P.G.

DIPLOMA IN FINANCIAL SERVICES

(BANKING & INSURANCE)
Session: 2017-18

GURU NANAK DEV UNIVERSITY AMRITSAR

CORPORATE
LEGAL
FRAMEWORK

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CORPORATE LEGAL FRAMEWORK

PART – I
Company: Meaning of company, Incorporation, Types of
Companies Memorandum and Articles of Association,
Prospectus.
Share Capital: Types of shares, Alterations of share capital,
Allotment of shares, Book building, Transfer of shares,
Dividend, Bonus shares, Buy Back of shares, Borrowing
Powers – Debentures, Charges.
Company Administration: Board of Directors and their
Qualifications, Appointment of Directors, Powers and legal
position, removal, remuneration of Directors (including
managing director, manager and company secretary).

PART – II
SEBI: Objectives, Status, Powers, Guidelines issued by
SEBI Regarding Disclosure and Investor Protection with
Reference to Pre-issue Obligations. IP: Limited Liability
Partnership-Incorporation, Conversion, winding up

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 Company
What is a 'Company'
A company is a legal entity formed by a group of individuals to engage
in and operate a business enterprise. A company may be organized in
various ways for tax and financial liability purposes depending on the
corporate law of its jurisdiction. The line of business the company is in
will generally determine which business structure it chooses, for
example a partnership, a proprietorship, or a corporation. As such, a
company may be regarded as a business type.

Breaking Down 'Company'

A company is essentially an artificial person (also known as corporate
personhood), in that it is an entity separate from the individuals who own,
manage and support its operations. A company has many of the same
legal rights and responsibilities as a person, such as entering into
contracts, the right to sue (or be sued), borrow money, pay taxes, own
assets, and hire employees. Companies are generally organized to earn a
profit from business activities, though some might be structured as a
nonprofit charity. Each country has its own hierarchy of company and
corporate structures, though with many similarities.

The benefits of starting a company include income diversification, a strong

correlation between effort and reward, creative freedom and flexibility. The
disadvantages of starting a company include increased financial
responsibility, increased legal liability, long hours, responsibility for
employees and responsibility for administrative, regulatory and tax issues.
Many of the world's largest personal fortunes have been amassed by
people who have started their own company.

Company Types

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In the United States, tax law as administered by the Internal Revenue
Service (IRS) dictates how companies are classified. Examples of company
types in the U.S. include the following:

 Partnerships: A formal arrangement in which two or more parties

cooperate to manage and operate a business.
 Corporation: A legal entity that is separate and distinct from its
owners and provides the same rights and responsibilities as a
person.
 Association: A vague and often misunderstood legal entity based on
any group of individuals who join together for business, social or
other purposes as a continuing entity. May or may not be taxable
depending on structure and purpose.
 Fund: A business engaged in the investing of pooled capital of
investors.
 Trust: A fiduciary arrangement in which a third party holds assets on
behalf of beneficiaries.

A company may also be described as any organized group of persons

(incorporated or unincorporated) engaged in an enterprise.

Company vs. Corporation

In the U.S., a company is not necessarily a corporation, though all
corporations can be classified as a company via a variety of structures. For
example, U.S. corporate structures include sole proprietorships, general
partnerships, limited partnerships, limited liability partnerships, limited
liability corporations, S corporations and C corporations.

Company Definition:
A legal entity, allowed by legislation, which permits a
group of people, as shareholders, to apply to the
government for an independent organization to be
created, which can then focus on pursuing set objectives,
and empowered with legal rights which are usually only
reserved for individuals, such as to sue and be sued, own
property, hire employees or loan and borrow money.
Company
A company has different definitions based on the country it is situated
in.

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In the UK:

A company is a body corporate or an incorporated

business organization registered under the companies act.
It can be a limited or an unlimited company, private or a
public company, company limited by guarantee or a
company having a share capital, or a community interest
company.

According to the law in the USA:

A company can be a “corporation, partnership,

association, joint-stock company, trust, fund, or organized
group of persons, whether incorporated or not, and (in an
official capacity) any receiver, trustee in bankruptcy, or
similar official, or liquidating agent, for any of the
foregoing”

The Companies Act 2013 of India defines a company as-

A registered association which is an artificial legal person,

having an independent legal, entity with a perpetual
succession, a common seal for its signatures, a common
capital comprised of transferable shares and carrying
limited liability.

A more precise, global and modern definition of a

company could be:

A business entity which acts as an artificial legal person,

formed by a legal person or a group of legal persons to
engage in or carry on a business or industrial enterprise.

Few points that should be noted in this definition:

Legal Person: A legal person could be human or a non-

human entity which is recognised by law as having legal
rights and is subject to obligations.

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A person or a group of persons: It is no more required to
be an association of persons to form a company. A
company can also be started as a single person company
(one-person company).

Since the definition, features, characteristics, and types of

companies differ in different countries (especially in the
United States), all the following sections will be focused on
an Indian and UK perspective of a company. Visit this
article for the US perspective of the types of companies.

Features & Characteristics Of A

Company
Incorporated association: A company comes into existence
when it is registered under the Companies Act (or other
equivalent act under the law). A company has to fulfil
requirements in terms of documents (MOA, AOA),
shareholders, directors, and share capital to be deemed as a
legal association.
Artificial Legal Person: In the eyes of the law, A company is
an artificial legal person which has the rights to acquire or
dispose of any property, to enter into contracts in its own name,
and to sue and be sued by others.
Separate Legal Entity: A company has a distinct entity and is
independent of its members or people controlling it. A separate
legal entity means that only the company is responsible to
repay creditors and to get sued for its deeds. The individual
members cannot be sued for actions performed by the
company. Similarly, the company is not liable to pay personal
debts of the members.
Perpetual Existence: Unlike other non-registered business
entities, a company is a stable business organisation. Its life
doesn’t depend on the life of its shareholders, directors, or
employees. Members may come and go but the company goes
on forever.

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Common Seal: A company being an artificial legal person,
uses its common seal (with the name of the company engraved
on it) as a substitute for its signature. Any document bearing
the common seal of the company will be legally binding on the
company.

Limited Liability: A company may be limited by guarantee or

limited by shares. In a company limited by shares, the liability of
the shareholders is limited to the unpaid value of their shares.
In a company limited by guarantee, the liability of the members
is limited to the amount they had agreed upon to contribute to
the assets of the company in the event of it being wound up.

Types of Companies
A company can be classified into various types depending upon
the following requirements:

Classification of Companies by Mode of Incorporation

Royal Chartered Companies

These companies are formed under a special charter by the

monarch or by a special order of a king or a queen. Few
examples of royal chartered companies are BBC, East India
Company, Bank Of England, etc.

Statutory Companies

These companies are incorporated by a special act passed by

the central or state legislature. These companies are intended
to carry out some business of national importance. For
example, The Reserve Bank of India was formed under RBI act
1934.

Registered or Incorporated Companies

These companies are formed/incorporated under the

companies act passed by the government. These companies

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come into existence only after these are registered under the
act and the certificate of incorporation is passed by the
Registrar of companies.

Classification of Companies based on the liability of the

members

The registered companies can be classified into the following

categories based on the liabilities of members:

Companies Limited By Shares

These companies have a defined share capital and the liability

of each member is limited by the memorandum to the extent of
the face value of shares subscribed by him.

Companies Limited By Guarantee

These companies may or may not have a share capital and the
liability of each member is limited by the memorandum to the
extent of the sum of money (s)he had promised to pay in the
event of liquidation of the company for payments of debts and
liabilities of the company.

Unlimited Companies

There is no formal restriction to the amount of money that the

shareholder/member of the company has to pay in the event of
the liquidation of an unlimited company.

Classification of Companies based on The

Number of Members
Public Company (or Public Limited Company)

A public company is a corporation whose ownership is open to

the public. In other words, anyone can buy the shares of a
public company. There are no restrictions to the number of

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members of a public company or to the transferability of shares.
However, there are some other restrictions:

 (In UK) A public limited company should have at least 2

shareholders and 2 directors, have allotted shares to the
total value of at least £50,000, be registered with company
house, and have a qualified company secretary.
 (In India) A public company should have at least 7
members and 3 directors, and issue a prospectus or file a
statement in lieu of prospectus with the Registrar before
allotting shares

Private Company (or Private Limited Company)

A private company cannot be owned by the public; it restricts
the number of members, the right to transfer its shares and
prohibits any invitation to the public to subscribe for any shares
or debentures of the company.
(In UK) A private company is a separate legal entity with a
suitable company name, an address, at least one director, at
least one shareholder, and memorandum of association and
article of association.
(In India) A private company is a separate legal entity with a
suitable company name, an address, at least 2 members and at
most 200 members, and at least two directors with one being
an Indian resident.

One Person Company

A one-person company is an Indian private limited company

which has only one founder/promoter. The founder should be a
natural person who is a country resident. There is also a
threshold of paid-up capital (₹ 50 lakh) and average turnover (₹
2 crores in 3 immediate preceding financial years) for a one-
person

The Startup Process

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We know how important your dream business is to you.
Therefore, we’ve come up with an all in one guide: The Startup
Process to help you turn your vision into reality.

What is a Company?
Organizations require huge investments. As the investments are big, the
risks involved are also very high. While undertaking a big business, the
two important limitations of partnerships are limited resources and
unlimited liabilities of partners. The company form of partnerships has
become popular to overcome the problems of partnership business.
Various multinational companies have their investors and costumers
spread throughout the world.

In order to maximize and utilize the organizational and managerial

abilities effectively, it is necessary for a limited liability company to be
supported not only by its own organs but also by clear and precise
regulations. It is necessary to have a brief overview of the business
organization from the framework of company law.

Commercial sector recognizes three principal categories of business

organizations −

 Sole proprietorship (Generally used for informal purposes)

 Partnership (General or limited)

 Company

There are three types of partnerships −

 Persecution per data (governed by the civil code)

 Persecution firms (governed by the civil code as well as the commercial

code)

 Persecution (governed by the civil code as well as the commercial

code)

It is difficult to determine the absolute equivalents between these

partnerships and partnerships under common law tradition.

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Meaning and Nature of Company
According to the Companies Act, 1956, “A company is a person, artificial,
invisible, intangible, and existing only in the contemplation of the law.
Being a mere creature of the law, it possesses only those properties
which the character of its creation confers upon it either expressly or as
incidental to its very existence.”

It can clearly be defined that −

 A company is defined as a group of people that contributes money or

the worth of money to a common stock to employ it in some trade or
business. The people in this group share the profit or loss (as the case
may be) arising as a result.

 The common stock is usually denoted in terms of money and is the

capital of the company.

 The persons who contribute to the common stock are the members.

 The proportion of the capital entitled to each member is called the

member’s share.

 Shares are always transferrable subject to the restrictions and

liabilities offered by the rights to transfer shares.

The main characteristics of a company are discussed below.

Incorporated Association
 A company can be created only under the registration of the Company
Act.

 It comes into existence from the date when the certificate of

incorporation is issued.

 At least seven persons are required to form a public company.

 At least two persons are required to form a private company.

 These persons will subscribe to the memorandum of associations and

also comply with the other legal requirements of the Company Act in
respect of registration to form and incorporate the company, with or
without liability.
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Artificial Legal Person
A company can be considered as an artificial person (a person who
cannot act on his own will). It has to act through a board of shareholders
elected or selected by the members of the company.

 The board of directors works as the only brain of the company.

 It has the rights to acquire and dispose the properties, to enter into
contract with third parties in its own name, and can sue and can be
sued in its own name.

 However, it cannot be considered as a citizen as it cannot enjoy the

rights of a citizen.

Separate Legal Entity

A company is perceived to be a distinct legal entity and one that does not
depend on its members. The money credited by the creditors of the
company can be recovered only from the company and the properties
owned by the company.

 Individual members cannot be sued.

 Similarly, the company in any way is not liable for the individual debts
of the members.

 The properties of the company can only be used for the development,
betterment, maintenance, and welfare of the company and cannot be
used for personal benefits of the shareholders.

 A member cannot claim any ownership rights over the company either
single-handedly or jointly.

 The members of the company can enter into contracts with the
company in the same manner as any other individual can.

 The Income Tax Act also recognizes company as a separate legal

entity.

 The company has to pay income tax as it earns profits and when
dividends are paid to the shareholders, the shareholders also have to
pay income tax based on the dividends earned. This highlights the

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 fact that the shareholders and the company are two separate
individual entities.

Perpetual Existence
 A company is said to be a stable form of business organization.

 A company’s life does not depend upon the death, insolvency or

retirement of any or all of its shareholders or directors.

 It is created by law and can only be dissolved by law.

 Members can join or leave the company but the company can continue
forever.

Common Seal

 A company cannot sign documents by itself.

 It acts through natural persons who are called its directors.

 A common seal is used with the name of the company engraved on it

as a substitute of its signature.

 To be legally binding on the company, a document has to carry the

company seal on it.
Limited Liability
 A company may be limited by shares or by guarantee.

 In a company limited by shares, the liability of members is limited to

the unpaid value of the shares.

 In a company limited by guarantee, the liability of members is limited

to such an amount as the members may undertake to contribute to
the asset of the company in the events of it being wound up.

Transferrable Shares
 The shares can be freely transferred in case of a public company.

 The right to transfer shares is a statutory right and it cannot be taken

away by any provision.

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  However, the manner in which such transfer of shares is to be made
should be provided and it may also contain bona fide and reasonable
restrictions on the rights of members for transfer of their shares.

 However, in case of private companies, the article shall restrict the

rights of the members to transfer their shares in companies with its
statutory description.

 If a company refuses to register the transfer of shares, a shareholder

may apply to the Central Government in order to make the right to
transfer shares legal.

Delegated Management
 Any company can be considered as an autonomous, self-governing
and self-controlling organization.

 Due to the presence of a large number of members, all members

cannot take part in the management of different affairs of the
company.

 Control and management is therefore delegated to the elected

representatives called directors, who are elected by the shareholders.

 The directors supervise the day-to-day work and progress of the

company.

Classification of Companies
All the companies must be registered under the Companies Act. A
certificate of incorporation must be issued by the registrar of the
company after registration. Different jurisdictions can form different
companies. Some of the most common types of companies are as follows
−

Private Company
 A company is said to be a private company if it does not allow its
shareholders to transfer shares.

 If any transfer of shares is allowed, the company limits the number of

its members to 50 and does not entertain any invitations to the public
for subscribing any shares of the company.
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  These types of companies offer limited liabilities to their shareholders
but also place some restrictions on their ownership.

 A private company can have a minimum of 2 members and a

maximum of 50 members, excluding the employees and the
shareholders.

 A private company is desirable in those cases where it is intended to

take the advantage of corporate life, has limited liability and the
control of the business is in the hands of few persons.

 In private sector, an individual can gain control of the entire business

firm.

Public Company

 At least seven members are needed to form a public company.

 The maximum number of members remains unrestricted in the case of

public companies.

 A Prospectus is issued by the public companies to invite people to buy

the shares of the company.

 The liability of the members is limited by the value of the shares they
purchase.

 The shares of a public company are sold and bought freely without any
obstruction in the stock market.
Companies Limited by Guarantee
 Every member of these companies promises to pay a fixed amount of
money in the event of liquidation of the company.

 This amount is denoted as guarantee.

 There is no liability to pay anything more than the value of the share
and the guarantee. Some of the substantial resultants of companies
limited by guarantee are charities, community projects, clubs,
societies, etc.

 Most of these companies are not into any profit-making.

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  These types of companies can be considered as private companies
offering limited liabilities to their members.

 A guarantee company substitutes share capitals with guarantors

willing to pay a guarantee amount upon the liquidation of the
company.

Companies Limited by Share

In the case of companies limited by shares, the shareholders pay a
nominal value of money contributing to the share capital. The payments
can be done either at a time or by installments.

 The members do not have to pay anything more than the fixed value
of the share. Companies limited by shares are the most popular
among the registered companies.

 These types of companies are required to have the suffix ‘Limited’ at

the end of their names so that the people know that the liability of its
members is limited.

Unlimited Company
 Unlimited companies are the companies where the liabilities of the
shareholders are unlimited as in the case of partnership firms.

 Such companies are permitted under the Companies Act but are not
known.

 These types of companies are incorporated either with or without a

share capital.

 The shareholders are liable to donate whatever sums are required to

pay the outstanding debts of the company, should it go into formal
liquidation and if there is any need to meet the insufficiency of assets
to pay the debts and liabilities and the fixed cost of liquidation.

 The members or shareholders have no direct liability to the creditors

or security holders of an unlimited company.

 What is Company Meaning, Definition &

Characteristics of Company

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Meaning
A company is a third legal business structure and has entirely
a different organizational structure from the
sole proprietorship or partnership. Its formation is due to
firstly, the sole proprietorship and partnership cannot meet the
increased capital demand of industry and commerce. Secondly,
the company ensures the protection of limited liability to the
shareholders and investors.
Definition
According to Prof. L.H. Haney, “Company is an artificial
person created by law having separated entity with a perpetual
succession and common seal”. According to Justice
Lindley a company means association of persons who
contribute in shape of money or money’s worth to a common
stock and employ it for some specific purpose.
There are three main activities of a business

1. Merchandising activities. This involve activities deal with goods

in a ready to sell condition.
2. Manufacturing Activities. This involve from purchase to raw
material and put labor and factory overhead on the raw material
and produce a product.
3. Services Activities. This involve banking, education, insurance
and training activities.

Characteristics of a Company

The company has several distinct characteristics; the significant ones

are discussed here:

Separate Legal Entity

A company is a separate legal entity from its members who constitute it.
It can hold, purchase and sell properties and enter into contracts in its
own name. It is an artificial legal person who can sue aid be sued.
Companies are owned by shareholders and they elect the Board of
Directors, who run the company. The board in turn selects the
management. Thus the shareholders exercise only indirect control over
the affairs of the company. The separation of ownership from the
management some-times results in a conflict of interests between

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owners and management. The best the shareholders can do is to
change some of the directors through vote in the annual general meeting
subsequent to any such conflict.

Limited Liability

The liability of the shareholders of a company is limited to the nominal

value of the shares held by them. In the event of liquidation the
maximum loss of a shareholder is equal to the nominal value of the
shares held by him. The creditors have no claim on the personal assets
of the shareholders in the event of liquidation.

Transferability of Shares

The shares of a joint stock company are freely transferable. It does not
require any permission from the company or consent of other
shareholders. The shares of listed companies can be sold or purchased
on the stock exchange and ownership transferred without any difficulty.
However, in case of a private limited company, the transfer of shares is
subject to the restrictions given in the company's articles.

Ability to Acquire a Broad Capital Base

Following are significant factors that enable a company to raise large

amount of capital

1. The nominal value of shares is kept small, as a result of which

investment of any size is possible.
2. Limited liability minimize the risk of the investors and makes
investment attractive and safer.

An Artificial Person created by Law

A company is called an artificial person because it does not take birth

like a natural person but it comes into existence through the law. The
company possess only those properties which are conferred upon it by
its Memorandum of Association (Charter).

Continuous Existence

The companies generally have a continuous existence irrespective of

changes in ownership. In the cases of sole proprietorship and
partnership, change in ownership means the dissolution of the original
business and formation of a new business.

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Common Seal

Being an artificial person, a company can act through natural persons

only. The acts of a company are authorized by the "common seal". The
"common seal" is the official signature of the company. A document not
bearing the common seal is not binding on the company.

Incorporation
What is 'Incorporation'
Incorporation is the legal process used to form a corporate entity or
company. A corporation is a separate legal entity from its owners.
Corporations can be created in nearly all countries in the world and
are usually identified as such by the use of terms such as "Inc." or
"Limited" in their names. It is the process of legally declaring a
corporate entity as separate from its owners.
BREAKING DOWN 'Incorporation'
Incorporation has many advantages for a business and its owners,
including 1) Protects the owner's assets against the company's liabilities 2)
Allows for easy transfer of ownership to another party 3) Achieves a lower
tax rate than on personal income 4) Receives more lenient tax restrictions
on loss carry forwards 5) Can raise capital through the sale of stock.

Throughout the world, corporations are the most widely used legal vehicle
for operating a business. While the legal details of a corporation's formation
and organization differs from jurisdiction to jurisdiction, most have certain
elements in common.

Creation and Organization of Corporations

Incorporation involves drafting an "Articles of Incorporation," which lists the
primary purpose of the business and its location, along with the number of
shares and class of stock being issued, if any. Companies are owned by
their shareholders. Small companies can have a single shareholder, while
very large and often publicly traded companies can have several thousand
shareholders. As a rule, the shareholders are only responsible for the
payment of their own shares. As owners, the shareholders are entitled to
receive the profits of the company, usually in the form of dividends. The
shareholders also elect the directors of the company.

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The directors of the company are responsible for day-to-day activities. They
owe a duty of care to the company and must act in its best interest. They
are usually elected annually. Smaller companies can have a single director,
while larger ones often have a board comprised of a dozen or more
directors. Except in cases of fraud or specific tax statutes, the directors do
not have personal liability for the company's debts.

Other Advantages of Incorporation

Incorporation effectively creates a protective bubble, often called a
corporate veil, around a company's shareholders and directors. As such,
incorporated businesses can take the risks that make growth possible
without exposing the shareholders, owners and directors to personal
financial liability outside of their original investments in the company.

What Is the Meaning of Incorporation?

Incorporation can identify a one-person home-based business
or mega organizations IBM or Microsoft. When you incorporate,
you create a "creature of the state." You give birth to a living,
breathing -- albeit, artificial -- being. Individual U.S. states and
the federal government recognize corporations as if they were
people. However, tax requirements are different than for
people, and stockholders -- owners -- enjoy protection for their
personal assets -- homes, autos, bank accounts and
investments. Should the business fail, owner's assets cannot
be seized.

Types of Business Organizations

Four primary types of business organizations dominate the U.S.

landscape. Sole proprietorships are the creations of one
person, tend to be small businesses, and all profits accrue to
the individual as income, which is taxed at the individual rate.
Partnerships are organizations owned by more than one
individual and income is taxed at the appropriate percentage of
partners' shares. Limited liability companies combine the
personal asset protection of corporations with the benefits of
sole proprietorships, with income taxed on an individual basis.
Corporations, recognized as "legal" individuals, are the

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preferred type for larger companies as stockholders -- owners -
- have asset and income protection.

Incorporation Realities

When you incorporate your business, you receive recognition

from your state -- and the federal government -- that your
company exists as a separate and distinct living entity. Like
creating a child, you have given birth to an organization that
has its own persona and legal standing in your home state. Just
as you must obey the laws -- auto, liability, real estate and
behavior -- of your state, a corporation must abide by the
regulations established for these organizations.

Considerations

Small businesses may or may not benefit from incorporation.

Advantages include protection of the assets of owners and a
typically lower tax rate than applicable to individuals.
Conversely, very small businesses might face higher overall
costs for annual registration fees, more expensive tax and
accounting services, and confusing additional operating
regulations. However, should your small business achieve
major success, converting from a sole proprietorship to a
corporation could be costly and confusing. More expensive to
set up than other organization types, the extra cost of
incorporating may be insignificant if your business grows
rapidly.

Incorporation Protections

Being incorporated delivers protection not offered by other

business structures. This structure, because the corporation is
a legal "person," means that only its assets -- real estate,
inventory, cash, investments -- are at risk. Even if you own 100
percent of the stock, your personal treasures, including your
home, are protected by the incorporation regulations. This
primary feature of incorporation makes a large organization

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attractive to investors, permitting an active and vibrant stock
market in the U.S.

Other Incorporation Benefits

Incorporation means creating an "individual" that can succeed

or fail on its own, without damaging the quality of life for its
owners. Certainly, large investors in corporations that fail suffer
negative -- sometimes serious -- financial hardship. However,
stockholders need not fear for their other personal assets
should the corporation face difficult or disaster situations. The
availability of additional business benefits -- pension plans, tax
shelters and other corporation-only advantages -- make
incorporation a beneficial business structure for all but the most
modest companies.

Incorporation

Share

WHAT IT IS:

Incorporation means to form a corporation. A corporation is a

legal form of business organization. It is sometimes referred to
as a "C Corp" in reference to a section of the IRS code
governing corporate taxes.

HOW IT WORKS (EXAMPLE):

Corporations have several distinguishing characteristics.

1. A corporation is owned by shareholders, and their

ownership is represented by shares of stock.
2. A corporation has a board of directors, which is a group of
people elected by the shareholders to oversee the
corporation's managers and represent the best interests of
the shareholders.
3. They have unlimited lives; that is, corporations don't "die"
or "expire" unless they do so intentionally or go bankrupt
and liquidate their assets.
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 4. The shareholders have limited liability. That is, the
liabilities of the corporation do not extend to the
shareholders. If the corporation goes bankrupt
or defaults on a loan, the corporation's creditors almost
always cannot repossess the shareholders' personal
assets or seek repayment from the shareholders
themselves.
5. Corporations pay income taxes on their taxable income,
even if they distribute some of that income directly to the
shareholders.
6. Corporations are legal entities that exist separate and
apart from their shareholders. In fact, they are usually
afforded the legal rights of people. That is, they can own
assets, borrow moneyand sue or be sued.

WHY IT MATTERS:

To incorporate means to form one of the dominant business

structures in the United States, and this is often because the
largest advantage to incorporating is the limited liability the
structure brings to the company's owners.
Incorporation's limited liability encourages investment and in
turn makes it easier to raise equity capital, among other things.
However, incorporating a business means agreeing to more
governance and regulation than other business forms, and this
makes them more expensive to operate.

One of the biggest complaints about incorporating is the double

taxation of profits it brings: the corporation must
pay income taxes on its taxable income, and shareholders
also must pay income taxes on that same income if
the corporation pays that income out as dividends.

Although some corporations are nonprofit entities, perhaps the

most important, prominent and sometimes controversial duty of
a corporation is to enhance shareholder value. This duty is
most often executed through the maximization of profits.

What Is Incorporation Definition Law?

23
Incorporation definition law refers to state and federal laws
surrounding the act of incorporating a business.3 min read

Incorporation definition law refers to state and federal laws

surrounding the act of incorporating a business. There are
some legal requirements for any corporation formed in the
country and some that are state specific.

What Is Incorporation?

When a business decides to form a corporate structure or

company, the process is called incorporation. Corporations, by
definition, are completely separate entities from their owners.
This separation is called the corporate veil, and it offers a level
of liability protection to the owners and shareholders in a
corporation.

Corporations, because they are viewed as their own legal

entity, have many of the same rights and responsibilities as an
individual, including:

 Paying taxes
 Owning property
 Filing suit
 Being sued
 Taking out loans

Most countries recognize corporations as legal business

entities, and they are the most popular form of business
structure. They can usually be identified by their business
names which include some form of corporate marker like the
words "incorporated" or 'limited."

Business Structures

When a business owner decides to start their own company,

they have a few choices when it comes to their structure. The
best fit for business structure depends on the long term goals of
the company, its size, and desire for growth.

24
Corporations are formed when a business owner files articles of
incorporation with the state in which they plan to conduct
business. Most other types of business entities can choose to
incorporate once they've already been formed. If a business
owner originally started a sole proprietorship, but they decide
that they want to incorporate, they can do so by following their
state's rules and regulations for the process and filling out the
appropriate documentation.

When a business changes structure from a sole proprietorship

to a corporation, the owner or owners are afforded liability
protection.

Many entrepreneurs choose to form corporations because such

a structure tends to be more well-known and respected among
other companies as well as customers or clients, both current
and potential.

Why Incorporate?

There are many advantages to incorporating a business. One

of the biggest draws of incorporating is the fact that an
incorporated company can be held liable for debts and legal
obligations apart from its owners. If the corporation is sued, the
assets of the owners are not liable in the suit. However,
because a corporation can own its own assets and property,
creditors and courts can go after anything the business itself
owns.

Shareholders invest in a corporation creating financial ties, to a

point. In the event of legal or financial trouble with the
corporation, its shareholders can only lose as much as they put
into the company, basically their amount of investment, but they
don't need to worry about their personal finances or assets.

The corporate structure offers several other advantages,

including:

 Ease of ownership and investment transfers

25
  Option to sell shares
 Different stock options
 Opportunities for growth through local and global stock
offerings
 Highly structured business management

The vast amount of stock options coupled with the protection of

the corporate veil offer corporations the chance to take risks
that could lead to massive success without worrying about
putting their owners, stockholders, or board of directors in
financial or legal trouble.

Cons to Incorporating

One of the most commonly-known disadvantages of

incorporating is the issue of double taxation. Because a
corporation is viewed as a separate legal entity, it is taxed as
such. Other entity types, like sole proprietorships and
partnerships, are not taxed at the business level, but their
owners are taxed on their profits and losses from the company.
This is called pass-through taxation.

Corporations are taxed at the company level, and their

shareholders are taxed on any profits that are distributed to
them.

Another possible disadvantage of incorporating a business is

the level of documentation and organization required. There
tend to be more state requirements for annual reporting and the
like when it comes to corporations, versus other business
types.

How To Incorporate

If a business owner decides that they want to incorporate, they

should make sure to complete these tasks:

 Decide where to incorporate (requirements for

incorporation vary from state to state).

26
  Meet with an experienced business attorney to make sure
to choose the best fit for the company.
 Decide on the management structure and board of
directors.
 Choose a registered agent for the business.
 File the articles of incorporation and any other
documentation requirements for the state in which the
business is incorporating.

If you need help with understanding incorporation definition law,

you can post your legal need on UpCounsel's marketplace.
UpCounsel accepts only the top 5 percent of lawyers to its site.
Lawyers on UpCounsel come from law schools such as
Harvard Law and Yale Law and average 14 years of legal
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Google, Stripe, and Twilio.

Definition of Memorandum of Association

A Memorandum of Association (MOA) is a legal document
prepared in the formation and registration process of a limited
liability company to define its relationship with shareholders.
The MOA is accessible to the public and describes the
company’s name, physical address of registered office, names
of shareholders and the distribution of shares. The MOA and
the Articles of Association serve as the constitution of the
company. The MOA is not applied in the U.S. but is a legal
requirement for limited liability companies in European
countries including the United Kingdom, France and
Netherlands, as well as some Commonwealth nations.

Name Clause

The name clause requires you to state the legal and recognized
name of the company. You are allowed to register a company
name only if it does not bear any similarities with the name of
an existing company. Your company name must end with the

27
word “limited” because the preparation of an MOA is a legal
requirement for limited liability companies only.

Registered Office Clause

The registered office clause requires you to show the physical

location of the registered office of the company. You are
required to keep all the company registers in this office in
addition to using the office in handling all the outgoing and
incoming communication correspondence. You must establish
a registered office prior to commencing business activities.

Objective Clause

The objective clause requires you to summarize the main

objectives for establishing the company with reference to the
requirements for shareholding and use of financial resources.
You also need to state ancillary objectives; that is, those
objectives that are required to facilitate the achievement of the
main objectives. The objectives should be free of any
provisions or declarations that contravene laws or public good.

Liability Clause

The liability clause requires you to state the extent to which

shareholders of the company are liable to the debt obligations
of the company in the event of the company dissolving. You
should show that shareholders are liable only their
shareholding and/or to their commitment to contribute to the
dissolution costs upon liquidation of a company limited by
guarantee.

Capital Clause

The capital clause requires you to state the company’s

authorized share capital, the different categories of shares and
the nominal value (the minimum value per share) of the shares.
You are also required to list the company’s assets under this
clause.

28
Association Clause

The association clause confirms that shareholders bound by

the MOA are willingly associating and forming a company. You
require seven members to sign an MOA for a public company
and not less than two people for a MOA of a private company.
You must conduct the signing in the presence of witness who
must also append his signature.

Memorandum of Association
A Memorandum of Association (MoA) represents the charter of
the company. It is a legal document prepared during the
formation and registration process of a company to define its
relationship with shareholders and it specifies the objectives for
which the company has been formed. The company can
undertake only those activities that are mentioned in the MoA.
As such, the MoA lays down the boundary beyond which the
actions of the company cannot go.

MoA helps the shareholders, creditors and any other person

dealing with the company to know the basic rights and powers
of the company. Also, the contents of the MoA help the
prospective shareholders in taking the right decision while
thinking of investing in the company.

MoA must be signed by at least 2 subscribers in case of a

private limited company, and 7 members in case of a public
limited company.

Format of MoA

The format of a MoA is specified in Table A to Table E

depending upon the type of company. A company can adopt
the table applicable to it; for instance, Table A is for a company
limited by shares, and Table B is for a company limited by
guarantee and having share capital etc.

Contents of MoA
29
MoA consists of the following clauses :

1. Name Clause: This clause specifies the name of the

company. The name of the company should not be
identical to any existing company. Also, if it is a private
company, then it should have the word ‘Private Limited’ at
the end. And in case of public company public company,
then it should add the word “Limited” at the end of its
name. For example, ABC Private Limited in case of the
private, and ABC Ltd for a public company.

2. Registered Office Clause: This clause specifies the

name of the State in which the registered office of the
company is situated. This helps to determine the
jurisdiction of the Registrar of Companies. The company is
required to inform the location of the registered office to
the Registrar of Companies within 30 days from the date
of incorporation or commencement of the company.

3. Object Clause: This clause states the objective with

which the company is formed. The objectives can be
further divided into following 3 subcategories:

30
 Main Objective: It states the main business of the
company

 Incidental Objective: These are the objects ancillary to

the attainment of main objects of the company

 Other objectives: Any other objects which the company

may pursue and are not covered in above (a) and (b)

4. Liability Clause: It states the liability of the members of

the company. In case of an unlimited company, the liability
of the members is unlimited whereas in case of a
company limited by shares, the liability of the members is
restricted by the amount unpaid on their share. For a
company limited by guarantee, the liability of the members
is restricted by the amount each member has agreed to
contribute.

5. Capital Clause: This clause details the maximum capital

that a company can raise which is also called the
authorized/nominal capital of the company. This also
explains the division of such capital amount into the
number of shares of a fixed amount each.

What is a Memorandum of Association?

Memorandum of Association is the most important

document of a company. It states the objects for which the
company is formed. It contains the rights, privileges and
powers of the company. Hence it is called a charter of the
company. It is treated as the constitution of the company.
It determines the relationship between the company and
the outsiders.
The whole business of the company is built up according
to Memorandum of Association. A company cannot
undertake any business or activity not stated in the
Memorandum. It can exercise only those powers which
are clearly stated in the Memorandum.
31
 Definition of Memorandum of Association

Lord Cairns:

“The memorandum of association of a company is the charter

and defines the limitation of the power of the company
established under the Act”.

Thus, a Memorandum of Association is a document which sets

out the constitution of the company. It clearly displays the
company’s relationship with outside world. It also defines the
scope of its activities. MoA enables the shareholders, creditors
and people who has dealing with the company in one form or
another to know the range of activities.

Contents of Memorandum of Association

According to the Companies Act, the Memorandum of

Association of a company must contain the following clauses:

1. Name Clause of Memorandum of Association

The name of the company should be stated in this clause. A

company is free to select any name it likes. But the name
should not be identical or similar to that of a company already
registered. It should not also use words like King, Queen,
Emperor, Government Bodies and names of World Bodies like
U.N.O., W.H.O., World Bank etc. If it is a Public Limited
Company, the name of the company should end with the word
‘Limited’ and if it is a Private Limited Company, the name
should end with the words ‘Private Limited’.

2. Situation Clause of Memorandum of Association

In this clause, the name of the State where the Company’s

registered office is located should be mentioned. Registered
office means a place where the common seal, statutory books
etc., of the company are kept.The company should intimate the

32
location of registered office to the registrar within thirty days
from the date of incorporation or commencement of business.

The registered office of a company can be shifted from one

place to another within the town with a simple intimation to the
Registrar. But in some situation, the company may want to shift
its registered office to another town within the state. Under such
circumstance, a special resolution should be passed. Whereas,
to shift the registered office to other state, Memorandum should
be altered accordingly.

3. Objects Clause of Memorandum of Association

This clause specifies the objects for which the company is

formed. It is difficult to alter the objects clause later on. Hence,
it is necessary that the promoters should draft this clause
carefully. This clause mentions all possible types of business in
which a company may engage in future.

The objects clause must contain the important objectives of the

company and the other objectives not included above.

4. Liability Clause of Memorandum of Association

This clause states the liability of the members of the company.

The liability may be limited by shares or by guarantee. This
clause may be omitted in case of unlimited liability.

5. Capital Clause of Memorandum of Association

This clause mentions the maximum amount of capital that can

be raised by the company. The division of capital into shares is
also mentioned in this clause. The company cannot secure
more capital than mentioned in this clause. If some special
rights and privileges are conferred on any type of shareholders
mention may also be made in this clause.

6. Subscription Clause of Memorandum of Association

33
It contains the names and addresses of the first subscribers.
The subscribers to the Memorandum must take at least one
share. The minimum number of members is two in case of a
private company and seven in case of a public company.

Thus the Memorandum of Association of the company is the

most important document. It is the foundation of the company.

Characteristics / Features :

The main features of memorandum of association are discuss

below –

1. It is a fundamental document of a company.

2. It is essential to every company to prepare its own

memorandum.

3. It should be in written form.

4. It contains Name, signature and other particulars of

persons.

5. On registration of memorandum , the company is deemed

to have been registered.

6. It contains information regarding company information.

7. Memorandum is a public document after registration and

inspected by any person.

8. It is a binding of company and its members.

Importance of Memorandum of Association :

The Memorandum of association is important document of an

organisation , and it is very significant and vital document of
every company.It is not only important for company also
important for shareholders , creditors and every person who

34
deals with company.The importance of memorandum are
discuss below :-

1. Basis for the company – Memorandum of association is

the basic document of company and company cant get
registered without it.

2. Determines company scope – It lay down the scope of

company activities which they perform and company
cannot go beyond that.

3. Source of company’s Power – Memorandum of

association also defines the the company powers and
help company members in workings.

4. Guide to directors – It serves as a guide to the directors

of the company. It guides them to work for achieving the
objectives of company and restrains them from doing
anything beyond memorandum.

5. Protect Investors – Memorandum protects the interest of

investors because their is a risk when person invest
money on a company.

Framing Memorandum :

Following factors must be considers while framing

memorandum of association of a company are :-

1. Must be in proper form.

2. Memorandum shall be printed.

3. It shall be divided in paragraphs numbered consecutively.

4. Their should be information regarding subscribers.

5. Signed by all the subscribers.

35
 6. It must be stamped as per stamp act .

7. Date must be written on it.

CONTENT OF MEMORANDUM

1. Name clause – The name of the company should be

mentioned in name clause and company can decide any
name but cant copy another company name and it ends
with private limited.

2. Situation Clause – The registered office of a company

can be shifted from one place to another within the town
with a simple intimation to the Registrar. But in some
situation, the company may want to shift its registered
office to another town within the state. Under such
circumstance, a special resolution should be passed.
Whereas, to shift the registered office to other state,
Memorandum should be altered accordingly.

3. Objects Clause – This clause specifies the objects for

which the company is formed. It also contain the company
objectives and methods to attains objectives of company.

4. Liability Clause – This clause states the liability of the

members of the company. The liability may be limited by
shares or by guarantee. This clause may be omitted in
case of unlimited liability.
.

5. Capital Clause – This clause mentions the maximum

amount of capital that can be raised by the company. The
division of capital into shares is also mentioned in this
clause and also states minimum and maximum capital of
company.

36
 6. Subscription Clause – It contains the names and
addresses of the first subscribers. The subscribers to the
Memorandum must take at least one share. The minimum
number of members is two in case of a private company
and seven in case of a public company.

Thus the memorandum of association is most important

document and necessary to every organisation. It also known
as company foundation because it contain information and
company objectives.

IMPORTANCE OF A MEMORANDUM OF ASSOCIATION

 It shows memorandum clauses, clauses include;

Name clause which tell a company name, a company

selects any name but it should not resemble the name of any
other company,

Situation clause which show the name of the province in

which the company office is located, object clause which tell the
nature of the company,

Liability clause which contains a declaration that the

liability of the members of the company is limited to the extent
of the value of the share purchase by them,

Capital clause (a company having a share capital shall

state the total maximum amount of share capital with which it is
registered,

 Association and subscription clauses (this contains a

declaration by the subscription that are decisions of

37
 forming a company and agree to have number of the
shares written against their respective names).

 Memorandum of association sets out the limits outside

which the company cannot go, the limits that a company
must not go beyond it, the limits of a company provide
what a company suppose to do and what a company must
not do, when a company breach that contract, the registrar
of the companies is powered to remove the license of that
company or other measures may take place.

 Memorandum of association enable share holders,

creditors and all those who deal with the company to know
what its permitted range of enterprise, also the
memorandum of association of many companies provides
for the minimum and maximum range of capital that a
shareholder can invest in the company, this help to direct
the companies and its shareholders to know the
contribution of each of them in forming a company. The
existence of a memorandum of association, also give
good ground for how the shareholders will benefit from
investment.

 Business objective of the company, every company must

have an objective to reach somewhere in success, this
objectives or goals of a company must always put on the
memorandum of association so as to enable the
shareholders to understand the where their company is
going, also the existence of company’s goals on
memorandum of association, it help the outsiders who
want to invest in such company to know how they will
benefit from the company and if the objective of the
company relate to what they want in such companies.

 It define the scope of the company’s activities as well as

its relation with the outside world, the memorandum of
association provide on various activities that a company
will deals with, sometime one company can have many

38
 different activities of different nature but only those
registered to be conducted by this company. A company
can be registered as food’s company but inside the
company there may be other activities like transporting
services and communication.

 The whole structure of the company is built upon

memorandum, the structure of the company includes the
branches or divisions of the company, leadership of the
company, and other necessary information which help to
control company

 Memorandum of association always work together with

Article of association (A.O.A), since article of association
help to provide for the responsibilities of the directors of
the company, the kind of business to be undertaken, and
the means by which shareholders exert control over the
board of directors.

MEANING OF THE DOCTRINE OF ULTRA VIRES

Doctrine of ultra-vires describe acts attempted by a

corporation that are beyond the scope of powers granted by the
corporation’s objects clause, articles of incorporation or in a
clause in it’s by laws, in the laws authorizing a corporations
formation, or similar founding documents. Acts attempted by a
corporation that are beyond the scope of it’s are void or
voidable.

The objective clause of the memorandum of the company

contains the objects for which the company is formed. An act of
the company must not be beyond the objects clause otherwise
it will be ultra vires and therefore, void and cannot be ratified
even if all the member wish to ratify. This is called the doctrine
of ultra vires. The expression “ultra vires” consists of two words,
“ultra” and “vires”, ulra means beyond and vires means powers.
Here the expression that ultra vires is used to indicate an act of

39
the company, which is beyond the powers. Conferred on the
company by the objects clause of its memorandum, an ultra
vires act is void and cannot be ratified even if all the directors
wish to ratify it. Sometime the expression ultra vires is used to
describe the situation when the directors of a company have
exceeded the powers delegated to them. Where a company
exceeds its powers as conferred on it by the objects clause of
its memorandum, its not bound by it because it lacks legal
capacity to incur responsibility for the action, but when the
directors of a company have exceeded the powers delegated to
them. This use must be avoided for it is apt to cause confusion
between two entity distinct legal principles consequently, here
are restricting the meaning of ultra vires objects clause of the
company’s memorandum

PROTECTION OF CREDITORS AND INVESTORS

Doctrine of ultra vires has been developed to protect the

investors and creditors of the company. This doctrine prevents
a company to employ money of the investors for a purpose
other than those stated in the objects clause of its
memorandum. Thus, the investors and the company may be
assured by this rule that their investment will not be employed
for the time of investing their money is so to be employed. This
doctrine protects the creditors of the company by ensuring
them that the funds of the company to which they must look for
the payment are not dissipated in un-authorized activities. The
wrongful application of the company’s assets may result in the
insolvency of the company and there by protects creditors from
departing the object for which the company has been formed
and thus, puts a check over the activities of the directions. It
enables the directors to know within what lines of business they
are authorized to act.

