January 31, 2016

Company Membership Under the Companies Act, 2013: Legal Framework and Pathways to Membership

Company Membership Under the Companies Act, 2013: Legal Framework and Pathways to Membership

Introduction

The concept of membership in a company forms the foundational pillar of corporate governance and shareholder rights in India. Under the Companies Act, 2013, the framework for company membership has evolved significantly from its predecessor, the Companies Act, 1956, introducing enhanced transparency mechanisms and regulatory safeguards. This legal analysis examines the various pathways through which an individual or entity can acquire membership in a company, the regulatory framework governing such membership, and the contemporary legal landscape surrounding these provisions.

The importance of understanding company membership cannot be overstated in today’s complex corporate environment. Membership determines not only the ownership structure of a company but also voting rights, dividend entitlements, and participation in corporate governance. The Companies Act, 2013, has introduced several progressive changes that reflect modern business practices while strengthening investor protection mechanisms.

Definition and Legal Framework of Company Membership

Statutory Definition Under Section 2(55)

The Companies Act, 2013, provides an exhaustive definition of “member” under Section 2(55) [1]. According to this provision, a member, in relation to a company, means:

“(i) the subscriber to the memorandum of the company who shall be deemed to have agreed to become member of the company, and on its registration, shall be entered as member in its register of members;

(ii) every other person who agrees in writing to become a member of the company and whose name is entered in the register of members of the company;

(iii) every person holding shares of the company and whose name is entered as a beneficial owner in the records of a depository.”

This tripartite definition encompasses the traditional concept of membership while acknowledging the modern depository system and beneficial ownership structures. The definition represents a significant evolution from the earlier framework, particularly in recognizing beneficial ownership as a form of membership [2].

Constitutional Foundation: The Memorandum of Association

The legal foundation of company membership rests upon the Memorandum of Association (MOA), which serves as the constitutional document of the company. As established in the landmark case of Ashbury Railway Carriage & Iron Co. Ltd. v. Riche (1875) L.R. 7 H.L. 653, “The memorandum of association of a company is its charter and defines the limitations of the powers of the company… it contains in it both that which is affirmative and that which is negative” [3].

Section 3 of the Companies Act, 2013, mandates that a company may be formed for any lawful purpose by seven or more persons in the case of a public company, two or more persons for a private company, or one person for a One Person Company [4]. These foundational subscribers become the initial members of the company upon its incorporation.

Pathways to Company Membership

Membership by Subscription to the Memorandum

The most fundamental pathway to company membership is through subscription to the Memorandum of Association. Under Section 2(55)(i) of the Companies Act, 2013, subscribers to the memorandum are deemed to have agreed to become members of the company [5]. This automatic membership takes effect upon the company’s registration, when their names are entered in the register of members.

The legal principle underlying this form of membership was articulated by the Madras High Court in K.P. Swami Gounder and Ors. case, where it was held that “subscribing their names to a Memorandum of Association implies an agreement between the persons concerned to associate each other into a body corporate and subscribing in the context means the signing by such persons or their nominees in the Memorandum in token of their agreement to so associate themselves” [6].

The subscribers’ commitment is legally binding and cannot be revoked on grounds of misrepresentation by promoters, as established by judicial precedent. The Supreme Court in Clariant International Ltd. and Anr. v. Securities and Exchange Board of India emphasized that “The subscribers of the memorandum are deemed to have agreed to become members of the company, and on its registration shall be entered as members in its register of members” [7].

Membership by Application and Registration

The second pathway to membership, governed by Section 2(55)(ii), involves persons who agree in writing to become members and whose names are subsequently entered in the register of members [8]. This category encompasses various modes of acquiring membership including:

Allotment of Shares: When a company issues new shares to the public or through private placement, applicants who are allotted shares become members upon registration. The process is regulated by Sections 23-42 of the Companies Act, 2013, concerning prospectus and allotment of securities.

Transfer of Shares: Existing shares may be transferred from one person to another through the transfer mechanism provided under Sections 56-58 of the Act. The transferee becomes a member upon registration of the transfer in the company’s records.

