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SHARES
QUESTION BANK
Q.1 Discuss valid allotment of shares.
Q.2 Define shares and explain kinds of shares.
Q.3. Define kinds of share capital.
Q.4. What is the share and share capital? Discuss the rights of shareholders and
provisions regarding buy-back of shares.
Q.5. “A valid allotment of shares has to comply with the requirements of the Act? And
principles of the law of contract. Explain and evaluate the statement.
SHORT NOTES
Q.1 Certificate of shares.
Q.2 Issue of share at discount.
Q.3. Transmission of shares.
Q.4. Share warrant.
SYNOPSIS
I. Definition and Legal Nature of a "Share"
1. Statutory Definition — Section 2(84)
2. Judicial and Commercial Formulations
II. Kinds of Share Capital (Section 43)
A. Equity Shares (Ordinary Shares)
B. Preference Shares
Important Classifications of Preference Shares:
1. Cumulative vs. Non-Cumulative
a. Cumulative Preference Shares:
b. Non-Cumulative Preference Shares:
2. Participating vs. Non-Participating
a. Participating Preference Shares:
b. Non-Participating Preference Shares:
3. Redeemable Preference Shares (Section 55)
a. The Absolute Ban on Perpetuity:
b. Infrastructure Exception:
c. Mandatory Conditions for Redemption [Section 55(2)]:
4. Important Differences: Equity vs. Preference Shares
a. As to Preference:-
b. Risk:-
c. Full Membership:-
III. The Allotment of Shares: Contractual Framework
Mandatory Requirements for Allotment (Section 39)
1. Minimum Subscription
2. Receipt of Application Money
3. The Sequence Restriction (Section 42)
IV. Important Corporate Instruments and Issuance Models
A. The Share Certificate (Section 46)
1. Evidentiary Value:
2. Demat Mode:
3. Duplicate Share Certificates:
4. Penalties for Fraudulent Issuance:
B. Sweat Equity Shares (Sections 53 & 54)
1. The Ban on Issuing Shares at a Discount (Section 53)
a. The Insolvency Exception:
b. Penalties for Violations:
2. The Statutory Framework for Sweat Equity (Section 54)
Mandatory Conditions for Issuance (Section 54):
C. The Buy-Back of Securities (Sections 68 & 70)
1. Permitted Sources
2. Mandatory Conditions for a Legal Buy-Back:
a. Charter Authorization:
b. Shareholder Approval:
Board Exception:
c. The 25% Limit:
d. The Debt-to-Equity Ratio:
e. Fully Paid-Up Shares:
f. The Solvency Declaration:
g. Physical Destruction (Section 68(7)):
h. The Cool-Off Window:
3. Absolute Prohibitions on Buy-Backs (Section 70)
D. Bonus Shares (Section 63)
1. Authorized Sources-
2. Mandatory Conditions for a Bonus Issue:
I. Definition and Legal Nature of a "Share"
1. Statutory Definition — Section 2(84)
Under Section 2(84) of the Companies Act, 2013, a "share" means a share in the share capital of a company and explicitly includes stock.
2. Judicial and Commercial Formulations
As observed by Justice Dixon:
"Primarily, the share of any company is a piece of property conferring rights in relation to the distribution of income and capital." (Peter's American Delicacy Co. Ltd. v. Heath, (1939) 61 CLR 457)
In corporate finance, the total capital of a company is divided into standard, measurable units of a fixed monetary value. Each individual unit is a share.
A share does not represent a direct claim to a specific physical piece of office equipment or property owned by the firm; rather, it represents a bundle of rights and liabilities that link the investor to the corporation.
These rights include:
a. The right to participate in corporate profits via dividends;
b. The right to attend general meetings and exercise voting power;
c. The right to share in the residual assets of the company during a winding-up or liquidation.
Because a company possesses an independent legal personality separate from its owners (Salomon v. Salomon), a shareholder does not co-own the company's real estate or factories. Shares are legally classified as movable property (Section 44) and are treated as "goods" under Section 2(7) of the Sale of Goods Act, 1930. Under Section 45, every share in a company with a share capital must bear a distinct distinctive number to ensure tracking and prevent fraud.