In Ashbury Railway Carriage and Iron Company Ltd V.

Riche[1], The object of the company as stated in the objects

40
clause of it’s memorandum, were to make and sell, or lend on
hire railway carriages and wagons, and all kinds of railway
plaint, fittings, machinery and rolling stock to carry on the
business of mechanical engineers and general contractors to
purchase and sell as merchants timber, coal, metal or other
materials and to buy and sell any materials on commissions or
as agents, the directors of the company entered into a contract
with Riches for financing a construction of a railway line in
Belgium. All the members of the company ratified the contract,
but later on the company repudiated it. Riche sued the
company for breach of contract.

The issue in this case was whether the contract was valid and if
not, whether it could be ratified by the members of the
company.

The court held that, the contract was beyond the objects as
defined in the objects clause of its memorandum and therefore
it was void. The company had no capacity to ratify contract,

According to the doctrine of ultra vires, the doctrine protect

the share holders to ratify things beyond the company’s object,
and even if they are forced, the contract will be null and void. If
the share holders are permitted to ratify ultra vires act or
contract, it will be nothing but permitting them to do the
everything which by the Act of parliament, they are prohibited
from doing.

Doctrine of ultra vires is not illusory protection to the

shareholders and not pitfall to outsiders dealing with the
company because, the existence of a doctrine, prevent the
shareholders to ratify the contracts beyond the objects which
can be harmful to a company if ratified. Also it prevent the
outsiders to enter into contact with unlawful company which act
beyond their company objects. It help to prevent loss to both
shareholders of the company and outsiders dealing with the
company.

41
Articles of Association

 What is the 'Articles of Association'

The articles of association is a document that specifies the

regulations for a company's operations and defines the
company's purpose. The document lays out how tasks are to
be accomplished within the organization, including the process
for appointing directors and handling of financial records.

 BREAKING DOWN 'Articles of Association'

Articles of association often identify the manner in which a

company will issue stock shares, pay dividends and audit
financial records and power of voting rights. This set of rules
can be considered a user's manual for the company because
they outline the methodology for accomplishing the day-to-day
tasks that must be completed. While the content of the articles
of association and the exact terms used vary from jurisdiction to
jurisdiction, the document is quite similar everywhere, The
articles of association generally contain provisions on the
company name, the purpose of the company, the share capital,
the organization of the company and provisions regarding
shareholder meetings.

Company Name

As a legal entity, the company must have a name which can be

found in the articles of association. All jurisdictions will have
rules concerning company names. Usually, a suffix such as
"Inc." or "Ltd" must be used to show that the entity is a
company. Also, some words that could confuse the public, such
"government" or "church" cannot be used or must be used only
for specific types of entities. Words that are offensive or
heinous are also usually prohibited.

Purpose of the Company

42
The reason for the creation of the company must also be stated
in the articles of association. Some jurisdictions accept very
broad purposes, for example "management" while others
require greater detail ("the operation of a wholesale bakery").

Share Capital

The number and type of shares that comprise a company's

capital are listed in the articles of association. There will always
be at least one form of common shares that makes up a
company's capital. In addition, there may be several types
of preferred shares as well. The company may or may not issue
the shares, but if they are found in the articles of association,
they can be issued if and when the need presents itself.

Organization of the Company

The legal organization of the company, including its address,

the number of directors and officers, the identity of the
founders, and original shareholders is found in this section.
Depending on the jurisdiction and type of business, auditors
and legal advisors of the company may also be in this section.

Shareholder Meetings

The provisions for the first general meeting of shareholders and

the rules that will govern subsequent annual shareholder
meetings, such as notices, resolutions and votes are laid out in
detail in this section.

 Articles of Association (AOA)

A company’s Articles of Association (AOA) is a primary

declaration of the company’s nature, purpose and ends which,
along with the Memorandum of Association, forms together
the company’s constitution. These must be submitted at the
time of application for incorporation. They define clearly the
responsibilities of the directors, the kind of business to be

43
undertaken, and the means by which the shareholders exert
control over the board of directors.

Articles of Association Content

As is evident, an Articles of Association must contain all the

information regarding who holds the power distribution among
directors, officers, shareholders etc, who holds right of vote and
veto, the nature and form in which the primary business of the
company is to be carried out, the structure for the internal
corporate governance of the company, the means of internal
review by which executive decisions are made, the bodies in
whom authority to make such decisions in the last resort finally
rest, the procedure and number or percentage of votes required
to establish a majority and make some key decisions etc.
Besides this the rights and duties of the members of the
company, their names and number, as well as other details
relating to the contributed share capital are included.

Scope and Extent of Articles of Association

The article is binding not only to the existing members, but also
to the future members who may join in the future. The hires of
members, successors and legal representatives are also bound
by whatever is contained in the Article. The Articles bind the
company and its members as soon as they sign the document.
It is a contract between the company and its members.
Members have certain rights and duties towards the company
and the company have certain obligations towards its
members. At the same time the company also expects some
duties and obligations which the member has to fulfil for the
smooth functioning of the company.

The Objectives and the purpose of the Company are

determined in advance by the shareholders and the
Memorandum of Association (MOA), if separate, which denotes
the name of the Company, its Head- Office, street address, and
(founding) Directors and the main purposes of the Company –

44
for public access. It cannot be changed except at an AGM or
Extraordinary General Meeting (EGM) and statutory allowance.
The MOA is filed with a Registrar of Companies who is an
appointee of the Ministry of Corporate Affairs. For their
assurance, the shareholders are permitted to elect an Auditor
at each AGM. There can be Internal Auditors (employees) as
well as an External Auditor.

Details included in AOA

If a company’s constitution contains any restrictions on the

objects at all, those restrictions will form part of the articles of
association. The Articles of Association also include, among
other details:

 valuation of intellectual rights, say, the valuations of the

IPR of one partner and, in a similar way as how we value
real estate of another partner

 the appointments of directors – which shows whether a

shareholder dominates or shares equality with all
contributors

 directors meetings – the quorum and percentage of vote

 management decisions – whether the board manages or a

founder

 transferability of shares – assignment rights of the

founders or other members of the company do

 special voting rights of a Chairman, and his/her mode of

election

 the dividend policy – a percentage of profits to be

declared when there is profit or otherwise

 winding up – the conditions, notice to members

45
  confidentiality of know-how and the founders’ agreement
and penalties for disclosure

 first right of refusal – purchase rights and counter-bid by a

founder

A company’s memorandum of association, by contrast,

contains an objects clause, which limits its capacity to act. The
objects clause in general is drafted in such a wide and
somewhat ambiguous way as not to restrict the board of
directors in their day to day activities, especially if the business
intends to gradually broaden its scale of operation.
Nonetheless, any significant change (for e.g. operating in a
completely different industry than registered in) in this clause
requires a separate application.

Article of Association

ARTICLES OF ASSOCIATION

 NATURE OF ARTICLES

According to Section 2(5) of the Companies Act, 2013, ‘articles’

means the articles of association of a company as originally
framed or as altered from time to time or applied in pursuance
of any previous company law or of this Act. It also includes the
regulations contained in Table A in Schedule I of the Act, in so
far as they apply to the company.

In terms of section 5(1), the articles of a company shall contain

the regulations for management of the company. The articles of
association of a company are its bye-laws or rules and
regulations that govern the management of its internal affairs
and the conduct of its business. The articles play a very
important role in the affairs of a company. It deals with the
rights of the members of the company inter se. They are
subordinate to and are controlled by the memorandum of
association. The general functions of the articles have been
aptly summed up by Lord Cairns, L.C. in Ashbury Railway
46
Carriage and Iron Co. Ltd. v. Riche, (1875) L.R. 7 H.L. 653 as
follows:

“The articles play a part that is subsidiary to the memorandum

of association. They accept the memorandum of association as
the charter of incorporation of the company, and so accepting
it, the articles proceed to define the duties, rights and powers of
the governing body as between themselves and the company
at large, and the mode and form in which business of the
company is to be carried on, and the mode and form in which
changes in the internal regulations of the company may from
time to time be made… The memorandum, is as it were… the
area beyond which the action of the company cannot go; inside
that area shareholders may make such regulations for the
governance of the company as they think fit”.

Thus, the memorandum lays down the scope and powers of the
company, and the articles govern the ways in which the objects
of the company are to be carried out and can be framed and
altered by the members. But they must keep within the limits
marked out by the memorandum and the Companies Act.

The articles regulate the internal management of the affairs of

the company by way of defining the powers of its officers and
establishing a contract between the company and the members
and between the members inter se. This contract governs the
ordinary rights and obligations incidental to membership in the
company [Naresh Chandra Sanyal v. The Calcutta Stock
Exchange Association Ltd., AIR 1971 SC 422, (1971) 41 Com
Cases 51]. But the Articles of Association of a company are not
‘law’ and do not have the force of law. In Kinetic Engineering
Ltd. v. Sadhana Gadia, (1992) 74 Com Cases 82 : (1992) 1
Comp LJ 62 (CLB), the CLB held that if any provision of the
articles or the memorandum is contrary to any provisions of any
law, it will be invalid in toto.

47
Articles Subordinate to Memorandum

The articles of a company are subordinate to and subject to the

memorandum of association and any clause in the Articles
going beyond the memorandum will be ultra vires. But the
articles are only internal regulations, over which the members
of the company have full control and may alter them according
to what they think fit.

Only care has to be taken to see that regulations provided for in

the articles do not exceed the powers of the company as laid
down by its memorandum [Ashbury v. Watson, (1885) 30 Ch. D
376 (CA)]. Articles that go beyond the company’s sphere of
action are inoperative, and anything done under the authority of
such article is void and incapable of ratification.

But neither the articles nor the memorandum can authorise the
company to do anything so as to contravene any of the
provisions of the Act. [See Re Peveril Gold Mines, (1989) 1 Ch
122 (CA)].

Articles in relation to Memorandum

The functions of the Articles in relation to the Memorandum

have already been summed up in the Ashbury Railway
Carriage case and even though the articles are subordinate to
the memorandum yet if there be any ambiguity in the
memorandum, the articles may be used to explain it but not so
as to extend the objects. [Re. South Durham Brewery Company
(1885) 3 Ch. D 261]. The memorandum of a company was not
clear as to the classes of shares to be issued by a company but
the articles made clear the doubt by giving the power to the
company to issue shares of different classes.

The relationship between the two documents was further

emphasised in Guinness v. Land Corporation of Ireland, (1882)
22 Ch D 349, where it was observed: “The memorandum
contains the fundamental condition upon which alone the
company is allowed to be incorporated. They are conditions
48
introduced for the benefit of the creditors, and the outside
public, as well as of the shareholders. The articles of
association are the internal regulations of the company. How
can it be said that in all cases the fundamental conditions of the
charter of incorporation and the internal regulations of the
company are to be construed together… In any case it is, as it
seems to me, certain that for anything which the Act of
Parliament says shall be in the memorandum you must look at
the memorandum alone. If the legislature has said one
instrument is to be dominant you cannot turn to another
instrument and read it in order to modify the provisions of the
dominant instrument”. Where the memorandum clearly
establishes the rights of shareholders, a reference in the
memorandum to the articles and an ambiguity said to arise
from the construction of the articles should not be used to
depart from the clear meaning of the memorandum so as to
diminish those rights [Scottish National Trust Co. Ltd. 1928 SC
499 (Scot); Kinetic Engineering Ltd. v. Sadhana Gadia, (1992)
1 Comp LJ 62 (CLB)].

REGISTRATION OF ARTICLES

Section 7(1) provides that at the time of incorporation of a

company there shall be filed with the Registrar within whose
jurisdiction the registered office of a company is proposed to be
situated, the memorandum and articles of the company duly
signed by all the subscribers to the memorandum in the
prescribed manner.

Every type of company whether public or private and whether

limited by shares or limited by guarantee having a share capital
or not having a share capital or an unlimited liability company
must register their articles of association.

Section 5(2) provides that the articles shall also contain such
matters, as may be prescribed. However, nothing prescribed in
this sub-section shall be deemed to prevent a company from

49
including such additional matters in its articles as may be
considered necessary for its management.

The articles of a company shall be in respective forms specified

in Tables, F, G, H, I and J in Schedule I as may be applicable
to such company. [Section 5(6)]

A company may adopt all or any of the regulations contained in

the model articles applicable to such company. [Section 5(7)]

Section 5(8) provides that in case of any company, which is

registered after the commencement of Companies Act 2013, in
so far as the registered articles of such company do not
exclude or modify the regulations contained in the model
articles applicable to such company, those regulations shall, so
far as applicable, be the regulations of that company in the
same manner and to the extent as if they were contained in the
duly registered articles of the company.

Therefore in terms of Section 5 of the Companies Act, 2013 a

public company limited by shares may at its option register its
articles of association signed by the same subscribers as to the
memorandum, or alternatively it may adopt all or any of the
regulations contained in Table F of First Schedule of the Act. If
articles are not registered, automatically Table F in Schedule I
apply, and if registered, Table F in Schedule I apply except in
so far as it is excluded or modified by the articles. To avoid any
confusion, normally every public company delivers its articles
alongwith the memorandum for registration. Further it will be
specifically stated therein that Table ‘F’ will not apply. The
articles of a private company must contain the three restrictions
as contained in Section 2(68).

A company limited by guarantee having a share capital or a

company limited by guarantee not having a share capital or an
unlimited company having a share capital or an unlimited
company not having a share capital might adopt any of the

50
appropriate regulations of Table G, H, I and J respectively in
Schedule I [Section 5(6)].

However nothing in section 5 shall apply to the articles of a

company registered under any previous company law unless
amended under this Act [Section 5(9)].

STATUTORY REQUIREMENTS

The articles must be printed, divided into paragraphs,

numbered consecutively, stamped adequately, signed by each
subscriber to the memorandum and duly witnessed and filed
along with the memorandum. The articles must not contain
anything illegal or ultra vires the memorandum, nor should it be
contrary to the provisions of the Companies Act, 2013.

 CONTENTS OF ARTICLES

The articles set out the rules and regulations framed by the
company for its own working. The articles should contain
generally the following matters:

1. Exclusion wholly or in part of Table F.

2. Adoption of preliminary contracts.

3. Number and value of shares.

4. Issue of preference shares.

5. Allotment of shares.

6. Calls on shares.

7. Lien on shares.

8. Transfer and transmission of shares.

9. Nomination.

51
10. Forfeiture of shares.

11. Alteration of capital.

12. Buy back.

13. Share certificates.

14. Dematerialisation.

15. Conversion of shares into stock.

16. Voting rights and proxies.

17. Meetings and rules regarding committees.

18. Directors, their appointment and delegations of

powers.

19. Nominee directors.

20. Issue of Debentures and stocks.

21. Audit committee.

22. Managing director, Whole-time director, Manager,

Secretary.

23. Additional directors.

24. Seal.

25. Remuneration of directors.

26. General meetings.

27. Directors meetings.

28. Borrowing powers.

29. Dividends and reserves.

52
 30. Accounts and audit.

31. Winding up.

32. Indemnity.

33. Capitalisation of reserves.

Utmost caution must be exercised in the preparation of the

articles of association of a company. At the same time, certain
provisions of the Act are applicable to the company
“notwithstanding anything to the contrary in the articles”.
Therefore, the articles must contain provisions in respect of all
matters which are required to be contained therein so as not to
hamper the working of the company later.

ALTERATION OF ARTICLES OF ASSOCIATION

A company has a statutory right to alter its articles of

association. But the power to alter is subject to the provisions of
the Act and to the conditions contained in the memorandum.
Section 14(1) provides that subject to the provisions of this Act
and the conditions contained in its memorandum, if any, a
company may, by a special resolution, alter its articles including
alterations having the effect of conversion of a private company
into a public company; or a public company into a private
company. First proviso to section 14(1) lays down that where a
company being a private company alters its articles in such a
manner that they no longer include the restrictions and
limitations which are required to be included in the articles of a
private company under this Act, the company shall, as from the
date of such alteration, cease to be a private company. Second
proviso to section 14(1) stipulates that any alteration having the
effect of conversion of a public company into a private company
shall not take effect except with the approval of the Tribunal
which shall make such order as it may deem fit.1

Every alteration of the articles under this section and a copy of

the order of the Tribunal approving the alteration as per section
53
14(1) shall be filed with the Registrar, together with a printed
copy of the altered articles, within a period of fifteen days in
such manner as may be prescribed, who shall register the
same. [Section 14 (2)]

Any alteration of the articles registered under section 14(2)

shall, subject to the provisions of this Act, bevalid as if it were
originally in the articles. [Section 14(3)]

The right to alter the articles is so important that a company

cannot in any manner, either by express provisions in the
articles or by independent contract, deprive itself of the powers
to alter its articles [Walker v. London Tramway Co. (1879) 12
Ch. D. 705].

However, in spite of the power to alter its articles, a company

can exercise this power subject only to certain limitations.
These are:

1. The alteration must not exceed the powers given by the

memorandum. In the event of conflict between the
memorandum and the articles, it is the memorandum that
will prevail.

2. The alteration must not be inconsistent with any provisions

of the Companies Act or any other statute.

Similarly, where a resolution was passed expelling a member

and authorising the director to register the transfer of his shares
without an instrument of transfer, the resolution was held to be
invalid as being against the provisions of the Act [Madhava
Ramachandra Kamath v. Canara Banking Corporation [1941]
11 Com Cases 78 (Mad)].

On the other hand, articles may impose on the company

conditions stricter than those provided under the law; for
example, they may provide that a matter should be passed by a
special resolution when the Act requires it to be passed by an
ordinary resolution.
54
 3. The Articles must not include anything which is illegal or
opposed to public policy.

4. The alteration must be bona fide for the benefit of the

company as a whole.

5. The alteration must not constitute a fraud on the minority

by a majority. If the alteration is not for the benefit of the
company as a whole, but for majority of shareholders,
then the alteration would be bad. In other words, an
alteration to the articles must not discriminate between the
majority shareholders and the minority shareholders so as
to give the former an advantage over the latter. [All India
Railway Mens Benefit Fund v. Jamadar Baheshwarnath
Bali (1945) 15 Com Cases 142 (Nag.)]

In Mathrubhumi Printing & Publishing Co. Ltd. v. Vardhaman

Publishers Ltd. [1992] 73 Com Cases 80 (Ker.), the Kerala High
Court held that no majority of shareholders can, by altering the
article retrospectively, affect, the prejudice of the consenting
owners of shares, the right already existing under a contract
nor take away the right accrued, e.g., after a transfer of share is
lodged, the company cannot have a right of lien so as to defeat
the transfer.

6. Articles cannot be altered so as to compel an existing

member to take or subscribe for more shares or in any
way increase his liability to contribute to the share capital,
unless he gives his consent in writing (Section 38).

7. By effecting alteration in its articles, a company cannot

defeat escape from its contractual obligation with any
person. The company will always be liable in such a case.

8. The Articles of Association cannot be altered so as to

have retrospective effects. The articles only operate from
the date of the amendment [Pyare Lal Sharma v.
Managing Director, J.K. IndustriesLtd. (1989) 3 Comp LJ
(SL) 70].
55
 9. The alteration must not be inconsistent with an order of
the Court under Sections 397 or 398 and 404 of the
Companies Act, 1956.

10. Amendment of Articles relating to Managing, Whole-

time director and non-rotational directors requires Central
Government’s approval. (Section 268 –This section is of
the Companies Act, 1956)

Subject to the foregoing conditions, the Articles in a company

can be altered and no clause can be included in the Articles
that it is not alterable. Persons who become members of a
company have no right to assume that the Articles will always
remain in a particular form.

Of course a section or a class of shareholders cannot be

unfairly or oppressively treated. Thus, though the requisite
majority of members could pass a special resolution to alter the
Articles and if the alteration has the effect of making a fraud on
the minority, the minority shareholders not being less than the
number specified

in Section 397 and 398 could move the Court for redressing
their grievances. The Courts have entertained such
applications from shareholders even where they are smaller in
number [See Menier N. Hooper Telegraph Works (1874) 9 Ch.
App. 350].

As already mentioned, a company is not prevented from

altering its Articles on the ground that such an alteration would
be breach of a contract but an action for damages may lie
against the company. [Southern Foundries v. Shirlaw, [1940]
AC 701].

The discussion on the above matter will not be complete

without referring to the rule in Foss v. Harbottle (1843) 2 Hare
461 where the court held that no individual shareholder nor a
minority of shareholders in a company can take it upon himself
or themselves to remedy an alleged wrong involved in the
56
actions of directors if the said wrongful act is something which
the majority can regularise and approve of.

 DISTINCTION BETWEEN MEMORANDUM AND

ARTICLES

The main points of distinction between the memorandum and

articles are given below:

1. Memorandum of association is the charter of the company

and defines the fundamental conditions and objects for
which the company is granted incorporation. Articles of
association are the rules and regulations framed to govern
this internal management of the company.

2. Clauses of the memorandum cannot be easily altered.

They can only be altered in accordance with the mode
prescribed by the Act. In some of the cases, alteration
requires the permission of the Central Government or the
Court. In the case of articles of association, members
have a right to alter the articles by a special resolution.
Generally there is no need to obtain the permission of the
Court or the Central Government for alteration of the
articles.

3. Memorandum of association cannot include any clause

contrary to the provisions of the Companies Act. The
articles of association are subsidiary both to the
Companies Act and the memorandum of association.

4. The memorandum generally defines the relation between

the company and the outsiders, while the articles regulate
the relationship between the company and its members
and between the members inter se.

5. Acts done by a company beyond the scope of the

memorandum are absolutely void and ultra vires and
cannot be ratified even by unanimous vote of all the

57
 shareholders. But the acts of the directors beyond the
articles can be ratified by the shareholders.

DOCTRINE OF INDOOR MANAGEMENT

While the doctrine of ‘constructive notice” seeks to protect the

company against the outsiders, the principal of indoor
management operates to protect the outsiders against the
company.

According to this doctrine, as laid down in Royal British Bank v.

Turquand, (1856) 119 E.R. 886, persons dealing with a
company having satisfied themselves that the proposed
transaction is not in its nature inconsistent with the
memorandum and articles, are not bound to inquire the
regularity of any internal proceedings. In other words, while
persons contracting with a company are presumed to know the
provisions of the contents of the memorandum and articles,
they are entitled to assume that the provisions of the articles
have been observed by the officers of the company. It is no part
of the duty of an outsider to see that the company carries out its
own internal regulations.

EXCEPTIONS TO THE DOCTRINE OF INDOOR

MANAGEMENT

The above noted ‘doctrine of indoor management’ is, however,

subject to certain exceptions. In other words, relief on the
ground of ‘indoor management’ cannot be claimed by an
outsider dealing with the company in the following
circumstances.

1. Where the outsider had knowledge of irregularity —

The rule does not protect any person who has actual or
even an implied notice of the lack of authority of the
person acting on behalf of the company. Thus, a person
knowing fully well that the directors do not have the
authority to make the transaction but still enters into it,
cannot seek protection under the rule of indoor
58
 management. In Howard v. Patent Ivory Co. (38 Ch. D
156), the articles of a company empowered the directors
to borrow upto one thousand pounds only. They could,
however, exceed the limit of one thousand pounds with
the consent of the company in general meeting. Without
such consent having been obtained, they borrowed 3,500
pounds from one of the directors who took debentures.
The company refused to pay the amount. Held that, the
debentures were good to the extent of one thousand
pounds only because the director had notice or was
deemed to have the notice of the internal irregularity.

2. No knowledge of memorandum and articles — Again,

the rule cannot be invoked in favour of a person who did
not consult the memorandum and articles and thus did not
rely on them. In Rama Corporation v. Proved Tin &
General Investment Co. (1952) 1All. ER 554, T was a
director in the company. He, purporting to act on behalf of
the company, entered into a contract with the Rama
Corporation and took a cheque from the latter. The articles
of the company did provide that the directors could
delegate their powers to one of them. But Rama
Corporation people had never read the articles. Later, it
was found that the directors of the company did not
delegate their powers to T. The Plaintiff relied on the rule
of indoor management. Held, they could not because they
even did not know that power could be delegated.

3. Forgery — The rule of indoor management does not

extend to transactions involving forgery or to transactions
which are otherwise void or illegal ab initio. In the case of
forgery it is not that there is absence of free consent but
there is no consent at all. The person whose signatures
have been forged is not even aware of the transaction,
and the question of his consent being free or otherwise
does not arise. Consequently, it is not that the title of the
person is defective but there is no title at all. Therefore,
howsoever clever the forgery might have been, the
59
 personates acquire no rights at all. Thus, where the
secretary of a company forged signatures of two of the
directors required under the articles on a share certificate
and issued certificate without authority, the applicants
were refused registration as members of the company.
The certificate was held to be nullity and the holder of the
certificate was not allowed to take advantage of the
doctrine of indoor management [Rouben v. Great Fingal
Consolidated (1906) AC 439].

4. Negligence — The ‘doctrine of indoor management’, in no

way, rewards those who behave negligently. Thus, where
an officer of a company does something which shall not
ordinarily be within his powers, the person dealing with
him must make proper enquiries and satisfy himself as to
the officer’s authority. If he fails to make an enquiry, he is
estopped from relying on the Rule. In the case of
Underwood v. Benkof Liverpool (1924) 1 KB 775, a person
who was a sole director and principal shareholder of a
company deposited into his own account cheques drawn
in favour of the company. Held, that, the bank should have
made inquiries as to the power of the director. The bank
was put upon an enquiry and was accordingly not entitled
to rely upon the ostensible authority of director.

Similarly, in the case of Anand Behari Lal v. Dinshaw & Co.

(Bankers) Ltd. AIR 1942 Oudh 417, an accountant of a
company transferred some property of a company in favour of
Anand Behari. On an action brought by him for breach of
contract, the Court held the transfer to be void. It was observed
that the power of transferring immovable property of the
company could not be considered within the apparent authority
of an accountant.

5. Again, the doctrine of indoor management does not apply

where the question is in regard to the very existence of an
agency. In Varkey Souriar v. Keraleeya Banking Co. Ltd.
(1957) 27 Com Cases 591 (Ker.), the Kerala High Court

60
 held that the ‘doctrine of indoor management’ cannot
apply where the question is not one as to scope of the
power exercised by an apparent agent of a company but
is with regard to the very existence of the agency.

6. This Doctrine is also not applicable where a pre-condition

is required to be fulfilled before company itself can
exercise a particular power. In other words, the act done is
not merely ultra vires the directors/officers but ultra vires
the company itself — Pacific Coast Coal Mines v.
Arbuthnot (1917) AC 607.

In the end, it is worthwhile to mention that section 6 of the

Companies Act, 2013 gives overriding force and effect to the
provisions of the Act, notwithstanding anything to the contrary
contained in the memorandum or articles of a company or in
any agreement executed by it or for that matter in any
resolution of the company in general meeting or of its board of
directors. A provision contained in the memorandum, articles,
agreement or resolution to the extent to which it is repugnant to
the provisions of the Act, will be regarded as void.

A corporation, organization or other entity set up to provide a

legal shield for the person actually controlling the operation.

Contents of the Articles of Association

Each limited liability company must have articles of association.
They are the company’s internal regulations, which bind the
company, its administrative bodies, management and auditors.
The articles of association must be complied with in the same
manner as the Limited Liability Companies Act.

The formulation of the articles of association is of great

importance from the point of view of the company’s activities.
Articles of association that are not suitable for the company’s
purposes may decrease the benefits, which the shareholders
can obtain from the company. It is recommendable to pay due

61
attention to the contents of the articles of association already
during the company's founding phase, because the
amendments thereof always require at least two-thirds (a
qualified majority) of the votes and of the shares represented at
the general meeting of shareholders. In practice, significant
amendments always need to be agreed between the
shareholders. Moreover, amendments always result in Trade
Register costs as the amendments become effective only
following registration in the Trade Register.

 The articles of association must include provisions

regarding the following:

1. Company name

The company name of a private limited liability company must

include the words “limited liability company” or the abbreviation
“limited / Ltd” (in Finnish “osakeyhtiö” / “Oy”, in Swedish
“aktiebolag” / “Ab”). If the company intends to use its company
name in two or more languages, the names in other languages
must be stated in the articles of association.

2. A Finnish municipality as the company’s place of

business

A company may practice its activities in several places and also

abroad, but its registered place of business can only be in one
Finnish municipality. The company’s registered place of
business is of significance, as the general meetings of
shareholders generally need to be held in the municipality of
the place of business and any legal actions against the
company need to be brought to the court of the municipality in
question (forum domicilii).

3. The company's field of activity

The term "field of activity" refers to the fields in which the

company carries on its business activity. Any activity, which
may be pursued legally in the form of a limited liability
62
company, can constitute the company’s field of activity. A
company can have several fields of activity, but they must all be
registered. Although legislation is silent about how precise the
definition of the field of activity needs to be, inexact and
unnecessarily extensive definitions should be avoided. The
definition of the field of activity has legal significance when
assessing the competence of the company’s organs to take
care of company matters. Moreover, the field of activity is of
importance when evaluating the use of company assets. The
field of activity may also consist of a general field of activity.
Definitions of the field of activity, which are too narrow, can
cause extra costs and inconvenience, as the expansion of the
company’s activity requires for the articles of association to be
amended correspondingly and for the changes to be registered
with the Trade Register.

In addition, the following provisions may be included in the

articles of association:

4. Share capital

The minimum amount of a private limited liability company's

share capital is 2,500 euros. The minimum amount of a public
limited liability company’s share capital must be at least 80,000
euros. The share capital can be stated either as a fixed amount
or as minimum and maximum amounts. In case the share
capital has been defined as minimum and maximum capital, it
can be increased and decreased within these limits without a
need to amend the articles of association.

5. Nominal value and number of shares

If the nominal value is defined in the articles of association, all

shares must have the same nominal value.

6. Number of members of the board of directors and

auditors as well as the possible deputy members, or the
minimum and maximum number thereof

63
The number of the members of the board of directors and
auditors, as well as the possible deputy members and their
term of office may be stated in the articles of association. The
number of the members may also be stated as a minimum or
maximum amount. At least one of the members of the board of
directors must have his/her place of residence in the EEA,
unless the National Office of Patents and Registration of
Finland grants the company a permission to deviate from this
requirement. Legally incompetent or bankrupt natural persons
or a legal person cannot be members of the board of directors.
In addition, the articles of association may include special
provisions concerning the eligibility of a board member and a
deputy member.

There may be more than one auditor. The competence of an

auditor is regulated in the Auditing Act [5.1.7 Audit]. In case
only one auditor has been elected and the auditor is not an
auditing KHT or HTM-firm approved in accordance with the
Auditing Act, then at least one deputy auditor must be elected
in addition.

7. Notice of a general meeting of shareholders

The articles of association may stipulate the manner in which

and when the notice to the annual general meeting of
shareholders must be given. The notice may be given e.g. by
announcement in a newspaper or by a written notice delivered
to the persons who have been entered in the share and
shareholders’ registers. If not mentioned in the articles of
association, according to the Limited Liability Companies Act,
the notice must be issued in private limited liability companies
no later than one week prior to the date of the general meeting,
or the special date of registration stated in the articles of
association, and no earlier than two months prior to the date of
the general meeting or the registration date.

8. The agenda of the annual general meeting

64
The articles of association may state the agenda of the annual
general meeting. Matters, which according to mandatory law
provisions must be considered at the annual general meeting,
shall also be included on the agenda.

9. Accounting period of the company

According to the Auditing Act, the accounting period of the

company may be a calendar year or any other period of twelve
(12) months. The accounting period may be shorter or longer
than this period when the company's activity is being set up or
closed down or when the time for the financial statements is
being changed.The maximum length of the accounting period is
eighteen (18) months.

10. Supplementary provisions

The Limited Liability Companies Act provides several legal

alternatives, the use of which requires supplementary
provisions to be inserted into the articles of association.
Regulating the matter in the articles of association is usually a
prerequisite, if the company wishes to derive a legal benefit
from the alternative. For instance, a redemption right does not
relate to a share, if the matter has not been stated in the
articles of association (a so-called redemption clause).
Nevertheless, the inclusion of such regulations in the articles of
association is entirely voluntary. The use thereof depends on
whether the company wants to utilize the alternative provided
by legislation.

11. Other provisions

In addition to mandatory provisions, the shareholders may also

quite freely include other provisions in the articles of
association. The other provisions may not, however, contradict
the mandatory principles provided by the Limited Liability
Companies Act, e.g. by limiting the transferability of the shares
in another way than by way of a redemption or consent clause

65
as provided by law. These voluntary provisions may concern
e.g. following matters:

 appointment of a managing director

 the manner of calling the general meeting;

 nomination of the chairman of the general meeting or

election of a director of the board;

 minimum attendance at the general meeting;

 expansion of the scope of the tasks of the general meeting

to cover e.g. decisions on transfers of or mortgage on
fixed assets, or on floating charges;

 determination of the majority required for resolutions

adopted by the general meeting above the ordinary;

 withdrawal of the decision power of the chairman in the

event of equal votes so that the outcome may be
determined e.g. by the drawing of lots;

 an arbitration clause, which binds the company, the

shareholders, the board, the supervisory board, a member
of the board and a member of the supervisory board, the
managing director and the auditor with the same effect as
an arbitration agreement.
 Articles of Association And Alteration of Articles
 To obtain the registration of a company an application has to be filed with the Registrar of
Companies. The application must be accompanied by the following documents,

1. Memorandum of Association
2. Articles of Association, if necessary and
3. The agreement, if any, which the company proposes to enter into with any individual
for his appointment as its managing or whole-time director or manager.

The articles of association of a company are its by-laws or rules and regulations which
govern the management of its internal affairs and the conduct of its business. They are
framed with the object of carrying out the aims and objects as set out in the
Memorandum of Association. According to Section 2(2) of the Companies Act, 1956
‘articles’ means the articles of association of a company as originally framed or as altered
from time to time in pursuance of any previous companies laws or of the present Act, i.e.
the Act of 1956.

66
The Articles regulate the internal management of the company. They define the powers
of its officers. In Naresh Chandra Sanyal vs Calcutta Stock exchange association Ltd
(AIR 1971 SC 422), the SC said that the articles of association also establish a contract
between the company and the members and between the members inter se. This
contract governs the ordinary rights and obligations incidental to membership in the
company.

Articles are like the partnership deed in a partnership. They set out provisions for the
manner in which the company is to be administered. In particular, they provide for
matters like the making of calls, forfeiture of shares, directors’ qualifications,
appointment, powers and duties of auditors, procedure for transfer and transmission of
shares and debentures.

1.2. Contents Of Articles Of Association

Articles usually contain provisions relating to the following matters-
1. Share capital including sub division thereof, rights of various shareholders, the
relationship of these rights, payment of commission, share certificates,
2. Lien of shares
3. Calls on shares
4. Transfer of shares
5. Transmission of shares
6. Forfeiture of shares
7. Surrender of shares
8. Conversion of shares into stock
9. Share warrant
10. Alteration of capital
11. General meetings and proceedings thereat
12. Voting rights of members, voting by poll, proxies
13. Directors, including first directors or directors for life, their appointment, remuneration,
qualifications, powers and proceedings of Board of directors’ meetings
14. Dividends and reserves
15. Accounts and audits
16. Borrowing powers
17. Winding up

Utmost care must be taken to prepare the articles of association of the proposed
company. They are certain matters in respect of which powers can be exercised by the
company only if the articles so provide and in the manner provided therein. Therefore,
the articles must contain provisions in respect of all matters which are required to be
contained therein so as not to hamper the working of the company later. At the same
time, the articles of association should not provide for matters in respect of which it has
no powers to exercise. It cannot, for example, provide for expulsion of a member, as
such a power is opposed to the fundamental principal of company jurisprudence and,
therefore, ultra vires the company.

1.3. Companies Which Must Have Articles (Section 26)

The following companies must have their own articles, namely

1. Unlimited companies
2. Companies limited by guarantee
3. Private companies limited by shares

The articles shall be signed by the subscribers of the Memorandum and registered along
with the Memorandum. A public company may have its own Articles of association. If it
does not have its own Articles, it may adopt Table A given in Schedule I to the Act.

67
Section 27 provides that the regulations with respect to the aforesaid companies should
provide for the following:-

1. In case of unlimited companies, the articles shall state the number of members with
which the company is to be registered and if the company has a share capital, the
amount of share capital with which the company is to be registered.

2. In case of companies limited by guarantee, the articles shall state the number of
members with which the company is to be registered.

3. In case of private company having a share capital, the articles shall contain provisions
which-

a) Restrict the right to transfer shares

b) Limit the number of its members to 50 (not including employee-members), and
c) Prohibit any invitation to the public to subscribe for any shares in, or debentures of, the
company.

1.4. No Article Company

According to section 28(1), company limited by shares may either frame its own set of
articles or may adopt all of any of the regulations contained in Table A. but if it does not
register any Articles, Table A applies, if it does not have some regulations, for the rest, as
far as applicable, table A applies, insofar as its regulations are not excluded [(section
28(2)].

Thus, in case of a limited liability company having share capital, if the articles do not
expressly exclude any or all provisions of table A, and at the same time not providing
anything for them, applicable clauses of Table A shall automatically apply to it.

1.5. Form And Signature Of Articles

According to section 30 of the Companies act, 1956 the articles shall

a) be printed;

b) be divided into paragraphs numbered consecutively; and

c) be signed by each subscriber of the memorandum of association (who shall add his
address, description and occupation, if any,) in the presence of at least one witness who
shall attest the signature and shall likewise add his address, description and occupation,
if any.

1.6. Alteration Of Articles

Sec. 31 of the Companies Act, 1956, provides that a company may by passing a special
resolution, alter regulations contained in its Articles any time subject to

a) the provisions of the Companies Act and

b) Conditions contained in the Memorandum of Association [Section 31(1)].

A copy of every special resolution altering the Articles shall be filed in Form no 23, with
the Registrar within 30 days its passing and attached to every copy of the Articles issued
thereafter. The fundamental right of a company to alter its articles is subject to the
following limitations:

a) The alteration must not exceed the powers given by the Memorandum of Association
of the company or conflict with the provisions thereof.
b) It must not be inconsistent with any provisions of Companies Act or any other statute.

68
c) It must not be illegal or against public policies
d) The alteration must be bona fide for the benefit of the company as a whole.
e) It should not be a fraud on minority, or inflict a hardship on minority without any
corresponding benefits to the company as a whole.
f) The alternation must not be inconsistent with an order of the court. Any subsequent
alteration thereof which of inconsistent with such an order can be made by the company
only with the leave of the court.
g) The alteration cannot have retrospective effect. It can operate only from the date of
amendment. [Pyarelal Sharma v. Managing Director, J & K Industries Ltd. [1989] 3 comp.
L.J. (SL) 70].

h) If a public company is converted into a private company, then the approval of the
Central Government is necessary. Printed copies of altered articles should be filed with
the Registrar within one month of the date of Central Government’s approval. [Section 31
(2A)].

i) An alteration that has the effect of increasing the liability of a member to contribute to
the company is not binding on a present member unless he has agreed thereto in writing.
j) A reserve liability once created cannot be undone but may be cancelled on a reduction
of capital.
k) An assumption by the Board of Directors of a company of any power to expel a
member by amending its Articles is illegal or void.

1.7.Procedures For Alteration Of Articles Of Association

For effecting alteration to the articles of association, the following procedures is required
to be followed-

1. Take the necessary decision by convening a Board Meeting to change all or any of the
existing Articles of Association and fix up the day, time, place and agenda for a general
meeting for passing special resolution to effect the change.

2. See that any such change in the Articles of the company conforms to the provisions of
the companies Act, 1956 and the conditions contained in the Memorandum of
Association of the company.

3. See that any such change does not increase the liability of any member who has
become so before the alteration to contribute to the share capital of or otherwise to pay
money to, the company.

4. See that any such change does not have the effect of converting a public company
into a private company. If such is the case, then make an application to the Central
Government for such alteration.

5. See that any such change does not provide for expulsion of a member by the
company.

6. Issue notices for the General Meeting proposing the Special resolution and explaining
inter alia, in the explanatory Statement the implication and reasons of the changes being
proposed.

7. If the shares of the company are enlisted with any recognised Stock Exchange, then
forward copies of all notices sent to the shareholders with respect to change in the
Articles of Association to the Stock Exchange.

8. Hold the General Meeting and pass the special resolution.

9. File with the stock exchange with which your company is enlisted six copies of such

69
amendments as soon as the company adopts it in General Meeting. Out of the six
copies, one copy must be a certified true copy.

10. Forward promptly to the Stock Exchange with which your company is enlisted three
copies of the notice and a copy of the proceedings of the General Meeting.

11. File the Special resolution with the concerned Registrar of companies with
explanatory statement in Form No.23 within thirty days of its passing after payment of the
requisite filing fee in cash as per Schedule X. If the Articles of Association have been
completely or substantially changed, file a new printed copy of the Articles after paying
the requisite fee in cash prescribed under Schedule X to the Companies Act, 1956.
payments upto Rs.50/-

12. Effect the changes in all copies of the articles of association.

13. Any alteration so made be as valid as if originally contained in the Articles of

Association and be subject to alteration by Special Resolution as above.

14. If the articles are altered pursuant to an order of the Company law Board made under
section 397 or 398 then see that such alterations is not inconsistent with the said and if it
is so then obtain first leave of the Company Law Board to make such alteration.

1.8. Effect Of Articles Of Association

Section 36 provides that the memorandum and articles, when registered, bind the
company and its members to the same extent as if they have been signed by the
company and by each member and contain covenants on its and his part to observe all
the provisions of the memorandum and of the articles. Thus the company is bound to its
members, the members are bound to the company and the members are bound to other
members by whatever is contained in these documents. But in relation to articles, neither
a company nor its members are bound to outsiders.

The articles of association merely govern the internal management, business or

administration of a company. They may be binding between the members affected by
them but do not have the force of statute- Irrigation Development Employees’ Association
vs Government of Andhra Pradesh [2005]55 SCL 459 (AP).

1.9. Binding effect of Articles of association

Merely because in articles of association, the board of directors is empowered to refer
any claim or demand to arbitration, provisions of section 36 cannot be interpreted to
mean that the company or its directors shall be bound to incorporate a provision for
arbitration in every agreement that a company executes- Skypark builders & distributors
Vs Kerala Police housing & construction Corpn Ltd. [2004] 50 SCL 254.