Transmission of Shares: In cases of death, insolvency, or other legal events, shares may be transmitted to legal heirs or other entitled persons. Section 72 of the Companies Act, 2013, governs the transmission of securities.

Succession and Inheritance: Legal heirs of deceased members may acquire membership through the process of succession, subject to compliance with the applicable legal requirements and the company’s Articles of Association.

The critical requirement for this category of membership is the written agreement to become a member and subsequent registration in the company’s records. The Companies (Management and Administration) Rules, 2014, specifically Rule 5, mandates that entries in the register of members must be made within seven days after Board approval of allotment or transfer [9].

Membership through Beneficial Ownership in Depository System

The third pathway, introduced to accommodate the modern depository system, recognizes beneficial owners as members under Section 2(55)(iii) [10]. This provision acknowledges the reality of contemporary securities trading where shares are held in dematerialized form through depositories.

Under the Depositories Act, 1996, and the Companies Act, 2013, a beneficial owner is defined as a person whose name is entered as such in the records of a depository. Section 89(10) of the Companies Act, 2013, defines beneficial interest as “the right or entitlement of a person alone or together with any other person to exercise or cause to be exercised any or all of the rights attached to such share; or receive or participate in any dividend or other distribution in respect of such share” [11].

The legal framework recognizes that while the depository participant may be the registered holder, the beneficial owner enjoys the economic benefits and voting rights associated with the shares. This distinction is crucial for maintaining transparency in ownership structures and preventing the misuse of nominee arrangements.

Regulatory Framework and Compliance Requirements

Register of Members: Section 88 and Rule 3

Section 88 of the Companies Act, 2013, mandates every company to maintain a register of members in the prescribed format [12]. Rule 3 of the Companies (Management and Administration) Rules, 2014, specifies that companies limited by shares must maintain this register in Form MGT-1.

The register must contain detailed information including:

  • Names and addresses of members
  • Number and class of shares held
  • Date of becoming a member
  • Date of cessation of membership
  • Email addresses and PAN details

The maintenance of an accurate register of members is not merely an administrative requirement but a legal obligation with significant consequences for non-compliance. Section 88(5) prescribes penalties ranging from Rs. 50,000 to Rs. 3,00,000 for companies failing to maintain proper registers [13].

Beneficial Ownership Disclosure Requirements

The Companies Act, 2013, introduced significant provisions regarding beneficial ownership disclosure through Sections 89 and 90. Section 89 requires declaration of beneficial interest in shares, while Section 90 mandates the maintenance of a register of significant beneficial owners [14].

The Companies (Significant Beneficial Owners) Rules, 2018, as amended in 2019, define a significant beneficial owner as an individual holding, directly or indirectly, not less than ten percent of shares, voting rights, or rights to participate in dividend distribution [15]. These provisions aim to enhance corporate transparency and prevent the misuse of complex ownership structures for illicit purposes.

Depository System Integration

The integration of the depository system with company membership is governed by Section 88(3) of the Companies Act, 2013, which states that “The register and index of beneficial owners maintained by a depository under section 11 of the Depositories Act, 1996, shall be deemed to be the corresponding register and index for the purposes of this Act” [16].

This provision creates a seamless legal framework where depository records serve as evidence of membership for companies whose securities are held in dematerialized form. The Securities and Exchange Board of India (SEBI) regulations further complement this framework by prescribing detailed procedures for maintaining beneficial ownership records.

Contemporary Legal Developments and Case Law

Judicial Interpretation of Membership Rights

The courts have consistently held that membership in a company is not merely a contractual relationship but a statutory status conferred by law. In the case of Committee of Administrators Pendente Lite v. Insilco Agents Ltd., the National Company Law Tribunal (NCLT) examined whether a significant beneficial owner could maintain proceedings under Section 241 for oppression and mismanagement [17].

The tribunal held that the definition of member under Section 2(55) is exhaustive and not inclusive, thereby clarifying that significant beneficial ownership cannot be automatically equated with membership for all purposes under the Act.