Share vs. Stock: While often used interchangeably, there is a technical distinction. "Stock" is a consolidated bundle of fully paid-up shares that can be split into fractional parts for transfer purposes. In contrast, "shares" cannot be divided into fractions and do not need to be fully paid up.
II. Kinds of Share Capital (Section 43)
The modern Act restricts the issuance of share capital by a company limited by shares to two primary classes:
A. Equity Shares (Ordinary Shares)
Equity shares are defined simply as any share capital that does not constitute a preference share. They represent the core ownership of the company and bear the highest risk, as well as the highest potential rewards. Under Section 43, equity share capital can be issued in two ways:
- With standard voting rights (one vote per share under Section 47); or
- With differential rights as to dividend, voting, or other variations (DVR shares), allowing founders to raise capital without diluting voting control.
B. Preference Shares
Preference shares grant the holder specific priority rights over equity shareholders. Under Section 43, these preferential rights are:
1. As to Dividends: A right to receive a fixed dividend rate out of the company’s net profits before any dividend is declared or paid to equity shareholders.
2. As to Capital Repayment: A priority claim to recover their paid-up capital contribution during a winding-up or liquidation before any residual funds are distributed to equity shareholders.
Important Classifications of Preference Shares:
1. Cumulative vs. Non-Cumulative
a. Cumulative Preference Shares: If the company fails to earn a profit in any given financial year, the unpaid fixed dividend does not lapse. Instead, it accumulates as an arrear. These arrears must be cleared in full during subsequent profitable years before any dividend can be distributed to equity shareholders.
Presumption: Under Indian law, preference shares are legally presumed to be cumulative unless the Articles of Association (AoA) or the terms of the issue explicitly state otherwise (Foster v. Coles and Foster & Sons Ltd., (1906) 22 TLR 555).
b. Non-Cumulative Preference Shares: If a company skips a dividend due to an absence of distributable profits in a specific year, the holder loses that dividend permanently. It does not carry forward into future years.
Precedent: In Staples v. Eastman Photographic Materials Co., [1896] 2 Ch 303, the court ruled that an explicit phrasing in the Articles stating that preference shareholders were entitled to a dividend "out of the net profits of each separate year" meant the shares were non-cumulative.
2. Participating vs. Non-Participating
a. Participating Preference Shares: Grant the holder their fixed dividend plus an additional right to share in any "surplus profits" remaining after the equity shareholders have been paid a specified dividend. They may also participate in any surplus assets left during liquidation after all capital repayments have been made.
b. Non-Participating Preference Shares: Entitle the holder exclusively to their fixed dividend rate. Any surplus profits belong entirely to the equity shareholders.
Presumption: Preference shares are legally presumed to be non-participating unless the company's charter explicitly states otherwise (Will v. United Lankat Plantations Co., [1914] AC 11).
3. Redeemable Preference Shares (Section 55)
"Redemption" refers to the formal process where a company buys back and retires its shares by returning the capital to the investor.
a. The Absolute Ban on Perpetuity: Section 55 states that no company limited by shares can issue any irredeemable preference shares. All preference shares must be redeemed within a maximum period of 20 years from their date of issue.
b. Infrastructure Exception: A company can issue preference shares with a redemption timeline extending up to 30 years for designated infrastructure projects, provided a fixed percentage of those shares is redeemed annually starting from the 21st year.
c. Mandatory Conditions for Redemption [Section 55(2)]:
i. The shares must be fully paid up before the company can redeem them.
ii. Redemption can only be financed through two sources:
(1) Out of the distributable profits of the company that would otherwise be available for dividends; or
(2) Out of the proceeds of a fresh issue of shares made specifically to fund the redemption.
iii. The Capital Redemption Reserve (CRR): If redemption is funded out of profits, a sum equal to the nominal value of the shares being redeemed must be transferred to a separate account called the Capital Redemption Reserve Account. The CRR must be managed strictly and can only be used by the company to issue unissued shares to its members as fully paid-up bonus shares.
4. Important Differences: Equity vs. Preference Shares
There are the following differences between the two, viz.-
a. As to Preference:-
Preference shares carry preferential rights to be distributed dividends and/or redeemed. Ordinary shares do not.
b. Risk:-
Preference shares get dividends at a fixed rate, and therefore, there is less risk, whereas equity shares carry no such fixed rate of return; however, in times of prosperity, they carry the major part of the profits.
c. Full Membership:-
Preference shareholders’ rights and membership are restricted, whereas equity shareholders hold full membership. Equity shareholders have the right to vote, whereas preference shareholders do not carry such a right except in a few circumstances (S. 47).