The discussion on legal effect of memorandum and articles may be made under
the following heads-
1. Members bound to the company
2. Company bound to its members
3. Members bound to members
4. Company and the outsiders

1.10. Members bound to the company

Each member must observe the provisions of articles and memorandum. For instance, a
company has a right of lien on member’s shares or to forfeit the shares on non-payment
of calls. Every member is bound by whatever is contained in the memorandum and
articles. In Borland’s Trustee vs steel Bros. Co. Ltd [1901] 1 Ch. 279, the articles of a
company contained a clause that on the bankruptcy of a member, his share should be
sold to the other persons and at a fixed price by the directors. ‘B’ a shareholder was

70
adjudicated bankrupt. His trustee in bankruptcy claimed that he was not bound by these
provisions and should be at liberty to sell the shares at the true value. It was held that the
trustee was bound by the articles as a share was purchased by B in terms of the articles.

In Malleson vs National Insurance & Guarantee Corpn, it was held that each member is
bound by the covenants of memorandum and articles as originally framed or as altered
form time to time in accordance with the provisions of the companies Act.

In V.B Rangaraj vs V.B Gopalkrishnan [1992], 73 SC, it was held that the articles are the
regulations of the company binding on the company and on its shareholders.
Shareholders, therefore, cannot among themselves enter into an agreement which is
contrary to or is inconsistence with the articles of the company.

1.11. Company bound to members

A company is bound to its members by whatever is contained in its articles and
memorandum. The company is bound not only to the “members as a body” but also to
the individual members as to their individual rights. The members can restrain the
company from spending money on ultra vires transaction. An individual can make the
company fulfil its obligation to him such as to send the notice for the meetings, to allow
him to cast his vote in the meeting.

In Wood vs Odessa waterworks [1889] 42Ch. D. 636, the directors proposed to pay
dividend in kind by issuing debentures. The articles provided for the payment of dividend.
The courl held that the payment means payment in cash and therefore the company
could be compelled to pay dividend in terms of the articles.

1.12. Members bound to members

The articles bind the members inter se, i.e. one to another as far as rights and duties
arising out of the articles are concerned. It is well settled that the articles of association
will have a contractual force between the company and its members as also between
members inter se in relation to their rights as such members- Ramakrishna industries (P)
Ltd vs P. R Ramakrishnan, 1988.

After the articles are registered, they not only constitute a contract between the
association or company on the one hand and its members on the other, but also they
constitute a contract between the members inter se- Shiv Omkar Maheshwari vs
Bansidhar Jagannath, 1957.

1.13. Company and the outsiders

The articles do not constitute any binding contract as between a company and an
outsider. An outsider cannot take advantage of the articles to found a claim against the
company. This is based on the general rule of law that a stranger to a contract cannot
acquire any rights under the contract. Thus if a right is conferred by the articles on a
person in any capacity other than that of the member, it cannot be enforced against the
company.

In Eley vs Positive Govt. Security Life Ass. Co. 1876,1 Ex. D. 88, the articles of a
company provided that E should be the solicitor of the company for life and could be
removed from office only for misconduct. E took office and became a shareholder. After
sometime the company dismissed him without alleging misconduct. E sued the company
for damages for breach of contract. It was held that the articles did not constitute any
contract between the company and the outsider and as such no action could lie.

71
  Importance of Articles of
Association of a Company–
Explained!
Articles of Association, the second important document of a
company, contain rules, regulations and bye-laws for the
internal administration of the company. The articles regulate
the internal management of the company.

Articles define the powers of the directors and other officers

of the company. Articles also govern the relationship
between the company and its constituent members by
prescribing the rights and obligations of the members of the
company. Section 2(2) of the Companies Act defines articles
of association as follows:

“Articles mean the articles of association as originally framed or

as altered from time to time in pursuance of any previous
company’s law or of this Act.”

According to section 26 of the Companies Act, the following

companies must file their own articles along with the
Memorandum of Association for registration:

(i) Private limited Companies

(ii) Companies limited by Guarantee

(iii) Unlimited Companies.

The Articles of Association of a private company must contain

the prescribed restrictions. The Articles of guarantee company
should state the number of members with which the company is
to be registered and the articles of an unlimited company

72
should state both the number of members as well as the
amount of share capital (if any) with which the company is to be
registered.

A public company limited by share capital may either have its

own articles or may adopt Table A (as given in Schedule I)
which contains a model set of Articles. In case such a company
does not file its own articles, it is presumed that it has adopted
Table A as its Articles.

Further, in case of company limited by shares if its articles are

silent on any point, the regulations of Table A would apply
unless the company has declared in its articles that Table A
shall not apply. [Sec. 28 (2)]

 The Importance of the Articles of Association(AoA)

after a round of funding

It is never too late and never too old to stress on the

importance of amending the Articles of Association (AoA) of
a company, especially after the company’s received some
funding. In fact, going by the judicial precedents that have
been set by the High Courts and the Supreme Court in India,
where there maybe any conflict between transaction
documents and the AoA, or when content from the
transaction documents has been omitted to be added via an
amendment to the AoA, it is always the AoA that prevails.

The AoA is an important charter document laying down

regulations governing the management of the company
including information regarding general meetings, board of
directors, proceedings by the Board and details on voting
rights. The relevant sections from the Companies Act, 2013
that refers to the AoA are sections 5, 6, 10, 14 and 15.

Difference between MOA and AOA

73
The fundamental points of distinction between MOA and
AOA are as follows:

BASIS FOR MEMORANDUM ARTICLES OF

COMPARISON OF ASSOCIATION ASSOCIATION
Memorandum of Articles of
Association (MOA) Association (AOA)
is a document that is a document
contains all the containing all the
Definition
fundamental data rules and
which are required regulations that
for the company govern the
incorporation. company
MOA must be
The articles may or
registered at the
Registration may not be
time of
registered.
incorporation.
The articles
demonstrate
The Memorandum obligations, rights,
is the charter, which and powers of
characterizes and individuals, who are
Scope
limits powers and endowed with the
constraints of the responsibility of
organization. running the
organization and
administration.
Supreme It is subordinate to
Status
document. the memorandum.
The memorandum The articles are
cannot give the constrained by the
company power to act, but they are
Power do anything also subsidiary to
opposed to the the memorandum
provision of the and cannot exceed
companies act. the powers

74
 contained therein.
The articles can be
A memorandum
drafted according to
Contents must contain six
the decision of the
clauses.
Company.
The articles provide
The memorandum the regulations by
contains the which those
Objectives objectives and objectives and
powers of the powers are to be
company. conveyed into
impact.
Any provision, as
The memorandum
opposed to a
is the dominant
Validity memorandum of
instrument and
association, is
controls articles.
invalid.

 Main Difference

A Memorandum of Association also called as MOA become a

legal document that exists to define the relationship of the
company with its shareholders and helps with the initiation and
registration of a limited liability company. An Articles of
Association also called AOA becomes a document that has all
the purposes and aims of a company and the type that defines
the duties and responsibilities of all the members that become
a part.

Comparison Chart

75
 Memorandum of
Basis of Distinction Association Article of Association

A legal document that exists A document that has all the

to define the relationship of purposes and aims of a
the company with its company and the type that
shareholders and helps with defines the duties and
the initiation and registration responsibilities of all the
Definition of a limited liability company. members that become a part.

Contains all the information Contains all the working

required to ensure that the principles and duties for
company has the capacity of individuals who work within
Format running on its own. the organization.

Type Objectives Rules

Benefit Makes a company registered. Keeps a company running.

 Memorandum of Association
A Memorandum of Association also called as MOA become a
legal document that exists to define the relationship of the
company with its shareholders and helps with the initiation and
registration of a limited liability company. A Memorandum of
Association (MOA) is an official archive arranged in the
development and enlistment procedure of a restricted obligation
organization to characterize its association with shareholders.
The MOA is open to general society and portrays the
organization’s name, the physical address of registered office,
names of shareholders and the dissemination of offers. The
MOA and the Articles of Association fill in as the constitution of
the organization. The MOA does not connect in the U.S. be that
as it may, is a legal necessity for constrained obligation
organizations in European nations including the United
Kingdom, France and Netherlands, and also some
Commonwealth countries. It must get recorded with the
Registrar of Companies amid the procedure of joining of a
Company. It contains the essential conditions after that the
organization is permitted to operate.Its reason for existing is to
empower shareholders, leasers, and the individuals who
manage the organization to recognize what is its allowed scope
of big business. It educates all people what the team is framed

76
to do and what capital it needs to do with. The report directs the
organization’s outside issues. The name condition obliges you
to express the official and perceived name of the group. You
are permitted to enroll a team name just on the off chance that
it doesn’t bear any likenesses with the name of a current group.

 Articles of Association
An Articles of Association also called AOA becomes a
document that has all the purposes and aims of a company and
the type that defines the duties and responsibilities of all the
members that become a part. It becomes a compulsion and
therefore gets filed with the registrar of companies. The article
of affiliation is a report that indicates the controls for an
organization’s operations, and they characterize the
administration’s motivation and lay out how assignments are to
be proficient inside the association, including the procedure for
selecting chiefs and how money related records will be dealt
properly. Articles of affiliation frequently recognize the way in
which an organization will issue stock offers, pay profits and
review financial records and energy of voting rights. This
arrangement of principles can be viewed as a client’s manual
for the organization since they diagram the approach for
achieving the everyday errands that must be finished. An
organization is a joined body so there ought to be a few
principles and directions framed for the administration of its
fundamental issues and lead of its business and the connection
between the individuals and the organization. Also, the rights
and obligations of its persons and the group are to record. It is
the reason Articles of Association are necessary. The Articles
of Association is an archive that contains the cause of the
group and also, the obligations and duties of its individuals
characterized and recorded unmistakably. It also becomes an
important document which needs to get filed with the Registrar
of Companies.

77
Key Differences

 A Memorandum of Association also called as MOA

become a legal document that exists to define the
relationship of the company with its shareholders and
helps with the initiation and registration of a limited liability
company.
 An Articles of Association also called AOA becomes a
document that has all the purposes and aims of a
company and the type that defines the duties and
responsibilities of all the members that become a part.
 Memorandum of Association contains all the information
required to ensure that the company has the capacity of
running on its own. On the other hand, the Article of
Association contains all the working principles and duties
for individuals who work within the organization.
 Memorandum of Association contains all the objectives of
a company, on the other hand, Article of Association
contains all the rules of a company.
 Changes can easily take place when we talk about an
item of association as new posts keep on creating and
working changes. On the other hand, memorandum of
association always stays fixed, and amendments cannot
occur.
 Six classes became a requirement for a memorandum of
association and fulfilled to get authority. On the other
hand, no such condition exists, and the provisions may
increase of decrease.

Prospectus
What is a 'Prospectus'
A Prospectus is a formal legal document that is required by and
filed with the Securities and Exchange Commission (SEC) that
provides details about an investment offering for sale to the
public. The preliminary prospectus is the first offering document

78
provided by a security issuer and includes most of the details of
the business and transaction in question; the final prospectus,
containing finalized background information including such
details as the exact number of shares/certificates issued and
the precise offering price, is printed after the deal has been
made effective. In the case of mutual funds, a fund prospectus
contains details on its objectives, investment strategies, risks,
performance, distribution policy, fees and expenses, and fund
management.

BREAKING DOWN 'Prospectus'

A prospectus includes the name of the company issuing the

stock or the mutual fund manager, the amount and type of
securities being sold and, for stock offerings, the number of
available shares. The prospectus also details whether an
offering is public or private, how much the underwriters are
earning per sale and names of the company’s principals. A brief
summary of the company’s financial information, whether the
SEC approved the prospectus and other pertinent information
is included as well.

Fees in a Prospectus

Because the fees that mutual funds charge take away from
investors’ profits, the fees are listed in a table near the
beginning of the prospectus. Fees for purchases, sales and
moving among funds are included. This simplifies comparing
the costs of various mutual funds. High-cost funds have fees
exceeding 1.5%, whereas low-cost funds have expenses below
1%.

Risks in a Prospectus

A prospectus is issued as a way of informing investors about

the risks involved with investing in a stock or mutual fund. The
information also guards the issuing company against claims
that pertinent information was not fully detailed before the
investor put money into a security.
79
Risks are typically disclosed early in the prospectus and
described in more detail later. The age of the company, amount
of management experience and involvement in the business,
and capitalization of the stock issuer are described. A table
detailing which people own stock is included and should be
studied to determine whether the principals are holding onto
their stock. If shares are being liquidated, there may be a
financial issue with the business.

Prospectus Example

When social media company Snap Inc. went public in March

2017, it issued a prospectus to shareholders and potential
investors that February. The document outlined what the
company does, its strategy, capital structure, share offering
details, financial information and risks involved in its business.
For instance, investors learned that 158 million people used
Snapchat daily and that it made $404 million in revenue in
2016.

Prospectus: Meaning, Contents, Types, Requirements on

Issue of Prospectus, Misleading of Prospectus, Liabilities
and Defence in Misleading of Prospectus

Prospectus:

Section 2(70) of the Companies Act, 2013 defines a

prospectus as ““A prospectus means Any documents
described or issued as a prospectus and includes any
notices, circular, advertisement, or other documents inviting
deposit fro the public or documents inviting offer from the
public for the subscription of shares or debentures in a
company.” A prospectus also includes shelf prospectus and
red herring prospectus. A prospectus is not merely an
advertisement.

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A document shall be called a prospectus if it satisfy two
things:

1. It invites subscription to shares or debentures or invites

deposits.

2. The aforesaid invitation is made to the public.

Contents of a prospectus:

1. Address of the registered office of the company.

2. Name and address of company secretary, auditors,

bankers, underwriters etc.

3. Dates of the opening and closing of the issue.

4. Declaration about the issue of allotment letters and

refunds within the prescribed time.

5. A statement by the board of directors about the separate

bank account where all monies received out of shares issued
are to be transferred.

6. Details about underwriting of the issue.

7. Consent of directors, auditors, bankers to the issue,

expert’s opinion if any.

8. The authority for the issue and the details of the resolution
passed therefore.

9. Procedure and time schedule for allotment and issue of

securities.

10. Capital structure of the company.

11. Main objects and present business of the company and

its location.

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12. Main object of public offer and terms of the present issue.

13. Minimum subscription, amount payable by way of

premium, issue of shares otherwise than on cash.

14. Details of directors including their appointment and

remuneration.

15. Disclosure about sources of promoter’s contribution.

16. Particulars relation to management perception of risk

factors specific to the project, gestation period of the project,
extent of progress made in the project and deadlines for
completion of the project.

Various Categories of Prospectus

1. Statement in lieu of Prospectus: A public company,

which does not raise its capital by public issue, need not
issue a prospectus. In such a case a statement in lieu of
prospectus must be filed with the Registrar 3 days before the
allotment of shares or debentures is made. It should be
dated and signed by each director or proposed director and
should contain the same particulars as are required in case
of prospectus proper.

2. Deemed Prospectus: Section 25 of the companies Act,

2013 provides that all documents containing offer of shares
or debentures for sale shall be included within the definition
of the term prospectus and shall be deemed as prospectus
by implication of law.

Unless the contrary is proved an allotment of or an

agreement to allot shares or debentures shall be deemed to

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have been made with a view to the shares or debentures
being offered for sale to the public if it is shown

a. That the offer of the shares or debentures of or any of

them for sale to the public was made within 6 month after the
allotment or agreement to allot; or

b. That at the date when the offer was made the whole
consideration to be received by the company in respect of
the shares or debentures had not been received by it.

All enactments and rules of law as to the contents of

prospectus shall apply to deemed prospectus.

3. Abridged Prospectus [Sec. 2(1)]: Abridged prospectus

means a memorandum containing such salient features of a
prospectus as may be specified by the SEBI by making
regulations in this behalf. No form of application for the
purchase of any of the securities of a company shall be
issued unless such form is accompanied by an abridged
prospectus. A copy of the prospectus shall, on a request
being made by any person before the closing of the
subscription list and the offer, be furnished to him.

Legal requirement regarding issue of prospectus: (Sec.

26 of the Companies Act, 2013)

The Companies Act has defined some legal requirements

about the issue and registration of a prospectus. The issue of
the prospectus would be deemed to be legal only if the
requirements are met.

1. Issue after the incorporation: As a rule, the prospectus

of a company can only be issued after its incorporation. A
prospectus issued by, or on behalf of a company, or in
relation to an intended company, shall be dated, and that
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date shall be taken as the date of publication of the
prospectus.

2. Registration of prospectus: it is mandatory to get the

prospectus registered with the Registrar of Companies
before it is issued to the public. The procedure of getting the
prospectus registered is as under:

A. A copy of the prospectus, duly signed by every person

who is named therein as a director or a proposed director of
the company must be filed with Registrar of Companies
before the prospectus is issued to the public.

B. The following document must be attached thereto:

i) Consent to the issue of the prospectus required under any

person as an expert confirming his written consent to the
issue thereof, and that he has not withdrawn his consent as
aforesaid appears in the prospectus.

ii) Copies of all contracts entered into with respect to the

appointment of the managing director, directors and other
officers of the company must also be filed with Registrar.

iii) If the auditor or accountant of the company has made any

adjustments in the company’s account, the said adjustments
and the reasons thereof must be filed with the documents.

iv) There must be a copy of the application which is to be

filled for the issue of the company’s shares and debentures
attached with the prospectus.

v) The prospectus must have the written consent of all the

persons who have been named as auditors, solicitors,
bankers, brokers, etc.

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C. Every prospectus must have, on the face of it, a statement
that:

i) A copy of the prospectus has been delivered to the

Registrar for registration.

ii) Specifies that any documents required to be endorsed by

this section have been delivered to the Registrar.

D. A copy of the prospectus must be filed with the Registrar

of Companies.

E. According to the Section 26, no prospectus shall be

issued more than ninety days after the date on which a copy
thereof is delivered for registration.

If a prospectus issued in contravention of the above –stated

provisions, then the company and every person who knows a
party to the issue of the prospectus shall be punishable with
a fine.

Misleading Prospectus or Mis-statement in prospectus:

A prospectus is said to be misleading or untrue in two

following cases:

1. A statement included in a prospectus shall be deemed to

be untrue, if the statement is misleading in the form and
context in which it is included.

2. Omission from prospectus of any matter to mislead the

investors.

CRIMINAL LIABILITY FOR MIS-STATEMENT IN

PROSPECTUS (SECTION 34):
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Where a prospectus, issued, circulated or distributed:

1. includes any statement which is untrue or misleading in

form or context in which it is included; or

2. where any inclusion or omission of any matter is likely to

mislead;

Every person who authorises the issue of such prospectus

shall be liable under section 447 i.e. fraud.

Defences available in this section are:

1. Person prove that statement or omission was immaterial;

2. Person has reasonable ground to believe and did believe

that statement was true; or

3. Person has reasonable ground to believe and did believe

that the inclusion or omission was necessary.

CIVIL LIABILITY FOR MIS-STATEMENTS IN

PROSPECTUS (SECTION 35):

Where a person has subscribed for securities of a company

acting upon any misleading statement, inclusion or omission
and has sustained any loss or damage as its consequence,
the company and every person who:

1. is a director at the time of the issue of prospectus;

2. has named as director or as proposed director with his

consent;

3. is a promoter of the company;

4. has authorised the issue of the prospectus; and

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 5. is an expert;

shall be liable to pay compensation to effected person. This

civil liability shall be in addition to the criminal liability under
section 36. Where it is proved that a prospectus has been
issued with intent to defraud the applicants for the securities
of a company or any other person or for any fraudulent
purpose, every person shall be personally responsible,
without any limitation of liability, for all or any of the losses or
damages that may have been incurred by any person who
subscribed to the securities on the basis of such prospectus.

Defences under this section are:

1. he has withdrawn his consent or never give his consent;

2. the prospectus was issued without his knowledge or

consent and when he become aware, gave a reasonable
public notice that prospectus was issued without his
knowledge or consent.

 Understanding Prospectus | Meaning | Objectives

| Contents
What is a Prospectus?
Prospectus is an invitation issued to the public to offer for
purchase/subscribe shares or debentures of the company. In
other words, any advertisement offering shares or debentures
of the company for sale to the public is a prospectus. A
company secures capital by the issue of prospectus inviting
deposits or offers for shares and debentures from the public.

Meaning of Prospectus

It is a document containing detailed information about the

company. It is an invitation to the public for subscribing to the
shares or debentures of the company.
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Private limited companies are strictly prohibited from issuing
prospectus and they cannot invite public to subscribe to their
shares. Only public limited companies can issue prospectus.
Thus, it is an open invitation extended to the public at large.

Objectives of Issuing Prospectus

1. To bring to the notice of the public that a new company has

been formed.

2. To preserve authentic record of the terms and allotment on

which the public have been invited to buy its shares or
debentures.

3. To secure that the directors of the company accept

responsibility for the statements in the prospectus.

Requirements of a Correct Prospectus:

The correct prospectus must have the following.

1. It must not be exaggerated

2. It must contain full and honest disclosures

3. Material facts must be disclosed and should not to be

concealed

Contents of Prospectus

The contents of the prospectus have been specified in

Schedule II of the Companies Act. The important contents in
the prospectus include the following.

1. Name and address of the company

2. Objects of the company

3. Full particulars of the signatories to the Memorandum and

number of shares taken by them.

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4. The names, addresses and occupations of the directors,
managing directors or managers etc.

5. The number and classes of shares.

6. The minimum subscription.

7. The qualification shares of a director and the remuneration of

the directors.

8. The amount payable on application, on allotment and on

calls.

9. The names of the underwriters.

10. The estimated amount of preliminary expenses.

11. The names and addresses of the auditors of the company.

12. Particulars about reserves and surpluses.

13. Voting rights of the different classes of shares.

14. Reports of the auditors regarding profits and losses of the

company.

15. A similar report by the Chartered Accountant regarding the

Profits and Losses and Assets and Liabilities of the Company.

Consequences of misstatements in Prospectus

The persons, responsible for preparing false and misleading

prospectus will face civil and criminal liabilities.

1. Civil liability

In case, misleading prospectus amounts to misrepresentation,

the aggrieved persons can repudiate the contract. They can
claim refund of their money. Damages can also be claimed
from the persons found guilty.

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2. Criminal liability

In case any deliberate concealment is made, directors will be

punished with a fine of Rs. 5,000 or imprisonment up to two
years or both. If it is fraud the fine will extend to Rs. 10,000 or 5
years imprisonment or both.

Statement in Lieu of Prospectus

When the prospectus is not issued by the company a statement

in lieu of prospectus, must be filed with the Registrar at least
three days before the allotment of shares. The contents of the
statement in lieu of prospectus are very much similar to the
prospectus. The statement must be signed by all the directors
or their agents authorized in writing. These provisions do not
apply to a private company.

 Importance of a Prospectus
A prospectus is a document that companies and others file
with the Securities and Exchange Commission when they
are offering new shares of a security to the public. One of
the most common reasons for issuing a prospectus is
when a company is making an initial public offering,
putting shares of stock up for sale for the first time. Mutual
funds issue a prospectus at regular intervals because they
routinely make new shares available.
Issuer Information
Among the most salient details in the prospectus for a new
stock are the descriptions that the company offers of itself, its
assets, its operations, its goals and its business plan. The
prospectus also features a section known as "certain
considerations," which explains any particular risk factors that
could impede the success of the company and harm a
shareholder's investment in its stock. Other company
information includes an examination of the competition,
pending legislation and the broader economy and its influence
on the company. A prospectus for a stock also features a

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financial statement for the company and the opinion of an
independent auditor about the company's financials. A bond
prospectus similarly features relevant financial information
about the corporation or public entity issuing the bond.
Offering Information
In addition to issuer information, a prospectus for a stock or
bond offering includes information about the security itself. It
describes the number of shares or bond certificates being sold
in an offering, the price, the underwriter and how the security
will be available for purchase. For either a stock or a bond, the
prospectus should specify how the company or public entity
that is selling the security will use the funds that are being
raised from the sale. If the prospectus is for a stock, it will
include information about its dividend policy and it will describe
the different classes of stock and the voting rights for
shareholders.
Mutual Fund Activity, Objectives and Leadership
A mutual fund prospectus details the performance of the fund,
often including both recent quarterly results and those from
previous calendar years. It also specifies the various goals for
the fund and the basic overarching investment strategies that
guide it. For instance, the prospectus for a fund might indicate
that the fund invests in American stocks with strong long-term
growth potential. This type of description gives investors an
opportunity to review a fund's objectives to make sure that they
match the investors' own goals. The identity of the managers
who are steering the fund also often appears in the prospectus.
Mutual Fund Fees, Expenses and Guidance
A mutual fund prospectus provides investors with guidance to
help with their role as shareholders. For instance, it gives
investors instructions on their tax obligations related to the
shares that they own, and it also details instructions on how to
buy and sell shares of the fund. The prospectus provides a
reliable place for investors to track down the various fees that
are attached to owning shares of the fund, such as the amount
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of the management fee. In addition, the prospectus is a
document that an investor can study in order to understand all
of a fund's expenses to determine if it is operating efficiently
enough for the investor's taste.
Meaning of Prospectus of Company
“prospectus of company” means any document described or
issued as a prospectus and includes a red herring prospectus
or shelf prospectus or any notice, circular, advertisement or
other document inviting offers from the public for the
subscription or purchase of any securities of a body corporate.
A prospectus of company may issued by or behalf of a public
company. It can issue either with reference to its formation or
subsequently, or on behalf of any person who has engaged or
interested in the formation of a public company.
Types of Prospectus
Advertisement of Prospectus
Where an advertisement of any prospectus of a company is
published in any manner, it shall be necessary to specify
therein the contents of its memorandum as regards the objects,
the liability of members and the amount of share capital of the
company, and the names of the signatories to the
memorandum and the number of shares subscribed for by
them, and its capital structure.
Shelf Prospectus
(1) Any class or classes of companies, as the Securities and
Exchange Board may provide by regulations in this behalf, may
file a shelf prospectus with the Registrar at the stage of the first
offer of securities included therein which shall indicate a period
not exceeding one year as the period of validity of such
prospectus which shall commence from the date of opening of
the first offer of securities under that prospectus, and in respect
of a second or subsequent offer of such securities issued
during the period of validity of that prospectus, no further
prospectus is required.

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(2) A company filing a shelf prospectus shall be required to file
an information memorandum containing all material facts
relating to new charges created, changes in the financial
position of the company as have occurred between the first
offer of securities or the previous offer of securities and the
succeeding offer of securities and such other changes as may
be prescribed, with the Registrar within the prescribed time,
prior to the issue of a second or subsequent offer of securities
under the shelf prospectus:
Provided that where a company or any other person has
received applications for the allotment of securities along with
advance payments of subscription before the making of any
such change, the company or other person shall intimate the
changes to such applicants and if they express a desire to
withdraw their application, the company or other person shall
refund all the monies received as subscription within fifteen
days thereof.
(3) Where an information memorandum then filed, every time
an offer of securities thus made under sub-section (2), such
memorandum together with the shelf prospectus shall deemed
as prospectus.
Explanation.—For the purposes of this section, the expression
“shelf prospectus” means a prospectus in respect of which the
securities or class of securities included therein hence issued
for subscription in one or more issues over a certain period
without the issue of a further prospectus.
Red Herring Prospectus
(1) A company proposing to make an offer of securities may
issue a red herring prospectus prior to the issue of a
prospectus.
(2) A company proposing to issue a red herring prospectus
under sub-section (1) shall file it with the Registrar at least
three days prior to the opening of the subscription list and the
offer.

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(3) A red herring prospectus shall carry the same obligations as
are applicable to a prospectus and any variation between the
red herring prospectus and a prospectus shall thus highlighted
as variations in the prospectus.
(4) Upon the closing of the offer of securities under this section,
the prospectus stating therein the total capital raised, whether
by way of debt or share capital, and the closing price of the
securities and any other details as not included in the red
herring prospectus shall then filed with the Registrar and the
Securities and Exchange Board.
Explanation.—For the purposes of this section, the expression
“red herring prospectus” means a prospectus which does not
include complete particulars of the quantum or price of the
securities included therein.
 PROSPECTUS (Companies Act 2013)
In last post, public offer and private placement we have
discussed public offer. In this post we will discuss Prospectus
under Companies Act, 2013
Clause (70) of Section 2 of this Bill define “prospectus” means
any document described or issued as a prospectus and
includes a red herring prospectus referred to in section 32 or
shelf prospectus referred to in section 31 or any notice, circular,
advertisement or other document inviting offers from the public
for the subscription or purchase of any securities of a body
corporate.
Section 26 deals with matters to be stated in prospectus.
MATTERS TO BE STATED IN PROSPECTUS (SECTION 26):
A prospectus may be issued by or behalf of a public company
either with reference to its formation or subsequently, or by or
on behalf of any person who is or has been engaged or
interested in the formation of a public company.
Information in Prospectus:
Every prospectus shall state following information:-

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 i. names and addresses of the registered office of the
company, company secretary, Chief Financial Officer, auditors,
legal advisers, bankers, trustees, if any, underwriters and such
other persons as may be prescribed;
ii. dates of the opening and closing of the issue, and
declaration about the issue of allotment letters and refunds
within the prescribed time;
iii. a statement by the Board of Directors about the
separate bank account where all monies received out of the
issue are to be transferred and disclosure of details of all
monies including utilised and unutilised monies out of the
previous issue in the prescribed manner;
iv. details about underwriting of the issue;
v. consent of the directors, auditors, bankers to the
issue, expert’s opinion, if any, and of such other persons, as
may be prescribed;
vi. the authority for the issue and the details of the
resolution passed there for;
vii. procedure and time schedule for allotment and issue
of securities;
viii. capital structure of the company in the prescribed
manner;
ix. main objects of public offer, terms of the present issue
and such other particulars as may be prescribed;
x. main objects and present business of the company
and its location, schedule of implementation of the project;
xi. particulars relating to—
1. management perception of risk factors specific to the
project;
2. gestation period of the project;
3. extent of progress made in the project;
4. deadlines for completion of the project; and
5. any litigation or legal action pending or taken by a
Government Department or a statutory body during the
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 last five years immediately preceding the year of the issue
of prospectus against the promoter of the company;
xii. minimum subscription, amount payable by way of
premium, issue of shares otherwise than on cash;
xiii. details of directors including their appointments and
remuneration, and such particulars of the nature and extent of
their interests in the company as may be prescribed; and
xiv. Disclosures in such manner as may be prescribed
about sources of promoter’s contribution.
Reports with Prospectus:
Every prospectus shall set out following reports for the purpose
of financial information:
i. Reports by the auditors of the company with respect
to its profits and losses and assets and liabilities and such other
matters as may be prescribed;
ii. Reports relating to profits and losses for each of the
five financial years immediately preceding the financial year of
the issue of prospectus including such reports of its
subsidiaries and in such manner as may be prescribed. Where
company has not completed five financial years than such
report for all financial years is required.
iii. Reports made in the prescribed manner by the
auditors upon the profits and losses of the business of the
company for each of the five financial years immediately
preceding issue and assets and liabilities of its business on the
last date to which the accounts of the business were made up,
being a date not more than one hundred and eighty days
before the issue of the prospectus. Where company has not
completed five financial years than such report for all financial
years is required.
iv. Reports about the business or transaction to which the
proceeds of the securities are to be applied directly or
indirectly.
Declaration of Compliance:

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Every prospectus shall make a declaration about the
compliance of the provisions of this Act and a statement to the
effect that nothing in the prospectus is contrary to the
provisions of this Act, the Securities Contracts (Regulation) Act,
1956 and the Securities and Exchange Board of India Act, 1992
and the rules and regulations made there under.
Other matters in Prospectus:
Clause (d) of Sub – section (1) of section 26 give unlimited
power to central government to list other matters and set out
other reports to be included in a prospectus.
Delivery of Prospectus with Registrar:
A copy of prospectus shall be delivered to the Registrar for
registration signed by every person who is named as a director
or proposed director of the company or by his duly authorised
attorney on or before the date of its publication and only then it
shall be issued by or on behalf of a company or in relation to an
intended company.
Statement of an Expert:
A statement made by an expert shall be included only if expert
is or was engaged or interested in the formation or promotion or
management of the company and has given his written consent
to the issue of the prospectus. Such consent of expert must not
be withdrawn by his before the delivery of prospectus to the
Registrar for registration and a statement to that effect shall be
included in the prospectus.
Every prospectus issued shall state that a copy has been
delivered to the Registrar and specify attached documents.
The registrar shall not register a prospectus all requirements
has been complied with and the prospectus is accompanied by
the consent in writing of all the person named in the
prospectus.
Prospectus shall not be valid if it is issued more than ninety
days after the date on which a copy thereof delivered to the
Registrar.

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Caution:
If a prospectus is issued in contravention of the provisions of
section 26, the company shall be punishable with fine which
shall not be less than fifty thousand rupees but which may
extend to three lakh rupees and every person who is knowingly
a party to the issue of such prospectus shall be punishable with
imprisonment for a term which may extend to three years or
with fine which shall not be less than fifty thousand rupees but
which may extend to three lakh rupees, or with both.
VARIATION IN TERMS OF CONTRACT OR OBJECTS IN
PROSPECTUS (SECTION 27):
A company may vary the terms of a contract refered in the
prospectus or object for which the prospectus was issued, only
under approval or authority given by way of special resolution.
The notice of such resolution to shareholders shall also be
published in the newspapers (one in English and one in
vernacular language) in the city where the registered office of
the company is situated. These notices shall clearly indicate
justification for such variation.
The shareholders who have not agreed to the proposal to vary
the terms of contracts or objects referred to in the prospectus,
shall be given an exit offer by promoters or controlling
shareholders at exit price as determined in accordance with
regulation made by the Securities and Exchange Board of
India.
Requirement in Deemed Prospectus (Section 25):
Section 26 as applied by Section 25 shall have effect as if —
1. it required a prospectus to state in addition to the matters
required by section 26 to be stated in a prospectus—
i. the net amount of the
consideration received or to be received by the company in
respect of the securities to which the offer relates; and

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 ii. the time and place at which the
contract where under the said securities have been or are to be
allotted may be inspected;
1. the persons making the offer were persons named in a
prospectus as directors of a company.
Prospectus as a topic is long to discuss. We will discuss
advertisement of prospectus, Shelf prospectus, Red herring
prospectus and application in a future post.
 VARIANTS OF PROSPECTUS (Companies Act, 2013)
In our last blog post Prospectus (Companies Act 2013) , we
discussed provisions related to prospectus. We will continue
our study in this post.
ADVERTISEMENT OF PROSPECTUS (SECTION 30):
When a company issue an advertisement of prospectus, the
advertisement shall specify contents of its memorandum; the
objects, the liability of members, amount of share capital, name
of signatories, and number of shares subscribed for by these
signatories and its capital structure.
SHELF PROSPECTUS (SECTION 31):
Any class of company may file a shelf prospectus with the
Registrar of Companies at the stage of first offer of securities.
“Shelf prospectus” means a prospectus in respect of which the
securities or class of securities included therein are issued for
subscription in one or more issues over a certain period without
the issue of a further prospectus.
The shelf prospectus shall indicate that validate period of the
shelf prospectus is a period not exceeding one year from the
date of first offer of securities under that prospectus. Once, a
shelf prospectus has been issued, there will be no requirement
of any further prospectus for any subsequent offer of these
securities issued during this validity period.
For any subsequent issue, company shall file an “Information
Memorandum”. This information memorandum shall contain all
material facts relating to (i) new charges created; and (ii)

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changes in financial position of the company from first/previous
offer to this second/subsequent offer under this Shelf
Prospectus.
It may be possible that a company or any other person has
received an application and advance payment of subscription
before any material changes like new charges or financial
position. In these cases, the company or that other person shall
intimate these changes to the applicants. If they express a
desire to withdraw their application, the company or other
person shall refund all the money received as share application
money for subscription within fifteen days.
When an offer of securities is made on shelf prospectus, the
information memorandum together with shelf prospectus shall
be deemed to be a prospectus.
RED HERRING PROSPECTUS (SECTION 32):
A company may issue a red herring prospectus before the
issue of a prospectus.
“Red herring prospectus” means a prospectus which does not
include complete particulars of the quantum or price of the
securities included therein.
The company shall file red herring prospectus with Registrar of
companies at least three days before the opening of the
subscription list and the offer.
A red herring prospectus shall carry the same obligation as are
applicable to a prospectus. In case there is any variation
between red herring prospectus and a prospectus shall be
highlighted as variation in the prospectus.
Upon the closing of the offer of securities, the prospectus shall
be filed with the Registrar and the Securities and Exchange
Board of India. This prospectus shall state (a) total capital
raised, (b) whether debt capital or share capital, (c) closing
price of the securities and (d) any other details not included in
red herring prospectus.

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ISSUE OF APPLICATION FORMS AND ABRIDGE
PROSPECTUS (SECTION 33):
Every application form for the purchase of the securities of a
company shall be issued unless the form is accompanied by an
“Abridge Prospectus”.
There is no need for abridge prospectus in case of:
a) Underwriting Agreement; and
b) Private placement.
Any person may make a request for a copy of the prospectus
before closing of the subscription list and the offer. The
company shall furnish a copy to him.
Any default in under this section, company shall be liable to a
penalty of fifty thousand rupees for each default.
In our next post, we will discuss matters related to issue and
allotment of securities.
What Are the Different Types of Prospectus?
A prospectus is a brief, legal document formulated in a simple
style and used to present to potential investors all important
information about a given company (issue of securities,
investment offering, etc) in relation to its . This document must
be prepared by the company which files it with and gets it
approved by the securities commission before the company
may issue shares or debt to the public. The company sets out
in its prospectus the securities offered for sale, the unit and
total issue price, its management, its operations, how it intends
to use the raised funds, and all relevant technical and financial
information (underwriting agreement, dividend
policy, capitalization, etc). A typical prospectus must contain all
material information that would allow investors to make an
informed decision as to whether to purchase the securities of
the company that constitute the offer.
The most common types (classifications) of prospectus are red-
herring prospectus, pink-herring prospectus, free-writing

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prospectus, abridged prospectus, and reconfirmation
prospectus.
 Red-herring prospectus: a prospectus that contains
most of the information that will be presented in the final
prospectus but often does not mention a price and/or the
number of securities. It can be distributed to potential
investors after the registration statement for a securities
offering has been filed with the securities commission. The
name is derived from the red legend printed across the
body of the prospectus illustrating that the registration has
been filed but is not yet effective. A red-herring prospectus
is alternatively known as apreliminary prospectus.
 Pink-herring prospectus: a prospectus that is issued
without disclosure of the number of securities being
offered or, in an initial public offering, the estimated or
indicative price range. It is a preliminary prospectus that
precedes the filing of a red-herring prospectus.
 Free-writing prospectus: any sort of written, electronic,
or graphic statement that describes an offer in terms of its
issuer or securities. It includes a legend stating that the
investor can have a copy of the prospectus at the website
of relevant securities commission. Typically, the issuer
must file this prospectus with the securities commission no
later than the first date it is obtained. In the case of
inexperienced issuers, the securities commission may
require that a preliminary prospectus is filed before the
filing of a free-writing prospectus.
 Abridged prospectus: a shorter version of the
prospectus that includes all the most key elements of the
typical prospectus. An abridged prospectus contains
information very similar to the typical prospectus but in a
concise and compact form. Both versions of the
prospectus must comply with the disclosure requirements
prescribed by the relevant securities commission.

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  Reconfirmation prospectus: a prospectus that a shell
company must prepare and submit for the approval of
relevant securities and exchange authorities (the SEC)
prior to considering areverse merger. This prospectus
contains detailed information about the private company
merging into the shell. It is handed over to purchasers in
the shell's initial public offering(IPO) who must reconfirm
their investment after perusing the prospectus before the
merger can be finalized. At least 80 percent of purchasers
must reconfirm so that the merger transaction can be
effected. Purchasers who do not confirm will receive their
investment back (of course, less expenses).
Other types that do exist in the global world of investment
include shelf prospectus and deemed prospectus:
 Shelf prospectus: a prospectus that describes a set of
unissued, but registered securities. It is used in situations
where securities are issued in consecutive stages over a
period of time because the size of issue is too large (and
funds to be raised are enormous, making the filing of
prospectus each time very expensive). Later on, an issuer
will only need to file the so-called information
memorandum with the relevant securities commission.
 Deemed prospectus: a prospectus that is deemed to
have been made by the issuer, though it is actually offered
to the public by a third party or the so-called issue
house (Indian terminology). The issuer saves the
underwriting expenses in selling its securities.
Types of business entities in India( Types of
Companies in India)
India is an emerging market with wide scope and opportunities
for both Indian and foreign investors. The Government of India
offers entrepreneurial friendly policies which makes invasion
and growth of businesses in India easier.

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Before starting a business it is very important for the
entrepreneur to prepare a blueprint of his business. This
blueprint is referred to as business plan which serves as a tool
for planning. It is a formal written document which specifies the
entrepreneurial vision, mission and strategy.

Every business plan must include the following:

1. Cover page
2. Table of contents
3. Executive Summary
4. Development and Production
5. Resource Requirement
6. Format and Presentation
7. Writing and Editing
8. Summary
There are various forms of business entities in India:
 Private Ltd Company

 Public Ltd Company

 Unlimited Company

 Sole proprietorship

 Joint Hindu Family business

 Partnership

 Cooperatives

 Limited Liability Partnership(LLP)

 Liaison Office

 Branch Office

 Project Office

 Subsidiary Company

Private Ltd Company

A private company has the following features:

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 1. Restricts the right of the shareholders to transfer their
shares.
2. Has a minimum of 2 and maximum of 50 members.
3. does not invite public to subscribe to its share capital
4. Must have a minimum paid up capital of Rs. 1 lakh or such
a higher amount which may be prescribed from time to
time.
Public Ltd Company :
A public Ltd company has the following characteristics:

1. It allows the shareholders to transfer their shares.

2. Has a minimum of 7 members, and for maximum there is
no limit.
3. it invites the general public to subscribe to its shares
4. Must have a minimum paid up capital of Rs 5 lakh or such
a higher amount as may be prescribed from time to time.
Unlimited Company
Unlimited Company is a form of business organization under
which the liability of all its members is unlimited. The personal
assets of the members can be used to settle the debts. It can at
any time re-register as a limited company under section 32 of
the Companies Act.

Sole proprietorship
Sole proprietorship is a form of business entity where a single
individual handles the entire business organization. He is the
sole recipient of all profits and bearer of all loses. There is no
separate law that governs sole proprietorship.

Joint Hindu Family

Joint Hindu Family is a form of business organization wherein
the members of a family can only own and manage the
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business. It is governed by Hindu Law.

Partnership
Partnership is “the relation between persons who have agreed
to share the profits of the business carried on by all or any one
of them acting for all”. It is governed by the Indian Partnership
Act 1932.

Co-operatives
Co-operatives is a form of voluntary organization, wherein the
members work together for the promotion of the interests of its
members. There is no restriction to the entry or exit of any
member. It is governed by Cooperative Societies Act 1912.

Limited Liability Partnership

Under LLP (Limited Liability Partnership) the liability of at least
one member is unlimited whereas rest all the other members
have limited liability, limited to the extent of their contribution in
the LLP. Unlike general partnership this kind of partnership
does not get terminated by the death or insolvency of the
limited partners. It is governed by Limited Liability Partnership
Act of 2008.