Electronic Records and Digital Compliance

Recent developments have emphasized the importance of maintaining electronic records and ensuring digital compliance. The Ministry of Corporate Affairs has issued various circulars promoting the use of digital platforms for maintaining statutory registers and filing returns.

The Companies (Amendment) Act, 2017, and subsequent rules have introduced provisions for electronic maintenance of registers, subject to prescribed safeguards and authentication procedures [18]. This evolution reflects the government’s push towards digitization and ease of doing business.

Specific Categories of Members and Special Provisions

One Person Company (OPC) Members

The Companies Act, 2013, introduced the concept of One Person Company under Section 2(62), allowing a single individual to form and own a company [19]. The membership structure in an OPC is unique, as it involves only one member with a nominee who would become the member in case of the subscriber’s death or incapacity.

The nomination provision in OPC membership serves as a succession mechanism, ensuring continuity of the corporate entity. Rule 3 of the Companies (Incorporation) Rules, 2014, prescribes detailed requirements for nomination in OPCs.

Foreign Nationals and NRI Membership

Foreign nationals and Non-Resident Indians (NRIs) can become members of Indian companies subject to the Foreign Exchange Management Act (FEMA) regulations and sectoral caps. The Companies (Incorporation) Rules, 2014, Rule 13(5), prescribes specific documentation requirements for foreign subscribers, including notarization and visa requirements [20].

The Reserve Bank of India’s directions on foreign direct investment provide the regulatory framework for foreign membership in Indian companies, with specific provisions for different sectors and investment routes.

Rights and Obligations of Members

Fundamental Rights of Members

Company membership confers various rights that are protected both by statute and common law. These include:

Voting Rights: The right to participate in general meetings and vote on resolutions affecting the company. Section 47 of the Companies Act, 2013, governs voting rights and procedures.

Dividend Rights: The right to receive dividends when declared by the company, as provided under Sections 123-127 of the Act.

Information Rights: The right to inspect registers, receive copies of financial statements, and access other statutory documents under Section 88 and related provisions.

Transfer Rights: The right to transfer shares subject to the provisions of the Articles of Association and applicable laws under Sections 56-58.

Member Obligations and Liabilities

Membership also imposes certain obligations and liabilities:

Payment of Calls: Members are liable to pay calls on shares as and when made by the company. Non-payment can lead to forfeiture of shares and disqualification from directorship under Section 164(1)(f) [21].

Compliance with Constitutional Documents: Members must comply with the Memorandum and Articles of Association of the company.

Disclosure Obligations: Significant beneficial owners and members holding substantial stakes must comply with disclosure requirements under Sections 89 and 90.

Cessation of Membership

Modes of Cessation

Membership in a company can cease through various modes:

Transfer of Shares: Complete transfer of shareholding results in cessation of membership for the transferor.

Death: Membership ceases upon death, leading to transmission of shares to legal heirs.

Surrender and Forfeiture: Shares may be surrendered or forfeited for non-payment of calls, resulting in cessation of membership.

Buy-back and Redemption: The company may buy back shares or redeem them as per the provisions of the Act, leading to cessation of membership.

Legal Consequences of Cessation

The cessation of membership has various legal implications including the loss of voting rights, dividend entitlements, and other membership privileges. However, certain statutory liabilities may continue even after cessation, particularly in cases of fraud or misconduct.

Regulatory Enforcement and Penalties

Statutory Penalties

The Companies Act, 2013, prescribes stringent penalties for non-compliance with membership-related provisions. Section 88(5) imposes fines for improper maintenance of registers, while Sections 89 and 90 prescribe penalties for non-disclosure of beneficial ownership.

The penalty structure reflects the legislature’s intent to ensure strict compliance with transparency and disclosure requirements, particularly in light of increasing corporate governance concerns.

Regulatory Actions

The Ministry of Corporate Affairs, through the Registrar of Companies, has the power to take enforcement actions for non-compliance. These may include striking off companies from the register, imposing penalties, and prosecuting officers in default.

