Illegal Association in Company

Illegal association – Section 11(2) of the companies act 1956 talks about illegal association which states No company, association or partnership consisting of more than twenty persons shall be formed for the purpose of carrying on any other business that has for its object the acquisition of gain by the company, association or partnership, or by the individual members thereof, unless it is registered as a company under this Act, or is formed in pursuance of some other Indian law. As important aim of companies act is to eliminate the evils caused by large number of partnerships trading In unincorporated form.

A business association consisting of a large number of members, unless incorporated as a company, leads to inevitable confusion and uncertainty concerning the rights and liabilities of members inter se and their relations with others. Its therefore, necessary to provide that every business association having a certain number of members must be registered as a company failing which it shall be regarede as an uillegal association. The conditions of illegality under the section are: 1. The membership of the association must be more than twenty 2.

The association must have been formed for the purpose of carrying on a business; 3. The object of the association must be to acquire profits for itself or for its members, and 4. The association must not have been registered as a company under the companies act, nor must it have been formed in the pursuance of some other Indian law. Thus for example, a stock exchange has been held to be not in the purview of the section as it is not formed for the purpose of carrying business much less a business which has for its objectsthe acquisition of gain.

The section however, doesnot apply to a joint hingdu family carrying on business, where a busiess is carried on by two or more joint hindu families, in computing the number of members for the purposes of this section, minor members must be excluded. Consequences of illegality Firstly, according to sub-section(4) every member of such an association shall be personally liable for all the laibilites incurred in the business. A part from this unlimited personal liability , members are punishable with a fine which may extend up to ten thousand rupees.

Secondly, the members of an illegal company cannot maintain an action in respect of any contract made by it. For example, the price of any goods sold by the association cannot be recovered. Thirdly, it cannot be wound up under the act even under the provisions relating to winding up of unregistered companies. Lastly, can there be a suit between the members of the partition or dissolution of taking of accounts of all legal company? This question arose in the high court of Allahabad in Mewa ram vs Ram gopal. The suit was in respect of a partition concerned with certain ginning factories.

There was more then twenty partners and, therefore, the partnership was illegal. The plaintiff claiming the eighth share in the partnership brought an action for the declaration that the partnership was invalid and prayed for the refund of his subscription out of the proceeds released by the auction sale of the factories or for the division of the properties of the factories. The case was first heard by the Division Bench consisting of SULAIMAN J (afterwards CJ) MUKHERJI J. The learned judges differed SULAIMAN J was of he opinion that the prayer for the refund of the original subscription could not be granted because the parties had been participating in the profits of the illegal partnership for several years. But he held that the plaintiff was entitled to a partition of the property. MUKHERJI J on the other hand, held that the plaintiff was not entitled to any relief, because partition would involve realization of the assets of the company and payment of its debts, the very thing which would be done in the suit for dissolution of partnership or winding up of a company.

The case was therefore referred to WALSH J who agreed with MUKHERJI J that a decree for the partition would be in substance a direction for winding up or a decree for the dissolution of accounts. He added that when such a precedent was once established there was nothing to prevent the formation of an unlimited number of such association consisting of more then twenty persons carrying on trade for the purpose of gain, any one of member of which could come to the court and ask for the relief in suit, in the nature of the winding up, for the partition of the assets and association.

The result would be to give such association under another guise cloak of legality although the statue has forbidden it. This opinion was followed in KUMARSWAMI CHETTER VS CHINATHAMBI CHETTER where the court added that “it is well establi8sh that the consequences of the illegality of the partnership is that its members have no remedy against each other for contribution or apportionment in respect of partnership dealing and transactions. ” The position was clarified by the Supreme Court in BADRI PRASAD VS NAGARMAL:

The case arises out of the suit for the recovery of contribution made to the illegal association and also for accounts. It was contended that the objects of the association was not illegal and the same, being dissolved, recovery should be allowed in the manner of the assets of the dissolved firm. The court held that “such a claim is clearly untenable. The only course to the courts to pursue is to say that he is not entitled to any relief as the ourts cannot adjudicate in respect of contracts with the law declared to be illegal. ” The partnership analogy was also rejected. “An unregistered firm is not illegal” Individual members would be entitled to recover their subscriptions and to have the asset realized for the purpose. This would not advance illegality. It would rather terminate the illegal gathering and would not prevent grabbing of assets and subscriptions by the members in whose hands they perchance fall.