement or since
incorporation of the company, whichever period is short and particulars.
p) The case in which no dividend have been paid in any class of shares in any of these
years.
STOCK EXCHANGE REQUIREMENTS
The stock exchange is a market where stocks or shares are bought and sold through
stockbrokers. The stock exchange is governed by a council elected by the members from
amongst themselves. The following conditions are fulfilled before a company is listed in the
stock exchange:
a) A completion of an application form and signing an agreement.
b) A short history of the company.

c) A certificate from the auditors that the company is public within the terms of the
Companies Act.
d) Issued share capital must not be less than £ 25000.
e) Payment of a hearing fee of five hundred shillings.
f) Further five hundred shillings for all quotations granted.
g) Council has to be satisfied that a reasonable number of shares are offered in order to start
a market.
h) Submission of three copies of the articles of association, which may be referred after
perusal by the committee members.
ALLOTMENT OF SHARES ON THE STOCK EXCHANGE
Section 53 where a prospectus states that application has been made for permission for the
shares or debentures offered thereby to be dealt in any stock exchanges, allotment made will be
void if:
a) The permission has not been applied for before the 3rd day after the first issue of the
prospectus.
b) Permission has been refused before the expiration of three weeks from the date of the
closing of the subscription list or such longer period not exceeding six weeks.
Section 53(2) states that where the permission has not been applied for or has been refused, the
company must immediately repay all money received from applicants. But if such money is not
paid within 8 days after the company became liable to repay the directors became liable to pay
with interest at 5% p.a. from the expiration of the 8th day, unless a director can prove that the
default was not due to any misconduct or negligence on his part. Section 53 provides further
that all money received from applicants must be kept in a separate account so long as the
company may become liable to repay it..
Underwriting commission
Underwriting refers to a situation where one agrees to take shares or debentures specified in an
agreement, if the public fails to subscribe for them. Consideration for this undertaking is a
commission. Section 55 provides that a company may pay a commission to any person in
consideration of his subscribing or agreeing to subscribe or his procuring or agreeing to procure

subscriptions for shares in or debentures of the company. Before commission is paid the
following conditions have to be fulfilled:
(i) The payment of commission should be authorized by the articles.
(ii) Commission cannot exceed 10% the price of shares.
(iii) The amount and rate of the commission and number of shares which
underwriters have agreed to subscribe must be disclosed as:
a) In the case of shares offered to the public for subscription, the disclosure
must be in the prospectus.
b) In the case of shares not offered to the public for subscription, the same
disclosure must be made in the statement in the prescribed form and
delivered to the Registrar before payment of the commission.
Section 55(4) a vendor or promoter of a company or any other person who receives payment in
money or shares from the company, has power to apply any part of the money or shares so
received in payment of any commission, the payment which if made by the company would have
been legal under this sections.
Apart from the above exceptions no company may apply its shares or capital to pay commission
discount or allowance to any one in consideration of his subscribing or agreeing to subscribe for
any shares in the company.
Section 55 applies to private and public companies alike.
Brokerage
Section 55 permits companies to pay brokerage if its articles so provide. Brokers are
professional persons such as stockbrokers, bankers who exhibit prospectuses and send them
to their customers and by whose mediation the customers are induced to subscribe. Unlike
underwriters, brokers do not undertake to subscribe shares or debentures, which are not
subscribed by the public.
Brokerage must be payable to brokers only
In Andreae v. Zinc Mines (1918) 2 K. B. 454, a company agreed to pay a lady 10% commission
on any capital the company as a result of an introduction by her. The lady was not carrying on
any business as a broker, it was held that she could not recover the agreed sum as she did not

carry on business as a broker and it was a mere accident that she came into the company's office
and was consulted on this matter.
COMMENCEMENT OF BUSINESS
Section 3 of the Act gives conditions and restrictions which a company must observe before it is
allowed to start business. This includes issuance of prospectus, and whether the minimum
subscription was raised. Form 211 which must be given to the Registrar confirms the following: -
a) The minimum subscription has been raised.
b) Every director of the company has paid the company for the shares taken or contracted to
be taken by him.
Having given Form 211 and 212 and the statement in lieu of prospectus the Registrar shall
certify that the company is entitled to commence business and issue it with a Trade Certificate. If
the company defaults on the contracts entered by it will be provisional only. Section 3(b)
provides a penalty for breaching the conditions. Section 3(7) exempts private companies from
the conditions and restrictions thus a private company can start business without the trading
certificate.
Test Questions
1. What is a prospectus? What are its contents? Is it obligatory for a company to file a
prospectus or statement in lieu of prospectus with the Registrar?
2. Who is liable for misstatements in a prospectus? Explain the extent of liability for such
misstatement.
3. What are the remedies open to an allottee of shares who had applied for them on the faith
of a false and misleading prospectus, and what are the defences available to the directors
of the company who have issued such a prospectus?
4. State the law regarding the payment of underwriting commission.
5. Define minimum subscription. What are the consequences if a company is not able to
raise the minimum subscription?

Company Law - FORMATION AND FLOTATION OF A COMPANY

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