Liaison Office
Liaison Office is a kind of representative office which is set up
to understand the business and investment environment. It is
barred from taking up any commercial/industrial/trading activity
and its role is limited to aggregation of information and
promotion of exports/imports. It has to maintain itself out of
inward remittances received from the parent company.

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Branch Office
Foreign companies which are into manufacturing and trading
activities abroad are permitted to set up branch offices in India
for various purposes like rendering of professional and
consultancy services, export/import of goods etc. Branch
offices are not permitted to carry out manufacturing activities on
their own. RBI is the statutory body that grants permission to
foreign companies for setting up branch offices in India.

Project Office
Foreign companies can set up temporary project offices in India
for carrying out activities related to that specific project.

Subsidiary Company
In India the sectors where 100% foreign direct investment is
permitted there foreign companies can set up wholly-owned
subsidiary. The wholly-owned subsidiary can be either of the
following business entities:
 Private Ltd Company

 Public Ltd Company

 Unlimited Company

 Sole Proprietorship

Choosing a form of business organization

Criteria Most beneficial Least beneficial

Cost of formation Sole Proprietorship Company

Ease of formation Sole proprietorship Company

Transfer of Ownership Public Ltd Company Partnership

Continuity Company Sole proprietorship

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Regulations Sole Proprietorship Company

Flexibility Sole proprietorship Company

Availability of capital Company Sole proprietorship

Liability Company and LLP Sole proprietorship

Regulatory requirements and statutory bodies involved in

starting a business
 Companies Act 1956 - It is “an act to consolidate and
amend the law relating to companies and certain other
associations”. It regulates the formation, functioning, the
winding up of the companies and also the relationship
between the company, government and public.
 Ministry of Corporate Affairs-It regulates the Companies
Act 1956 and other allied acts.

The ministry governs the following acts:

1. The Partnership Act 1932
2. The Chartered Accountants Act 1949
3. Companies Fund Act 1951
4. The Companies Act 1956
5. The Chartered Secretaries Act 1980
6. The Monopolies and Restrictive Trade Practices Act
in 1969
7. The Companies Amendment Act 2006

 Office of Registrar of Companies - The responsibility of

the Registrar of Companies is to register the companies
for their respective states and Union Territories and
ensuring that the companies abide to the legal
requirements of the Companies Act.

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  Company Law Board
 The Ministry of Environment and Forest -It is the major
administrative entity for:
1. Governing and ensuring environmental protection
2. Designing the environmental policy framework in
India
3. Undertaking conservation and survey of flora, fauna,
forest and wildlife

 The Environment Protection Act- It is an all-inclusive

legislation which affirms the Central Government to protect
and improve environmental quality control and reduce
pollution from all sources. Under the Act, the Central
Government shall have the power to take all such actions
which it considers necessary or appropriate for the
purpose of protecting and improving the quality of
environment and for abating environmental pollution.
 RBI-It regulates and controls the monetary system of the
country.
 SEBI-It is a statutory body that controls the Indian capital
market.
Types Of Companies In India: Detailed Breakdown
A company is an incorporated association of persons created
by law to carry on the expressly laid down objectives. A
company exists on in the contemplation of law. It may be
formed by an act of parliament, or by Royal Charter or by
registration under the company law. A company has perpetual
existence i.e. the existence of a company can only be
terminated by law and not by the death, retirement, insanity of
its members.
A company may be: (1) Statutory Company, or (2) Registered
Company
Statutory Company

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A company formed by a special Act passed either by the
central or the state legislature is called a statutory company.
These companies are governed by the provisions of their
special Acts. These companies are usually formed to carry out
some special public undertakings. The object such companies
are not to as such earn profits but to serve people. The audit of
such companies is conducted under the supervision, control
and guidance of the Comptroller and Auditor General of India.
Some important statutory companies are Reserve Bank of
India, State Bank of India, Life Insurance Corporation of India,
industrial Finance Corporation etc.
Registered Company
Company registered under the Indian Companies Act is known
as Registered Company. These companies are governed and
regulated by the provisions of the Companies Act, 2013. They
may be limited by shares or limited by guarantee or unlimited
companies.
KINDS OF COMPANIES ON THE BASIS OF LIABILITY OF
MEMBERS
1. Company limited by shares: This is a company having the
liability of its members limited by the memorandum to the
amount unpaid on the shares respectively held by them. A
large majority of the companies registered in India belong to
this category. The last word of the name of such companies
should be “Limited”. For example, if AB Ltd. has a share capital
of 10,000 shares of Rs. 0 each, and A has purchased 100
shares on which he has paid so far Rs. 6 per share, the
maximum liability of A is only Rs. 4 per share.
2. Company limited by Guarantee: This is a company in
which the liability of each member is limited to such amount as
the members may voluntarily undertake under the
memorandum to contribute to meet out the deficiency of the
assets of the company in the event of its being wound up. Such
companies may or may not have share capital. If it has share
capital, the liability of the members becomes two-fold; firstly,
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the amount unpaid on the shares held by them and secondly,
amount payable under the guarantee.
3. Unlimited companies: a company not having any limit
towards the liability of its members is an unlimited company.
The liability extends to the whole amount of the company’s
debts and liabilities. The registered companies (whether limited
or unlimited) may be either private or public companies.
Private limited company
Private limited company is held by few individuals privately
having separate legal entity. In this the shareholders cannot
trade shares publicly. Shareholders cannot sell their shares
without the approval of other shareholders. It is a company
which restricts the right of its members to transfer its shares
and it doesn’t send invitation to the public for subscription of its
shares.
Characteristics of the private limited company:
1. Members– To start a company, a minimum number of 2
members are required and a maximum number of 200
members as per the provisions of the Companies Act 2013.
2. Index of members– A private company has a privilege over
the public company as they don’t have to keep an index of its
members whereas the public company is required to maintain
an index of its members.
3. Exemptions regarding directors– When it comes to
directors, a private company needs to have only two directors.
With the existence of 2 directors, a private company can come
into operations. Also, private company need not appoint
independent directors. The maximum number of companies of
which a person may be appointed as a director is 20 in case of
private company.
4. Paid up capital– It must have a minimum paid-up capital of
Rs 1 lakh or such higher amount which may be prescribed from
time to time.

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5. Prospectus– Prospectus is a detailed statement of the
company affairs which is issued by a company for its public.
However in case of private limited company there is no such
need to issue a prospectus because in this public is not invited
to subscribe for the shares of the company.
6. Name– It is mandatory for all the private companies to use
the word private limited after its name.
In the case if any private limited company doesn’t follow any of
the above mentioned features, it ceases to be private company.
Public Company
A public limited company is a form of business organization that
operates as a separate legal entity from its owners. It is formed
and owned by shareholders. Shares of a public limited
company are listed and traded at a stock exchange market
freely.
Characteristics of a public company:
1. It must have a minimum of 7 members and no limit with
regards to the maximum number of members.
2. The shares of a public company are freely transferable.
3. It can invite the public to subscribe to its shares or
purchase its shares.
4. It must constitute an Audit Committee of the Board.
ONE PERSON COMPANY
This is a type of company that has only one member. OPC
provides the benefits of both forms of business- Proprietorship
and Company. With formation of an OPC business can be run
in the same way as a proprietorship by complying with law and
keeping the liability of the member limited by shares or
guarantee.
Provisions of OPC under Companies Act 2013:
 All the provisions of the Act applicable to private
companies shall also be applicable to OPC unless
otherwise excluded from compliance.

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  It should be treated as a private company for all legal
purposes.
 The name of the company shall include the words ‘One
Person Company’ within brackets below the name of the
company.
 The person forming an OPC has to nominate a person
with that person’s written consent as a nominee of the
OPC.
 It should have a maximum of 15 directors, and they aren’t
required to retire by rotation.
HOLDING AND SUBSIDIARY COMPANY
A company which controls another company is called a Holding
Company and the company so controlled is called a Subsidiary
Company.
A company shall be deemed to control another company in the
following cases-
1. If it controls the majority composition of the board of directors
of another company.
2. If it exercises or controls more than one-half of the total
share capital either at its own or together with one or more of its
subsidiary companies.
3. If another company is a subsidiary of the first mentioned
company’s subsidiary (i.e. subsidiary of the subsidiary)
ASSOCIATE COMPANY
“Associate Company” as in relation to another company, means
a company in which that other company has a significant
influence, but which is not a subsidiary company of the
company having such influence and includes a Joint Venture
Company. “Significant Influence” means control of at least 20%
of total share capital but less than 50% of share capital by
another company, or control of business decisions under an
agreement.
SMALL COMPANY

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Small company means a company, other than a public
company, whose-
1. Paid-up share capital doesn’t exceed Rs. 50 lakhs or such
higher amount as may be prescribed.
2. Turnover of which as per its last P&L A/C doesn’t exceed Rs.
2 crore or such higher amount as may be prescribed.
However, a small company cannot be-
 A holding or a subsidiary company

 A company registered under section 8 of the 2013 Act.

 A company or body corporate governed under any special

Act.
Exemptions of a small company:
 Financial statements may not include the cash flow
statement.
 The annual return shall be filed by director and company
secretary or when there is no company secretary, by two
directors.
 It is sufficient if at least one meeting of the Board of
Directors has been conducted in each half of a calendar
year.
GOVERNMENT COMPANY
A Government company means, any company in which not less
than fifty one percent of the share capital is held by the-
 Central Government, or

 Any State Government, or

 Partly by the Central Government and partly by one or

more State Governments.
It also includes a company which is a subsidiary of a
Government company.
Special provisions:
(a) The auditor of a Government Company shall be appointed
or reappointed by the Central Government on the advice of the
Comptroller and Auditor General of India. The Auditor General

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will have the power to direct the company’s auditor relating to
the manner of audit and the performance of his duties. He shall
also have the power to conduct a supplementary test audit of
the company’s account by persons appointed by him; and the
auditor is required to submit a copy of his audit report to the
Comptroller and Auditor General, who shall have the right to
comment upon the report.
(b) Where the Central Government is a member of a
Government Company, the Central Government shall prepare
an annual report on the working and affairs of the company
within three months of its annual general meeting before which
the audit report is placed. The annual report is to be laid before
both houses of Parliament together with a copy of the audit
report
FOREIGN COMPANY
Foreign company is a company incorporated outside India
which-
 Has a place of business in India whether by itself or
through an agent, physically or through electronic mode.
 Conducts any business activity in India in any other
manner.
PRODUCER COMPANY
It means a body corporate having objects or activities specified
in section 581B and deals primarily with the produce of its
active Members for carrying out any of its specified objects.
The objects of producer companies shall include one or more of
the eleven items specified in the Act, the more important being:
 Production, harvesting, procurement, grading, pooling,
handling, marketing, selling, export of primary produce of
members or import of goods or services for their benefit;
 Processing including preserving, drying, distilling, brewing,
venting, canning and packaging of produce of its
members; and

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  Manufacture, sale or supply of machinery, equipment or
consumables mainly to its members.
 rendering technical or consultancy services,

 generation, transmission and distribution of power and

revitalization of land and water resources;
 promoting techniques of mutuality and mutual assistance;

 Welfare measures and providing education on mutual

assistance principles.
DORMANT COMPANY
Where a company is formed and registered under this Act for a
future project or to hold an asset or intellectual property and
has no significant accounting transaction, such a company or
an inactive company may make an application to the Registrar
in such manner as may be prescribed for obtaining the status of
a dormant company.
Inactive company means a company which has not been
carrying on any business or operation, or has not made any
significant accounting transaction during the last two financial
years, or has not filed financial statements and annual returns
during the last two financial years.
 Types Of Companies
There are different types of company, which can be classified
on the basis of formation, liability, ownership, domicile and
control.
1. Types Of Companies On The Basis Of Formation Or
Incorporation

a. Chartered Companies
Companies which are incorporated under special charter or
proclamation issued by the head of state, are known as
chartered companies. The Bank Of England, The East India
Company, Chartered Bank etc. are the examples of chartered
companies.

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b. Statutory Companies
Companies which are formed or incorporated by a special act
of parliament, are known as statutory companies. The activities
of such companies are governed by their respective acts and
are not required to have any Memorandum or Articles Of
Association.

c. Registered Companies
Registered companies are those companies which are formed
by registration under the Company Act. Registered companies
may be divided into two categories.

* Private Company
A company is said to be a private company which by its
Memorandum of Association restricts the right of its members
to transfer shares, limits the number of its members and does
not invite the public to subscribe its shares or debentures.
* Public Company
A company, which is not private, is known as public company. It
needs minimum seven persons for its registration and
maximum to the limit of its registered capital. There is no
restriction on issue or transfer of its shares and this type of
company can invite the public to purchase its shares and
debentures.

2. Types Of Companies On The Basis Of Liability

Registered companies are divided into two types, namely,
companies having limited liability and companies having
unlimited liability.

a. Companies Having Limited Liability

This liability can be limited in two ways:
* Liability Limited By Shares
These are those companies in which the capital is divided into
shares and liability of members (share holders) is limited to the
extent of face value of shares held by them. This is the most
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popular class of company.
* Liability Limited By Guarantee
These are such companies where shareholders promise to pay
a fixed amount to meet the liabilities of the company in the case
of liquidation.

b. Companies Having Unlimited Liability

A company not having any limit on the liability of its members
as in the case of a partnership or sole trading concern is an
unlimited company. If such a company goes into liquidation, the
members can be called upon to pay an unlimited amount even
from their private properties to meet the claim of the creditors of
the company.

3. Types Of Companies On The Basis Of Ownership

a. Government Companies
A government company is a company in which at least 51% of
the paid up capital has been subscribed by the government.

b. Non-government Companies
If the government does not subscribe a minimum 51% of the
paid up capital, the company will be a non-government
company.

4. Types Of Companies On The Basis Of Domicile

a. National Companies
A company, which is registered in a country by restricting its
area of operations within the national boundary of such country
is known as a national company.

b. Foreign Companies
A foreign company is a company having business in a country,
but not registered in that country.

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c. Multinational Companies
Multinational companies have their presence and business in
two or more countries. In other words, a company, which
carries on business activities in more than one country, is
known as multinational company.

5. Types Of Companies On The Basis Of Control

a. Holding Companies
A holding company is a company, which holds all, or majority of
the share capital in one or more companies so as to have a
controlling interest in such companies.

b. Subsidiary Company
A company, which operates its business under the control of
another company (i.e holding company), is known as a
subsidiary company.

 Discuss the various kinds

of companies recognized
under the Companies Act,
2013.
Discuss the various kinds of companies recognized under the
Companies Act, 2013.
Ans. It must be noted that the incorporated companies may be
formed in three different ways, namely, (i) Companies
incorporated by Royal Charter; (ii) Companies incorporated
under the State Legislatures and (iii) Companies incorporated
under the Companies Act. These are ‘respectively called the
Chartered, Statutory and Registered Companies. The
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Chartered Companies were formed under the royal charter
issued by the British Crown during British Rule in India and
have lost their significance in the present time. The Statutory
Companies, on the other hand, are formed by an Act of
Legislature to carry on a National business while the registered
companies arc those business undertakings which are
incorporated under the Companies Act, 1956.. However, there
may be certain registered companies which are created for
non-commercial purposes such as propagation of religion
education, charity, etc.

Kinds of Companies – The Companies Act, 2013. provides, for

three basic types of companies which may be registered under
the Act. They Are:—

1. One Person Company (OPC)

2. Private Company; and

3. Public Company.

These Companies may be:-

1. Company limited by shares;

2: Company limited by guarantee; and

3. Unlimited Company.

1. Companies Limited by Shares- The main attribute of limited

companies which attracts the investors is limited liability of
share-holders. In other words, liability of a member, in the event
of company’s winding up, in respect of the shares held by him,
is limited to the extent of the unpaid value of such shares.
Thus, the liability does not fluctuate but remains limited to the

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unpaid amount of the share-holder, whether original or the
transferee.

2. Companies Limited by Guarantee- A company limited by

guarantee may also be called a Guarantee Company. It is a
company wherein the liability of its members extends to the
amount undertaken to be contributed by each of them towards
the assets of the company in the event of it’s being wound up
as stated in the Memorandum of Association of the company.
The liability would arise only in the event of the company being
wound up and not otherwise.

A guarantee company may or may not have a share capital. In

case, it has a share capital, the liability of the members would
also extend to the amount remaining unpaid in their shares in
addition to the guarantee amount. The voting power of a
guarantee company having share capital is determined by the
shareholding of the members. However, in case of Guarantee
Company not having share capital, every member has only one
vote, Vide; CI 14 of Table C, Schedule 1 of the Act. A
Guarantee company must suffix the word “Ltd”. Or ‘Pvt. Ltd.’,
as the case may be in its name and register its Articles along
With the Memorandum. The Memorandum and Articles of a
guarantee company not having share capital should be in the
form provided in Table C of Schedule 1 of the Act while that of
a company having share capital, should be in the Form as
provided in Table D.

PRIVATE AND PUBLIC COMPANIES

3. Private Companies- The companies under the first two
categories, namely, companies limited by shares and
companies limited by guarantee, may be either Private or
Public companies.

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S.2(68) of the Companies Act, 2013 define a ‘private company’
means a company having a minimum paid-up share capital of
one lakh rupees or such higher paid-up share capital as may be
prescribed, and which by its articles,—

(i) restricts the right to transfer its shares;

(ii) except in case of One Person Company, limits the number

of its members to two hundred: Provided that where two or
more persons hold one or more shares in a company jointly,
they shall, for the purposes of this clause, be treated as a
single member:

Provided further that—

(A) persons who are in the employment of the company; and

(B) persons who, having been formerly in the employment of

the company, were members of the company while in that
employment and have continued to be members after the
employment ceased, shall not be included in the number of
members; and

(iii) prohibits any imitation to the public to subscribe for any

securities of the company;

4. Public Companies-According to S. 2(71) of the Companies

Act, a ‘public company’ means a company which is not a
private company. “public company” means a company which—

(a) is not a private company;

(b) has a minimum paid-up share capital of five lakh rupees or

such higher paid-up capital, as may be prescribed:

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Provided that a company which is a subsidiary of a company,
not being a private company, shall be deemed to be public
company for the purposes of this Act even where such
subsidiary company continues to be a private company in its
articles.

In Shyam Nandan Prasad V.s. State of Bihar (1993), the

Supreme Court held that a cooperative housing society
registered under the Bihar and Orissa Corporative Societies
Act, the paid up capital of which is not subscribed to by
Government and the Membership of which exceeding fifty is
neither a Government company nor a private company but a
public company within the meaning of S.3 of the Companies
Act.

5. Unlimited Companies- According to Sec. 2(92) “unlimited

company” means a company not having any limit on the liability
of its members; a company may be incorporated with the
unlimited liability. A company having no limit on the liability of
its members is termed an unlimited company. An unlimited
company must have articles of association stating the number
of members and the share capital, if any, with which it is
proposed to be registered .The obvious disadvantages of an
unlimited company is that its, members are liable, like the
partners of a firm, for all its trade debts without any limit. But
the creditors cannot sue the members directly. They have to
sue the company or resort to winding up and the liquidators
may call upon the members to contribute to the assets of the
company. The advantages of this are that such a company
need not have arty share capital. Even if, it has, it may reduce
its capital without any restriction. It may pay back the members
and buy their shares.

6. Holding and Subsidiary Companies— Holding and subsidiary

companies are relative terms that is, a company is a holding

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company of another if the other is its subsidiary. According to
Sec.2(46) “Holding Company”, in relation to one or more other
companies, means a company of which such companies are
subsidiary companies;

7. Government Companies— According to S.(45) “Government

company” means any company in which not less than fifty one
per cent. of the paid-up share capital is held by the Central
Government, or by any State Government or Governments, or
partly by the Central Government and partly byone or more
State Governments, and includes a company which is a
subsidiary company of such a Government company;

8. Foreign Companies— According to Sec. 2(42) a foreign

company is a company which is incorporated in any country
outside India under the law of that country and has aplace of
business in India. Foreign companies are of two kinds— (i)
Companies incorporated outside India which established a
place of business in India after 1.4.1956, and (ii) Companies
incorporated outside India which established a place of
business in India before that date and continue to have an
established place of business in India.

9. Finance Companies (Financial lnstitutions)—A ‘Finance

Company’ means a non- banking company, which is a financial
institution within the meaning of S.45(1) (c) of the Reserve
Bank of India Act,1934. According to this section, a financial
institution is a non-banking institution which carries on any of
the following activities as its business or part of its business—

(i) The financing , whether by way of making loans or advances

or otherwise, or any activity other than its own;

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(ii) The acquisition of shares, stocks, bonds, debentures, or
securities issued by a Government or a local authority or other
marketable securities of similar nature;

(iii) The letting or delivery of any goods to a hirer under a hire

purchase agreement as defined in S.2( c)of the Hire- Purchase
Act,1972;

(iv) Carrying on any class of insurance business.

(v) Managing, conducting or supervising agency of chits or

kuries etc. under the law for the time being in force;

(vi) Collecting money in lump-sump or otherwise, by way of

subscription or by sale of units or other instruments or awarding
prizes, gifts, whether in cash or kind or disbursing money in any
other form to persons from whom money is collected or to any
other person.

10. FERA Companies—The companies operating in India

under the Foreign Exchange Regulation Act, 1973 are
technically called the FERA Companies. Broadly speaking, they
fall under the following categories-

1. Indian companies having no foreign interests or having less

than 40 per cent interest;

2. Indian companies having more than 40 per cent non-resident

interest. Such companies were earlier known as “foreign
eiantrolled companies”; and

3. Foreign incorporated companies which are registered in

India merely for business operations. The Central Government
may impose certain restrictions on FERA Companies U/S. 26 of
the Foreign Exchange Regulation Act, 1973.

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11. Companies Regulated by Special Acts- The companies
which are regulated by Special Acts such as the Banking
Companies governed by the Banking Companies Act, 1949;the
Insurance Companies governed by the Insurance Act,1938;
Electrcity (Supply) Acts 1948; Food Corporation Act,1964 etc.
shall have to be incorporated and registered under the
Companies Act and the provisions of the Companies Act, 1956
shall, therefore, also apply to them like any other company
except in so far as they are inconsistent with the Special Act
which constitutes them.

Characteristics of Company:

On the basis of definitions studied above, the following are

the characteristics of a company:

1. An Artificial Person Created by Law:

A company is a creation of law, and is, sometimes called an

artificial person. It does not take birth like natural person but
comes into existence through law. But a company enjoys all the
rights of a natural person. It has right to enter into contracts and
own property. It can sue other and can be sued. But it is an
artificial person, so it cannot take oath, cannot be presented in
court and it cannot be divorced or married.

2. Separate Legal Entity:

A company is an artificial person and has a legal entity quite

distinct from its members. Being separate legal entity, it bears
its own name and acts under a corporate name; it has a seal of
its own; its assets are separate and distinct from those of its
members.

Its members are its owners but they can be its creditors
simultaneously as it has separate legal entity. A shareholder
cannot be held liable for the acts of the company even if he

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holds virtually the entire share capital. The shareholders are not
agents of the company and so they cannot bind it by their acts.

3. Perpetual Succession:

The life of company is not related with the life of members. Law
creates the company and dissolve it. The death, insolvency or
transfer of shares of members does not, in any way, affect the
existence of a company.

According to Tennyson-

“For men may come, men may go,

ADVERTISEMENTS:

But I go on forever.”

In the case of company it may be said that members may come

and members may go but the company goes on. It is a legal
person having come into being by law and only law can bring
its end and none else.

4. Common Seal:

On incorporation a company becomes legal entity with

perpetual succession and a common seal. The common seal of
the company is of great importance. It acts as the official
signature of the company. As the company has no physical
form, it cannot sign its name on a contract. The name of the
company must be engraved on the common seal. A document
not bearing the common seal of the company is not authentic
and has no legal importance.

5. Limited Liability:

The limited liability is another important feature of the company.

If anything goes wrong with the company his risk is only to the

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extent of the amount of his shares and nothing more. If some
amount is uncalled upon a share, he is liable to pay it and not
beyond that.

The creditors of a company cannot get their claims satisfied

beyond the assets of the company. The liability of members of
a company ‘limited by guarantee’ is limited to the amount of
guarantee.

6. Transferability of Shares:

A shareholder can transfer his shares to any person without the

consent of other members. Under Articles of Association, a
company can put certain restriction on the transfer of shares
but it cannot altogether stop it. Private company can put more
restrictions on the transferability of shares.

7. Limitation of Work:

The field of work of a company is fixed by its charter. The

Memorandum of Association. A company cannot do anything
beyond the powers defined in it. Its action is, therefore, limited.
In order to do the work beyond the memorandum of
association, there is a need for its alteration.

8. Voluntary Association for Profits:

A company is a voluntary association of persons to earn profits.

It is formed for the accomplishment of some public good and
whatsoever profit is divided among its shareholders. A
company cannot be formed to carry on an activity against the
public policy and having no profit motive.

9. Representative Management:

The shareholders of company are widely scattered. It is not

possible for all the shareholders to take part in the
management. They leave their task to the representatives the
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Board of Directors and the company is managed by Board of
Directors.

10. Termination of Existence:

A company is created by law, carries on its affairs according to

law and ultimately is affected by law. Generally, the existence
of a company is terminated by means of winding up.

Characteristics of a Company
A company as an entity has many distinct features which
together make it a unique organization. The essential
characteristics of a company are following:

Separate Legal Entity:

Under Incorporation law, a company becomes a separate legal
entity as compared to its members. The company is distinct
and different from its members in law. It has its own seal and its
own name, its assets and liabilities are separate and distinct
from those of its members. It is capable of owning property,
incurring debt, and borrowing money, employing people, having
a bank account, entering into contracts and suing and being
sued separately.

Limited Liability:
The liability of the members of the company is limited to
contribution to the assets of the company upto the face value of
shares held by him. A member is liable to pay only the uncalled
money due on shares held by him. If the assets of the firm are
not sufficient to pay the liabilities of the firm, the creditors can
force the partners to make good the deficit from their personal
assets. This cannot be done in the case of a company once the
members have paid all their dues towards the shares held by
them in the company.

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Perpetual Succession:
A company does not cease to exist unless it is specifically
wound up or the task for which it was formed has been
completed. Membership of a company may keep on changing
from time to time but that does not affect life of the company.
Insolvency or Death of member does not affect the existence of
the company.

Separate Property:
A company is a distinct legal entity. The company's property is
its own. A member cannot claim to be owner of the company's
property during the existence of the company.

Transferability of Shares:
Shares in a company are freely transferable, subject to certain
conditions, such that no share-holder is permanently or
necessarily wedded to a company. When a member transfers
his shares to another person, the transferee steps into the
shoes of the transferor and acquires all the rights of the
transferor in respect of those shares.

Common Seal:
A company is an artificial person and does not have a physical
presence. Thus, it acts through its Board of Directors for
carrying out its activities and entering into various agreements.
Such contracts must be under the seal of the company. The
common seal is the official signature of the company. The
name of the company must be engraved on the common seal.
Any document not bearing the seal of the company may not be
accepted as authentic and may not have any legal force.

Capacity to sue and being sued:

A company can sue or be sued in its own name as distinct from
its members.

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Separate Management:
A company is administered and managed by its managerial
personnel i.e. the Board of Directors. The shareholders are
simply the holders of the shares in the company and need not
be necessarily the managers of the company.

One Share-One Vote:

The principle of voting in a company is one share-one vote i.e.
if a person has 10 shares, he has 10 votes in the company.
This is in direct distinction to the voting principle of a co-
operative society where the "One Member - One Vote" principle
applies i.e. irrespective of the number of shares held, one
member has only one vote.

Advantages and Disadvantages

of a Company Form of Business
– Explained!
Advantages:

The important advantages of company form of ownership

are as follows:

1. Limited Liability:

The liability of shareholders, unless and otherwise stated, is

limited to the face value of shares held by them or guarantee
given by them.

2. Perpetual Existence:

Deaths, insanity, insolvency of shareholders or directors do not

affect the company’s existence. A company has a separate
legal entity with perpetual succession.

3. Professional Management:

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In company business, the management is in the hands of
the directors who are elected by the shareholders and are
well experienced persons. In order to manage the day-to-
day activities, salaried professional managers are
appointed. Thus, the company business offers
professional management.

4. Expansion Potential:

As there is no limit to the maximum number of

shareholders in a public limited company, expansion of
business is easy by issuing new shares and debentures.
Companies normally use their reserves for expansion
purposes.

5. Transferability of Shares:

If the shareholders of a company are displeased with the

progress of the business, they can sell their shares any
time. During all this change of ownership, the business
continues to operate.

6. Diffusion of Risk:

As the membership is very large, the whole business risk

is divided among the several members of the company.
This is an advantage particularly for small investors.

Disadvantages:

In spite of its several advantages, the company form of

ownership also suffers from some disadvantages.

The important ones are:

1. Lack of Secrecy:

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As per the legal provisions, a company has to make
various statements available to the Registrar of the
Companies, Financial Institutions; the secrecy of business
comes down. It is further reduced when the company
provides its annual report to the shareholders as the
competitors do also find out the details of all financial
data.

2. Restrictions:

Compared to proprietorship and partnership, a company

has to comply with more legal requirements. It consumes
considerable time and effort.

3. Management Mischief’s:

Sometimes the managers and directors misuse the

company resources for their personal benefits. This brings
losses to the company and company is closed.

4. Lack of Personal Interest:

Unlike proprietorship and partnership, the day-to-day

affairs of a company are looked after by salaried
managers. Since they are the employees not the owners,
they do have hardly any personal interest and commitment
in the company. This may result in inefficiency and, in turn,
losses.

Corporations also have disadvantages compared to

proprietorships and partnerships when it comes to
taxation. Since the corporation and the stockholders are
considered to be two different legal entities, they face the
problem of double taxation, meaning that the owners are
taxed twice.

If an owner of a corporation works for the corporation, he

is paid a salary, and possibly bonuses, like any other
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employee. He pays taxes on this income, as do regular
employees, reporting and paying the tax on his personal
tax return. The corporation also pays taxes on whatever
profits are left in the businesses after paying out all
salaries, bonuses, overhead and other expenses.

Another issue that some might take as a disadvantage to

corporations is that the stockholders are not actually
owners considering the fact that they are not the decision
makers, rather the management is the one that owns the
corporation as they have all the decision making power.

Share Capital

What is 'Share Capital'

Share capital consists of all funds raised by a company in

exchange for shares of either common or preferred shares of
stock. The amount of share capital or equity financing a
company has can change over time. A company that wishes to
raise more equity can obtain authorization to issue and sell
additional shares, thereby increasing its share capital.

BREAKING DOWN 'Share Capital'

With share capital, the amount a company reports on

its balance sheet only accounts for the total amount initially
paid by shareholders. If those shareholders later resell their
shares on the secondary market, any difference between the
initial and subsequent sales prices does not impact the
company's share capital.

The term "share capital" is often used to mean slightly different

things, depending on the context. When discussing the amount
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of money a company can legally raise through the sale of stock,
there are actually several categories of share capital.
Accountants have a much narrower definition.

Authorized, Issued and Paid Share Capital

Before a company can raise equity capital, it must obtain

permission to execute the sale of stock. The company must
specify the total amount of equity it wants to raise and the base
value of its shares, called the par value. The total par value of
all the shares a company is permitted to sell is called its
authorized share capital. While a company may elect not to sell
all its shares of stock during its initial public offering (IPO), it
cannot generate more than its authorized amount. If a company
obtains authorization to raise $5 million and its stock has a par
value of $1, for example, it may issue and sell up to 5 million
shares of stock.

The total value of the shares the company elects to sell is

called its issued share capital. Not all these shares may sell
right away, and the par value of the issued capital cannot
exceed the value of the authorized capital. The total par value
of the shares that the company sells is called its paid share
capital. This is what most people refer to when speaking about
share capital.

Share Capital in Accounting

The technical accounting definition of share capital is the par

value of all equity securities – either common or preferred stock
– sold to shareholders. Lay people, however, often include the
price of the stock above par value in the calculation of share
capital. The par value of stock is typically $1 or less, so the
difference between the par and sale price of stock, called the
share premium, may be considerable, but it is not technically
included in share capital or capped by authorized capital limits.

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Assume company ABC issues and sells 1,000 shares. Each
share has a par value of $1 but sells for $25. The company
accountant logs $1,000 raised as paid share capital and the
remaining $24,000, attributed to share premium, as additional
paid in capital.

 Share Capital: It’s Meaning

and Types – Explained!
Meaning:

The Joint Stock Company is a big form of business

organization. The amount required by the company for its
business activities is raised by the issue of shares. The amount
so raised is called ‘Share Capital’ (or capital) of the company. It
may be noted that a company limited by shares will have share
capital. A company limited by guarantee or an unlimited
company may not have any share capital. The persons who
buy the shares of company are called ‘Shareholders’.

Types of Share Capital:

(i) Authorized, registered or nominal capital:

This is the amount of capital with which the company intends to

get itself registered. This is the amount of share capital which a
company is authorized to issue. Nominal capital is divided into
shares of a fixed amount. It must be set out in the
memorandum of association. It can be increased or decreased
by following the prescribed procedure.

(ii) Issued capital:

It is that part of the nominal capital which is actually issued by

the company for public subscription. A company need not issue

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the entire authorized capital at once. It goes on raising the
capital as and when the need for additional funds is felt.

The difference between the nominal and the issued capital is

known as ‘unissued capital’, which can be issued to the public
at a later date. Where the whole of authorized capital is offered
to the public, the authorized and issued capital will be the
same. Issued Capital cannot be more than the authorized
capital. Issued capital includes the shares allotted to public,
vendors, signatories to memorandum of association etc.

(iii) Subscribed capital:

It is that amount of the nominal value of shares which have

actually been taken up by the public. It is that part of the
nominal capital which has actually been taken up by
shareholders who have agreed to give consideration in kind or
in cash for shares issued to them. Where shares issued for
subscription are wholly subscribed for, issued capital would
mean the same thing as ‘subscribed capital’. That part of
issued capital which is not subscribed by the public is called
‘Unsubscribed Capital’. Subscribed capital cannot be more than
issued capital.

Example:

A company was incorporated with capital f 9, 00,000 divided in

to Rs.90,000 equity shares of f Rs. 10 each. It issued, 70,000
shares to the public.

The public subscribed for:

(a) 50,000 shares

(b) 70,000 shares

(c) 75,000 shares.

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Apart from the above 5,000 shares are issued to vendor as fully
paid. What will be amount of different capitals?

Solution:

Authorized Capital Since the company is incorporated i.e.

registered with capital of Rs.9,00,000 divided into shares of
Rs.10 each. Therefore, the authorized capital is Rs. 9,00,000
(90,000 shares of Rs .10 each).

Issued Capital:

The company issued 70,000 shares of Rs. 10 each to public

which means Capital of Rs. 7, 00,000 (i.e. 70,000 shares x 10
each). It also issued 5,000 shares of Rs. 10 each fully paid to
vendor which means capital of Rs .50, 000.

Total Issued capital = Rs. 7, 50,000

Unissued Capital:

It is that part of authorized capital which has not been issued. In

this case out of total authorized capital of Rs. 9, 00,000, Rs 7,
50,000 capital has been issued. The balance left Rs 1, 50,000
is unissued capital.

Subscribed capital:

(a) Public has subscribed for 50,000 shares of Rs 10 each.

Therefore, subscribed capital is Rs. 5, 00,000.

Unsubscribed Capital:

In this case it will be the difference between the shares issued

to the public and shares subscribed by the public. This
difference is Rs 2,00,000 i.e. Rs 7,00,000— Rs 5,00,000, it is
unsubscribed capital.

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(b) Public has subscribed for 70,000 shares of Rs 10 each.
Therefore, subscribed capital is Rs 7, 00,000 since subscribed
capital is equivalent to issued capital, therefore, there is No
unsubscribed capital.

(c) In this case public has subscribed for 75,000 shares of Rs

10 each. It is important to note that subscribed capital cannot
be more than the issued capital. Hence, the subscribed capital
in this case will be equivalent to issued capital of Rs 7,00,000.
There is no unsubscribed capital in this case.

(iv) Called up capital:

The amount due on the shares subscribed may be collected

from the shareholders in installments at different intervals.
Called up capital is that amount of the nominal value of shares
subscribed for which the company has asked its shareholders
to pay by means of calls or otherwise.

If 10,000 shares of Rs 100 each have been subscribed by the

public, and the company has asked the shareholders to pay Rs
10 on application, Rs. 20 on allotment and Rs 30 on first call,
then the called up capital of the company would be Rs. 6,
00,000 (i.e. 10,000 x 60). The remaining amount i.e. Rs. 40 per
share on 10,000 shares (i.e. Rs 4, 00,000) would be the
uncalled capital of the company.

(v) Paid up capital:

That part of the called up capital which is actually paid up by

the members is known as the paid up capital. In other words,
paid up capital represents the total payments made by the
shareholders to the company in response to the calls made by
the company. Paid up capital of the company is calculated by
deducting the calls in arrears from the called up capital.

Paid up capital = Called up capital Less Calls-in-arrears:

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If in the above example, out of 10,000 shares of Rs 100 each,
on which Rs 60 has been called by the company from the
shareholders, one shareholder, holding 100 shares, fails to pay
the first call of Rs 30 per share on his shares, the paid up
capital of the company would be Rs 6, 00,000— Rs 3,000 i.e.
Rs 5, 97,000.

 What is Share Capital?

Share capital (shareholders’ capital, equity capital, contributed

capital or paid-in capital) is the amount invested by a
company’s shareholders for use in the business. When a
company is created, if its only asset is the cash invested by the
shareholders, the balance sheet is balanced on the right side
through share capital, an equity account.

Share capital is a major line item but is sometimes broken out

by firms into the different types of equityissued. This can
represent common stock and preferred stock, the latter
including the par value of the stock.

Share capital is separate from other equity generated by the

business. As the name “paid-in capital” dictates, this equity
account refers only to the amount “paid-in” by investors and
shareholders, as opposed to the amounts generated by the
business itself which flows into the retained earnings account.

 Meaning and types of share capital:

Share capital is the sum of money received by a company by

selling its shares to the investors. When a company issues
fresh share to the investors and raises fund, it directly
increases the value of share capital.

The amount of total share capital cannot be more than the

amount of authorized share capital of a company. Increase in
market price of shares does not affect the value of share capital

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because share capital is calculated based on the par value of
shares and not on the basis of market price.

Share capital is shown on the balance sheet of a company.

 Types of share capital

Share capital can be categorized as authorized share capital,

issued share capital, subscribed share capital, called up share
capital and paid up share capital.

Authorized share capital:

Authorized share capital refers to the total capital that a

company is authorized to accept from investors by issuing
shares. In simple terms, a company cannot raise capital more
than its authorized capital.

It represents the capital with which a company is registered

that’s why it is also known as ‘registered capital’.

Issued share capital:

It represents that part of total authorized share capital which

has been issued by a company for subscription by investors.
Usually, companies do not issue all of their shares for control
purpose. Thus, the part which is issued represents the issued
share capital.

Subscribed share capital:

It refers to that part of issued share capital, which has been

subscribed by investors. It means when a company issues
shares to raise capital, it may or may not receive subscriptions
for all of its shares. The part of issued share capital for which
subscription has been received is known as subscribed share
capital. So subscribed share capital can be equal to subscribed
share capital but not more than that.

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Called up share capital:

A company collects the full amount of share price in more than

one lot. The part of subscribed share capital which has been
asked for payment represents called up share capital.

Paid up share capital

It represents that part of called up share capital which has been

paid by investors.

Paid up capital = Called up capital – Call in arrears.

Example:

Suppose ABC Ltd. is registered with a capital of Rs 1 crore

divided into shares of Rs 10 each. It issues 8 lakh shares to
raise a fund of Rs 80 lakh but investors subscribe for 6 lakh
shares. The company calls for Rs 4 per share out of Rs 10
(Nominal value of shares) and it receives payment for only 5
lakh and 50 thousands shares.

Now,

Authorized share capital (10 lakh shares of 10 each) = 1 crore

Issued share capital (8 lakh shares of 10 each) = 80 lakh

Subscribed share capital (6 lakh shares of 10 each) = 60 lakh

Called up share capital (6 lakh × 4) = 24 lakh

Paid up share capital (5 lakh and 50 thousand × 4) = 22 lakh

Call in arrears (50 thousand × 4) = 2 lakh

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 Features of Share Capital:

 Owned capital: Share capital is owned capital of the

company. It is actually the money of the shareholders and
since the shareholders are the owner of the company, so
share capital is the owned capital.

 Remains with the company: It remains with the company

till its liquidation.

 Dependable sources: Share capital is the most

dependable source of finance for the joint stock
companies.

 Raises creditworthiness: It raised the credit worthiness

of the company.

 Substantial funds: It provides substantial funds to the

company.

 Available for: Share capital is easily available for

expansion and diversification of business activities.

 Amendment: The amount of share capital can be raised

by amending the capital clause of the Memorandum of
Association.

 No charge: Share capital does not create any charge on

the assets of the company.

 Opportunity to participate: Share capital give its

shareholders an opportunity to participate in the
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 company's management with normal rights of
shareholders.

 Benefit of bonus shares: It gives it shareholders the

benefit of bonus shares.

 Benefit of limited liability: Share capital also gives its

shareholders the befit of limited liability as the liability of its
shareholders is limited up to the face value of each share.

 Meaningful participation: Share capital enables its

shareholders to have a meaningful participation in the
expansion of corporate sector.

The Advantages and

Disadvantages of Share Capital
There are various ways to raise capital for a company. The
company can use debt capital to fund a business (such as a
bank loan) or it can raise equity capital by the sale of shares in
the business. This can be more appealing and/or appropriate
than other methods, but it raises further issues on the business
that must be considered.

Advantages of Share Capital

One of the attractions of raising capital via the sale of shares is
that the company does not have repayment requirements for
the initial investment or for interest payments. This can make it
more appealing than other forms, such as bank loans and
bonds, that are debts of the company. Debts require the
company to make payments at regular intervals in relation to
interest, as well as eventually repaying the initial amount that
was borrowed. Any shares sold can require a distribution of
profits as a dividend but these can be halted if necessary.
Therefore, the business is given more flexibility over its
finances.
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Any money raised through the sale of shares can be used by
the company however it wants. There are no stipulations or
requirements attached to the funds. In comparison a creditor
can limit the use of the funds they will lend to the company,
which will restrict how the company can use them.
Raising equity via share sales is also very flexible. The
business has full control over how many shares to issue, what
to initially charge for them and when it wishes to issue them. It
can also issue further shares in the future if it wishes to raise
more money. The company can also decide on the type of
shares it issues and what rights these give the shareholders,
and it can also repurchase issued shares if desired.
Another advantage is that there is a much lower risk that the
business will become bankrupt. Shareholders cannot force a
company into bankruptcy if it fails to make payments (unlike
creditors if the company fails to repay interest).
Shareholders want the business to succeed and can bring in
skills and experience and assist with business decisions.