Recent years have witnessed increased regulatory scrutiny of beneficial ownership structures, with the government taking a proactive approach to ensuring compliance with disclosure requirements.

Future Outlook and Reforms

Proposed Amendments and Reforms

The government has indicated its intention to further strengthen the regulatory framework governing company membership. Proposed reforms include enhanced disclosure requirements, stricter penalties for non-compliance, and greater integration of digital technologies in maintaining membership records.

The ongoing digitization initiatives under the “Digital India” program are expected to transform the way membership records are maintained and accessed, potentially leading to real-time updates and enhanced transparency.

International Best Practices

India’s regulatory framework for company membership is increasingly aligning with international best practices, particularly in areas of beneficial ownership disclosure and corporate transparency. The Financial Action Task Force (FATF) recommendations on beneficial ownership have influenced domestic policy formulation.

Conclusion

The framework governing company membership under the Companies Act, 2013, represents a sophisticated legal structure that balances the traditional concepts of corporate ownership with contemporary business realities. The tripartite definition of membership accommodates various forms of shareholding while ensuring adequate transparency and regulatory oversight.

The evolution from the Companies Act, 1956, to the current framework demonstrates the legislature’s commitment to creating a robust corporate governance environment that protects stakeholder interests while facilitating business growth. The integration of the depository system, enhanced disclosure requirements, and stringent penalties for non-compliance reflect modern regulatory approaches to corporate transparency.

As India continues to strengthen its position as a global business destination, the legal framework governing company membership will undoubtedly continue to evolve. The emphasis on beneficial ownership disclosure, digital compliance, and enhanced transparency mechanisms positions Indian corporate law at the forefront of international best practices.

For legal practitioners, corporate professionals, and stakeholders, understanding the nuances of company membership under the current legal framework is essential for ensuring compliance and protecting rights. The comprehensive nature of the current provisions, while complex, provides a solid foundation for transparent and accountable corporate governance in India.

References

[1] Section 2(55), Companies Act, 2013. Available at: https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf 

[2] Enterslice. (2022). “Non-receipt of Subscription Money under Companies Act, 2013.” Available at: https://enterslice.com/learning/non-receipt-of-subscription-money-under-companies-act-2013/ 

[3] Ashbury Railway Carriage & Iron Co. Ltd. v. Riche, (1875) L.R. 7 H.L. 653

[4] Section 3, Companies Act, 2013

[5] TaxGuru. (2020). “Non-Receipt of Subscription Money Under Companies Act, 2013.” Available at: https://taxguru.in/company-law/non-receipt-subscription-money-companies-act-2013.html 

[6] K.P. Swami Gounder case, AIR 1966 Mad 231, (1965) 2 MLJ 504

[7] Clariant International Ltd. and Anr. v. Securities and Exchange Board of India, AIR 2004 SC 4236 

[8] Rule 5, Companies (Management and Administration) Rules, 2014

[9] Companies Act Integrated Ready Reckoner. “Section 88 – Register of members.” Available at: https://ca2013.com/register-of-members-etc/ 

[10] MMJC. (2024). “Shareholding v/s Beneficial Ownership.” Available at: https://www.mmjc.in/shareholding-v-s-beneficial-ownership/ 

[11] Section 89(10), Companies Act, 2013

[12] TaxGuru. (2019). “Compulsory Maintenance of Register of Members as per Companies Act 2013.” Available at: https://taxguru.in/company-law/compulsory-maintenance-register-members-companies-act-2013.html 

[13] Section 88(5), Companies Act, 2013

[14] TaxGuru. (2020). “All about Significant Beneficial Ownership under Companies Act 2013.” Available at: https://taxguru.in/company-law/significant-beneficial-ownership-companies-act-2013.html 

[15] Companies (Significant Beneficial Owners) Rules, 2018, as amended in 2019

[16] Section 88(3), Companies Act, 2013

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Authorized by Rutvik Desai

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