CAN A FIRM BE A SHAREHOLDER IN A COMPANY?

 " 1.   Like many other questions, this question has also been left unanswered by the Indian
Partnership Act, 1932. Interestingly, Section 41 of the Companies Act, 1956, which deals with
definition of `member' in respect of a company, is also keeping mum on this point.
2.     Under Section 11 of the Indian Contract Act, 1872, read with Sections 2(e) and 3 of the
Indian Partnership Act, only such persons as are competent to contract, are of sound mind,
major and are not disqualified from contracting by any law in force would be entitled to become
partner. Legally speaking, a company or corporation can become a partner in a partnership
firm. This is because a company  or corporation is a legal person in eyes of law.
3.     Further, there is no general principle of law, which prevents a corporation or company,
from being a partner with another corporation or with ordinary individuals, except the
principle that a corporation cannot lawfully employ its funds for purposes not authorised by its
constitution. There cannot be any legal objection for companies and individuals forming
partnership firms for purposes of trade –            Sri Murugan Oil Industries (P.) Ltd. v. A. V.
Suryanarayan Chettiar, (1963) 33 Com Cases 833: AIR [1963] Mad 128.
4.     However, as regards the question whether a partnership firm can be member or
shareholder of a company, the DCA Circular [Circular No. 4/72, dated 9-3-1972] is relevant. As
per the clarification issued by the Department of Company Affairs, vide Circular No. 4/72,
dated     9-3-1972, a firm of partnership, (not being a legal person) cannot be registered as a
member of a company.
5.     However, as an exception, a firm of partnership can become a member of a charitable
company. In other words, in case where the company is licensed under Section 25 of the
Companies Act, 1956, a firm of partnership can become a member of such a company.
6.     Further, under Section 41(2) of the Companies Act, 1956, any person who has agreed in
writing to become a member and whose name is entered in the register of members, shall be
treated as a member of the company. Accordingly, only a person can be a member and a person
for this purpose may mean any natural person or artificial person or legal person or any
corporation. In this context, another question may arise whether a partnership firm, which is
not a legal person, can be a member of a company.
7.     In this context, where a firm of partnership was allotted certain shares and its name was
registered in the register of members of the company, the Income-tax authorities refused to
recognise this as a valid allotment for tax purpose. However, the court overruled the objection
raised by the taxmen. The court further held that an allotment in favour of a firm is not
inoperative and when shares are registered in name of a firm, such registration in effect would
render all partners as joint holders of the shares – Bansidhar Durgadutt v. CIT (1975) Tax LR 900
(Cal.).
8.     According to Palmer's Company Law, (51-04, p. 802, 24th ed. 1987) "A firm can be
registered in England under its partnership name although it is not a legal entity. Further, as
per the Halsbury's laws of England, 109   (3rd edn., Vol. VI Art. 227) "  if   a   firm  with  the
authority  of the firm, has subscribed to a memorandum, the partners are  joint  holders of  the
shares  subscribed for. Neither such registration is void, nor can it be treated as non est."   
9.     However, practically speaking, the articles of association of most of the         companies in
India do provide that only individuals, companies and         registered   associations   will be
admitted as members.  Further,  a         partnership  firm  as  such  could  not  be  a  member of a
company as   decided  in case of Seth Mengraj v. SMES Corporation, (1960) 2 (Mad) LJ 46.
Similarly, in case where the debenture is convertible into shares (either automatically or at the
option of the holder) it  is  advisable   for  the  issuing  companies  to  restrict the same only to
legal entities.          This is because these convertible debentures do involve contract or  option to
be a member of the company.   
10.    Further,  the  clarification  of  the  Department of  Companies Affairs is  now  relevant. 
Accordingly,  a  firm  (not  being a legal person for this  purpose)  cannot  be  registered  as  a 
member  of  a company except  where the company is licensed under Section 25 of the
Companies Act,  1956. Further, companies which have firms registered  as shareholders  should
be   advised  to   take  steps  to  rectify  the  position  within  a   specified time.  In  case  the 
irregularity  persists,  despite  a  warning necessary   action   can  be  taken  under  section
150(2)   of  the  Act   [Circular  No. 4/72, Dated 9-3-1972]. In other words, the department may
launch prosecution against the defaulting company under Section  150  of  the Act for not
keeping the register of members in accordance  with the law."                                     
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Many years ago, I had successfully contested a wealth tax appeal case( involving old
provisions), in which  investment in shares of a private limited company was appearing  in  the
Balance Sheet of a partnership firm. These shares were held in the name of a partner but the
purchase consideration was paid by the firm.  The learned WTO treated this investment as
belonging to the partner. In my written submissions, I had , inter alia, argued as under :-
"Section 14 of the Indian partnership Act, 1932 clearly lays down that unless the contrary
intention appears, property and rights  and interests in property acquired with money
belonging to the firm are deemed to have been acquired for the firm. M/s ………   has paid for
the shares and the investment is duly appearing in the audited Balance Sheet of the firm.
Therefore, the assets of the firm cannot be treated as those of the partner(s). 
Further, the expression "owner" was considered by the Supreme Court in R. B. Jodha Mal
Kuthiala v. CIT (1971) 82 ITR 570 (SC), in respect of section 9(1) of the Income-tax Act, 1922,
corresponding to section 22 of the Income-tax Act, 1961. It was laid down in that case that the
person in whose name the property stood was not necessarily the owner of that property.
According to the Supreme Court, the owner must be that person who can exercise the rights of
the owner."
……………………. The moment the value of the shares is included in the Net Wealth of the
assessee, the investment made by the firm in the said shares becomes a debt owed by the
assessee to the firm. As a result, there will be no effect on the Net Wealth of the assessee.’