Disadvantages of Share Capital

When a business sells shares to raise equity it is effectively
reducing its control and ownership over the company. Every
share is a tiny piece of ownership in that company and so has
benefits for the shareholder. Shareholders have rights in
relation to voting on business deals and corporate policy and
even the management of the company. Where the
shareholders hold a majority of the company, they can remove
the current leadership and bring in new management where
they disapprove of how things are operating. Issuing shares
can also result in a hostile takeover since a competitor could
acquire the majority of the voting shares.
Because of the fact that shareholders take more risks than
creditors in the event of the company going bankrupt,
shareholders expect a higher rate of return on their investment

145
than creditors. Therefore, a company typically loses more stock
for a lower price to a shareholder to compensate for this risk.
An additional cost is that a company cannot deduct any
dividends it pays out or any money it uses to repurchase
shares. In comparison, any interest paid on a debt can be
deducted from its taxes.
There is also a cost implication for the arrangement of
organising a public share offering since the company has to
prepare an IPO (initial public offering) prospectus to invite the
general public to buy shares. There will probably also be
advertising costs and the company may need an underwriting
agreement with an underwriter to purchase shares that are not
purchased by investors. The fee for this will have to be paid
whether or not the shares are all purchased by investors. The
company will probably also need to take legal advice, which is
another cost.
There is also a time implication. Shareholders will need to be
kept updated by the company on how it is performing and other
relevant matters. In the initial states of offering shares for sale,
the focus of the business can be moved from the main
business activities to dealing with the issues around the share
sales. The company will need to prepare the prospectus and
other related documents as well as organising advertising of
the sale of shares and arranging for the implementation of the
shares being issued.
Although it is possible to issue further shares in the future, this
does have an impact on the value of the shares that have
already been sold. Usually this will mean that the share price
will drop and so will the dividends paid out on each share. This
can anger current shareholders who then use their voting
power as described above.
Finally, any company issuing shares to the public has to make
sure that it discloses certain information on the finances of the
company and how it functions. This obviously will result in a

146
cost to the firm but also means that information that was
previously able to remain private is now in the public domain.

Equity finance

Advantages and disadvantages of equity finance

Equity finance, the process of raising capital through the sale

of shares in a business, can sometimes be more appropriate
than other sources of finance, eg bank loans - but it can place
different demands on you and your business.

Advantages of equity finance

Raising money for your business through equity finance can

have many benefits, including:

 The funding is committed to your business and your

intended projects. Investors only realise their investment
if the business is doing well, eg through stock market
flotation or a sale to new investors.
 You will not have to keep up with costs of servicing bank
loans or debt finance, allowing you to use the capital for
business activities.
 Outside investors expect the business to deliver value,
helping you explore and execute growth ideas.
 Some business angels and venture capitalists can
bring valuable skills, contacts and experience to your
business. They can also assist with strategy and key
decision making.
 Like you, investors have a vested interest in the
business' success, ie its growth, profitability and increase
in value.
 Investors are often prepared to provide follow-up
funding as the business grows.

Disadvantages of equity finance

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However, there are drawbacks of equity finance too. It's worth
considering that:

 Raising equity finance is demanding, costly and time

consuming, and may take management focus away from
the core business activities.
 Potential investors will seek comprehensive background
information on you and your business. They will look
carefully at past results and forecasts and will probe the
management team. However, many businesses find this
process useful, regardless of whether or not any
fundraising is successful.
 Depending on the investor, you will lose a certain
amount of your power to make management decisions.
 You will have to invest management time to provide
regular information for the investor to monitor.
 At first you will have a smaller share in the business -
both as a percentage and in absolute monetary terms.
However, your reduced share may become worth a lot
more in absolute monetary terms if the investment leads
to your business becoming more successful.
 There can be legal and regulatory issues to comply with
when raising finance, eg when promoting investments.
Shares

 What are 'Shares'
 Shares are units of ownership interest in
a corporation or financial asset that provide for an equal
distribution in any profits, if any are declared, in the form
of dividends. The two main types of shares are common
shares and preferred shares. Physical paper stock
certificates have been replaced with electronic recording
of stock shares, just as mutual fund shares are recorded
electronically.

BREAKING DOWN 'Shares'

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When establishing a corporation, owners may choose to issue
common stock or preferred stock.

Most companies issue common stock. The stock may benefit

shareholders through appreciation and dividends, making
common stock riskier than preferred stock. Common stock also
comes with voting rights, giving shareholders more control over
the business. In addition, certain common stock comes with
pre-emptive rights, ensuring that shareholders may buy new
shares and retain their percentage of ownership when the
corporation issues new stock.

In contrast, preferred stock typically does not offer appreciation

in value or voting rights in the corporation. However, the stock
typically has set payment criteria; a dividend that is paid out
regularly, making the stock less risky than common stock. Also,
preferred stock may often be redeemed at a more beneficial
price than common stock. Because preferred stock takes
priority over common stock, if the business files for bankruptcy
and pays its lenders, preferred shareholders receive payment
before common shareholders.

Authorized and Issued Shares

Authorized shares comprise the number of shares a company’s

board of directors may issue. Issued shares comprise the
number of shares that are given to shareholders and counted
for purposes of ownership.

Because shareholders’ ownership is affected by the number of

authorized shares, shareholders may limit that number as they
see appropriate. When shareholders want to increase the
number of authorized shares, they conduct a meeting to
discuss the issue and establish an agreement. When
shareholders agree to increase the number of authorized
shares, a formal request is made to the state through filing
articles of amendment.

Example of Shares
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As the 10-year bull market that began in 2008 stretched on,
shares of companies continually reached new highs through
2017. So-called FANG (Facebook, Apple, Netflix and Google)
tech stocks led the market rally, as their share prices soared by
double digits in 2017 on strong earnings results. The increasing
price meant that investors were willing to pay more to own
shares of these companies. All told, the shares of the
companies in the S&P 500 Technology Select Sector traded up
34.57% in 2017. In 2018, the shares of companies on the stock
market began to experience volatility due to economic and
political uncertainty.
 What is a share? Definition and meaning

A share is a unit of account for financial instruments, such as

the stock market, limited partnerships, and investment trusts.
It is essentially an exchangeable piece of value of a company
which can fluctuate up or down, depending on several different
market factors.
Companies divide capital into shares as a means of raising
capital. Shares are also known as stocks.
There are common stocks, which British people call ordinary
shares, and preference shares. Ordinary shareholders have
voting rights and receive dividends according to profit levels.
The value of a share that a company issues depends on its
face value – the capital of a company divided by the total
number of shares. A firm’s authorized capital refers to
the maximum amount in shares it is allowed to sell.

People who own shares in a company are called shareholders

or stockholders. Shareholders receive income from the shares
they own on a routine basis – these are called dividend
payments.

Shares are exchanged through a stockbroker – who acts as the

middle man or woman.
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How is a share valued?

The value of a share depends on several key market principles.

Put simply, a share’s value is what people are willing to pay for
it if is on sale. Shares are not sold at any given time though –
the transaction of shares strongly depends on the liquidity of
the market.

Investors buy shares because they predict the value of the

share will go up, and for the streaming long term dividend
payments.

Companies try to please investors by allowing shareholders to

vote on who directs the company and other major decisions.
Stockholders are, after all, the owners of the company.

When the press writes favorably about a particular stock, it

might suddenly become popular. Many analysts make
optimistic predictions. Often, they are startup companies. We
call these types of shares glamour stocks. However, if their
glamour fades, their prices can crash.

Market sentiment – a major factor driving share values

When future profits are expected to rise, the price of shares

rises too. Experts say this market sentiment is often more
powerful than the straightforward publication of profit data.

As illogical as it may sound, if an analyst or expert says that a

company will double its profits, that simple prediction will push
up the value of its shares. Obviously, the analyst needs to be
well recognized.

When the profits are published, the price of that company’s

shares will probably fall if the prediction was wrong.

In order to appreciate how markets behave, especially

individual shares, it is important to understand the dynamics of
market sentiment.

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In the past, stock certificates were issued as evidence of
ownership of a share. However, nowadays systems such as
CREST record a shareholder’s ownership electronically.

Shares are sold, listed and traded on stock exchanges. The

largest stock exchange markets in the United States are the
New York Stock Exchange (NYSE), followed by NASDAQ, in
Europe the London Stock Exchange is the biggest.

Unlisted share are traded overt the counter. The whole

environment of trading in shares, including those bought and
sold in stock exchanges and over the counter, is known as the
stock market.

 What types of share can a company have?

Most companies only ever have one type of share (or

class of share). The shares are commonly called ordinary
shares and will be the ones the company was
incorporated with. The typical rights that go with ordinary
shares (and the rights conferred by the Model Articles for
private limited companies) are:

“Each share is entitled to one vote in any circumstances.

Each share has equal rights to dividends. Each share is
entitled to participate in a distribution arising from a
winding up of the company.”

However, some companies choose to have two or more

different types of share, often referred to as “alphabet
shares“. It’s relatively straightforward to create a new
share class. Indeed, if the shareholders consent then a
company can have as many different share classes as it
likes, each representing a different type of share. The

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rights that go with different classes of shares, which are at
least in part described in the prescribed particulars for the
class, can be whatever the shareholders are willing to
accept.

Equally, it should be noted that the shareholders’

rightsattached to different classes of shares do not have to
be different. In fact, different share classes can have
identical rights to other classes. In some companies,
“alphabet shares” (“Ordinary A Shares”, “Ordinary B
Shares” etc) with identical rights are issued to different
shareholders.

Creating different share classes in this way might allow

dividends to be paid to some shareholders but not to
others, but the company should be careful to ensure that
any such strategy does not constitute a breach of HMRC
rules and guidelines.

However, in general, if a company has more than one type

of share the main differences between them will be found
in one or more of the following areas:

Entitlement to dividends

Shares may have the right to normal dividends,

preferential dividends (that is, the right to be paid a
dividend before other share classes), a dividend only in
certain circumstances or no dividends at all.

Entitlement to capital on winding up

If the company is dissolved, any assets left after the

company’s debts are paid can be distributed to
shareholders. However, different share classes may have
different rights to capital distribution – with some shares
ranking first and others only paid if sufficient assets

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 remain after others have received their full distribution of
capital.

Voting rights

Usually, this is as simple as shares either carrying voting

rights or not. However, weighted or tiered voting rights are
also possible – so, for example, shares may carry extra
voting rights in certain circumstances or on certain
important matters affecting the company.

While there are a few conventions which are best followed

to avoid any misunderstandings a company can call
shares by whatever name it likes. That said, you cannot
simply assume that shares called ordinary in one
company will have exactly the same rights as the ordinary
shares in another company. Indeed the only way to
ascertain what rights go with a particular share class is to
read the Articles of Association of that company.

The reasons why a company would want to have different

share classes will generally fall into one of the below
categories:

 To attract investment
 To push dividend income in a certain direction
 To remove (or enhance) voting powers of certain
individuals
 To motivate staff (to remain as employees)

Provided it follows due process, and subject to any restrictions

in its Articles of Association, a company can create new share
classes at any time. When it needs a new share class a
company can choose to either create a new share class in
addition to an existing class or convert an existing share class
into one or more new share classes.
It is the Articles of Association which set out the division of
shares into their different classes. The Articles will also detail
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the precise rights attaching to each class. Most classes of
share will fall into one of the below categories of types of share:
1.Ordinary shares
These carry no special rights or restrictions. They rank after
preference shares as regards dividends and return of capital
but carry voting rights (usually one vote per share) not normally
given to holders of preference shares (unless their preferential
dividend is in arrears).
Some companies create more than one class of ordinary
shares – e.g. “A Ordinary Shares”, “B Ordinary shares” etc.
This gives flexibility for different dividends to be paid to different
shareholders or, for example, for pre-emption rights to apply to
some shares but not others.

In some cases, different classes of ordinary share may be of

different nominal values – for example, there may be £1
Ordinary shares and £0.01 Ordinary shares. If each share had
the right to one vote (and assuming the shares were issued at
their nominal value), then the £0.01 Ordinary shareholders
would get 100 votes per £1 paid while the £1 Ordinary
shareholders would get 1 vote for paying the same amount.

2.Deferred ordinary shares

A company can issue shares which will not pay a dividend until
all other classes of shares have received a minimum dividend.
Thereafter they will usually be fully participating. On a winding
up they will only receive something once every other
entitlement has been met.

3.Non-voting ordinary shares

Voting rights on ordinary shares may be restricted in some way

– e.g. they only carry voting rights if certain conditions are met.
Alternatively, they may carry no voting rights at all. They may
also preclude the shareholder even attending a General
Meeting. In all other respects they will have the same rights as
ordinary shares.
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4.Redeemable shares

The terms of redeemable shares give the company the option

to buy them back in the future; occasionally, the shareholder
may (also) have the option to sell them back to the company,
although that’s much less common.

The option may arise at or after a specific date, between two

dates or be effective at any time the shares are in issue. The
redemption price is usually the same as the issue price, but can
be set differently. A company can only redeem shares out of
profits or the proceeds of a new share issue, which may restrict
its ability to redeem shares even if the directors would like to
exercise the option.

If a company chooses to have redeemable shares, it must also

have non-redeemable shares in issue. At no point can all of its
share capital be made up of redeemable shares.

5.Preference shares

These shares are called preference or preferred since they

have a right to receive a fixed amount of dividend every year.
This is received ahead of ordinary shareholders. The amount
of the dividend is usually expressed as a percentage of the
nominal value. So, a £1, 5% preference share will pay an
annual dividend of 5p. The full entitlement will be paid every
year unless the distributable reserves are insufficient to pay all
or even some of it. On a winding up, the holders of preference
shares are usually entitled to any arrears of dividends and their
capital ahead of ordinary shareholders. Preference shares are
usually non-voting (or only have a vote only when their
dividend is

6.Cumulative preference shares

If the dividend is missed or not paid in full then the shortfall will
be made good when the company next has sufficient
distributable reserves. It follows that ordinary shareholders will

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not receive any dividends until all the arrears on cumulative
preference shares have been paid.

By default, preference shares are cumulative but many

companies also issue non-cumulative preference shares.

7.Redeemable preference shares

Redeemable preference shares combine the features of

preference shares and redeemable shares. The shareholder
therefore benefits from the preferential right to dividends (which
may be cumulative or non-cumulative) while the company
retains the ability to redeem the shares on pre-agreed terms in
the future.

Most companies start by just having one type of shares in the

form of an ordinary share class. These will typically carry equal
rights to voting, capital and dividends. The issue of new
shares after company incorporation will generally be allotments
of these ordinary shares, unless circumstances suggest a need
for flexibility or varied rights.

Just as a company may issue shares in multiple share classes,

there’s also nothing to stop a shareholder holding more than
one class of share in the same company and thereby benefiting
from the differing rights (e.g. voting or dividend entitlement) that
each class offers.

 The 7 different types of shares you can issue in your

company

A company can issue ordinary or multiple types of shares

during and after incorporation. Companies that issue only
ordinary ones can simply adopt the Model articles of
association.

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To register any class other than ordinary, you will have to
amend the Model articles to reflect the prescribed particulars of
rights attached to each class.

If a company wishes to issue different classes after

incorporation, the members must pass a resolution to amend
the articles to include the different prescribed particulars.

The majority of companies issue standard ‘ordinary’ shares.

This keeps things simple by offering equal rights and
responsibilities to all shareholders. The rights attached to
shares, which include voting rights, dividend rights and capital
rights, are specified in prescribed particulars in the statement of
capital and articles of association.

It is possible to issue different types of shares. This is often

required when the owners wish to distinguish the value of their
shares and the various rights attached to them.

Different types, or ‘classes’ include:

Preference share
These carry the preferential right of certain owners to receive a
fixed percentage of profits before others . In some cases, they
also offer the preferential right to capital distribution before
other classes. As a result, however, they often carry no voting
rights.

Non-voting shares
Typically issued to family members of the main shareholders,
or to employees as part of a share scheme. This class enables
existing members to maintain full control of the company whilst
distributing a portion of profits to other people in a tax-efficient
way.

An employee scheme is an effective way to align the interests

of staff with a company’s values and objectives. The potential
reward from their vested interest can motivate staff to work

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harder. Dividends from non-voting ordinary shares can be used
as a tax-efficient way to pay part of an employee’s salary.

Redeemable shares
This class enables a company to buy back its issued shares
after a fixed period of time. Often, they are created for
employees and issued with the provision of being taken back if
an employee leaves the company. They are often non-voting.

Alphabet shares
These are usually ordinary shares that are divided into different
sub classes, such as ‘A’, ‘B’ and ‘C’. This allows a company to
vary the percentage of each prescribed particular. Example:

A company has two owners. They each hold one share but
contribute different amounts of capital to the business.
One owner is given 50% voting rights, 50% dividend rights and
70 % capital rights. The other owner is given 50% voting rights,
50% dividend rights, and only 30% capital rights to reflect his or
her smaller capital contribution upon company formation.

Management shares
These carry a smaller nominal value than other classes and/or
provide multiple voting rights. They are often held by the
original members as a way to retain more control of the
business than newer members.

Deferred ordinary shares

Offer dividend rights to the holder only after dividends have
been paid to all other members who hold different share
classes.

 Shares:

To raise the capital these marketable instruments are issued by

the companies. Each issued share goes to the public. They are
traded in everyday stock market and the value of the company
is decided by the value of the shares at the end of the day.

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A company to put its share in the market have to first prepare a
memorandum in which the authorized capital is to be written
down which is further to be verified by the competent authority
which is SEBI.

 Types of Shares:

1. Equity Shares: they are generally issued and traded in

everyday stock market. Their returns are not fixed.

Types of Equity Shares:

a. Blue Chip Shares: The big companies which have the

potential to dictate the terms come under this umbrella. These
companies are never fixed as performance of these companies
may fall apart sometimes.
b. Income Shares: The companies coming in this area, are
generally stable and do not vary much in their performance.
c. Growth Shares: These companies have secured their
positions in specific industry; their shares have less dividend
payout ratio and thus, more growth potential.
d. Cyclical Shares: The share of the companies coming into
this umbrella varies with the economy. A definite business cycle
keeps on operating and the performance keeps on operating
with the stages of the cycle.
e. Defensive Shares: The shares of the company do not
vary with the economy.
f. Speculative Shares: The shares of a company which has
usually more speculation than others and they cannot be
categorized into one category only and may overlap with blue
chip shares.

Another classification is given by investor Peter Lynch:

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a. Slow growers: These are the companies having growth
rate equal to the industrial growth rate or higher than GDP.
b. Fast Growers: Newly started companies having good
growth rate.
c. Stalwarts: The big companies having and whose dividend
payout is high.
d. Cyclicals: The shares of these companies are not going
through the business cycle or varying to the business cycle.
e. Turn-around: The shares of those big companies whose
performance were very bad in the past but a sudden turn
around takes place and they started performing very good.
f. Asset Plays: these shares generally do not have recognition
instead of having a large asset base.

2. Preference Shares: It has the qualities of both equity

shares and debentures. As in case of debentures, fixed rate of
dividends is paid to the preference shareholder, despite the
profits earned by the company it is liable to pay interest to the
preference shareholders.

 Types of Preference Shares:

a. Cumulative and Non-cumulative Shares: Let us say that

a company was not doing well for 4 years but suddenly in the
5th year it started performing well. Then, the persons having
cumulative shares will get the interest of past 5 years but the
persons having non-cumulative shares will get only the interest
of the 5th year.
b. Redeemable and Non-redeemable: Redeemable shares
could be matured during the lifetime of the company or before
the company closes down , they have a maturity period but the
non-redeemable shares mature only after closing down of the
company.
c. Convertible and Non-convertible: Shares that could be
converted into other kinds of shares and security say equity
shares or debentures is known as convertible shares and if
they are not convertible on their maturity they are known as

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non-convertible shares.
d. Participating and Non-participating: In case of winding
up of the company, the debenture holders were paid up first,
then the preference shareholders and then the equity
shareholders were paid up, after this if any surplus amount is
left, it is distributed equally to equity shareholders and
participating shareholders if investors have participating
preference.

Types of Shares
This article describes about the different types of shares that
are present in the market. Read this article to know more about
equity shares, preference shares, deferred shares, bonus
shares and other related information.
There are different types of shares. I have mentioned about the
most popular shares which are as follows:-
Equity shares: These shares are also known as ordinary
shares. They are the shares which do not enjoy any preference
regarding payment of dividend and repayment of capital. They
are given dividend at a fluctuating rate. The dividend on equity
shares depends on the profits made by a company. Higher the
profits, higher will be the dividend, where as lower the profits,
lower will be the dividend.

Preference shares: These shares are those shares which are

given preference as regards to payment of dividend and
repayment of capital. They do not enjoy normal voting rights.
Preference shareholders have some preference over the equity
shareholders, as in the case of winding up of the company,
they are paid their capital first. They can vote only on the
matters affecting their own interest. These shares are best
suited to investors who want to have security of fixed rate of
dividend and refund of capital in case of winding up of the
company.

Deferred shares: These shares are those shares which are

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held by the founders or pioneer or beginners of the company.
They are also called as Founder shares or Management
shares.
In deferred shares, the right to share profits of the company is
deferred, i.e. postponed till all the other shareholders receive
their normal dividends. Being the last claimants of the profits,
they have a considerable element of speculation or uncertainty
and they have to bear the greatest risk of loss. The market
price of such shares shows a very wide fluctuation on account
of wide dividend fluctuations. Deferred shares have
disproportionate voting rights. These shares have a small
denomination or face value.

Deferred shares are not transferable if issued by a private

company. Deferred shareholders do not enjoy the right of
priority to have shares offered in case of the issue of shares by
the company. If the company goes into liquidation the deferred
shareholders can get refund of capital and participate in the
surplus capital, if any, after the rights of preference and equity
shareholders have been satisfied.

Bonus shares: The word bonus means a gift given free of

charge. Bonus shares are those shares which are issued by the
company free of charge as bonus to the shareholders. They are
issued to the existing shareholders in proportion to their
existing share holdings. It is a kind of gift to the shareholders
from the company. It is bonus in the form of shares instead of
cash. It is given out of accumulated profits and reserves. These
shares have all types of preferences which are available to the
existing shares. For example. two bonus shares for five equity
shares. The issue of bonus shares is also termed as
capitalization of undistributed profits.
Bonus shares is a type of windfall gain to the equity
shareholders. They are advantageous to the equity
shareholders as they get additional shares free of cost and also
they earn dividend on them in future.

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Conditions for issue of bonus shares:

(i) Sufficient amount of undistributed profits: There must be

sufficient amount of undistributed profits for the issue of bonus
shares.

(ii) Provision in the articles: There must be a provision in the

articles of association regarding the issue of bonus shares. If
there is a provision in the articles regarding the issue of bonus
shares the company can issue bonus shares if there is no
provision, the company cannot issue the bonus shares.

(iii) Suitable Resolution: The Board of Directors must pass a

suitable resolution in the Board meeting for the issue of bonus
shares.

(iv) Shareholders approval: The shareholders must give

formal approval for the issue of bonus shares in the Annual
General Meeting.

(v) When a company can issue: A company can issue bonus

shares only twice in a period of five years.

(vi) Fully paid up shares: Bonus shares can be issued only

when the existing shares are fully paid up.

 What is ALTERATION OF SHARE

CAPITAL?
An increase or decrease in share value allowed by the
association. The change must pass the meeting and a notice
must be filed with the proper authorities.

Alteration of Capital
Alteration of Capital can be done by way of increasing
authorized and paid capital of a company. Authorized Capital is
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the maximum amount of capital which a Company can raise
through the issue of shares to its shareholders. It is mentioned
in the Memorandum of Association of the company. The
company can raise capital up to this amount. Therefore to
increase the authorized capital of company we always need the
approval of shareholder in general meeting of the company.

Paid up capital of the company is the amount of shares the

company has already issues to its shareholders. But a
company may, during its course of business operation, require
additional capital for expansion, meet working capital
requirements etc. Paid up capital of the company will always be
less than authorized share capital of the company. An increase
in capital is required for issuing new shares and inducting more
capital into the company.
Therefore, it is mandatory to comply the provision of Act in
each and every aspect. So, Tax return wala can help the
corporate in this regard and making their working more easy
and smooth.

Alteration of share capital definitions

1. Increase or decrease in (or rearrangement of) the authorized
share capital of a firm, as permitted in its articles of association.
Any such change requires (1) passing of a resolution to the
effect in the firm's general meeting, and (2) filing of the notice of
alteration with the appropriate governmental office such as (in
the UK) the Registrar Of Companies.

2.An increase, reduction, or any other change in the authorized

capital of a company (see share capital). If permitted by the
articles of association, a limited company can increase its
authorized capital as appropriate. It can also rearrange its
existing authorized capital (e.g. by consolidating 100 shares of
£1 into 25 shares of £4 or by subdividing 100 shares of £1 into
200 of 50p) and cancel unissued shares. These are reserved
powers, passed – unless the articles of association provide
165
otherwise – by an ordinary resolution. See also reduction of
capital.

3.A change in the number of authorized

shares a company may issue. Authorized shares are the total
shares acompany is permitted by its charter to issue, as oppos
ed to the number it actually has issued. To alter share capital, a
company must amend its charter and/or bylaws and register the
change with the appropriate regulatory authority.

Alteration of Share Capital under

Companies Act, 2013
Introduction

The capital of a company is separated into units of a fixed

denomination and such unit is a share. A share in the share
capital of a company and includes stock which is defined under
Section 2(84).

Section 2(8) of The Companies Act 2013, defines that

“Authorised capital” or “nominal capital” means such capital
which is authorized by the memorandum of a company to be
the maximum amount of share capital of the company. The
companies are allowed to alter the authorized share capital
according to the procedures mentioned in Section 61 to 64 read
with Section 13 and 14 of the Companies Act. An increase or
decrease in the share capital of a company may be carried out
as and when the company requires thus leading to an alteration
in the company’s share capital. The alterations to the capital
clause have to be done according to the Companies Act, 2013.

The procedure involved in altering the Share Capital

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 1. It has to be confirmed whether a company is authorized to
increase its share capital according to the Articles of
Association (AOA) and if it does not authorize then the
procedure for such alteration has o be carried out.

2. A board meeting should be called for an Extraordinary

General Meeting (EGM) to get the approval of the
shareholders for such alteration.

3. The EGM should be called comprising of the shareholders

by sending a notice mentioning the purpose of the
scheduled meeting regarding the alteration of the MOA
and AOA thus altering the Share capital of the company.

4. The Special resolution shall be passed to alter the MOA

and AOA thus altering the Share Capital of the Company.

5. Authorising the board to file necessary forms and

resolutions with Registrar of Companies (ROC) having
jurisdiction.

6. The e- form SH-7 with ROC on payment of a stipulated

fee.

Once the AOA has been altered the board meeting has to be
called by the company. Every member, legal representative or
the assignee, the auditor(s) and every director of the company
has to be given a notice of 21 days prior to the actual date of
the meeting. The notice shall be written or in an electric form.
The general meeting can also be convened at a shorter notice
if 95 percent of the members who are allowed to vote at the
meeting give their consent in the manner prescribed written or
electronic.

The place of the meeting, the date of the meeting and the hour
of the meeting shall be specified in the notice along with the
business agenda of the meeting which is mentioned under
Section 101 of the Companies Act. Along with the notice a
statement should be attached therewith specifying the

167
particulars and objects regarding every point of extraordinary
business to be carried on at the general meeting, concerning
the financial or any other kind of interest related to all the
directors and the managers and people related to the key
managerial persons according to section 102 of the CA, 2013.

Once the formalities of the notice have complied with the

company shall call an EGM and the members have to vote
either in favor or against the alteration of the authorized share
capital. An ordinary resolution is passed by the board members
after holding of the EGM.

Alteration of the MOA and AOA

1. The power of a limited company to alter its share capital is

given under Section 61 of the Companies Act, 2013. Sub-
clause further states that a limited company having a
share capital may, if so authorized by its articles, alter its
memorandum in its general meeting to:

1. Increase its authorized share capital by such amount

as it thinks expedient

2. The authorized share capital of the company can be

increased by altering the memorandum of association.
The provisions regarding the alteration of memorandum of
association and Articles of association are given under
Section 13 and 14 of the Companies Act respectively.

3. A company may alter the provisions of the memorandum

after it has passed a special resolution thus complying
with the procedural requirements given under Section 13.

4. An alteration has to be made in the Memorandum Of

Association and the Articles Of Association under clause 5
and 4 respectively.

5. According to Clause 5 ‘, The Authorized Share Capital of

the company is INR 1,00,000/- divided into 10,000 Equity

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 Shares of INR 10 each. The minimum paid up share
capital of the company is INR 1,00,000.

6. Alteration of AOA with regards to increasing of share

capital is given under Clause 4.

7. Section 14 of the Companies Act, 2013 also states that

where the company does not have the authorization to
amend its AOA then the alteration can be carried out by
the procedure of passing a special resolution.

8. Section 14 states that the alteration to a company’s

articles can be done only by passing a special resolution
and the order of approval of the alteration carried out has
to be filed with the ROC accompanied with the hard copy
of the actual altered articles not later than fifteen days in
the manner which is prescribed. The alteration is only
valid if there was a provision in the original articles

Registrar to be given Notice

The registrar of companies shall be notified within a period of

thirty days from such alteration and a copy of the altered
memorandum has to be provided as well. In case of default by
the company or any of its officers, the company or its officers
shall be liable and punishable with a fine which may extend up
to thousand rupees for each day of delay or rupees five lakh
whichever is less. The above provision is given under Section
64 of the Companies Act.

Purpose of the form

Whenever a company alters its share capital or number of

members independently or increases the share capital by
conversion of debentures/loans due to the order of Central
Government, then a return shall be filed with the registrar within
30 days of such alteration. The return shall also be filed where
the company redeems any redeemable preference shares.

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Stamp duty can be paid electronically through the MCA portal
and the following documents are to be attached

1. Notice of extraordinary general meeting

2. Certified true copy of the ordinary resolution

3. Altered Memorandum of association

4. Altered AOA, if any.

E-Form MGT 14 to be filed

While the filing of the Form MGT- 14 the provisions mentioned

under section 117 (1) and Section 192 of The Companies Act
2013 have to be dealt with. Under sub-section 3 clause 1 of
Section 117, the provision mentioned therein also apply to a
special resolution.

The copy of all the decision taken with respect to the matters
which are specified under subsection 3 along with the
explanations under section 102 shall be attached therewith to
the notice convening the EGM in which the proposed resolution
shall be passed should be filed with registrar not exceeding
thirty days along with the stipulated fees which has to be paid
as specified under Section 403 of the Companies Act.

Section 117(1) states that a copy of the resolution which has

the effect of altering the articles and copy of every agreement
referred in sub-section 3 shall be attached to every copy of the
articles issued after passing of the resolution or making of the
agreement.

Repercussions of not filing the form

According to section 117 (2) where the company fails to comply

with the provisions mentioned in sub-section (1) the company
shall be liable to pay a fine which shall not be less than five
lakh rupees and may extend up to twenty-five lakh rupees.
Each officer of the company who has defaulted along with the
170
liquidator of the company shall be liable to pay a fine of rupees
one lakh which may extend up to five lakh rupees.

Attachments

The below-mentioned documents have to be attached:

1. The true copy of the resolution with the copy of

explanations under Section 102.

2. Altered MOA (Mandatory in case any change in MOA).

3. Altered AOA

Therefore, by complying with the above provisions and

procedure the company can alter its capital clause by altering
the MOA and AOA when it needs to raise more money.

Rules regarding Alteration of

Share Capital of a Company
Introduction

Increase or decrease of authorized share capital of a company

is known as alteration of share capital.

There two type of share capital of a company:- equity share

capital and preference share capital. Power of a company to
alter its share capital is defined and explained in section 61 of
the Companies Act, 2013. It can be done by ordinary resolution
of the company, thus it is not necessary to confirm the
alteration of the share capital of the company from the tribunal.

The Companies Act 2013 allows the companies to alter and

make some changes in its authorized share capital with certain
specified procedures for alteration of share capital is
specifically mentioned in the Companies Act, 2013.

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Alteration in the share capital can be done only if it is so
authorized by its Articles of Association to alter the capital
clause of its Memorandum of Association.

Basic and Mandatory Rules Necessary to Follow

First step: It is important for a company to check and evaluate

whether the company on the first face is authorized by the
Articles of Association to increase the share capital if
company’s Article of Association does not permit or authorize,
then it is to be done with the objective of altering them.

Second step: The company has to take the confidence of

other individuals. The board meeting has to be conducted for
enabling the board to call for the extraordinary general meeting,
it is mandatorily required to get approval from the shareholders
for increasing the authorized share capital.

Third step: The company then calls for an extraordinary

general meeting of the shareholders of the company by
sending them a notice with clear agenda and proper
explanatory statements, explanation, with a proper reasoning
along with the resolutions to be passed to alter the
Memorandum of Association and Articles of Association which
are to be altered for the purpose of increasing the authorized
share capital.

Fourth Step: Thereafter, resolutions for increasing the

authorized share capital of the company and corresponding
alterations in the Memorandum of Association and Articles of
Association by resolution. After completing the whole
procedural part, the company authorizes the board to file
necessary forms and resolutions with ROC having jurisdiction.

The company, if thinks necessary and suitable for the growth,

can increase its share capital by issuing new shares. A
company may consolidate and divide all or part of its share
capital into shares of a large amount. A company may also sub-
divide its shares of lower denomination. It may cancel those
172
shares which have not been taken by any person and reduce
its share capital.

Thus, the right to alter share capital must be given in the article
of association of the company.

Procedure for alteration of share capital:

 Authorized by article

 By resolution

 Notice to registrar

Notice To Registrar

Notice of alteration is required to be given from the hands of the

company to the registrar within a period of 30 days, if the
company fails to do there are provisions for a hefty penalty
under the statute.

Alteration of Share Capital with Different ways of Journal

Entries

Increase in share capital by making a fresh issue of shares, if a

company wants to increase the share capital beyond the
amount of share capital, it must increase its authorized capital
by the number of new shares. The company can convert all or
any of fully paid up shares into stock or reconvert stock into
fully paid up shares of any denomination.

Provisions Relating to Alteration

The capital clause can be altered if the Article of Association

contains the provision for such alteration otherwise, the first
basic step is to alter Article of Association by passing a special
resolution. The basic principle for alteration is that the alteration
of share capital be bonafide & in the interest of the company.

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Generally, ordinary resolution is enough to alter the capital
clause, thus notice of alteration to be given to the ROC, when
share capital automatically stands increased. Loan taken from
central government also increases the capital of a company.

Condition for Alteration of Share Capital

The company should be limited by shares, the company limited

by guarantee having a share capital, the Article of Association
must permit the company for alteration of share capital.

Alteration of Share Capital can be done by

Alteration of share capital can be done by issuing new shares

of the company in the market, by consolidating the shares, the
company can do the alteration in its capital by the conversion of
previous shares, the company can subdivide its share in the
market, the company can cancel its unused shares from the
market.

Share Capital may Automatically be Increased

When government by its order states that any debenture issued

to any government by a company or any part under such
circumstances, the debenture be converted into shares on the
transfer of capital issued by the company.

Reduction of Share Capital

After confirmation by the tribunal on an application by the

Company, limited by shares and guarantee, having a share
capital and share capital of a company can be reduced by
special resolution. The reduction of share capital is governed
by Section 66 of the Companies Act, 2013. It is necessary to
confirm it by the decision of the tribunal in writing.

For reduction of share capital, the company is required to

conduct the board meeting, a notice for the general meeting is

174
necessarily required to be given to every shareholder and
concerned person

Every notice of a meeting shall specified by mentioning the

place, date, day and the hour of the meeting and shall contain a
statement of the business to be transacted at such meeting. A
notice is required to be proper and elaborate, the material facts
concerning each item of special business to be transacted at a
general meeting, such as the nature of concern or interest,
financial or otherwise to every director and the manager every
other key managerial personnel and their relatives.

A notice which is given to the concerned person should itself be

self-explanatory

After the notice, the Extraordinary General meeting is called

and the concerned members vote in favor or against of the
authorized share capital of the company. The votes of the
members play a crucial role in taking appropriate decision.
Thus, during the course of meeting the members decide the
alteration in the memorandum of association. Thus, after
considering all the facts in the welfare of company, the board
members by utilizing their powers pass an ordinary resolution.

Reduction in Share Capital Not Allowed

Reduction in share capital is not allowed in the case where

there are arrears in the repayment of interest and thereon. The
creditor of a company has a right to object against the reduction
in its share capital. For reduction in the share capital of the
company, the registrar shall issue a certificate to the company
for reduction.

Reason for Reduction in Share Capital of a Company

There are many reasons for the reduction of share capital of a

company some are as follows.

 If there is a returning of surplus capital of a company.

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  The company wants to smooth its capital structure by
simplifying it.

 Sufficient reserve is also one of the reasons for the

reduction in share capital.

Assets of the company also play a vital role in the variation of

the share capital of the company.

Altering the Memorandum of Association and Articles of

Association

Section 61 of the Companies Act, 2013 states about Power of

limited company to alter its share capital, sub-clause further
states that (1) A limited company having a share capital may, if
so authorised by its articles, alter its memorandum in its
general meeting to— increase its authorised share capital by
such amount as it thinks expedient. A company can increase its
authorised share capital by altering the memorandum of
association. Section 13 of the Companies Act deals with
altering the memorandum of association and section 14 of the
above-said act deals with altering the articles of association.

Section 13 of the Act states that as provided in Section 61, a

company may, by a special resolution and after complying with
the procedure specified in this section, alter the provisions of its
memorandum.

If there is no provision to alter the provision of section 14 of the

companies act, 2013, then the company is required to make
suitable application to the concerned stock exchange, where
the company is listed in a prescribed form.

Precedents in Regard to the Alteration of Share Capital of a

Company

In Re North Cheshire Brewery Co., 1920 WN 149. Re

Metropolitan Cementry Co., (1934) SC 65

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Ratio

In this case law, powers are given to the members to alter its
share capital only if it is authorized by its article of association

In [Needle Industries (India) Ltd. v. Needle Industries

Newey (India) Holding Ltd. (1981) 1 Com Cases 743 (SC)].

Ratio

Powers to alteration must be exercised in the interest of the

company and not for the welfare of some particular members

Conclusion

The company is bind to follow each and every part of the

procedure as explained and mentioned in the statute failing
which, the company shall be punishable with a hefty penalty.
The procedural part mention in the statute for alteration of
share capital also give security to its shareholder.

However, the increase in capital of the company, in the long

run, benefit its investors in the form of increased return
on equity through capital gains, an increase in dividend payouts
or both.

Bank also usually prefer to give a loan to the company

depending upon the authorized capital. Thus, authorized capital
is also helpful for a company in growth. It is helpful in avoiding
unnecessarily implications

Alteration of Share Capital: 5 Ways (With Journal Entries) |

Company Accounts

The following points highlight the five ways of alteration of

share capital.

Share Capital Alteration Way # 1. Increase its share capital

by making fresh issue. If a company wants to increase its

177
capital beyond the amount of its authorised capital, it must
increase its authorised capital by the amount of new shares.

Entries for the purpose will be the same as in the case of

original issue of shares.

Share Capital Alteration Way # 2. Consolidate and divide all

or any of its share capital into shares of larger denomination.

Journal entry, for this purpose, will be as under:

(i) Share Capital (say Rs. 10) A/c Dr.

To Share Capital (Say Rs. 100) A/c

By this consolidation, only the number of shares are reduced

but the amount of share capital will remain unchanged.

Share Capital Alteration Way # 3. Subdivide all or any of its

share capital into shares of smaller denomination.

Entry will be:

(ii) Share Capital (say Rs. 100) A/c Dr.

To Share Capital (say Rs. 10) A/c

In this case, only the number of shares are increased whereas

the amount of share capital will not make any change.

Share Capital Alteration Way # 4. Convert all or any of fully

paid-up shares into stock or reconvert stock into fully paid-up
shares of any denomination.

The entries will be:

(iii) Equity Share Capital A/c Dr.

To Equity Stock A/c Or, vice versa, in the opposite case.

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Share Capital Alteration Way # 5. Cancel unissued share
capital (not taken or agreed to be taken by any person) and
thereby diminish the amount of share capital. No journal entry
is required for this purpose. Only the details of authorised
capital are to be incorporated in the next Balance Sheet. It
should be remembered that if reduction results in a decrease of
paid-up capital, it requires the approval of Court which are
discussed subsequently under the head ‘Capital Reduction’.

Alteration of Capital Clause: 5

Types | Company
Alteration in the capital clause of Memorandum of Association
of a company may be of the following types: 1. Alteration of
Share Capital 2. Reduction in Share Capital 3. Reserve Capital
or Reserve Liability 4. Variation of the Rights of Shareholders 5.
Reorganisation of Capital.

Type # 1. Alteration of Share Capital:

Under Section 94 of the Companies Act, a company limited

by shares may in general meeting, if so authorised by its
Articles of Association, alter the capital clause of its
Memorandum of Association in any of the following ways:

(i) It may increase its share capital by issuing new shares.

(ii) It may consolidate and divide all or part of its share capital
into shares of a large amount.

(iii) It may convert all or any of its fully paid-up shares into stock
or reconvert that stock into fully paid-up shares of any
denomination.

(iv) It may sub-divide its shares into shares of lower

denomination.

(v) It may cancel those shares which have not been taken by
any person and reduce the amount of its share capital.
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Procedure:

The following procedure should be followed for altering

the share capital of the company:

(i) Authorised by article:

The right to alter the share capital must be given in the Articles
of Association of the company.

(ii) To pass a resolution:

Alteration can be effected in the capital by passing an ordinary

resolution in the general meeting of the company.

(iii) Confirmation of court is not required:

For such an alteration of capital, the confirmation of court is not

required.

(iv) Notice to the registrar:

The company shall give notice of the alterations to the

Registrar within 30 days of doing so.

(v) Change by registrar:

The Registrar will record the above notice and make necessary
alterations in the memorandum and articles of the company.

(vi) Economic penalty:

If any default is made in complying with the above provisions,

the company and every officer of the company who is in default
is punishable with a fine which may extend to fifty rupees for
every day the default continues.

(vii) Effect of conversion of shares into stock:

If a company has converted any of its shares into stock, such

provisions of the Act as are applicable only to shares shall
180
cease to apply to such shares which have been converted into
stock.

(viii) Information of increase in share capital:

The information must be given to the Registrar within 30 days if

the company has increased its authorised capital or, in the case
of a company not limited by shares. Notice of the increase must
be given to the Registrar even when the new shares may not
have been issued to any shareholder, if default is made in
complying with the provisions, the company and every officer
who is in default is punishable with a fine, which may extend to
Rs. 50 for every day the default continues.

Type # 2. Reduction in Share Capital:

A company limited by shares or a guarantee company with

a share capital is permitted to reduce its share capital by
Section 100 in any of the following ways:

(i) Extinguish or reduce:

By extinguishing or reducing the liability on any of its shares in

respect of share capital not paid up.

(ii) Cancel:

By cancelling any paid-up capital which is lost or unrepresented

by available assets.

(iii) Pay off:

By paying off any paid-up capital which is in excess of the

needs of the company.