Redemption:-
Equity shares are not redeemable except by a company's special resolution, whereas preference shares are redeemable.
III. The Allotment of Shares: Contractual Framework
An allotment occurs when a company accepts an investor's offer to buy its shares, creating a valid contract. In administrative law, the process follows standard contract principles:
1. The Prospectus: An invitation to offer, providing details to the public.
2. The Share Application: A formal offer by an individual to purchase a specific number of shares.
3. The Allotment: The acceptance of that offer by the Board of Directors, which brings the shares into existence.
Mandatory Requirements for Allotment (Section 39)
To protect the public from speculative or undercapitalized corporate launches, the Act imposes strict statutory safeguards before any allotment can take place:
1. Minimum Subscription
A public company cannot allot shares to the public unless it raises the minimum subscription amount listed in its prospectus.
a. Purpose: This ensures the company raises enough initial capital to cover essential launch costs, including buying land or equipment, paying underwriting commissions, and securing initial working capital.
b. The Timeline: The minimum subscription must be received within 30 days of issuing the prospectus (or a timeframe matching SEBI rules). If the company fails to raise this minimum amount within the deadline, all application monies must be refunded to the investors within 15 days. If the company delays this refund, the directors become jointly and severally liable to repay the money with interest at 15% per annum.
2. Receipt of Application Money
No allotment can be made unless the applicant has paid the required application fee. Under Section 39(2), the amount payable on application for each share cannot be less than 5% of the nominal value of the share, or an alternative percentage mandated by SEBI.
3. The Sequence Restriction (Section 42)
A company cannot launch a fresh offer or invitation for shares unless an earlier made offer has been successfully completed, withdrawn, or officially abandoned by the corporation.
Precedent: This procedural sequence was reinforced in Kal Airways Pvt. Ltd. v. SpiceJet Ltd., (2016), where the court affirmed that a company cannot introduce a new private placement offer while a previous issuance remains open and unsettled.
IV. Important Corporate Instruments and Issuance Models
A. The Share Certificate (Section 46)
A share certificate is a formal document issued by a company under its common seal (if any) or signed by authorized directors, certifying that the person named is the legal owner of a specific number of shares.
1. Evidentiary Value: It serves as prima facie evidence of the holder's legal title to the shares. It allows the shareholder to trade, pledge, or transfer their shares with confidence.
2. Demat Mode: If shares are held in electronic or "dematerialized" form, the official electronic records maintained by the Depository (such as NSDL or CDSL) serve as prima facie evidence of the beneficial owner's title.
3. Duplicate Share Certificates: A duplicate certificate can only be issued if the original is proven to have been lost or destroyed, or if it is defaced and surrendered to the company.
4. Penalties for Fraudulent Issuance: If a company issues a duplicate certificate with the intent to defraud, it faces a minimum fine of five times the face value of the involved shares, which can extend up to ten times the value or ₹10 crores, whichever is higher. Defaulting officers can also be prosecuted for fraud under Section 447.
B. Sweat Equity Shares (Sections 53 & 54)
1. The Ban on Issuing Shares at a Discount (Section 53)
Under Section 53, companies are strictly prohibited from issuing shares at a discount price. Any share issued at a discount is legally void ab initio.
a. The Insolvency Exception: A company can issue discounted shares to its corporate creditors only if its debt is being converted into equity shares as part of a statutory resolution plan or debt restructuring scheme authorized by the Reserve Bank of India (RBI).
b. Penalties for Violations: Any company that breaches this ban faces a penalty equal to the amount raised through the discounted issue or ₹5 lakhs, whichever is less. The company is also required to refund all received funds to the allottees with interest at 12% per annum.
2. The Statutory Framework for Sweat Equity (Section 54)
Sweat equity shares are an explicit exception to the discount ban. Under Section 2(88), Sweat Equity Shares mean equity shares issued by a company to its directors or employees at a discount or for consideration other than cash.
These are awarded in exchange for providing specialized know-how, intellectual property rights (like patents or copyrights), or significant value additions to the company.
