Monday, May 21, 2012

Today's question of law is
What if the subscriber fails to bring in the agreed amount of subscription capital?

From: Mani <>
Date: Mon, Jun 22, 2009 at 7:31 PM
Subject: Re: [CS_yahoogroups) subscriber to MOA


Whether the substratum of a company is lost or not is a question of fact to
be decided on various surrounding facts and circumstances. For example, when
the main business of the company is prohibited by operation of law and it is
impossible for the company to carry any other business as per its MoA, then
it can be said that the substratum is lost. When major assets of a company
are lost in any accident or otherwise, and there is no possibility of
carrying on the business,then one can conclude that the sub stratum is lost.

Failure of subscribers to pay the amounts towards the shares subscribed them
does not mean that the substratum is lost.

If such a view is taken, the employees, creditors and general public who
have entered into various contracts, obligations/transactions with the
Company will be put in a rather disadvantageous position. Such a view will
encourage unscrupulous persons to form companies with huge subscribed
capital,raise money from the public  and then repudiate their obligation to
honour their commitments  with impunity.

Mere failure to pay for the shares undertaken to be paid by the subscriber
at the time of formation of a company shall not therefore be construed as
loss of substratum. The company should exhaust all the legal remedies to
enforce the statutory obligation on the part of the subscriber to pay for
the shares subscribed by him.

When a person subscribes his name to the memorandum of association and
agrees to pay for the shares subscribed by him a statutory obligation arises
between him and the company immediately on its incorporation.

A subscriber’s liability is therefore a subsisting liability till the agreed
amount is paid or the liquidation process is completed.

A conjoint reading of sections 41,426 and 428 of the Act supports the above

The process of incorporation is a classical example of “fiction of law”.
When a person undertakes to pay for the shares subscribed him, the company
is not in existence. The RoC, who issues the certificate on the basis of the
duly executed memorandum of association which includes the subscription
clause, is definitely not a party to the transaction.

Even though the words “agree to take” occurs in the subscription clause of
Table B of Schedule A to the Companies Act, 1956, in fact, there is no
agreement at all since the company was not  in existence at the time of
execution of memorandum and the certificate of incorporation is always
issued after the memorandum and other documents are duly executed.

Can we conclude that the subscriber enters into a contract with a company
agreeing to pay for the shares when the company is not yet born? The process
of incorporation being a legal process is totally different from what is
known as pre incorporation contracts.

 Even in respect of such pre incorporation contracts, the promoter enters
into a contract with a third party on behalf a company yet to be formed.
Here, at the time of formation, there is no other party involved. The RoC on
being “satisfied” that the requirements of the Act are fulfilled issues the
certificate of incorporation which gives legal life to the artificial entity
with limited liablility.

I therefore prefer to use the term “statutory obligation” rather than
contractual obligation to describe the legal effect of subscription clause
in the memorandum of association of a company limited by shares.

It is an obligation imposed by the Statute on the subscribers to pay for the
shares subscribed and the company to issue such shares.

The subscription clause in the MoA casts a legal obligation to issue the
subscribed shares on the company and the subscribers to pay for such
shares.This transaction  cannot  be called as the relationship between a
debtor and his creditor even though section 36(2) is widely worded .

If we construe it as the debt recoverable from the subscribers under section
36(2), what is the nature of right of a subscriber to acquire the shares
subscribed by him from the company on its incorporation?

When both the parties (the subscriber to the memorandum & the company) are
under obligation to pay for the shares and issue of the shares
respectively,how can the company unilaterally  recover the amount due on
shares subscribed as a debt?

I am left with no alternative but to conclude that the subscription clause
does not create any debtor /creditor relationship between the subscribers
and the company under incorporation. It creates only a legal obligation on
both the parties based on equitable consideration to be honoured by them
after the company is born.

Being a statutory obligation,either party can approach the civil court of
competent jurisdiction to enforce their respective rights. It means the
company has the right to ask for money against the shares subscribed by the
defaulting subscriber to the MoA and issue the shares on receipt of the
amount. In the event, the company declines to issue the shares, the
aggrieved subscriber can enforce his rights in the same manner.

Even if we agree that the amount subscribed by a subscriber to a memorandum
of association is a debt, then ,it is a” pre incorporation debt”.

The question then arises is whether section 36(2) could be invoked in
respect of debts incurred before the company was born. Thus, applying
section 36(2)  in the present case, creates more problems.

One should not forget that capital maintenance clauses are always sacrosanct
in any company law jurisdiction in the world.In order to satisfy the
requirements relating to the minimum number of members on incorporation and
to enforce the liability of subscribers who have not paid their subscribed
amounts, the subscribers to a memorandum have been brought within the
of  a member under section 41.Read with sections 426 &428 of the Act, the
legislative intention is clear. Otherwise, there will be promoters without
any liability and the legislative intent of limited liability concept will
become infructuous.

If the company does not pursue the legal remedy against the subscriber in
default  to recover the moneys against the shares subscribed by him,or
delays such a course of action with malafide intentions or acts in a
collusive manner with the subscribers to delay the payment of money towards
the subscribed shares, an affected party whether a creditor or any other
member can approach the civil court for enforcing this legal obligation.

I am unable to agree with the suggestion regarding issue of share
certificates when the total subscription money is outstanding or making any
accounting entries without approaching the court of law to enforce the
obligations on the subscribers. There cannot be any issue/allotment of
shares without some consideration in advance except in the case of issue of
bonus shares.

The courts can order arrest of a contributory under section 479 of the Act
under any of the circumstances mentioned in that section. The definition of
a contributory means every person liable to contribute to the assets of a
company in the event of its being wound up.

A subscriber’s liability is therefore a civil liability to pay for the
shares as long as the company is a going concern. When the company comes
under liquidation, the subscriber to its memorandum who has not fully taken
the shares subscribed by him will be hit by section 479 if his intentions
are not good since he is liable to pay for the shares subscribed by him.

Thus civil liability during the period when the company is a going concern
and and criminal liability at the time of liquidation looms at large on the
subscriber who gleefully signs the memorandum without understanding the
legal implications.

Though there are no specific sections relating to the liability of a
subscriber in this regard, the Act as it stands today, provides adequate
safeguards against an unscrupulous subscriber who wants to evade his

The company can therefore approach the civil court of competent jurisdiction
to enforce the obligation of the subscriber in default to pay for the shares
subscribed by him.

Recently, I interacted with a partner of one of the biggest accounting firms
in the country.

In that case, the company had a few hundred millions of authorised capital
which was  fully subscribed at the time of incorporation by the parent
company and its subsidiary abroad.

The auditors insisted that entire subscribed capital should be paid up even
though the company had the minimum paid up capital.

Finally when the matter came to me, I asked the partner of the audit firm to
show me any provisions in the Act to that effect   or   any Judgement to
substantiate their argument.

They had no other option but to drop the objection since the company was
running its business efficiently and did not require any more funds from the

The situation should therefore be examined in its totality before coming to
any conclusion.


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