(iv) By Court:

By any other method approved by the court.

Procedure:

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The following procedure is to be followed for effecting a
reduction in share capital:

(i) Company limited by shares:

A company limited by shares or a guarantee company with a

share capital is permitted to reduce its share capital.

(ii) Authorised by articles:

Reduction in share capital can be effected when it is authorised

by Articles of Association of the company. If the articles do not
give this power to the company, they may be altered by special
resolution to enable the company to reduce its share capital. It
is of no avail, where this authority is contained in the
memorandum only.

(iii) To pass a special resolution:

The company must pass a special resolution effecting the

reduction in share capital.

(iv) An application to the court:

After having passed the special resolution for reducing the

share capital, the company must apply to the court for an order
confirming the reduction in share capital. The court must look
after the interest of shareholders and creditors.

Interest of Creditors:

The special resolution of the company reducing the share

capital must in all cases be confirmed by the court and the
court is empowered to enquire into the objection that may be
raised by the creditors in that behalf, unless the court directs
not to make such an equity.

If the reduction of share capital involves:

(i) Diminution of liability in respect of unpaid share capital; or

182
(ii) Payment to the shareholder of any paid up share capital;
and

(iii) In any other case is the court so directs, every creditor of

the company is entitled to object to the reduction.

Only such creditors are entitled to object the reduction to whom

the company owes a debt which would have been provable in
the winding up of the company.

The court should settle the list of creditors entitled to object and
issue public notices fixing a day or days within which creditors
who are entered on such list are to claim to be so entered or to
be excluded from the right of objecting to the reduction.

Interest of Shareholders:

Before sanctioning the scheme of reduction of share capital,

the court must also look after the interest of shareholders.
Court should see that the scheme for reduction of capital is fair
and equitable to all kinds of shareholders.

(i) Order confirming the reduction:

The court may make an order confirming the reduction of share

capital on such terms and conditions as it thinks fit, if it is
satisfied that every creditor entitled to object has consented to
the reduction or that his debt has been discharged or secured
by the company.

(ii) To add “and reduced” word to the name of the

company:

The court may also order the company to add the words ‘and
reduced’ to the name of the company for such period as may
be specified in the order, and these words will be deemed to be
part of the company’s name for such specified time [Sec. 102].

(iii) Production of court order before the registrar:

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The order of the court confirming the reduction must be
produced before the Registrar and a certified copy thereof,
along with minutes should be filed with him for registration. On
such registration by the Registrar, the resolution for reduction of
share capital as confirmed by the court takes place. Notice of
the registration shall be published in such a manner as the
court may direct.

The Registrar shall certify registration of the order and the

minutes in hand. The Certificate of Registrar to this effect is a
conclusive evidence that all the requirements of the Act
regarding the reduction of share capital have been complied
with and that the share capital is such as is stated in the
minutes. (Sec. 103).

Once the certificate has been issued by the Registrar, the

reduction in share capital cannot be upset towards on the
ground that the company had not by its Articles of Association
the power to reduce its share capital or the special resolution
for reduction was invalid.

Liability of Members on Reduction:

Section 104 of the Act provides for liability of members

regarding the reduced shares. A member of the company shall
be liable to make the payment of the amount deemed to have
been unpaid on his shares, which would be equal to the
amount deemed to have been paid up on his shares, and
reduced value of shares as fixed by minutes of reduction. But in
one case the members may be made liable to pay the original
nominal value of shares.

This will happen when a creditor entitled to object to the

reduction has been left out of the list of such creditors by
reason of his ignorance of the proceedings and the company is
unable to pay the amount of his debt. In these circumstances
the court may order the members to pay upto the original
nominal value of the shares held by them.

184
Reasons for Reduction in Share Capital:

1. The share capital of the company may be more than enough

for its present and future needs, and so, it may return the
surplus capital to the shareholders.

2. The paid-up capital of the company is sufficient and it may

refrain from calling up the unpaid portion of share money.

3. Some of the capital may in fact have been lost or diminished

e.g., share of Rs. 100 may represent assets worth Rs. 50. The
company may wish to write off the lost capital.

Reduction under item (1) and (2) will reduce the funds available
to the creditors. Reduction under item (3) affects the rights of
different classes of shareholders as well as the interest of the
members of the public who may be induced to take shares in
the company.

Type # 3. Reserve Capital or Reserve Liability:

By Reserve Capital we mean that amount which is not callable

by the company except in the event of the company being
wound up. The company cannot demand the payment of
money on the shares to that extent during its life time. Reserve
Capital may be created by means of a special resolution
passed by the company in its General Meeting by 3/4th majority
of these voting on it.

When once the Reserve Capital has been so created the

company cannot alter its Articles of Association so as to make
the reserve liability available at any time. The Reserve Capital
cannot be charged as security for loans by the creditors. It
cannot be turned into ordinary capital without the order of the
court. It cannot be cancelled at the time of reduction of capital.

Type # 4. Variation of the Rights of Shareholders:

185
The share capital is divided into different classes of shares
which may have different rights attached to them, generally
provided from the Articles of Association of the company. If the
company wants to change the rights of any class of
shareholders, the following procedure has to be followed.

(i) The provision with respect to variation of the rights of

shareholders should be there in memorandum or articles of the
company. In the absence of any such provision in the
memorandum or articles, there should be nothing in terms of
issue of shares of that class which prohibits such a variation.

(ii) The written consent of the holders of not less than three-
fourths of the issued shares of that class should be obtained or
the variation should be sanctioned by special resolution at a
separate meeting of the holders of shares of that class [Sec.
106].

Where the rights of shareholders have been varied in

pursuance of the above provisions, those who did not consent
or vote in favour of the resolution for the variation may apply to
the court to have the variation cancelled. Such an application
can be made only by persons who held at least ten per cent of
the issued shares of that class. The application shall be made
to the court within 21 days after passing of the resolution or
consent given as the case may be.

After hearing the applicant and any other person interested in

the application, the court may if it is satisfied that the variation
would unfairly prejudice the shareholders of the class
presented by application, disallow the variation and shall, if not
satisfied, confirm the variation. On any such application the
decision of the court shall be final.

Company must file a copy of the order of the court with the
Registrar within thirty days. If default is made a fine of upto Rs.
50 may be imposed. [Sec. 107].

Type # 5. Reorganisation of Capital:

186
The term arrangement includes a reorganisation of the share
capital of the company by consolidation of shares at different
classes, or by division of shares into different classes, or by
both these methods [Sec. 380 (b)].

When a reorganisation of share capital of a company is

proposed:

(i) Between a company and its creditors or any class of them,

or

(ii) Between a company and its members or any class of them,

the court may order a meeting of creditors or members of the
company on an application by the company or by any creditor
or members or by a liquidator in case the company is being
wound up.

The reorganisation of share capital of a company shall be

binding if the scheme is approved by a majority in number
representing three fourths in value of the creditors or members,
as the case may be present and voting in person or by proxy,
where proxies are allowed, and the scheme is sanctioned by
court. [Sec. 391].

Issue of Shares at a Discount [Sec. 79]:

Issue of shares at a discount means the issue price of shares is

less than their nominal face value.

A company can issue at a discount (i.e., for a

consideration less than the nominal value of the shares)
subject to the following conditions:

1. Shares to be issued at a discount shall be of a class already

issued.

2. The issue of shares at a discount is authorised by a

resolution passed by the company in its general meeting.

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3. The issue of shares at a discount must be sanctioned by the
Company Law Board (CLB).

4. The resolution specifies the maximum rate of discount at

which shares are to be issued. No such resolution shall be
sanctioned by the Company Law Board if the maximum rate of
discount specified in the resolution exceeds ten per cent,
unless Board is of the opinion that a higher percentage of
discount may be allowed in the special circumstances of the
case.

5. One year must have passed since the date at which the
company was entitled to commence business.

6. Shares are issued within two months after the date on which
the issue is sanctioned by the Company Law Board unless the
time is further extended.

7. Other conditions, if any, imposed by the Company Law

Board at the time of sanction.

8. Every prospectus relating to the issue of shares shall

disclose particulars of the discount allowed on the issue of
shares or that amount which has not been written off at the
date of the issue of prospectus.

The secretary of the company has also to do all general acts

regarding issue of shares at discount in addition to the acts
relating to the issue of share as discussed above.

Issue of Share at a Premium [Sec. 78]:

A company can always issue its shares at premium. In this

case, the issue price of shares is higher than their nominal or
face values. The difference between issue price and face value
is called premium. The power to issue shares at a premium
need not be given in the articles of the company.

188
The total premium amount shall be transferred to Share
Premium Account which may be applied only for the
following purpose and not for others:

1. To issue fully paid bonus shares to the members of the

Company.

2. To write off preliminary expenses of the company.

3. To write off the expenses or the commission paid or discount

allowed, on any issue of shares or debentures of the company.

4. To provide any premium on redemption of redeemable

preference shares or debentures of the company.

In addition to the above acts regarding the issue of shares at a

premium, the secretary of the company has also to do all
general acts regarding the issue of shares at discount.

Further Issue of Capital Right Issue:

Section 81 of the Companies Act laid down the procedure for

further issue of share capital after the first issue. When the
shares are issued further by the directors, such further shares
are offered to the existing equity shareholders of the company.

The conditions regarding further issue of share capital are

as follows:

1. To pass a resolution:

To increase the share capital a resolution must be passed by

the board of directors.

The further issue of share capital can take place after two years
from the date of formation of the company and one year after
allotment whichever is earlier. [Sec. 81(1)].

2. Increase in share capital:

189
The increase in the share capital must be of subscribed capital
and not of authorised.

3. Further shares are offered to existing shareholders:

The further shares must be offered to the equity shareholders

in proportion of capital paid by them on their shares.

A notice is being served by the company on the shareholders

defining therein the number of shares offered and time which
should not be less than fifteen days, must be given to give the
acceptance. If the acceptance does not reach within the
prescribed time then it is assumed that they do not accept the
shares offered.

4. Right of renunciation in favour of others:

Unless the articles of the company otherwise provide the

shareholders the right to renounce all or any of them in favour
of any person he likes.

5. Power of board to dispose of shares:

When the time expires as given in the notice to shareholders,

the board of directors may dispose of the shares in such a
manner as they think appropriate. They may offer these shares
to outsiders if a special resolution has been passed, then
consent of Central Government is to be obtained.

The above provisions do not apply to a private company or in

case of public company when increase of share capital takes
place due to conversion of debentures or loans into shares.

Right Shares:

As per Section 81 of the Companies Act, when the unissued

portion of the authorised capital is not issued earlier but is
issued now, then the existing shareholders of the company
have a first right to get them. This right is known as right of pre-

190
emption, and the shares which are meant for existing
shareholders are known as Right Shares.

The issue of right shares can be made at any time after the
expiry of two years from the formation of the company or after
the expiry of one year from the first allotment of shares after its
formation (Whichever is earlier).

A meeting of board of directors should consider the proposal for

right share and the terms of issue. A resolution should be
passed in the general meeting of the shareholders for increase
in share capital and a copy of resolution should be filed with the
registrar within thirty days.

Bonus Shares:

The issue of bonus shares implies the payment of dividend in

the form of shares instead of cash. A bonus issue occurs where
the company does not distribute the profits and reserve by way
of dividend, but retains them and uses them to make the
payment for the issue of new fully paid shares. The shares so
issued are called bonus shares. In case of bonus shares,
shareholders have not to make any payment to the company.

The provisions, regarding the issue of bonus shares, are

as follows:

1. The Company is authorised to issue bonus share or not.

2. The permission of ‘Controller of Capital Issues’ regardless of

the amount involved should be obtained.

3. A meeting of directors should be held to consider the

proposal for bonus issue and the proportion in which the same
should be issued.

4. Notices should be issued to the members relating to the

meeting.

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5. A resolution in the general meeting should be passed. If it is
a special resolution, a copy of it should be filed with the
Registrar within 30 days.

6. The list of members showing their present shareholding and

the number of bonus shares to which they are entitled should
be prepared.

7. A public notice regarding the closure of Register of Members

and Transfer Books for the purpose of issue of bonus share
should be given. .

8. ‘Allotment letters’ to the members alongwith a circular

explaining how the allotment has been made should be issued.

9. Necessary entries in the Register of Members should be

made.

10 New share certificates should be prepared and issued.

11. Within 30 days of the allotment a ‘Return of Allotment’

should be filed with the Registrar.

Difference between Bonus Shares and Right Shares:

The points of distinction between bonus and right shares

are listed in the following table:

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Power of Central Government to Convert Loans into Equity
Capital:

The Companies (Amendment) Act, 1963, has empowered the

Central Government to direct the conversion of its debentures
or loans into Equity Share Capital on such terms and conditions
as appear to government to be reasonable in the
circumstances of the case, even if the terms of issue of such
debentures or loans do not include a term providing for an
option for such conversion. The power is to be exercised only if
such conversion appears to be necessary in the interest of the
public.

In determining the terms and conditions of such

conversion the central government shall have due regard:

(i) To the financial position of the company,

(ii) Its liabilities,

(iii) It reserves,

(iv) Its profits during the preceding five years,

(v) The current market price of the company’s shares, and

(vi) The terms of the issue of the debentures or loans.

If the terms and conditions proposed by the government are not

acceptable to the company, it may within thirty days, from the
date of receiving the said order, or within such extended time
as may be granted by the court, prefer an appeal to the court
and the decision of the court shall be final and conclusive.

Restriction on Purchase by a Company of its Own Shares:

According to section 77, it is not open to a company, (whether

public or private) to purchase its own shares, for it involves a
reduction in capital which is not allowed except when the
capital of the company is legally reduced in pursuance of
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Sections 100 to 104 or Section 402. Under Sections 100 to
104, it is provided that a special resolution and sanction of the
court are needed for any reduction of share capital.

Section 402 provides that a company can purchase its own

shares to relieve and oppressed part of members with a view of
prevention of oppression under the order of the court. Any
reduction in share capital contrary to these Section is illegal
and ultra virus since the preservation of capital is one of the
most important aims of the Act. An unlimited liability company is
free from the restriction imposed by this section and it can
purchase its own shares.

Further, to make this section really effective sub-section

(2) provides that no public company, and no private
company which is a subsidiary of a public company, can
give any financial assistance in any shape towards the
purchase of its own shares or of its holding company,
except in the following cases:

1. Where a loan is made by a ‘banking company’ in the ordinary

course of its business.

2. Where provision of money is made under a scheme (e.g. a

pension scheme) to enable trustees to purchase fully paid
shares in the company to be held for the benefit of the
employees of the company, including salaried directors.

3. Where loans are made by a company to ’employees other

than directors’ to enable them to buy fully paid shares in the
company to be held by them as beneficial owners. The amount
of loan cannot exceed the employee’s salary for a period of 6
months.

It may, however be noted that the above sub-section does

not prohibit financial assistance:

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(i) By any company (public or private) for the purchase of
shares in any of its subsidiary companies, except to the extent
restricted by Section 195 and 369 of the Act; and

(ii) By and independent private company to any person,

whosoever, for purchasing shares in it.

If a company acts in contravention of the above provisions, the

company and every officer who is in default shall be punishable
with a fine which may extend to one thousand rupees.

What is Allotment of Shares?

Allotment of Shares; Procedures regarding allotment of shares;
Steps regarding allotment of shares

Meaning: It means an appropriation of a certain number of

shares to an applicant in response to his application for shares.
Allotment means distribution of shares among those who have
submitted written application.

Procedures regarding Allotment of Shares:

(1) Fulfillment of statutory conditions which need to be

fulfilled: The company secretary has to see that the statutory
conditions regarding the allotment of shares are fulfilled before
the Board proceeds to allot the shares.

The following are the statutory conditions which need to

be fulfilled:
(i) Valid offer and acceptance: There should be a valid offer
and acceptance for the allotment to be a valid one. Here the
company is the offertory and the acceptors are the general
public. If there is no company to offer then there would be no
public to accept.

(ii) Unconditional Allotment: The allotment must be absolute

and unconditional and also as per the terms and conditions

195
mentioned in the application. The allotment should be
unbiased, and not according to the caste, creed, religion. It is
not that rich shareholders pay more on the shares and the poor
share holders pay less on the shares. All have to pay the same
price on the shares.

(iii) Collection of minimum subscription amount: The

minimum subscription amount as noted in the prospectus has
been received within 120 days of the issue of prospectus.

(iv) Receipt of application money: Not less than 5% of the

nominal value of the share has been secured and has been
received along with the applications.

(v) Deposition of application of money in a scheduled

bank: All application money received along with the
applications must be deposited in a scheduled bank. It cannot
be withdrawn until the company gets trading certificate or
where such certificate is already received or till the minimum
subscription amount is received.

(vi) Filing of prospectus with the registrar: A copy of the

prospectus or statement in lieu of prospectus has been duly
filed with the registrar and at least three days have elapsed
after such filing before the allotment is taken up.

(vii) Time of allotment: No allotment of shares can be effected

until the beginning of the fifth day from the date of issue of
prospectus. The subscription list must be opened for at least 3
days as disclosed in the prospectus.

(viii) Proper communication: The allotment must be duly

communicated to the applicant through post i.e. registered post
with necessary details.

(ix) Allotment strictly as per documents issued: The Board

of Directors have to make the allotment of shares strictly as per

196
the documents issued which include the prospectus and the
application form. The provisions made in the Memorandum of
Association and the Articles of Association must also be given
due consideration.

(x) SEBI nominee: If the issue is over subscribed, the shares

are allotted on a proportionate basis. SEBI's nominee is
associated while finalizing the basis of allotment. The purpose
is to see that the allotment is done on a fair and just basis. The
allotment also needs to be approved by a leading stock
exchange.

(2) Appointment of allotment committee: The secretary

informs the Board, that the share applications are received and
are ready for allotment. If the issue is just subscribed or under
subscribed, the Board will do the allotment of shares, but if the
issue is over subscribed, the Board appoints an allotment
committee to do the allotment work. The allotment committee
will study the problem, prepare a report and submit to the
Board.

(3) Board meeting for finalization of allotment formula: A

meeting of the Board of Directors will be called to finalize the
allotment formula, which is being prepared by the allotment
committee. If the shares are listed, the allotment formula is to
be finalized with the approval of the concerned Stock Exchange
Authorities.

(4) SEBI's association with allotment work: A representative

of SEBI need to be associated while finalizing the allotment
formula. For this, the company has to request SEBI to nominate
a public representation for allotment work. SEBI's nominee is
necessary when the issue is over subscribed.

(5) Signature of chairman on application and allotment

list: The secretary has to see that every sheet of application
and allotment list is signed by the chairman. The secretary also

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has to sign the application and allotment lists.

(6)Resolution of the Board for allotment: The secretary has

to see that the Board passes a resolution regarding the
allotment of shares and authorizing him to issue letters of
allotment and letters of regret.

(7) Issue of letters of allotment and letters of regret: After

the Board's resolution to allot shares, the secretary prepares
the allotment list. Then he will send allotment letters to those
who have been allotted shares and regret letters to those who
could not be allotted shares.

(8) Refund / Adjustment of application money: The

secretary has to make suitable arrangement for the repayment
of application money sent by the applicant. The refunded
application money is made to those share holders who could
bot be allotted shares. The refund order is sent along with the
letters of regret. If an applicant has been allotted a smaller
number of shares than the number applied for, the secondary
has to adjust the excess amount with the amount due on
allotment.

(9) Collection of allotment money: The secretary has to

make suitable arrangements with the Company's Bankers for
collection of allotment money against the allotment letters.

(10) Arrangement relating to letters of renunciation: To

renounce means to give up. Certain applicants who are being
allotted shares do not want them, so they return the shares
back to the company. this is known as renunciation. The blank
form of letter of renunciation and letter of request for allotment
along with the letter of renunciation duly executed and the
original letter of allotment from the renounces, the secretary
has to make necessary changes in the Application of Allotment
list in order to enter the names of the new allot-tees.

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(11) Arrangement relating to splitting of allotment
letters: Splitting means putting the shares in one or more
names. In case any allottee requests for a split of the allotment
letter, the secretary places such a request before the Board for
approval. Once the Board approves the splitting of the
allotment letter, the secretary has to enter the details of the split
in a separate list of split allotments and issue the necessary
'split' letters.

(12) Submission of return of Allotment: Every company

whether public or private and having a share capital ans within
30 days of allotment is required to send to the Registrar, a
document known as the "Return of Allotment". The return of
allotment contains various details on allotment of shares such
as the nominal value of shares allotted, names and addresses
of allotees, amount paid or payable on each share and
particulars of bonus shares and shares issued at discount. The
secretary has to see that these documents are prepared and
submitted in time to the Registrar.

(13) Preparation of Register of members and issue of share

certificates: The secretary has to prepare the Register of
members from the Application and Allotment lists. He has to
see that the shares certificates are properly printed, sealed,
signed and distributed to all the allot-tees within three months
after the allotment of shares. He has also to see that the share
certificates are issued against the letters of allotment.

Allotment
What is 'Allotment'
An allotment commonly refers to the allocation of shares
granted to a participating underwriting firm during an initial
public offering (IPO). Remaining surpluses go to other firms
that have won the bid for the right to sell the remaining IPO
shares. There are more unique situations of allotment that arise
when new shares are issued and allocated to either a new or
existing shareholder.

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BREAKING DOWN 'Allotment'

In business, allotment describes a systematic distribution of

resources across different entities and over various time
periods. In finance, the term typically relates to the distribution
of shares during a public share issuance. Two or more financial
institutions usually underwrite a public offering. Each
underwriter receives a specific number of shares to sell.
However, an IPO is not the only case of share allocation.
Allotment arises when directors of a company earmark new
shares to predetermined shareholders. These are shareholders
who have either applied for new shares or earned them by
owning existing shares. For example, in a stock split, the
company allocates shares proportionately based on existing
ownership.

Reasons for New Share Issuance and Allotment

The number one reason a company issues new shares for

allotment is to raise money to finance business operations. An
IPO is also used to raise capital. In fact, there are very few
other reasons why a company would issue and allocate new
shares.
New shares can be issued to repay a public company's short-
or long-term debt. Paying down debt helps a company with
interest payments and changes critical financial ratios such as
the debt-to-equity ratio and debt-to-asset ratio. There are times
when a company may want to issue new shares, even if there
is little or no debt. When companies face situations where
current growth is outpacing sustainable growth, they may issue
new shares to fund the continuation of organic growth.
Company directors may issue new shares to fund an
acquisition or takeover of another business. In the case of
a takeover, new shares can be allotted to existing shareholders
of the acquired company, efficiently exchanging their shares for
equity in the acquiring company.
As a form of reward to existing shareholders and stakeholders,
companies issue and allot new shares. A scrip dividend, for

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example, is a dividend that gives equity holders some new
shares proportional to the value of what they would have
received if the dividend was cash.

 Allotment of Shares: Rules, Restrictions and Effects |

Company Accounts

Let us make an in-depth study about the allotment of shares.

After reading this article you will learn about: 1. Rules
Regarding Allotment 2. Restrictions 3. Effects of an Irregular
Allotment 4. Returns as to Allotment.

Rules Regarding Allotment of Shares:

The following rules regarding allotment of shares are noted:

(a) Application Form:

A prospectus is an invitation to the public to purchase shares.

Naturally, the intending purchaser has to apply in a prescribed
form (given in the prospectus) for the purpose which is known
as ‘application form’.

Needless to mention that the prospectus fixes the time when

the application will be opened and the allotment will be made.
Letter of allotment should be sent to the applicant of shares
after the allotment is made.

(b) Offer and Acceptance:

We know that membership of a company after purchasing

shares is nothing but a contract. The application form which is
given by the members is the ‘offer’ and allotment by directors is
the ‘acceptance’ of that ‘offer’ and, similarly, the notice of
acceptance which is sent is the ‘acceptance of the offer.’

(c) Conditional offer and Acceptance for ‘Offer’:

Usually, the conditions are printed in the application form, e.g.,

in case of over-subscription of shares, shares will be allotted on

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pro-rata basis etc. Conditions for acceptance is practically
invalid.

(d) Proper Authority:

It should be remembered that allotment of shares should

always be made by the proper authority e.g., by the board of
directors, and allotment made without proper authority is void.
Although allotment can be delegated to some persons if the
Articles so provide.

(e) Reasonable Time:

After receiving the application form allotment should be made

as soon as possible by the directors i.e., within a reasonable
time. Otherwise, applications for ‘offer’ will be revoked if such
reasonable time expires.

(f) Fictitious Name:

Sec. 68A states that any person who

(i) Makes in a fictitious name for acquiring or subscribing for

any share; or,

(ii) induces a company to allot, register any transfer of shares to

him or any other person in a fictitious name shall be punishable
by imprisonment up to 5 years.

Restrictions on Allotment of Shares:

The following restrictions have been prescribed by the

Companies Act regarding allotment of shares:

(a) Minimum Subscription:

Sec. 69(1) states that no allotment can be made by the

company until the minimum subscription has been received.

(b) Application Money:

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Sec. 69(3), however, lays down that the amount payable on
each share with the application form must not be less than 5%
of the nominal value of the shares.

(c) Money to be Deposited in a Scheduled Bank:

Sec. 69(4) states that money received from the applicants must
be deposited in a Scheduled Bank until the certificate to
commence business has been obtained or until the entire
amount payable on applications for shares in respect of the
minimum subscription has been received by the company.

(d) Returns of Money:

Sec. 69(5) states that if the minimum subscription has not been
raised or if the allotment could not be made within 120 days
from the date of publication of the prospectus, the directors
must return the money received from the applicants. If the
money is refunded within 130 days no interest is payable,
beyond which the directors are liable to pay interest @ 6% p.a.
from the 130th day to the day of repayment.

(e) Statement in lieu of Prospectus:

Sec. 70 of the Companies Act states that a public company

which has not issued any prospectus must deliver to the
Registrar for registration a statement in lieu of prospectus
signed by every director or proposed director or his agent in the
form prescribed in Schedule III of the Act, at least 3 days before
the first allotment of shares.

(f) Opening of the Subscription List:

Sec. 72 lays down that no allotment can be made until the

beginning of the 5th day after the publication of the prospectus
or such later time as may be prescribed for the purposes in the
prospectus.

(g) Revocation of Application:

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Application for shares cannot be revoked until after the
expiration of the 5th day after the time of opening of the
subscription list except in one case, i.e. if any responsible
person gives public notice of withdrawal of the consent to the
issue of the prospectus, any applicant can revoke his
application.

Effects of an Irregular Allotment of Shares:

The following consequences are to be made if the

allotment is made in contravention of Sees. 69, 70 and 73,
stated earlier:

(i) Option:

See. 71(1) and (2) states that the allotment becomes voidable
at the option of the shareholders. The option to avoid the
contract must be exercised within 2 months of holding the
statutory meeting or where no statutory meeting is held or
where the allotment is made after the holding of the statutory
meeting, within 2 months after the date of allotment.

The same can be exercised even if the company is in course of

liquidation.

(ii) Compensation:

Sec. 71(3) lays down that if any director knowingly or wilfully

contravenes the rules or authorizes the contravention, he is
liable to pay compensation to the shareholders concerned for
any loss or damage suffered by him. But the suit for
compensation must be filed within 2 years from the date of
allotment.

(iii) Fine:

Sec. 72(3) states that the validity of an allotment shall not be

affected by any contravention of the foregoing provisions of this
section, but,, in the event of any such contravention, the

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company, a fid every officer of the company who is in default,
shall be punishable with fine which may extend to Rs. 5,000.

(iv) Void:

If any allotment is made in violation of Sec. 73, the same is

treated as void.

Returns as to Allotment of Shares:

According to Sec. 75 of the Companies Act, a company

having a share capital (whether public or private) must file
with the Registrar a return of the allotment within 30 days
after making such allotment of shares giving full
particulars of allotment made, such as:

(i) The number and the nominal amount of the shares allotted;

(ii) The names, addresses and occupations of the allottees; and

(iii) The amount paid or payable on each share.

If any shares (other than bonus shares) are allotted as

partly paid-up or fully paid-up (other than cash) the
company must produce for the inspection of the registrar:

(i) A contract in writing constituting the title of the allottee to the

shares;

(ii) The contract of sale or for services or other consideration for

which the allotment was made; and

(iii) file with the Registrar—(a) copies or the contract

(mentioned above) and (b) a return stating the number and
nominal amount of the share so allotted.

While allotting bonus shares, the return should state the

names, addresses and occupations of the allottee, in addition
to the number and nominal amount of the shares constituted in

205
allotment together with a copy of the resolution authorising the
issues of such shares.

It should be remembered that no return need be filed relating to

the issues and allotment of shares which the company had
forfeited for non-payment of calls. Re-issue of forfeited shares
is not an allotment within the meaning of Sec. 75(1).

Procedures for Issue and Allotment of Shares | Provisions of

Companies Act

A private company can start business as soon as it gets the

certificate of incorporation. It is prohibited by law to issue any
prospectus, inviting the general public to subscribe towards its
share capital. The shares are taken up privately by the
promoters and their relatives and friends. But in case of public
company, a proper procedure has been laid down in the
Companies Act for the issue and allotment of shares. The
following are the main provisions of the Companies Act relating
to the issue and allotment of shares.

Provisions of companies act relating to issue and

allotment of shares

1. A public company must file a prospectus or statement in

lieu of prospectus, inviting offers from the public for the
purchase of shares in the company.

2. After studying the prospectus, the public applies for shares

of the company in the printed prescribed forms. The company
can ask for the issue price of the share to be paid in full along
with the application or it can be payable in installments as
share application money, share allotment money, share first
call, share second call and so on. The amount payable as
application money must be at least 5 percent of the nominal
amount of the share.

3. No allotment of shares can be made unless the ‘Minimum

Subscription‘ as given in the prospectus had been subscribed
206
or applied for. Minimum Subscription is the minimum amount
which, in the estimate of the directors, is required to run the
business. It has to be stated in the prospectus.

4. The amount of share application money must be

deposited in a bank. It can be operated by the company only
after getting the certificate of commencement.

5. If the minimum subscription amount of 90% of the issue was

not achieved by the company within 60 days from the date of
closure of the issue, the company has to refund the entire
subscription amount immediately. For any delay beyond 78
days, the company has to pay an interest of 6% per annum.

After allotment, the directors can call upon the shareholders to

pay the full amount due on shares in one or more installments
as mentioned in the prospectus. The articles of a company
usually contain provisions regarding calls. If there is no such
provision in the Articles, the following provisions shall apply:

i. No call shall be for more than 25% of the nominal value of

each share.
ii. Interval between any two calls should not be less than one
month.
iii. At least 14 days’ notice must be given to each member for
a call specifying the amount, date and place of payment.
iv. Call should be made on a uniform basis on the entire body
of shareholders falling under the same class.

Allotment of shares
Introduction

Offers for shares are made on application forms supplied by the

company. When an application is accepted, it is an allotment. A
valid allotment has to comply with the requirements of the Act
and principles of the law of contract relating to acceptance of
offers.
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Statutory restrictions on allotment

1. Minimum subscription and application money [s.39] –

When Shares are offered to the public, the amount of minimum
subscription has to be stated in the prospectus. No shares can
be allotted unless at least so much amount has been
subscribed and the application money (which must not be less
than five percent, SEBI may prescribe different percentage) has
been received in by cheque or other instrument. An application
for shares, if not accompanied by any such payment, does not
constitute a valid offer. If the minimum subscription has not
been received within 30 days of the issue of the prospectus, or
such other period as may be prescribed by SEBI, the amount
received is to be returned within such time and manner as may
be prescribed. [S. 39 (3)]

2. Shares to be dealt in on stock exchange [S. 40] –

Every company intending to offer shares or debentures to the
public by the issue of a prospectus has to make an application
before the issue to any one or more of the recognized stock
exchange for permission for the shares or debentures to be
dealt with at the exchange. This is known as listing. The name
or names of the stock exchange to which the application has
been made must also be stated in the prospectus. Where an
appeal has been preferred under Section 22, Securities
Contracts (Regulation) Act, 1956 against the refusal of a stock
exchange, the allotment does not become void until the
dismissal of the appeal.

General principles as to allotment

1. Allotment by proper authority – In the first place, an

allotment must be made by a resolution of the Board of
Directors. “Allotment is a duty primarily falling upon the
directors”, and this duty cannot be delegated except in
accordance with the provisions of the articles.

2. Within reasonable time – Allotment must be made within

reasonable period of time, otherwise the application lapses.
208
What is reasonable time depends upon the facts of the case.
On the expiry of reasonable time Section 6, Contract Act
applies and the application must be deemed to have been
revoked.

3. Must be communicated – The allotment must be

communicated to the applicant. Posting of a properly
addressed and stamped letter of allotment is sufficient
communication even if the letter is delayed or lost in the course
of post. [SP Gaekwad v. Shantadevi Gaekwad, (2005) 11 SCC
314]

4. Absolute and unconditional – Allotment must be

absolute and in accordance with the terms and conditions of
the application, if any.

Book Building
What is 'Book Building'
Book building is the process by which an underwriter attempts
to determine the price to place an initial public offering (IPO)
based on demand from institutional investors. An underwriter
builds a book by accepting orders from fund managers,
indicating the number of shares they desire and the price they
are willing to pay.

BREAKING DOWN 'Book Building'

Book building is the process of price discovery that involves

generating and recording investor demand for shares during
an initial public offering (IPO) or other issuance stages. The
issuing company hires an investment bank to act
as underwriter. The underwriter determines the price range the
security can be sold for, and ends out the draft prospectus to
multiple investors. The large-scale buyers and investors bid the
number of shares that they are willing and able to buy, given
the price range. As initial prices are provided by investors, the
book is created by listing the information provided during the

209
predetermined time period before the book is considered to be
closed.

The book is open for a fixed period of time, during which the
bidder can revise the price offered. After five days, the book is
closed and the aggregated demand for the issue can be
evaluated so that a value is placed on the security. Once
closed, the underwriter analyzes the information to determine
the initial selling price, also known as the issue price, for the
particular offering. The final price chosen in simply the weighted
average of all the bids that have been received by the
investment banker.

Even if the information collected during the book building

suggests a particular price point is best, that does not
guarantee a large number of actual purchases once the IPO is
open to buyers. Further, it is not a requirement that the IPO be
offered at that price suggested during the analysis.

Accelerated Book Building

An accelerated bookbuild is often used when a company is in

immediate need of financing, in which case, debt financing is
out of the question. This can be the case when a firm is looking
to make an offer to acquire another firm. Basically, when a
company is unable to obtain additional financing for a short-
term project or acquisition due to its high debt obligations, it can
use an accelerated bookbuild to obtain quick financing from the
equity market.

With an accelerated bookbuild, the offer period is open for only

one or two days and with little to no marketing. In other words,
the time between pricing and issuance is 48 hours or less. A
block build that is accelerated is frequently implemented
overnight, with the issuing company contacting a number of
investment banks that can serve as underwriters on the
evening prior to the intended placement. The issuer solicits bids
in an auction-type process and awards the underwriting
contract to the bank that commits to the highest back stop
210
price. The underwriter submits the proposal with the price
range to institutional investors. In effect, placement with
investors happens overnight with the security pricing occurring
most often within 24 to 48 hours.

IPO Pricing Risk

With any IPO, there is a risk of the stock being overpriced or

undervalued when the initial price is set. If it is overpriced, it
may discourage investor interest if they are not certain that the
company’s price corresponds with its actual value. This
reaction within the marketplace can cause the price to fall
further, lowering the value of shares that have already been
secured.

In cases where a stock is undervalued, it is considered to be a

missed opportunity on the part of the issuing company; it could
have generated more funds than were acquired as part of the
IPO.

Book Building: Meaning,

Process and Comparison
Meaning of Book Building:

Every business organisation needs funds for its business

activities. It can raise funds either externally or through internal
sources. When the companies want to go for the external
sources, they use various means for the same. Two of the most
popular means to raise money are Initial Public Offer (IPO) and
Follow on Public Offer (FPO).

During the IPO or FPO, the company offers its shares to the
public either at fixed price or offers a price range, so that the
investors can decide on the right price. The method of offering
shares by providing a price range is called book building
method. This method provides an opportunity to the market to
discover price for the securities which are on offer.
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Book Building may be defined as a process used by companies
raising capital through Public Offerings-both Initial Public Offers
(IPOs) and Follow-on Public Offers (FPOs) to aid price and
demand discovery. It is a mechanism where, during the period
for which the book for the offer is open, the bids are collected
from investors at various prices, which are within the price band
specified by the issuer. The process is directed towards both
the institutional investors as well as the retail investors. The
issue price is determined after the bid closure based on the
demand generated in the process.

Book Building vs. Fixed Price Method:

The main difference between the book building method and the
fixed price method is that in the former, the issue price to not
decided initially. The investors have to bid for the shares within
the price range given. The issue price is fixed on the basis of
demand and supply of the shares.

On the other hand, in the fixed price method, the price is

decided right at the start. Investors cannot choose the price.
They have to buy the shares at the price decided by the
company. In the book building method, the demand is known
every day during the offer period, but in fixed price method, the
demand is known only after the issue closes.

Book Building in India:

The introduction of book-building in India was done in 1995

following the recommendations of an expert committee
appointed by SEBI under Y.H. Malegam. The committee
recommended and SEBI accepted in November 1995 that the
book-building route should be open to issuer companies,
subject to certain terms and conditions. In January 2000, SEBI
came out with a compendium of guidelines, circulars and
instructions to merchant bankers relating to issue of capital,
including those on the book-building mechanism.

Book Building Process:

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The principal intermediaries involved in a book building process
are the companies, Book Running Lead Manager (BRLM) and
syndicate members are the intermediaries registered with SEBI
and eligible to act as underwriters. Syndicate members are
appointed by the BRLM. The book building process is
undertaken basically to determine investor appetite for a share
at a particular price. It is undertaken before making a public
offer and it helps determine the issue price and the number of
shares to be issued.

The following are the important points in book building

process:

1. The Issuer who is planning an offer nominates lead merchant

banker(s) as ‘book runners’.

2. The Issuer specifies the number of securities to be issued

and the price band for the bids.

3. The Issuer also appoints syndicate members with whom

orders are to be placed by the investors.

4. The syndicate members put the orders into an ‘electronic

book’. This process is called ‘bidding’ and is similar to open
auction.

5. The book normally remains open for a period of 5 days.

6. Bids have to be entered within the specified price band.

7. Bids can be revised by the bidders before the book closes.

8. On the close of the book building period, the book runners

evaluate the bids on the basis of the demand at various price
levels.

9. The book runners and the Issuer decide the final price at
which the securities shall be issued.

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10. Generally, the number of shares is fixed; the issue size gets
frozen based on the final price per share.

11. Allocation of securities is made to the successful bidders.

The rest bidders get refund orders.

How is the Price Fixed?

All the applications received till the last dates are analyzed and
a final offer price, known as the cutoff price is arrived at. The
final price is the equilibrium price or the highest price at which
all the shares on offer can be sold smoothly. If the price quoted
by an investor is less than the final price, he will not get
allotment.

If price quoted by an investor is higher than the final price, the

amount in excess of the final price is refunded if he gets
allotment. If the allotment is not made, full money is refunded
within 15 days after the final allotment is made. If the investor
does not get money or allotment in a month’s time, he can
demand interest at 15 per cent per annum on the money due.

Example:

In this method, the company doesn’t fix up a particular price for

the shares, but instead gives a price range, e.g., Rs. 80 to 100.
When bidding for the shares, investors have to decide at which
price they would like to bid for the shares, e.g., Rs. 80, Rs. 90
or Rs. 100. They can bid for the shares at any price within this
range. Based on the demand and supply of the shares, the final
price is fixed.

The lowest price (Rs. 80) is known as the floor price and the
highest price (Rs. 100) is known as cap price. The price at
which the shares are allotted is known as cut off price. The
entire process begins with the selection of the lead manager,
an investment banker whose job is to bring the issue to the
public.

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Both the lead manager and the issuing company fix the price
range and the issue size. Next, syndicate members are hired to
obtain bids from the investors. Normally, the issue is kept open
for 5 days. Once the offer period is over, the lead manager and
issuing company fix the price at which the shares are sold to
the investors.

If the issue price is less than the cap price, the investors who
bid at the cap price will get a refund and those who bid at the
floor price will end up paying the additional money. For
example, if the cut off in the above example is fixed at Rs. 90,
those who bid at Rs. 80, will have to pay Rs. 10 per share and
those who bid at Rs. 100, will end up getting the refund of Rs.
10 per share. Once each investor pays the actual issue price,
the share are allotted.

Book Building vs. Reserve Book Building:

While book building is used to raise capital for the company’s

business operations, reverse book building is used for buyback
of shares from the market. Reverse book building is also a
price discovery method, in which the bids are taken from the
current investors and the final price is decided on the last day
of the offer. Normally the price fixed in reverse book building
exceeds the market price.

Concepts and Process of Book Building

Book building is a method of price discovery. In this method,

offer price of securities is determined on the basis of real
demand for the shares at various price levels in the market.

As defined by SEBI guidelines, 1995, “book building is a

process undertaken by which a demand for the securities
proposed to be issued by a body corporate is elicited and built
up and the price for such securities is assessed for the
determination of the quantum of such securities to be issued by
means of a notice, circular, advertisement, document or
information memoranda of offer document.”
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In book building method, the final issue price is not known in
advance. Only a price band is determined and made public
before opening of the bidding process. The spread of price
between floor price and cap in the price band should not be
more than 20%. It means that the cap should not be more than
120% of the floor price. The issuer company appoints a
merchant banker as book runner lead manager (BRLM), who
may be assisted by other co-managers and by a team of
syndicate members acting as underwriters to the issue. The
BRLM sends copies of Red Herring Prospectus to the Qualified
Institutional Buyers (QIBs), large Investors, SEBI
registered Foreign Institutional Investors (FIIs) and to the
syndicate members

BRLM also appoints brokers of the stock exchanges, called

bidding centers. They accept the bids and application forms
from the investors. These bidding centers place the order of
bidders with the company through BRLM. They are liable for
any default, if any, made by their clients, who have applied
through them. Brokers/Syndicate members collect money from
clients/ investors. Money received by them at the time of
accepting bids is called margin money. Bids can be made
through on-line and transparent system of National Stock
Exchange and Bombay Stock Exchange depending upon the
agreement of the issuer with the stock exchange(s). An issue
through book building system remains open for 3 to 7 working
days. In case of revision of price band, it can be extended by 3
days. Rights issue remains open for at least 30 days and not
more than 60 days.

The BRLM, on receipt of the feedback from the syndicate

members about the bid price and the quantity of shares applied
builds up an order book showing the demand for the shares of
the company at various prices. The syndicate members must
also maintain a record book for the orders received from
institutional investors for subscription to the issue out of
placement portion.

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On the completion of book building process, the final price is
determined by Issuer Company in consultation with the BRLM.
Then the BRLM files final offer document with the Registrar of
Companies before allotment of shares. The final offer
document mentions the issue size and the offer price
discovered through book building process.