Mandatory Conditions for Issuance (Section 54):
a. The issue must be authorized by a special resolution passed by the shareholders.
b. The resolution must specify the exact number of shares being issued, their current market price, the value of the consideration, and the specific class of employees or directors receiving them.
c. If the company's shares are listed on a stock exchange, the issuance must comply with SEBI regulations. If unlisted, it must follow the Companies (Share Capital and Debentures) Rules.
d. Equal Treatment (Pari Passu): Sweat equity holders enjoy the exact same rights, limitations, and restrictions as standard equity shareholders, ranking pari passu with them in all corporate matters.
C. The Buy-Back of Securities (Sections 68 & 70)
A buy-back occurs when a company purchases its own outstanding shares or securities from its investors, effectively reducing its total share capital base.
1. Permitted Sources
Under Section 68, a buy-back can only be financed out of:
a. The company's free reserves;
b. The securities premium account; or
c. The proceeds of a fresh issue of shares or specified securities. (However, a company cannot fund a buy-back using a fresh issue of the same kind of shares).
2. Mandatory Conditions for a Legal Buy-Back:
a. Charter Authorization: The buy-back must be explicitly authorized by the company's Articles of Association (AoA).
b. Shareholder Approval: Requires a special resolution passed at a general meeting.
Board Exception: No shareholder resolution is required if the proposed buy-back is 10% or less of the company's total paid-up equity capital and free reserves, provided the buy-back is approved by the Board of Directors via a resolution at a board meeting.
c. The 25% Limit: The total number of shares bought back in any financial year cannot exceed 25% of the company's aggregate paid-up capital and free reserves.
d. The Debt-to-Equity Ratio: The ratio of the company's secured and unsecured debts after the buy-back cannot exceed 2:1 relative to its paid-up capital and free reserves.
e. Fully Paid-Up Shares: The securities targeted for a buy-back must be fully paid up.
f. The Solvency Declaration: Before launching a buy-back, the company must file a formal Declaration of Solvency with the RoC and SEBI. This affidavit, signed by at least two directors, confirms that the Board has evaluated the company's finances and verified that it will not face insolvency within one year.
g. Physical Destruction (Section 68(7)): Once a buy-back is complete, the company must extinguish and physically destroy the securities within seven days of completing the buy-back.
h. The Cool-Off Window: A company cannot launch a new offer for a buy-back within one year of closing a previous buy-back offer. It is also barred from making any fresh issues of the same class of shares within six months (except via bonus issues or converting active convertibles).
3. Absolute Prohibitions on Buy-Backs (Section 70)
No company can directly or indirectly purchase its own shares:
a. Through any subsidiary company or its own step-down subsidiaries;
b. Through any investment or shell companies; or
c. If the company has defaulted on repaying public deposits, interest liabilities, debenture redemptions, or term loans owed to financial institutions. A buy-back is also barred if the company fails to comply with statutory rules on filing annual returns (Section 92), declaring dividends (Section 123), or preparing financial statements (Section 129).
D. Bonus Shares (Section 63)
Bonus shares are additional, fully paid-up shares issued by a company to its existing shareholders for free, in proportion to their current holdings. This process is known as the capitalization of profits, as it converts undivided corporate reserves into formal share capital.
1. Authorized Sources-
A company can issue bonus shares only out of:
i. Its free reserves;
ii. The securities premium account; or
iv. The capital redemption reserve account (CRR).
Absolute Exclusion: A company cannot issue bonus shares by capitalizing reserves created by the revaluation of its physical assets.
2. Mandatory Conditions for a Bonus Issue:
a. It must be authorized by the Articles of Association (AoA).
b. It must be recommended by the Board of Directors and subsequently authorized by the shareholders in a general meeting.
c. The company must not have defaulted on paying principal or interest sums due on public deposits or debt securities.
d. The company must not have defaulted on its statutory dues to employees, including provident fund (PF), gratuity, or mandatory bonuses.
e. Any partly paid-up shares outstanding on the date of allotment must be made fully paid up before the bonus issue can proceed.
f. No Dividend Substitution: Bonus shares cannot be issued as a substitute for a cash dividend. Once a bonus issue is announced by the Board, it cannot be withdrawn.