Book building method is a flexible method for the issuing

company as well as the bidders. The issuing company has the
option to withdraw the offer from the market if the demand for
the securities does not exist. The bidders can revise their bids
before the closing of bidding process and offer different
quantities at different prices. The investor can change or revise
the quantity or price in the bid using the form for
changing/revising the bid that is available along with the
application form. However, the entire process of changing or
revising the bids is to be completed within the date of closure of
the issue. The investor can also cancel the bid anytime before
the finalization of the basis of allotment by approaching/ writing/
making an application to the registrar of the issue. The
syndicate member returns the counterfoil with the signature,
date and stamp of the syndicate member. Investor can retain
this as a sufficient proof that the bids have been accepted by
the trading / syndicate member for uploading on the terminal.

In Indian primary capital market, book building process was

introduced in 1995 on the recommendations of an expert
committee appointed by SEBI under the Chairmanship of
Y.H.Malegam to review the existing disclosure requirements in
offer documents and the basis of pricing the issue. Initially,
book building process was permitted for placement portion of
the issue and for the issues exceeding Rs. 100 crores. But no
issuer company used this process for pricing their issues till the
end of 1998 due to stringent entry norms of SEBI and the
bearish conditions in the Indian capital market. In 1998-99,
SEBI reduced the issue size limit of Rs. 100 crore to 25 crore in
order to encourage the use of this method. On the suggestions
of market intermediaries, SEBI issued modified guidelines
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during the year 1999-2000, whereby the issuer company was
given the option to book build either 90% of the net public offer
or 75% of the net public offer. The balance of the issue was
allowed to be offered to the public at fixed price, determined
through book building process. In 1999-2000, an IT company,
Hughes Software Systems Ltd. was the first company to use
book building process for its initial public issue of equity shares
amounting to Rs.275.63 crore. The issue was oversubscribed
by 26 times and its books were built at the upper ceiling of the
price. During the year 2000-01, both unlisted and listed
companies were allowed to make public offerings through book
building route after satisfying the eligibility norms set by SEBI.
These norms required pre issue net worth of not less than one
crore in three out of five years and a track record of distributing
profits for at least 3 out of preceding 5 years; and issue size not
exceeding 5 times its pre issue net worth for unlisted
companies and not more than 5 times of pre issue net worth in
case of listed companies.

The minimum issue size limit of Rs. 25 crore was removed by

SEBI in 2001 in order to broaden the base of book building
facility. Further, in August 2003, the new criterion of net
tangible assets was added besides appraisal route as an
alternative to the mandatory book building route. The new
guidelines require that the issuer company should have net
tangible assets of at least 3 crore for 3 full years, of which not
more than 50% should be held in monetary assets. The SEBI
has amended these guidelines from time to time in order to
make the price discovery process more realistic.

Types of Book Building Process

Three types of options have been provided by SEBI to the

issuer companies under book building. These options are as
follows:

1. 75% Book Building, 25% Fixed Price Offer: In this type

of offer, 75% of the issue is offered to institutional

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 investors who participated in the bidding process. Balance
25% is offered to the public through prospectus and shall
be reserved for allocation to individual investors who had
not participated in the bidding process. The price for 25%
offer is the price as determined through book building.
First, the book building portion remains open for 3 to 7
days and on discovery of issue price after the completion
of book building process, the fixed price portion opens for
subscription.
2. 90% Book Building, 10% Fixed Price Offer: Here issuer
company offers 90% of the issue through book building
and the balance 10% through fixed price offer at a price
discovered through book building. This option was
available to the issuers during 1999-2000 and 2000-01
and later on discontinued by SEBI.
3. 100% Book Building Offer: In this type of offer, the whole
issue is offered through book building route. Issue opens
and closes on the same dates for all categories of
investors. Different categories of bidders bid at the point of
time. This type of issue takes minimum number of days for
the completion of the process of issue and allotment of
shares. Generally, the issue is listed on a Recognized
Stock Exchange after 3 weeks from the closure of the
issue (2 weeks for completion of allotment +1 week for
completion of listing formalities).

Allocation/ Allotment Procedure in Book Building Issues

In case of 100% one stage book building, the allocation to

Retail Individual Investors (RIIs), Non Institutional Investors
(NIIs) and Qualified Institutional Buyers (QIBs) is made in the
ratio of 35:15:50 respectively. Retail Individual Investor (RII)
means an individual who offers for securities up to the value of
Rs.2,00,000 and Non Institutional Investor means an individual,
who applies for securities for value exceeding Rs.2,00,000 (
limit revised by SEBI from Rs. 50,000 to Rs. 1,00,000 vide
circular no. SEBI/CFD/DIL/DIP/15/2005/29/3 dated March 29th
2005. In SEBI Board meeting held on October 25, 2010 (PR
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No. 231/2010), this limit was further increased to Rs. 2,00,000).
In case the book built issue is made pursuant to the
requirement of mandatory allocation of 60% to QIBs in terms of
Rule 19(2) (b) of Securities Contract (Regulation) Rules (in
case of big issues where issue size exceeds five times pre-
issue net worth of the issuer company), then allocation to RIIs,
NIIs and QIBs is made in the ratio of 30:10:60 respectively.
When book building issue is made on ‘75% Book Building and
25% fixed Price’ basis, the allotment to RIIs, NIIs and QIBs is
made in the ratio of 25:25:50 respectively. In case of 90% book
built issues, a minimum of 15% of the offer size was reserved
for individual investors who made bids through the syndicate
members and the balance of book built portion was available
for allocation to investors other than retail investors. The 10%
fixed price portion was allotted to individual investors who could
not participate in book building process. All applicants are
allotted shares on a proportionate basis within their respective
investor category. Earlier, the applicants of QIBs category were
allotted shares on discretionary basis which was later on
discontinued by SEBI in September, 2005.

What are the advantages and disadvantages for a company

going public?

An initial public offering (IPO) is the first sale of stock by a

company. Small companies looking to further the growth of
their company often use an IPO as a way to generate the
capital needed to expand. Although further expansion is a
benefit to the company, there are both advantages and
disadvantages that arise when a company goes public.

What are some of the advantages for a company going public?

 As said earlier, the financial benefit in the form of

raising capital is the most distinct advantage. Capital can
be used to fund research and development (R&D),
fund capital expenditure, or even used to pay off existing
debt.

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  Another advantage is an increased public awareness of
the company because IPOs often generate publicity by
making their products known to a new group of potential
customers. Subsequently, this may lead to an increase in
market share for the company.
 An IPO also may be used by founding individuals as
an exit strategy. Many venture capitalists have used
IPOs to cash in on successful companies that they helped
start-up.

Public companies often face many new challenges as well

Even with the benefits of an IPO, public companies often face

several disadvantages that may make them think twice about
going public.
 One of the most important changes is the need for added
disclosure for investors. Public companies are regulated
by the Securities Exchange Act of 1934 in regard to
periodic financial reporting, which may be difficult for
newer public companies. They must also meet other rules
and regulations that are monitored by the Securities and
Exchange Commission (SEC).
 More importantly, especially for smaller companies, is
that the cost of complying with regulatory
requirements can be very high. These costs have only
increased with the advent of the Sarbanes-Oxley Act.
Some of the additional costs include the generation of
financial reporting documents, audit fees, investor relation
departments, and accounting oversight committees.
 Public companies also are faced with the added pressure
of the market which may cause them to focus more on
short-term results rather than long-term growth. The
actions of the company's management also become
increasingly scrutinized as investors constantly look for
rising profits. This may lead management to use
somewhat questionable practices in order to boost
earnings.

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IPO or stay private?

Before deciding whether or not to go public, companies must

evaluate all of the potential advantages and disadvantages that
will arise. This usually happens during the underwriting process
as the company works with an investment bank to weigh the
pros and cons of a public offering and determine if it is in the
best interest of the company for that time period.
One of the highest profile IPOs of 2017 was Snap Inc (SNAP),
best known for their flagship product Snapchat. Despite
an initial surge, the stock has been unable to gain much
traction with investors during its first year as a public company.

Meaning of Book Building:

Book building is a process of price discovery. Book building is a
process by which the issuer company before filing of the
prospectus, builds-up and ascertains the demand for the
securities being issued and assesses the price at which such
securities may be issued and ultimately determines the
quantum of securities to be issued.

Under book building process, the issuing company is required

to tie up the issue amount by way of private placement. The
issue price is not priced in advance. It is determined by offer of
potential investors about price which they may be willing to pay
for the issue. To tie-up the issue amount, the company
organizes road shows and various advertisement campaigns.

During book building process, the issuer company ties up with

a selected group of individuals and agencies for private
placement. The entire exercise is done on a whole sale basis.

The issuing company appoints a lead manager who builds the

order book by forming a syndicate of eligible potential buyers.
The book runner (lead manager) notes the amounts offered by
various investors such as Institutional Investors, Mutual Funds,
Underwriters, Foreign Institutional Investors etc.

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The price of the instrument is the weighted average at which
the majority of investors are willing to buy the instrument. The
price is investor driven and based on market forces of demand
and supply. Book building refers to the collection of bids from
investors, which is based on an indicative price range, the offer
price being fixed after the bid closing date.

The principal parties/intermediaries involved in a book

building process are:

(a) The Company.

(b) A Book Running Lead Manager who is a category I

Merchant Banker registered with SEBI. The book running lead
manager is also the lead merchant banker.

(c) Syndicate members who are intermediaries registered with

SEBI and who are permitted to carry on activities as
underwriters. Syndicate members are appointed by the book
running lead manager.

 Benefits of Book Building:

Book building helps in evaluating the intrinsic worth of the

instrument being offered and the company’s credibility in the
eyes of public. The entire exercise is done on a wholesale
basis.

(a) Price of instrument is determined in a more realistic way on

the commitments made by the prospective investors to the
issue.

(b) The prime objective of book building process is to determine

the highest market price for shares and securities and demand
level from highest quality investors in order to adjust pricing and
allocation decision.
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(c) Book building is a process of fixing price for an issue on
feedback from potential investors on how they are willing to bid
to pick up issues and instruments.

(d) The process of book building is advantageous to the issuer

company as the pricing of issue would be more realistic as the
final price is decided about 11 to 12 days before the opening of
the issue. Book building also offers access to capital more
quickly than the public issue.

(e) As the issue is pre-sold, there would be no uncertainties

relating to the fate of the issue involved.

(f) The Issuer company saves advertising and brokerage

commissions.

(g) Issuers can choose investors by quality.

(h) Investors have a voice in the pricing of issues. They have a

greater certainty of being allotted what they demand. Investors
need not lockup huge amounts of capital with the Issuer as they
pay at the end of the process.

(i) The issue price is market-determined. As it is a distant

possibility that the market price of the shares would fall lower
than the issue price. Hence, the investor is less likely to suffer
from erosion of his investment on listing.

(j) Optimal demand based pricing is possible.

(k) Efficient capital raising with improved issue procedures,

leading to a reduction in issue costs, paper work and lead
times.

(l) Flexibility to increase/decrease price and/or size of offering

the issues is possible.

(m) Transparency of allocations is made.

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(n) Upgraded information flow of issues, lead managers,
syndicate members and investors is made possible.

(o) Book-building process inspires investors confidence leading

to a larger investor universe.

(p) Book-building process creates a liquid and buoyant after

market.

(q) As the syndicate members will get firm allocation, the

investors to that extent are assured of allotment.

(r) Immediate allotment and listing of placement portion of

securities.

Limitations of Book Building:

The book-building system has various limitations, some of

these limitations are summarized as follows:

1. Book building is appropriate for mega issues only. In the

case of small issues, the companies can adjust the attributes of
the offer according to the preferences of the potential investors.
It may not be possible in big issues, since the risk-return
preference of the investors cannot be estimated easily.

2. The issuer company should be fundamentally strong and

well known to the investors.

3. The book building system works very efficiently in matured

market conditions. In such circumstances, the investors are
aware of various parameters affecting the market price of the
securities. But, such conditions are not commonly found in
practice.

4. There is a possibility of price rigging on listing as promoters

may try to bailout syndicate members.

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  Transferring shares

What Is Transfer Of Shares?

Transfer of Shares:- Shares are movable property and
transferable like any other property. Transfer of shares is one of
the beneficial features of a public company. Transfer is a
voluntary act of parties which results in transfer of ownership.

A shareholder cannot withdraw his money from the company as

the amount received on shares is the permanent capital of the
company. This is the reason why transferability of shares has
been given importance from the very beginning of the
company. A shareholder can only convert their shares into cash
by transferring them to any other person either in share market
or by private sales.

For an effective transfer, the ‘Transfer Deed’ which contains

the particulars of transferor and transferee and is duly signed
by both of them is sent to the company along with the
Share Certificates. The company will examine
the particulars and on getting satisfied with the particulars,
company will enter the name of transferor in the ‘Register of
Members’ and remove the name of transferee will be removed
from the Register.

Transfer of shares

Company Law Solutions provides an expert service for all

aspects of share capital for private companies,
including issuing and transferring shares,share transfer
provisions, setting up different classes of shares, converting
shares from one class to another, consolidating and sub-
dividing shares, companies buying their own
shares and reductions of capital. More practical advice is
available on the Company Law Solutions website.

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Under the law of England and Wales, Scotland and Northern
Ireland, s hares are items of property and, like any other
property, can be sold or given away. The sale or gift will require
a transfer of the shares. Shares were developed as a means of
allowing a group of people to invest in a business project by
buying shares of it. To be an attractive investment, the shares
had to be transferable, so that the investor could sell the shares
to retrieve their value. So shares are presumed to be capable
of transfer, even in a private company, unless the company has
restricted the right to transfer them by a provision in its articles,
or the shareholder has entered into a contract, such as a
shareholders' agreement, not to transfer the shares.

 Transfer procedure
 Stamp duty
 Restrictions on transfer
 Model Articles provisions
 Table A provisions
 New statutory provisions under CA 2006

The standard form required to transfer shares is a 'stock

transfer form', duly stamped with payment of stamp duty (where
necessary). A stock transfer from (in accordance with the Stock
Transfer Act 1963) will be a proper instrument for the transfer of
any shares in any company in England and Wales, Scotland or
Northern Ireland.

Share transfer procedure

The shareholder (usually called 'the transferor') provides the

transferee with a duly completed and signed stock transfer form
and the share certificate in respect of the shares to be
transferred. The transferee has the transfer stamped by paying
the relevant amount of stamp duty (see below) and then sends
the stock transfer form and the share certificate to the
company. It is not lawful for a company to register a transfer of
shares unless a duly stamped proper instrument of transfer has
been delivered to it, or the transfer is an exempt transfer within

227
the Stock Transfer Act 1982. This applies notwithstanding
anything in the company's articles.

The company decides whether to accept the transfer. This

should be done by a resolution of the directors unless the
secretary has previously been authorised by the board to
accept transfers. The company must accept the transfer unless
there is some provision in its articles which restricts transfers or
gives the board a discretion to decline them. If a company
refuses to register a transfer it shall within two months after the
date on which the transfer was lodged with it, send to the
transferee notice of the refusal. See Companies Act 2006,
sec177 below.

If the transfer is accepted by the company, the company will

make the necessary entries in the register of members (and, if
the company keeps one, the register of transfers) and issues a
share certificate to the transferee. The certificate must be
available within two months after the date when the transfer
was lodged.

The company keeps the stock transfer form and the old share
certificate (which should have 'Cancelled' stamped or written
across it so that it cannot be re-issued inadvertently). No form
or notice is sent to Companies House.

If the transfer is for part only of the transferor's shareholding,

and the transaction is at arms' length, the transferor may not
wish to part with a share certificate for the larger number of
shares. Either the transferor could request the company for split
certificates or a "certificated transfer", a stock transfer form
certificated by the company to the effect that the certificate has
been lodged. This procedure is rarely used in small private
companies.

The transfer may affect the the identity or details of one or more
people who have significant control of the company. Typically,
this is where someone become, or ceases to be, the holder of
more than 25% of the voting shares, but the rules are much
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more complicated than that. If there is a change, the details
must be entered on the company's PSC register and
Companies House must be notified. See further Register of
people who have significant control (PSC register).

Stamp duty

Stamp duty is payable on the sale of shares at a rate of 50p per

£100 or part thereof. It is payable on the full amount and is
subject to a minimum amount of £5. There is no exempt band.
If the shares are transferred for consideration below £1,000 or
by way of a gift or settlement, exemption can be claimed by
completing and signing the reverse of the form. Stamp duty is
paid by taking or sending the form to the stamp office of the
Inland Revenue.

Restriction on transfer

These will depend on the company's articles. The Model

Articles have a restriction, but Table A (from 1981) does not. In
practice most private companies will want some control over
the transfer of their shares. Provisions vary from a simple
power for the directors to decline any transfer (as found in the
Model Articles) to pre-emption provisions, free transfers to
family members and even provisions for enforced transfer in
certain circumstances (e.g. if the shareholder ceases to be a
director). Having the right provisions in the articles can be
vitally important. Company Law Solutions can advise and draft
any required provisions.

Model Articles provisions

Share transfers
26. (1) Shares may be transferred by means of an instrument of
transfer in any usual form or any other form approved by the
directors, which is executed by or on behalf of the transferor.
(2) No fee may be charged for registering any instrument of
transfer or other document relating to or affecting the title to any
share.
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(3) The company may retain any instrument of transfer which is
registered.
(4) The transferor remains the holder of a share until the
transferee's name is entered in the register of members as
holder of it.
(5) The directors may refuse to register the transfer of a share,
and if they do so, the instrument of transfer must be returned to
the transferee with the notice of refusal unless they suspect
that the proposed transfer may be fraudulent.

Table A provisions

Transfer of shares
23. The instrument of transfer of a share may be in any usual
form or in any other form which the directors may approve and
shall be executed by or on behalf of the transferor and, unless
the share is fully paid, by or on behalf of the transferee.

24. The directors may refuse to register the transfer of a share

which is not fully paid to a person of whom they do not approve
and they may refuse to register the transfer of a share on which
the company has a lien. They may also refuse to register a
transfer unless -
(a) it is lodged at the office or at such other place as the
directors may appoint and is accompanied by the certificate for
the shares to which it relates and such other evidence as the
directors may reasonably require to show the right of the
transferor to make the transfer;
(b) it is in respect of only one class of shares; and
(c) it is in favour of not more than four transferees.

25. If the directors refuse to register the transfer of a share ,

they shall within two months after the date on which the transfer
was lodged with the company send to the transferee notice of
the refusal.

26. The registration of transfers of shares or of transfers of any

class of shares may be suspended at such times and for such
230
periods (not exceeding thirty days in any year) as the directors
may determine.

27. No fee shall be charged for the registration of any

instrument of transfer or other document relating to or affecting
the title to any share.

28. The company shall be entitled to retain any instrument of

transfer which is registered, but any instrument of transfer
which the directors refuse to register shall be returned to the
person lodging it when notice of the refusal is given.

Sec771, Companies Act 2006 provides a statutory

procedure on a transfer being lodged

(1) When a transfer of shares in or debentures of a company

has been lodged with the company, the company must either-
(a) register the transfer, or
(b) give the transferee notice of refusal to register the transfer,
together with its reasons for the refusal,
as soon as practicable and in any event within two months after
the date on which the transfer is lodged with it.
(2) If the company refuses to register the transfer, it must
provide the transferee with such further information about the
reasons for the refusal as the transferee may reasonably
request. This does not include copies of minutes of meetings of
directors.
(5) This section does not apply-
(a) in relation to a transfer of shares if the company has issued
a share warrant in respect of the shares (see section 779);
(b) in relation to the transmission of shares or debentures by
operation of law.

The second most common restriction which is often included in

articles is a pre-emption provision, i.e. that shares must be
offered to existing shareholders in proportion to their present
holdings. Note that the statutory pre-emptive rights in CA 2006,

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sec561-577 apply only to allotments of shares. (See related
topic: What are pre-emptive rights?)

There may be other provisions, e.g. that shares are freely

transferable to other members, or members of the family
(defined) of the shareholder, but that other transfers may be
refused by the directors. There can be provisions that a person
who ceases to be a director has to transfer their shares.

 What is a share transfer?

There may be times when you want to change the share

structure of your company; either by adding a new shareholder
or by changing the existing proportion of shares between
shareholders. A share transfer is the process of transferring
existing shares from one person to another; either by sale or
gift.

Transferring shares

Shares can be transferred from a shareholder to another

person (either a new or existing shareholder). Shares are
transferred by way of gift or sale. Typically, shares are
transferred to introduce a new shareholder.

So long as a company has enough shares, it’s possible to

transfer shares in a limited company any time after
incorporation.

Before you take any action on changing your share structure

within your company contact your Account Manager so we can
understand and advise on your plans.

The process

Any transfer of shares needs to be formally actioned by you as

the director. You will need to complete the following steps:

Confirm your shareholdings

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Existing inniAccounts clients

If you’re an existing client of inniAccounts, your first port of call

should be to inform your account manager of your plans; we’ll
then be able to guide you through the process and update our
software to reflect any changes.

When it comes to updating Companies House, we can take

care of this for you if you prefer. Ask your account manager
about our £35 one off fee or about adding our Company
Secretarial Service to your package.

Before you transfer any shares, you need to confirm your

current shareholdings, the number of shares you wish to
transfer and the resulting share structure of your
shareholders. If you are transferring shares to a new
shareholder you will also need to confirm their name, date of
birth, nationality, residential address, proof of ID and
relationship to the other shareholders in your company.

In some cases, you may have insufficient shares in your

company to allow your intended transfer. This would mean that
you need to allot new shares. If you are unsure about the
number of shares in your company, please contact your
account manager.

Hold a board meeting

The share transfer must be approved through a board

agreement. A board meeting should be held to review the stock
transfer form and agree the transfer. Be sure to keep detailed
minutes of your meeting that clearly display the revised share
structure and share holdings. These minutes will need to be
kept safe with your company records, they’ll later be used when
updating Companies House and also provide a solid audit trail.
If you’re an inniAccounts client, we’ll send you a template for
the minutes of your meeting.

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 Complete a stock transfer form

A stock transfer form (or J30 form) is a standard document that

can be used to transfer existing shares. It contains details of
the seller (or gifter) of the shares and the receiver, the type and
number of shares being transferred as well as any
consideration that has been paid for the shares. As director,
you need to complete these details before signing and dating
the form. It’s standard practice to complete a stock transfer
form in black ink and BLOCK CAPITALS. This form will need to
be stored with your company records. If you’re an inniAccounts
client, we’ll send you a template of the stock transfer form.

In some scenarios, once a transfer is agreed, a stock transfer

form certificate may be required. In most cases, if the shares
are being transferred for ‘nil consideration’ i.e. gifted, then a
certificate is not required.

Issue new share certificates

Having agreed your share structure, you will need to issue new
share certificates detailing the shareholdings – these will render
any previous share certificates as effectively cancelled. If you
are an inniAccounts client, we will send you a template share
certificate to be signed and dated.

Update your company’s confirmation statement

(CS01) with the new share totals

You now need to update your company’s confirmation

statement, with Companies House, to show the new share
structure within your company. If you transferred shares to a
new shareholder, you need to include their details in your
confirmation statement.

Don’t forget
If a shareholder has over a 25% holding in the company, you
234
will need to add them to the PSC register as part of your
confirmation statement.

 How to Transfer Shares? Procedure and Steps Involved

The basic object of establishing public companies is to make

the shares freely transferable. This is not a right conferred by
the Articles but is a power cast upon every shareholder by the
express provisions of the Companies Act. Therefore, even
the Articles cannot take away this power altogether but can
impose reasonable restrictions regarding the mode of transfer.
In case of private companies, the Articles should prescribe
limitations on the right to transfer the shares.

Who can Transfer shares?

Only a person who has the capacity to transfer can transfer a

share. A person who properly becomes a member of the
company is entitled to effect a transfer. The capacity to transfer
shares is not co-extensive with the capacity to enter into a
contract. Even a minor or an infant can become a member. If
he properly becomes a member, he acquires a right to transfer
his shares.

Procedure for Transfer of Shares

Sec. 108 deals with transfer of shares in and debentures of a

company. The said section stipulates that

“unless a proper instrument of transfer duly stamped and

executed by or on behalf of the transferor and by or on behalf
of the transferee and specifying the name, address and
occupation, if any, of the transferee has been delivered to the
company along with the certificate relating to shares or
debentures or if no such certificates is in existence along with
the letter of allotment of the shares or debentures, a company
shall not register a transfer.”

235
This section is mandatory and unless all the pre-requisites
mentioned in the section are complied with, the transfer will be
void. The Central Government have prescribed the form for
transfer which should be used in the case of all transfers of
shares in or debentures of a company including a private
company.

The form seeks the particulars prescribed in the section

namely, name, address and occupation of the transferee, and
provision for signatures of the transferor and the transferee. It
also seeks other particulars namely, name of the company to
which the shares relate, the distinctive numbers of the shares
and the number of shares involved in the transfer and also the
stock exchange on which the shares are quoted.

Stamp Duty in transfer of shares

Before the instrument of transfer is lodged with a company, it

should be duly stamped. The transfer of shares attracts stamp
duty under the Indian Stamp Act (Act II, 1899).

The Government has prescribed a stamp duty of Re.0.50 for

every Rs.100 of the value of the shares at which shares were
bought and not the face value of shares under transfer.

If a share transfer instrument is lodged with the company,

which is sufficiently stamped but the stamps have not been
cancelled, it would perfectly be in order of the company to
return the transfer deed as incomplete. Such return of
incomplete transfer should be distinguished from rejection of
transfers.

The stamping has to be done by the transferor unless there is a

contract to the contrary.

In the case of transfer of shares by the holder thereof to the

name of a bank as a security for financial assistance granted by
the bank to the holder and to none else and subsequent re-

236
transfer of shares on the release of the security, the Central
Government have reduced the stamp duty.

Steps in Transfer of Shares

The following are the steps in transfer of shares:

1. On receipt of the transfer instrument, duly executed, in the

prescribed form together with the share certificate or allotment
letter, it is usual for companies to give an acknowledgment for
the same.

2. The instrument is to be checked thoroughly to find out

whether the same is in order.

3. Where the instrument of transfer is received from a person

other than the transferor and the shares are partly paid-up, the
company has to send a notice to the transferee.

4. It is also advisable to send notice to the transferor, as a

measure of causation.

5. Before effecting any transfer, the company should ensure

that the instrument is lodged within the time limit as prescribed
in Sec. 108(1A) of the Companies Act.

6. Where the shares are intended to be transferred to a body

corporate, it should be ascertained as to whether—

a. the Memorandum and Articles of Association empower the

transferee company to make the investment,
b. the Board of directors of the intended transferee body
corporate has passed the necessary resolution and has
empowered the person concerned to deal with the matter
in this behalf,
c. the person executing the deed on behalf of the body
corporate has valid authority to do so, and
d. if the provisions of Sec. 108 A to 108 I are attracted,
whether the necessary formalities there under have been
complied with.
237
7. Where the intended transferee is a trust or a partnership firm
or other association of persons, it should be ensured whether—

1. The trust is registered under the Societies Registration Act or

not. If it is registered, as aforesaid, the trust becomes a body
corporate and shares can be registered in the name of the
trust. Otherwise, shares have to be registered in one or more
names of the trustees of the trust, authorized by resolution of
the Board of Trustees by whatever name called.

2. If the shares are purchased by a partnership firm or an

association of persons, the shares are to be registered in the
individual name(s) of one or more partners, in the case of
partnership firms; or in the name or names of any of the office
bearers of the association, in case of association of persons.
Similarly, in case the shares are purchased by a Hindu
Undivided Family, shares have to be registered in the name of
the Karta, without mentioning the representative character.

8. Where the transferee is minor, transfer of shares should be

in accordance with provisions of Articles of Association of the
company. If they are fully paid-up shares, there wont be a
problem in registering the same in favour of minors through
guardian.

9. After making thorough scrutiny, the officer in charge will put

his initial on the form and the particulars of the transfer
instrument will be entered in the Share Transfer Register.

10. At periodic intervals, the register along with necessary

transfer documents and enclosures will be put up to the Board
or the Shares Transfer Committee thereof if there is one or
such other authority as may be determined by the Board, in this
behalf, depending upon the practice of the company and the
concerned authority will initial the Share Transfer Register for
having approved the transfer. The date of approval of the
transfer will be indicated in the register.

238
11. Where transfer of shares are duly approved, endorsements
in favor of the transferees will be made on the share certificates
and the secretary or the officer authorized by the board certifies
the same. Then the share certificates are returned to the
sender together with a covering letter. New certificates are to
be issued as per companies rules.

12. Necessary entries shall be made in the Register of

Members in regard to the transferor and the transferee.

13. In case of a refusal to register the transfer, the company

must send notice to the transferor and transferee as per the
provisions of Sec. 111 of the Companies Act.

 Transfer of Shares Under Companies Act 2013

The provisions related to the transfer of shares are provided

under Section 56 of the Companies Act 2013 and Rule 11 of
Companies (share capital & Debentures) Rules 2014.

As per Section 56 of the Companies Act 2013, Company shall

not register a transfer of shares of the company other than
those persons whose name is mentioned in records of
depository as beneficial interest holders.Unless a proper
transfer instrument which is duly stamped, dated and executed
by or on the behalf of transferor and transferee specifying the
name, address, and occupation of the transferee deliver to the
company by the transferor or transferee within a period of 60
daysfrom the date of execution along with the certificate related
to securities;

Provided that

1. In the case of transfer, an instrument has been lost or not

delivered within the prescribed time limit then in that case
company may register transfer of shares on such terms as
to indemnity as the board may think fit.
2. Nothing in above mention subsection shall prejudice the
power of the company to register on receipt of an

239
 intimation of transmission of any right to securities by
operation of law from any person to whom such right has
been transmitted.
3. In case application related to the partly paid shares made
by the transferor then transfer shall not be registered
unless the company gives notice to the transferee and the
transferee gives no objection to transfer to the company
within two weeks from the date of receipt of the notice.
4. The transfer of shares or other interest of a deceased
person made by his legal representative shall be valid as if
he had been the holder at the time of the execution of the
instrument of transfer.
5. Every company shall deliver the certificates of all
securities allotted, transferred or transmitted unless
prohibited by any provision of law or by the order of Court,
Tribunal or other authority—

 Within a period of two months from the date of

incorporation, in case of subscribers to the memorandum
of the company;
 Within a period of two months from the date of allotment,
in case of any allotment of any of its shares;
 within a period of one month from the date of receipt of the
transfer instrument by the company under sub-section (1)
or, as the case may be, of the intimation of transmission
under subsection (2), in the case of a transfer or
transmission of securities;
 Within a period of six months from the date of allotment in
case of allotment of a debenture.

Rule 11 of Companies (Share Capital & Debentures) Rules

2014

1. A share transfer instrument held in physical form shall be

in form SH 4 and within 60 days from the date of
execution of such share transfer instrument shall be
delivered to the company.

240
 2. Before registering a transfer of partly paid shares, the
company has to give notice in form SH-5 to the transferee
and within two weeks from the date of receipt of the
notice, transferor has to give no objection to the transfer.

Important Provisions related to Transfer of Shares

 Share Transfer Instrument is Compulsory

As per Section 56 of the Companies Act 2013 provides that to

register a transfer of shares by the company, Share transfer
deed in Form SH 4 must be duly stamped and executed by or
on the behalf of the transferor/transferee specifying the name,
address and occupation of the transferee must be delivered to
the company along with the certificate or in case of no
certificate then letter of allotment of shares.

 Time Period For Deposit of Instrument Transfer

A share transfer instrument in form SH 4 is required to be

delivered to the company within 60 days from the date of such
execution by or on the behalf of transferor and transferee.

 Share Transfer Stamp

A share transfer stamp is to be affixed to the share transfer

deed and stamp duty is 25 Paisa for every 100 Rs. or part
thereof as per notification number SO 130 (E) issued by
Ministry of Finance, New Delhi

 Time period for issue of certificate

Every company within one month deliver the certificate of all

shares transferred after the application for the registration of
such transfer of securities has been received.

 Private Company restricts the right to transfer its

shares

241
According to Section 2(58) provides that the article of
association of a private company shall restrict the right to
transfer the company’s shares.

However, the restriction is not applicable in certain cases:

1. Restriction on the right to transfer shares by the members

do not apply in case where the shares are transferred to
their representative;
2. In a case of death of members, their legal representative
may require the registration of such shares on the name of
heirs.

 Time Limit for Refusal of Registration of Transfer

Within 30 days from the date on which the intimation of transfer

of a security is delivered, the company has the power to refuse
to register the transfer of shares.

 Appeal Against the Refusal of Registration of Transfer

by Private Company

Share transferee has a right to appeal to tribunal against the

refusal by the company to register transfer of shares within a
period of 30 days from the date of the notice received from the
company or in case of no notice has been received from the
company then within a period of 60 days from the date on
which the share transfer instrument delivered to the company.

 Appeal Against the Refusal of Registration of Transfer

by Public Company

Share transferee has a right to appeal to tribunal against the

refusal by the company to register transfer of shares within a
period of 60 days from the date of the notice received from the
company or in case of no notice has been received from the
company then within a period of 90 days from the date on
which the share transfer instrument delivered to the company.

 Penalty
242
In the case of non-compliance with the provisions of transfer of
securities then the company shall be punishable by the fine
which shall not be less than Rs. 25000, which may extend to
Rs. 500000 an officer in default shall be punishable by the fine
of not less than Rs.10000 and which may extend to Rs.
100000.

Transfer and Transmission of Shares

Shares are like any other goods. A purchaser gets no better

title than the seller [1] .

The capital of a company is divided into a number of

undividable units of a preset amount called 'shares [2] '. The
Supreme Court of India in CIT v. Standard Vacuum Oil
Co, [3] observed, that a share is an interest measured by a sum
of money and made up of diverse rights conferred on it. [4] It
implies the existence of some person entitled to the rights,
which are rights in action as distinct from rights in possession,
and until the share is issued the person does not exist. [5]

Transferability is an important feature of a share in a company

registered under the Companies Act, from which emanates
another feature of a company- perpetual succession. It endows
a company with perpetual and uninterrupted existence. Upon
incorporation, a company acquires its own independent legal
personality and legal entity in the company. Section
82 [6] states that the share shall be a movable property and
transferable in a manner provided by the articles of the
company. It has, however, been consistently held by the courts
that subject to restrictions imposed by the articles, a
shareholder is free to transfer shares to a person of his own
choice and that the articles cannot put a complete ban or
unreasonable restriction on the transfer. While shares in a
private company are not freely transferable and are subject to
the restrictions imposed by the articles of the company, shares
in a public company are freely transferable [7] . There are

243
different types of transfer such as transfer of share by gifts, in
case of joint holdings and transfer in private companies. [8]

Transfer of shares is a transaction resulting in a change of

share ownership. A shareholder, whether in public or private
company, has a property in his share which he has a right to
dispose of, subject only to any express restriction which may be
found in the articles of the company [9] .

Transmission is the automatic process; when a shareholder

dies, his shares immediately pass to the personal
representatives or, if a member is declared bankrupt, their
shares will vest in the trustee in bankruptcy [10] .

The Depositories Act, 1996 provides for an alternate mode of

effecting transfer of shares. Investors have the choice of
continuing with the existing share certificates (i.e., in physical
form) and adopt the existing mode of effecting their transfer.
Every depository is registered with the SEBI and receives a
certificate of commencement of business on fulfillment of such
conditions. Upon entry into the system, share certificates
belonging to the investor will be dematerialized and their names
entered in the books of participants as beneficial owners. The
investor’s names in register of companies concerned will be
replaced by the name of the depository as the registered owner
of the securities. The investors will, however, continue to enjoy
the economic benefits from the shares as well as voting rights
on the shares concerned [11] .

Chapter one

Transfer of shares – Procedure and Scope

"When joint stock companies are established, the great object

was that the shares should be capable of being easily
transferred [12] ."

One of the most important features of a Company is that its

shares are transferable. Rights of a shareholder to transfer his

244
share are always subject to provisions in Articles of
Association. [13] Upon incorporation a company acquires its
own independent legal personality and distinct entity, and its
shareholders acquire the right to hold and transfer shares. A
Company limited by guarantee and having no share capital, no
transfer of share is involved as there are no shares to transfer.
A member of such a company may transfer his 'interest' as per
section 82 that allows for transfer of shares or 'other
interest.' [14]

1.1 Need for an instrument of transfer

Shares are moveable goods. The ownership of moveable

goods may be transferred by delivery of possession, but as per
section 36 there is a contractual relationship between the
members and the company. When shares are transferred the
contractual relationship is assigned to the transferee which
requires an instrument of transfer. [15] Transferring a share
involves a series of steps, first an agreement to sell, then
execution of a deed of transfer and finally registration of the
transfer. Section 108 lays down the procedure for transfer.

1.2Procedure for transfer of Shares

1) Instrument of transfer must be executed by both transferor

and transferee.

2) It must be duly stamped

3) It must be delivered to the company along with certificate

relating to shares transferred

4) Must be in the prescribed form and presented to prescribed

authority. [16]

Section 108 requires the transfer to be in a proper instrument of

transfer known as ‘Share Transfer Form’ which is required to be
presented to the Registrar of Companies before it is signed and
filled up by the transferor [17] . Any instrument of transfer which

245
is not in conformity with these provisions shall not be accepted
by the company. In cases of hardship the Central Government
may extend the period of time. The transferee becomes a
member of a company only when the transfer is registered by
the company [18] .

In Prafulla Kumar Rout v. Orient Engg. Works (P.) Ltd [19] it

was observed that all that section 108 requires is that before
delivery, the stamps should be affixed. However, in
Mathrubhumi Printing & Publishing Co. Ltd. v. Vardhaman
Publishers Ltd [20] ., the Kerala High Court observed that
instrument is unstamped if the it is not properly executed.
Cancellation of the stamps by the staff of the company does not
make the transfer instrument duly stamped [21] . Provisions of
Section 108 are inapplicable to transfer where transferee or
transferor are entitled as beneficial owners in the records of
depository [22] .

1.3Demat Shares

In the case of fresh issue (IPO), the investor would indicate his
choice in the application form, if he opts to hold the security in
the depository mode, commonly known as 'demat' mode. An
investor, who opts for a depository mode may at any time, opt
to choose out of it and claim share certificate from the company
by substituting his name as the registered owner in the place of
the depository. Ownership changes in the depository system
will be made automatically on the basis of delivery vs. payment.
The provisions of section 108 are inapplicable to transfer where
transferee and transferor are entered as beneficial owners in
records of depository [23] .

Under the depository system securities may be

dematerialized [24] that may be transferred by recording entries
in a depository. SEBI (Disclosure and Investor Protection)
Guidelines, 2000 [25] stipulates that no company shall make
public or offer sale of securities unless it enters into an
agreement with the depository or gives an option to its

246
shareholders to hold securities in dematerialized form no stamp
duty is charged. [26]

Where there is an immediate and unconditional transfer of

shares with stipulation for determination of consideration for
transfer to be mutually agreed on in future, it cannot not be said
that agreement for transfer of shares was conditional on
determination of price of shares [27] . Forgery [28] does not
confer any title because it is not merely an absence of free
consent but there is no consent at all [29] .

1.4Time Limit

As per section 113, a company is required, within 2 months

after the application for transfer, to deliver the share certificates
duly transferred. In Re, Reliance Industries Ltd. [30] the
company failed to deliver shares within the prescribed time of 2
months. CLB [31] fined the company and share transfer agents.
The default under section 113 is a continuing offence and,
therefore, shall not be subject to limitation. [32]

1.5 Board of Directors- Power of refusal

Where the AoA [33] of a Company give power to the Board to

refuse registration of a transfer of shares, such power must be
exercised by a resolution of the Board. The Board may refuse
to register the transfer as long as they are acting in the
interests of the Company, but if they exercise their discretion to
refuse malafide, i.e. they act oppressively or corruptly, the
CLB [34] or the Court will now interfere and order registration.

AoA of a company may be specific and empower the BOD to

refuse to register transfers on certain specific grounds. Thus,
where AoA of a company contain a provision to the effect that
no share shall be transferred to an outsider if any member of
the Company was willing to purchase the same at fair price to
be determined by the directors, and transfer to an outsider shall
be allowed only when the Board of Directors was unable to find
a willing member within a stipulated period; the directors having
247
offered to purchase those shares, the question of registering
shares in favour of an outsider not arise. [35] The refusal to
register transfer of shares on the ground that the transferor had
been indulging in acts which were against the interests of the
company is not right. [36] As per section 111 if a Company
refuses to register the transfer of shares, within 2 months from
the date of lodging the instrument of transfer, send notice of
refusal to the transferor or transferee giving reasons.
CLB [37] on appeal may direct the registration of the
transfer [38] .

In Hemanigiri Finance & Leasing (P.) Ltd v. Tamilnad

Mercantile Bank Ltd. [39] , the CLB/ Tribunal held that there is
no blanket authority available to a company to refuse
registration of transfer, even if Articles provide absolute
discretion. When the Articles do not provide for any powers for
refusal, the company cannot refuse.

In case of refusal, on appeal to the CLB/Tribunal [40] , it is

always for the party assailing the decision of the BOD to
demonstrate that such decision suffers from unsustainable
reasons. [41] The Tribunal while dealing with an appeal against
refusal may, after hearing the parties, either dismiss the appeal
or, by order, direct that the transfer shall be registered by the
Company and the company shall comply with such order within
10 days of the receipt of the order. [42]

Certification of an instrument of transfer lodged with the

company is a process in which the company certifies on the
instrument of transfer that the share certificate as stated in the
certification stamp has been lodged with the company for
registration of transfer. It is an endorsement made by the
company on the instrument of transfer lodged, to the effect that
stated above. It is a kind of receipt. This provision has been
made to facilitate the sale of smaller number of shares in case
the share certificate is for a larger number of shares [43] .

1.6rights of transferees

248
Till the company has registered the transfer, the name of the
transferor continues to appear in the register of members and
thus he continues to be the lawful owner but transferee is the
beneficial owner (cestui que trust). In order to protect the
interest of the transferees; section 206A was added by the
Amendment Act, 1988 which provides that where any
instrument of transfer of shares has been delivered to the
company for registration and transfer has not been registered,
the right to dividend, rights shares and bonus shares will be
kept on hold. This dividend would be kept in an “Unpaid
Dividend Account" [44] unless the company is authorized by the
registered holder of such shares in writing to pay dividend to
the transferee. [45]

1.7Blank Transfer

Where a shareholder signs a share transfer form without filling

in the name of the transferee and hands it over along with the
share certificate to the transferee thereby enabling him to deal
with the shares, he is said to have made a transfer ‘in blank’ or
a ‘blank transfer’. It is not a negotiable instrument because it
may be transferred by mere delivery. Accordingly, the title of
the transferee acquiring shares through a blank transfer is
subject to the title of the transferor.

A bona fide transferee from a person who has acquired a blank

transfer form by fraud does not acquire good title to the shares
included in the deed. A transfer in blank, when accompanied by
a share certificate, carries to the transferee both the legal and
equitable rights to the shares and also the right to call upon the
company to register the transfer. [46] This right to get himself
registered as a member is available to the transferee even after
the death of the transferor. [47] Blank transfer, however, results
in loss of stamp duty and income tax. To prevent abuse of
blank transfer subsections (1A) and (1B) of section 108 were
introduced in 1965 [48] .

1.8Right to Pre-emption

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It is a common practice to provide in the articles that any
member intending to transfer his shares must offer the shares
first to other members of the company. Such restrictions are not
invalid. The conditions imposed and the formalities prescribed
by the articles are mandatory. [49] The pre-emption clause
does not, however, completely bar transfers to outsiders [50] .

1.9 Restrictions on Transfer of Shares

I General grounds

Malafide instrument of transfer, inadequacy of reasons,

irrelevant considerations and bad delivery of transfer
documents, contravention of law, prejudicial to company or
public interest and stay order [51] by Court are the reasons
when transfer of shares can be restricted. [52]

II Special circumstances

1) On transfer with regard to the company's borrowing

2) Under SEBI Guidelines shares allotted to certain categories

of shareholders such as promoters, employees, etc are subject
to condition of non-transferability for a period of 3-5 years
accordingly.

3) CLBs power under Section 250 -- prohibit public transfers.

4) Under FEMA and joint venture agreements. [53]

Chapter Two

Applicability of section 111 to Private and Public Companies

2.1Transfer of shares in a private company

In Dr. Jitendra Nath Saha v. Shyamal Mondal, [54] it was

observed that after the amendment of Section 111 in 1988, all
the provisions of S.111 are applicable to private companies and
deemed public companies. In Canara Bank v. MTNL. [55] CLB

250
has held that the Depositories Act, 1996 has introduced
important changes in the CLB’s jurisdiction regarding transfer of
shares and debentures, namely, the entire provisions as
contained in Section 111 are now made applicable only to
private companies which also include a private company which
has become a public company by virtue of Section 43-A.

In Charanjit Shingh Ghumman v. Dr. Reddy’s Laboratories

Ltd. [56] the CLB observed that though with the coming into
force of sub-section 14 of S. 111, S. 111 is not applicable to
public companies, the CLB may consider a petition on merits
under S. 111-A of the Act to meet the ends of justice.

2.2Transfer of shares in a public company

Recently, the Bombay High Court has said in the case of

Western Maharashtra Development Corporation Ltd. Vs. Bajaj
Auto Ltd [57] that a pre-emptive right would impose a fetter on
transferability of shares – a requirement envisaged only for
private companies and in fact prohibited for public companies,
in the scheme of the Act – and therefore “patently illegal [58] ".

According to sec. 111 A, the shares or debentures and any

interest therein of a company, other than a private company
and a deemed public company shall be freely transferable. [59]

However, if a company, without sufficient cause, refuses to

register transfer of shares within two months from the date on
which, the instrument of transfer or the intimation of transfer, as
the case may be, is delivered to the company, the transferee
may appeal to the Company Law Board (now Tribunal) and it
shall direct such company to register the transfer of shares.

In Peerless General Finance and Cement Co. Ltd v. Poddar

Projects Ltd. [60] , it was held that provisions of section 111A
do not put any time restriction on approaching the CLB and,
therefore, a public company cannot refuse rectification of the
plea of limitation. Only when a company refuses to register
transfer of shares on grounds that transfer is in violation of
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provisions of SEBI Act or regulations, provisions of SlCA will
apply.

In Turner Morrison Ltd. v. Jenson & Nicholson (India) Ltd [61] ,

the Bench held that in terms of recently introduced section
111A, the CLB's scope of power for rectification of register of
members is restricted only to cases of refusal by the company
to make transfer of shares or securities. This section applies to
public companies.

2.3 Further Rights Granted

The right of shares or Debenture holders, to transfer shall

including voting rights unless they have been suspended by an
order of the CLB [62] . Notwithstanding anything contained in
this section, any further transfer, during the pendency of the
application with the Company Law Board, of shares or
debentures shall entitle the transferee to voting rights unless
the voting rights in respect of such transferee have also been
suspended [63] . CLB should decide all matters pertaining to
rectification under section 111 and if it is found that matter in
question does not fall under it, and then only it may direct a
party to get its right adjudicated by Civil Court. [64]

Chapter Three

Transmission of Shares

Transmission of shares takes place, when the registered

shareholder dies; or when he is adjudicated an insolvent; or
where the shareholder is a company it goes into liquidation. On
the death of a shareholder, his shares vest in his legal
representative. The legal representative may transfer the
shares devolved upon him by transmission. According to
s.109 [65] , a transfer share or other interest in a company of a
deceased member made by his legal representative is not a
member, is valid as if he had been a member at the time of the
execution of the instrument of transfer. Likewise, according to
Reg 26(1) in Table A [66] , any person entitled to a share due
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to the death or insolvency of a member, may either reelect to
be registered himself as a member; or alternatively, transfer the
shares to someone else [67] .

The legal representative can sell the shares without being

registered subject to the provisions of the Articles. A company
has no powers to refuse registration of transmission of shares
once the legal heir produces a proper legal representation to
the estate by way of will/probate/succession certificate, etc., if
the same is required in terms of the Articles, unless there is an
injunction against acting in terms of the legal
representation [68] .

Transmission of shares in favour of a member of a private

company who is engaged in a competing business cannot be
refused. In S.M. Hagee Abdul Hye Sahib v. KNS Hajee Shaik
Abdul Kadar Labbai Sahib Co. (P.) Ltd [69] ., the CLB held that
a transfer of shares in a private company may be refused in
case the transferee is engaged in a competing business but
transmission cannot be refused on that
ground. [70] Succession certificate covering shares held by a
deceased member on the date of his death would cover
subsequent issue of bonus shares and no fresh succession
certificate would be required [71] .

It is for the court to be satisfied about the payment of proper

court fees and if coin fees paid is insufficient, the recovery of
deficit court fees along with penalty is to be decided by the
authority of the court or revenue authority. Once the succession
certificate has been produced from the competent court which
has declared the appellant as legal heir for the shares in
question and there is no other claimant for the said shares, the
company ought to effect the transmission of shares on the
basis of succession certificate produced where shares are held
in joint names [72] .

3.1Transmission v Transfer

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Transfer is by the act of the parties. Transmission is by
devolution of law, i.e. death or bankruptcy. In transmission of
shares no procedures are required to be followed unlike in
transfer of shares. [73]

Conclusion- Position in UK and Indian Companies Bill 2009

In the UK Companies Act 1985 the directors in their absolute

discretion and without assigning any reason therefore, decline
to register the transfer of any share. The exercise by the
directors of such a power is difficult to challenge. It would be
necessary for the transferee to show bad faith. [74] The second
most common restriction which is often included in articles is a
pre-emption provision, i.e. that shares must be offered to
existing shareholders in proportion to their present holdings.
There can be provisions that a person who ceases to be a
director has to transfer their shares [75] .

The Indian Companies Bill, 2009 paved the way for modern
legislation to ensure growth and regulation of corporate sector
in India. In view of various reformatory and contemporary
provisions proposed coupled with omission of existing obsolete
compliance requirements, the companies in the country would
be able to comply with the requirements of the proposed
Companies Act in a better and more effective manner [76] . The
Companies Bill, 2009 contains the words ‘as may be
prescribed’ many times which consequently permit the
Government to make discretionary rules. Quantity rather than
substance floods the situation in a highly litigious country like
India. If the Companies Bill, 2009 is passed as it is into Law,
the intensity of Company Law and of corporate governance
regulation would be noticeably diluted [77] .

Section 111(2) to the effect the shares and debentures in a

public company are freely transferable and Section 111A (3) to
the effect that in the case of public company rectification of
register of members is only possible when there is a violation of
statute law and that such an action is to be brought before the

254
Tribunal within two months from the date of registration of
transfer, have been omitted [78] . These are very significant
lacunae, which can create a lot of corporate litigation.

 Difference Between Transfer and Transmission of Shares

One of the most important features of the securities is that they

are transferable, which facilitates the company in acquiring
permanent capital and liquid investments to the
shareholders. Transfer of shares is a voluntary act of a
member that takes place by way of contract. It is not exactly
same astransmission of shares, as the two differ in their
meaning and concept as well. The transmission of shares
occurs due to the operation of law i.e. in case if the member
passes away or becomes insolvent/lunatic.

Transfer of shares requires and instrument of transfer, whereas

no such instrument is required in the transmission of shares. To
further understand, the difference between transfer and
transmission of shares, you need to have a glance at the article
excerpt, provided below.

Content: Transfer of Shares Vs Transmission of Shares

1. Comparison Chart
2. Definition
3. Key Differences
4. Conclusion

Comparison Chart

BASIS FOR TRANSFER OF TRANSMISSION OF

COMPARISON SHARES SHARES

Meaning Transfer of shares refers to Transmission of shares means

the transfer of title to the transfer of title to shares
shares, voluntarily, by one by the operation of law.

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BASIS FOR TRANSFER OF TRANSMISSION OF
COMPARISON SHARES SHARES

party to another.

Affected by Deliberate act of parties. Insolvency, death, inheritance

or lunacy of the member.

Initiated by Transferor and transferee Legal heir or receiver

Consideration Adequate consideration No consideration is paid.

must be there.

Execution of valid Yes No

transfer deed

Liability Liabilities of transferor Original liability of shares

cease on the completion of continues to exist.
transfer.

Stamp duty Payable on the market No need to pay.

value of shares.

Key Differences Between Transfer and Transmission of Shares

The significant differences between transfer and transmission

of shares are provided below:

1. When the shares are transferred by one party to another

party, voluntarily, it is known as transfer of shares. When
the transfer of shares happens due to the operation of law,
it is referred to as transmission of shares.
2. Transfer of shares is done intentionally whereas death,
bankruptcy and lunacy are the reasons for transmission of
shares.
3. The transfer of shares is initiated by the parties to transfer,
i.e. transferor and transferee. Unlike transmission of

256
 shares which is initiated by the legal representative of the
concerned member.
4. Transferee pays an adequate consideration to the
transferor for the transfer of shares. In the case of
transmission of shares, no consideration shall be paid.
5. Execution of valid transfer deed is necessary when there
is the transfer of shares, but not in the transmission of
shares.
6. When the transfer is completed, the liability of the
transferor is over. On the other hand, the original liability
of shares exists.
7. Stamp duty is payable on the market value of shares in
case of transfer while in the transmission of shares no
stamp duty is to be paid.

Conclusion

By and larger, transfer of shares is the normal course of

transferring property, while the transmission of shares takes
place only on demise or insolvency of the shareholder.
Moreover, Transfer of shares is very common, but the
transmission of shares takes place only on the happening of
the certain event.

 Dividend

Definition of 'Dividend'

Definition: Dividend refers to a reward, cash or otherwise, that

a company gives to its shareholders. Dividends can be issued
in various forms, such as cash payment, stocks or any other
form. A company’s dividend is decided by its board of directors
and it requires the shareholders’ approval. However, it is not
obligatory for a company to pay dividend. Dividend is usually a
part of the profit that the company shares with its shareholders.

Description: After paying its creditors, a company can use part

or whole of the residual profits to reward its shareholders as
dividends. However, when firms face cash shortage or when it
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needs cash for reinvestments, it can also skip paying dividends.
When a company announces dividend, it also fixes a record
date and all shareholders who are registered as of that date
become eligible to get dividend payout in proportion to their
shareholding. The company usually mails the cheques to
shareholders within in a week or so. Stocks are normally
bought or sold with dividend until two business days ahead of
the record date and then they turn ex-dividend. A recent study
found that dividend-paying firms in India fell from 24 per cent in
2001 to almost 16 per cent in 2009 before rising to 19 per cent
in 2010.

In the US, some of the companies like Sun Microsystems,

Cisco and Oracle do not pay dividends and reinvest their total
profit in the business itself. Dividend payment usually does not
affect the fundamental value of a company’s share price.
Companies with high growth rate and at an early stage of their
ventures rarely pay dividends as they prefer to reinvest most of
their profit to help sustain the higher growth and expansion. On
the other hand, established companies try to offer regular
dividends to reward loyal investors.

Dividend

What is a 'Dividend'

A dividend is a distribution of a portion of a company's

earnings, decided by the board of directors, paid to a class of
its shareholders. Dividends can be issued as cash payments,
as shares of stock, or other property.

BREAKING DOWN 'Dividend'

The board of directors can choose to issue dividends over

various timeframes and payout rates. Dividends are typically
monthly or quarterly. It is also common for a company to issue

258
special dividends either individually or simultaneously with a
scheduled dividend.

Investors often view the company’s dividend by its dividend

yield which measures the dividend in terms of a percent of the
current market price. The dividend rate can also be quoted in
terms of the dollar amount each share receives (dividends per
share, or DPS).

A company's net profits are an important factor in determining a

dividend. Net profits can be allocated to shareholders via a
dividend, or kept within the company as retained earnings. A
company may also choose to use net profits to repurchase their
own shares in the open market in a share buyback. Dividends
and share buybacks do not change the fundamental value of a
company's shares. Dividend payments must be approved by
the shareholders and are managed by the board of directors.

Companies That Issue Dividends

Start-ups and other high-growth companies such as those in

the technology or biotechnology sectors rarely offer dividends.
These companies often report losses in their early years and
any profits are usually reinvested to help sustain higher-than-
average growth and expansion. Larger, established companies
with more predictable profits are often the best dividend payers.
These companies tend to issue regular dividends as they seek
to maximize shareholder wealth in ways aside
from supernormal growth.

Companies in the following sectors and industries have among

the highest historical dividend yields: basic materials, oil and
gas, banks and financial, healthcare and pharmaceuticals, and
utilities. Companies structured as master limited partnerships
(MLPs) and real estate investment trusts (REITs) are also top
dividend payers since their designations require specified
distributions to shareholders.

Arguments for Issuing Dividends

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The bird-in-hand argument for dividend policy claims
that investors are less certain of receiving future growth and
capital gains from the reinvested retained earnings than they
are of receiving current (and therefore certain) dividend
payments. The main argument is that investors place a higher
value on a dollar of current dividends that they are certain to
receive than on a dollar of expected capital gains, even if they
are theoretically equivalent.

If a company has a long history of past dividend payments,

reducing or eliminating the dividend amount may signal to
investors that the company could be in trouble. For example,
GE, one of the U.S. market’s largest industrials, announced a
financial plan that included decreasing its dividend by
approximately 50% on November 13, 2017. The stock fell -
7.26% following the announcement. Alternatively, an
unexpected increase in the dividend rate might be a positive
signal to the market.

Dividend Payout Policies

A company that issues dividends may choose the amount to

pay out using a number of methods.

 Stable dividend policy: Even if corporate earnings are in

flux, stable dividend policy focuses on maintaining a
steady dividend payout.
 Target payout ratio: A stable dividend policy could target a
long-run dividend-to-earnings ratio. The goal is to pay a
stated percentage of earnings, but the share payout is
given in a nominal dollar amount that adjusts to its target
as the earnings baseline changes.
 Constant payout ratio: A company pays out a specific
percentage of its earnings each year as dividends, and the
amount of those dividends therefore vary directly with
earnings.
 Residual dividend model: Dividends are based on
earnings less funds the firm retains to finance the equity

260
 portion of its capital budget and any residual profits are
then paid out to shareholders.

Dividend Irrelevance

Economists Merton Miller and Franco Modigliani argued that a

company's dividend policy is irrelevant, and it has no effect on
the price of a firm's stock or its cost of capital. Assume, for
example, that you are a stockholder of a firm and you don't like
its dividend policy. If the firm's cash dividend is too big, you can
just take the excess cash received and use it to buy more of the
firm's stock. If the cash dividend you received was too small,
you can just sell a little bit of your existing stock in the firm to
get the cash flow you want. In either case, the combination of
the value of your investment in the firm and your cash in hand
will be exactly the same. When they conclude that dividends
are irrelevant, they mean that investors don't care about the
firm's dividend policy since they can create their own
synthetically. It should be noted that the dividend irrelevance
theory holds only in a perfect world with no taxes, no brokerage
costs, and infinitely divisible shares.

Investing in Dividend Paying Investments

Investors seeking dividend investments have a number of

options including stocks, mutual funds, ETFs and more.
The dividend discount model, or Gordon growth model, can be
helpful in choosing stock investments. These techniques rely
on anticipated future dividend streams to value shares.

Taxes may also be a consideration. In many countries, the

income from dividends is treated at a more favorable tax rate
than ordinary income. Investors seeking tax-advantaged cash
flows may look to dividend-paying stocks in order to take
advantage of potentially favorable taxation. The clientele
effect suggests especially those investors and owners in high
marginal tax brackets will choose dividend-paying stocks.

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Similar to stocks, mutual funds and ETFs pay out interest and
dividend income received from their portfolio holdings as
dividends to fund shareholders. In addition, realized capital
gains from the portfolio's trading activities are generally paid out
(capital gains distribution) as a year-end dividend.

Total return is an important performance metric to follow for

dividend investors as it factors in the value of the dividend in its
performance calculations. Dividend investors also typically
have the option to reinvest dividends paid which helps to
increase the total return of the investment.

 Meaning and Types of Dividend Policy | Financial

Management

Meaning of Dividend Policy:

The term dividend refers to that part of profits of a company
which is distributed by the company among its shareholders. It
is the reward of the shareholders for investments made by
them in the shares of the company. The investors are
interested in earning the maximum return on their investments
and to maximise their wealth. A company, on the other hand,
needs to provide funds to finance its long-term growth.

If a company pays out as dividend most of what it earns, then

for business requirements and further expansion it will have to
depend upon outside resources such as issue of debt or new
shares. Dividend policy of a firm, thus affects both the long-
term financing and the wealth of shareholders.

As a result, the firm’s decision to pay dividends must be

reached in such a manner so as to equitably apportion the
distributed profits and retained earnings.

Since dividend is a right of shareholders to participate in the

profits and surplus of the company for their investment in the
share capital of the company, they should receive fair amount
of the profits. The company should, therefore, distribute a
reasonable amount as dividends (which should include a
262
normal rate of interest plus a return for the risks assumed) to its
members and retain the rest for its growth and survival.

Types of Dividend Policy:

The various types of dividend policies are discussed as

follows:

(a) Regular Dividend Policy:

Payment of dividend at the usual rate is termed as regular

dividend. The investors such as retired persons, widows and
other economically weaker persons prefer to get regular
dividends.

A regular dividend policy offers the following advantages:

(a) It establishes a profitable record of the company.

(b) It creates confidence amongst the shareholders.

(c) It aids in long-term financing and renders financing easier.

(d) It stabilises the market value of shares.

(e) The ordinary shareholders view dividends as a source of

funds to meet their day-to-day living expenses.

(f) If profits are not distributed regularly and are retained, the
shareholders may have to pay a higher rate of tax in the year
when accumulated profits are distributed.

However, it must be remembered that regular dividends can be

maintained only by companies of long standing and stable
earnings, A company should establish the regular dividend at a
lower rate as compared to the average earnings of the
company.

(b) Stable Dividend Policy:

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The term ‘stability of dividends’ means consistency or lack of
variability in the stream of dividend payments. In more precise
terms, it means payment of certain minimum amount of
dividend regularly.

A stable dividend policy may be established in any of the

following three forms:

(i) Constant dividend per share:

Some companies follow a policy of paying fixed dividend per

share irrespective of the level of earnings year after year. Such
firms, usually, create a ‘Reserve for Dividend Equalisation’ to
enable them pay the fixed dividend even in the year when the
earnings are not sufficient or when there are losses.

A policy of constant dividend per share is most suitable to

concerns whose earnings are expected to remain stable over a
number of years.

(ii) Constant payout ratio:

Constant pay-out ratio means payment of a fixed percentage of

net earnings as dividends every year. The amount of dividend
in such a policy fluctuates in direct proportion to the earnings of
the company. The policy of constant pay-out is preferred by the
firms because it is related to their ability to pay dividends.
Figure given below shows the behaviour of dividends when
such a policy is followed.

(iii) Stable rupee dividend plus extra dividend:

Some companies follow a policy of paying constant low

dividend per share plus an extra dividend in the years of high
profits. Such a policy is most suitable to the firm having
fluctuating earnings from year to year.

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  Dividend Law and Legal Definition

A dividend is a participation in the profit, usually based on the

number of shares of stock in a corporation and the rate of
payout approved by the board of directors or management, that
is paid to shareholders for each share they own. Dividends may
be paid in money, but can also be paid in shares of stock,
known as a stock dividend. The stock dividend may be
additional shares in the company, or it may be shares in a
subsidiary being spun off to shareholders. Stock dividends are
often used to conserve cash needed to operate the business.
There are three important dates to remember regarding
dividends.
 Declaration date: The declaration date is the day the Board of
Director’s announces their intention to pay a dividend. On this
day, the company creates a liability on its books; it now owes
the money to the stockholders. On the declaration date, the
Board will also announce a date of record and a payment date.
 Date of record: This is the day upon which the stockholders of
record are entitled to the upcoming dividend payment. Only the
owners of the shares on or before that date will receive the
dividend.
 Payment date: This is the date the dividend will actually be
given to the shareholders of company.
A vast majority of dividends are paid four times a year on a
quarterly basis.

Additional Definitions

Dividends
Dividends and stock repurchases are the two major ways that
corporations can distribute cash to shareholders. Dividends
may also be distributed in the form of stock (stock dividends
and stock splits), scrip (a promise to pay at a future date), or
property (typically commodities or goods from inventory). By
law, dividends must be paid from profits; dividends may not be
265
paid from a corporation's capital. This law, which is designed to
protect the corporation's creditors, is known as the impairment
of capital rule. The law stipulates that dividend payments may
not exceed the corporation's retained earnings as shown on its
balance sheet.
Companies usually pay dividends on a quarterly basis. When
the company is about to pay a dividend, the company's board
of directors makes a dividend announcement that includes the
amount of the dividend, the date of record, and the date of
payment. The date on which the dividend announcement is
made is known as the declaration date.
The date of record is significant for the company's
shareholders. All shareholders on the date of record are
entitled to receive the dividend. The ex-dividend date is the first
day on which the stock is traded without the right to receive the
declared dividend. All shares traded before the ex-dividend
date are bought and sold with rights to receive the dividend
(also known as the cum dividend). Since it usually takes a few
business days to settle a stock transaction, the ex-dividend
date is usually a few business days before the record date. On
the ex-dividend date the trading price of the stock usually falls
to account for the fact that the seller rather than the purchaser
is entitled to the declared dividend.
Corporate dividend policy is a sometimes under-appreciated
element of overall company strategy and financial planning. "It's
difficult to generalize about dividend policy because it is usually
very company-specific or industry-specific, [but] some general
observations are possible," wrote Frederic Escherich
in Directors and Boards. "Dividend policy's most important uses
are to: 1) return excess cash to shareholders; 2) effectively
manage the company's cash needs and capital structure; and
3) credibly signal shareholders about future earnings
prospects." Indeed, when a company puts together its dividend
policy, it must decide whether to distribute a certain amount of
earnings to the company's shareholders or retain those
earnings for reinvestment. Dividend policy is influenced by a
266
number of factors that include various legal constraints on
declaring dividends (bond indentures, impairment of capital
rule, availability of cash, and penalty tax on accumulated
earnings) as well as the nature of the company's investment
opportunities and the effect of dividend policy on the cost of
capital of common stock. Most firms have chosen to follow a
dividend policy of issuing a stable or continuously increasing
dividend. Relatively few firms issue a low regular dividend and
declare special dividends when annual earnings are sufficient.
Opinions vary regarding the relationship between dividend
policy and corporate taxation. "The usual argument is that since
dividends are taxed as income, they have a tax disadvantage
with respect to capital gains in a relatively light capital gains tax
regime, especially for recipients in high tax brackets," wrote
Francesca Cornelli in The Complete MBA Companion.
"Therefore, other things being equal, companies that pay out
high dividends should be valued less than companies that pay
out low dividends. In response to this argument, however,
economists have argued that the increasing domination of the
market by tax-exempt institutions, the reduction of personal
marginal income tax rates, the moves in both the UK and US to
tax dividends and capital gains at the same rate and the
abundance of tax shelters have all combined largely to
neutralize the potential tax disadvantage of dividend
payments."

 What is a dividend?

A dividend is the share of profits and retained earnings a

company pays out to its shareholders. When a company
generates a profit and accumulates retained earnings, those
earnings can be either reinvested in the business or paid out to
shareholders as a dividend. The annual dividend per share
divided by the share price is the dividend yield.

How a divided works

267
A dividend’s value is determined on a per share basis and is to
be paid equally to all shareholders of the same class (i.e.
common, preferred, etc.). The payment of a dividend must be
approved by the by the board of directors.

When a dividend is declared, it will then be paid on a certain

date, known as the payable date.

Steps of how it works:

1. The company generates profits and retained earnings

2. The management team decided some excess profits
should be paid out to shareholders (instead of being
reinvested)
3. The board approves the planned dividend
4. The company announces the divided (the value per share,
the date it will be paid, the record date etc.)
5. The dividend is paid to shareholders

Dividend example

Below is an example from General Electric (GE)’s

2017 financial statements. As you can see in the screenshot,
GE declared a dividend per common share or $0.84 in 2017,
$0.93 in 2016, and $0.92 in 2015.

This figure can be compared to Earnings per Share (EPS) from

continuing operations and Net Earnings for the same time
periods.

Types of dividends

There are various types of dividends a company can pay to its

shareholders. Below you will find a list and a brief description
of the most common types shareholders receive.

Types include:

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  Cash – this is the payment of actual cash from the
company directly to the shareholders and is the most
common type of payment. The payment is usually made
electronically (wire transfer), but may also be paid by a
check or cash (in rare cases).
 Stock – stock dividends are paid out to shareholders by
issuing new shares in the company. Just as with cash
dividends, these are paid out pro rata based on the
number of shares the invesor owns.
 Assets – a company is not limited to paying distributions
to its shareholders in the form of cash or shares. A
company may also payout other assets such as
investment securities, physical assets, property, real
estate and others.
 Special – a special dividend is one that’s paid outside of a
company regular policy (i.e. quarterly, annual, etc.) and is
usually the result of an excess cash build up.
 Common – this refers to the class the shareholders (i.e.
common shareholders), not what’s actually being received
as payment.
 Preferred – this also refers to the class of shareholder
receiving the payment.
 Other – other, less common, types of financial assets can
be paid out such as options, warrants, shares in a new
spin-out company, etc.

Dividend vs buyback

Managers of corporations have several types of distributions

they can make to the shareholders. The two most common
types are dividends and share buybacks. A share buyback is
when a company uses cash on the balance sheet to
repurchase shares in the open market. This has two effects: (1)
it returns cash to shareholders, and (2) it reduces the number
of shares outstanding.

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The reason to perform share buybacks as an alternative means
of returning capital to shareholders is that it can help boost a
company’s EPS. By reducing the number of shares
outstanding, the denominator in EPS (net earnings / shares
outstanding) is reduced and thus EPS increases. Manager of
corporations are frequently evaluated on their ability to grow
earnings per share, so they may be incentivized to use this
strategy.

Dividends Types

A dividend is generally considered to be a cash payment issued

to the holders of company stock. However, there are several
types of dividends, some of which do not involve the payment
of cash to shareholders. These dividend types are:

 Cash dividend. The cash dividend is by far the most

common of the dividend types used. On the date of
declaration, the board of directors resolves to pay a
certain dividend amount in cash to those investors holding
the company's stock on a specific date. The date of
record is the date on which dividends are assigned to the
holders of the company's stock. On the date of payment,
the company issues dividend payments.
 Stock dividend. A stock dividend is the issuance by a
company of its common stock to its common shareholders
without any consideration. If the company issues less than
25 percent of the total number of previously outstanding
shares, then treat the transaction as a stock dividend. If
the transaction is for a greater proportion of the previously
outstanding shares, then treat the transaction as a stock
split. To record a stock dividend, transfer from retained
earnings to the capital stock and additional paid-in
capital accounts an amount equal to the fair value of the
additional shares issued. The fair value of the additional
shares issued is based on their fair market value when the
dividend is declared.

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 Property dividend. A company may issue a non-monetary
dividend to investors, rather than making a cash or stock
payment. Record this distribution at the fair market value
of the assets distributed. Since the fair market value is
likely to vary somewhat from the book value of the assets,
the company will likely record the variance as a gain or
loss. This accounting rule can sometimes lead a business
to deliberately issue property dividends in order to alter
their taxable and/or reported income.
 Scrip dividend. A company may not have sufficient funds
to issue dividends in the near future, so instead it issues a
scrip dividend, which is essentially a promissory
note (which may or may not include interest) to pay
shareholders at a later date. This dividend creates a note
payable.
 Liquidating dividend. When the board of directors wishes
to return the capital originally contributed by shareholders
as a dividend, it is called a liquidating dividend, and may
be a precursor to shutting down the business. The
accounting for a liquidating dividend is similar to the
entries for a cash dividend, except that the funds are
considered to come from the additional paid-in capital
account.

Types of Dividend:
 There are three common types of dividend that you may
hear of; cash, stock and extraordinary.
 A cash dividend is what is explained above, a regular
payment of your share of a company’s profits, paid in
cash. Unless otherwise specified, we will deal here with
cash dividends.
 A stock dividend is when, rather than pay cash, the board
decides to reward investors by granting them whole or
partial shares in the company for each share held.
 An extraordinary dividend is when a board decides to
distribute cash previously held back to shareholders. This

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 was quite common at the end of 2012, when it was
forecast that capital gains tax would rise steeply in 2013.
Directors at many companies felt that it was in the
interests of shareholders to distribute cash before tax
liabilities increased.
 Payment Options: If you hold your shares in a
brokerage account, you have 2 options: 1) You can be
paid each dividend in cash in your account 2) You can
opt for automatic dividend re-investment. In this case,
any cash paid is used to purchase shares, or partial
shares, in the company that paid the dividend. Option 1 is
best if you own dividend paying stock to generate
income, option 2 if your objective is long term growth of
capital.
 If you hold the shares yourself, a check will be sent to the
address of record for each payment unless the company
has a Dividend Reinvestment Plan, or DRIP. In that case
you have the option of receiving a check or having the
payment used to buy shares or partial shares in the
company.
 The Importance of Dividends: For those seeking
income, the importance of dividends is self-evident. It is
less obvious when seeking growth, but dividends are an
important part of total returns over time. Indeed, since
1930, 40% of the total returns in the US stock market are
attributable to dividends.
 Record Date& Ex-Dividend: When a dividend is
declared by a board, they also say when it will be paid.
The important date for the investor is the “record date” .
The dividend will be paid to the owner of the shares on
that day. The next day, when the stock will be trade after
(or ex) the dividend is known as the ex-date and the
stock is said to be “ex-dividend”. On that day the stock
will usually open lower by the amount of the dividend, all
things being equal.

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 Advantages of Dividend Paying Stock: The most
obvious advantage is that you get paid to own the stock.
As explained above, these payments, usually quarterly,
can be used for income or reinvested. Dividend income is
currently taxed at a lower rate in the US than other forms,
so there can be significant benefits for high rate tax
payers. Less obviously, the ability of a company to
consistently declare and pay a dividend can be a good
sign for conservative investors. It means that the
company is making money and expects to continue to do
so.
 Risks of Dividend Paying Stock: As dividends are often
seen as an alternative to interest paying securities, such
as bonds or CDs, the underlying price of the stock is
sensitive to changes in interest rates. In a rising rate
environment, stocks with good dividends can lose value
dramatically.
 When a company starts to pay a dividend it can mean
that the board can see no other use for the cash. This
means that growth through acquisition or expansion is
less likely.
 Calculating Yield: The yield of an asset is the percent
return paid over 1 year. Thus, for dividend stocks, the
yield is the sum of the last four quarterly dividends
divided by the price of the stock x100. For example, let’s
say you buy GE at $24.00 per share. At the time of
writing the last four quarterly dividends have been $0.19,
$0.19, $0.19 and $0.17, giving a total of $0.74 per share.
0.74/24.00 = 0.0308. Multiply that by 100 for a 3.08%
yield.
 When evaluating the suitability of stock for your portfolio,
dividends are an important consideration. As with most
things in life, they can be as complicated as you wish to
make them, but with just a little basic knowledge, your
stock selection will be much more informed.

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  Bonus Issue
What is a 'Bonus Issue'
A bonus issue, also known as a scrip issue or a capitalization
issue, is an offer of free additional shares to existing
shareholders. A company may decide to distribute further
shares as an alternative to increasing the dividend payout. For
example, a company may give one bonus share for every five
shares held.

BREAKING DOWN 'Bonus Issue'

Bonus issues are given to shareholders when companies are

short of cash and shareholders expect a regular income.
Shareholders may sell the bonus shares and meet their liquidity
needs. Bonus shares may also be issued to restructure
company reserves. Issuing bonus shares does not involve cash
flow. It increases the company’s share capital but not its net
assets.
Bonus shares are issued according to each shareholder’s stake
in the company. For example, a three-for-two bonus issue
entitles each shareholder three shares for every two they hold
before the issue. A shareholder with 1,000 shares receives
1,500 bonus shares (1000 x 3 / 2 = 1500).

Advantages and Disadvantages of Issuing Bonus Shares

Companies low on cash may issue bonus shares rather

than cash dividends as a method of providing income to
shareholders. Because issuing bonus shares increases the
issued share capital of the company, the company is perceived
as being bigger than it really is, making it more attractive to
investors. In addition, increasing the number of outstanding
shares decreases the stock price, making the stock more
affordable for retail investors.
However, issuing bonus shares takes more money from the
cash reserve than issuing dividends does. Also, because
issuing bonus shares does not generate cash for the company,
it could result in a decline in the dividends per share in the

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future, which shareholders may not view favorably. In addition,
shareholders selling bonus shares to meet liquidity needs
lowers shareholders' percentage stake in the company, giving
them less control over how the company is managed.

Stock Splits and Bonus Shares

Stock splits and bonus shares have many similarities and

differences. When a company declares a stock split, the
number of shares increases, but the investment value remains
the same. Companies typically declare a stock split as a
method of infusing additional liquidity into shares, increasing
the number of shares trading and making shares more
affordable to retail investors.
When a stock is split, there is no increase or decrease in the
company's cash reserves. In contrast, when a company issues
bonus shares, the shares are paid for out of the cash reserves,
and the reserves deplete.

 Definition of 'Bonus Share'

Definition: Bonus shares are additional shares given to the

current shareholders without any additional cost, based upon
the number of shares that a shareholder owns. These are
company's accumulated earnings which are not given out in the
form of dividends, but are converted into free shares.

Description: The basic principle behind bonus shares is that

the total number of shares increases with a constant ratio of
number of shares held to the number of shares outstanding.
For instance, if Investor A holds 200 shares of a company and
a company declares 4:1 bonus, that is for every one share, he
gets 4 shares for free. That is total 800 shares for free and his
total holding will increase to 1000 shares.

Companies issue bonus shares to encourage retail participation

and increase their equity base. When price per share of a
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company is high, it becomes difficult for new investors to buy
shares of that particular company. Increase in the number of
shares reduces the price per share. But the overall capital
remains the same even if bonus shares are declared.

 Bonus Shares: Meaning,

Effects and Advantages
Meaning of Bonus Shares:
Sometimes a company cannot pay dividend in cash due to
shortage of liquid funds—viz. cash—in spite of earning a large
amount of profit for a particular period. Under the
circumstances, the company issues new shares to the existing
shareholders in lieu of paying dividend in cash.

These shares are known as ‘Bonus Shares’. Such bonus

shares are to be offered to the existing shareholders in
proportion to the shareholdings and dividend rights.

Generally, the company issues bonus shares out of profits

and/or reserve to the existing shareholders. Since the
profit/reserve is being capitalized, it is also called capitalisation
of profit/reserve. As the company cannot receive cash from the
shareholders for the purpose of issuing bonus shares, a sum
equal to the total value of bonus issue is to be adjusted against
profit/reserve and transferred to Equity Share Capital Account.

Effect of Bonus Issue:

(a) Issue of bonus share does not invite liquidity crisis like
payment of cash dividends. As no cash payment is made,
liquidity position remains unaffected.

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(b) Since total numbers of shares are increased as a result of
bonus issue, dividend per share may be less.

(c) Issue of bonus shares earns confidence of the public.

Advantages of Issuing Bonus Shares:

A. From the company’s viewpoint:
(a) By issuing bonus shares, shareholders are to be satisfied
when the company cannot pay dividend in cash due to
shortage of liquid funds, i.e., profit can be distributed without
distributing the liquid resources, viz. cash.

(b) By issuing bonus shares, shareholders are to be satisfied,

particularly when the company does not prefer to pay dividend
in cash for the purpose of either its expansion or its working
capital or any other specific purpose, such as any particular
programme of diversification or modernisation.

(c) Sometimes a company is bound to reduce its reserve for the

interest of its own. It may so happen that the amount of earning
profits exceeds the amount of total paid-up capital of the
company which, in other words, encourages the competitors
and creates unhealthy relationship between workers and the
company.

B. From the shareholder’s viewpoint:

(a) Shareholders need not pay tax on the bonus shares but
they are to pay them on the dividend so received in cash.

(b) Shareholders, if they so desire, can convert the shares into

cash by disposing off the same at a higher price.

(c) If partly paid shares are converted into fully paid by issuing
bonus, the shareholders need not pay a further sum for the
purpose. On the other hand, their shares become fully paid-up.

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Disadvantages of issuing Bonus Shares:

From the company’s viewpoint:

(a) More dividend would be paid as the number of shares are

increased.

(b) Over-capitalisation may appear due to the issues.

(c) If the rate of dividend cannot be maintained market value of

shares may go down.

From the shareholder’s point of view:

(a) If the rate of dividend fluctuates, i.e., cannot be maintained,

the market value of shares may go down.

(b) If the rate of profit is not increased, the rate of dividend may
be decreased.

(c) It encourages speculation which is not desirable.

Conditions for the Issue of Bonus Shares:

The following conditions must be fulfilled before issuing bonus

shares:

(i) The issue must be authorised by the Articles of the

company;

(ii) The same must be recommended by a resolution of the

Board of Directors and this approved by the shareholders in the
general meeting; and

(iii) The same also must be permitted by the Controller of

Capital Issues (regardless of the amount involved).

Bonus Shares: Objectives,

Procedure and Other Details
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It is quite natural that every prudent company would like to
create reserve out of its profit for the purpose of future
expansion as-well-as for declaring dividend in the lean periods.

A company that has built up substantial reserves some decides

to capitalize a part of these reserves:
(i) By issuing fully paid bonus shares to existing shareholders
and/or

(ii) By converting partly paid-up shares into fully paid- up shares

without the shareholders to pay anything.

All successful companies increase their capital base by giving

free shares to its existing shareholders out of the reserves
when there are large accumulated, which cannot, either by law
or as a matter of financial prudence, be distributed as dividend
in cash to shareholders. Since bonus shares are created by
conversion of retained earnings or other reserves into equity
share capital, issue of bonus shares does not represent a
source of fund to the company.

The following circumstances warrant issue of bonus

shares:

(i) Accumulated large reserves

 When a company has accumulated large reserves
(whether capital or revenue) and it wants to capitalize
these reserves by issuing bonus shares.

 (ii) Not in a position to give cash bonus:

 When the company is not in a position to give cash bonus
because it adversely effects its working capital.

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  (iii) Value of fixed assets far exceeds the amount of
capital:
 When the value of fixed assets for exceeds the amount of
capital.

 (iv) Higher rate of dividend is not advisable:

 When the higher rate of dividend is not advisable for the
distribution of the accumulated reserves because
shareholders will demand the same rate of dividend in
future, which the directors may not be able to give. To get
rid of this difficulty, bonus shares are issued to facilitate
the payment of the regular dividend from year to year.

 (v) Big difference between the market value and paid-up

value:
 When there is a bit value of the shares of a company i.e.
market value of shares far exceeds the paid up value of
the shares. A company issuing bonus shares is better
placed in the market. There is a sharp rise in the price of
equity shares following the declaration of bonus issue.

Objects of Bonus Issue:

Bonus shares are usually made by company for following

reasons:

(i) Inexpensive:

Issue of bonus shares is an inexpensive mode of raising capital

by which the cash resources of company are conserved.

(ii) More Marketable:

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Issue of bonus shares reduces the market price of the shares,
thus rendering them more marketable.

(iii) Indicator of Good Prospects:

Issue of bonus shares is an indication to the investors that the

company has good prospects.

Procedure of Bonus Issue:

I. The authorized capital should be increased, if necessary, by

passing ordinary resolution.

II. After passing necessary entries in the books of accounts,

additional share certificates are distributed among the existing
shareholders, free of charge.

Types of Bonus Issue:

1. Fully Paid Bonus Shares:

When bonus shares are distributed free of cost in proportion of

holding, it is called Fully Paid Bonus Shares.

2. Partly Paid Bonus Shares:

When bonus is applied for converting partly paid shares into

fully paid shares, it is called Partly Paid-up Bonus Shares.

Source of Bonus Issue:

Fully paid-up bonus shares can be issued out of following

sources:

(i) Capital redemption reserve

(ii) Security premium** (realised in cash)

(iii) Capital reserve* (realised in cash)

(iv) Profit and loss account

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(v) General reserve

(vi) Investment allowance reserve

(vii) Sinking fund for redemption of debentures (after

redemption)

(viii) Development rebate reserve.

*Capital reserve not realised in cash cannot be utilised for

issuing bonus shares e.g. capital reserve created by
revaluation of fixed assets.

** Security premium not realised in cash cannot be utilised for

issuing bonus shares.

Partly paid-up bonus shares can be issued from the following

sources:

(i) Capital Reserve* (realised in cash)

(ii) Profit and loss account

(iii) General reserve

(iv) Investment allowance reserve

(v) Development rebate reserve

(vi) Sinking fund for redemption of debentures (after

redemption)

Note:

1. Security premium account and capital redemption reserve

account cannot be utilised for issuing partly paid bonus shares.

2. If a choice is to be made between revenue reserves and

capital reserves; the capital reserves are normally utilised first
as far as legally permissible.

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  17 main reasons given for the issue of bonus shares

Usually, the following reasons are given for the issue of

Bonus Shares:

(1) When the company has sufficient reserves, which it

does not need in future, it issues Bonus Shares

(2) When there is a big gap between the paid-up capital and the
capital actually employed in the business of account of huge
reserves, it is thought proper to issue Bonus Shares and, thus
to fill up the gap.

(3) Payment of dividend at a high rate is possible if there are

excessive divisible profits with the company. This attracts the
competitors in the business. Thus, Bonus Shares are issued to
reduce the rate of dividend and to regularize it from year to
year.

(4) A high rate of dividend paid to the shareholders is usually

resented by the employees and customers. Hence, Bonus
Shares are issued and the rate of dividend is kept down.

It is thus seen that the issue of Bonus Shares is a good method

of capitalizing large profits or reserves. The following points
have to be noted:

(i) The issue of Bonus Shares increases the volume of the

Share Capital of a company. It should be seen that the profits
are enough so as to enable the company to pay the same rate
of dividend.

(ii) There should be a sufficient number of unissued shares for

allotment as Bonus Shares. Only then, Bonus Shares can be
issued.

(iii) If there is no unissued Share Capital, a resolution altering

the Memorandum and Articles of Association should be passed
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so as to enable the company to increase the authorized capital
of the company.

(iv) For making payment of dividend otherwise than in cash,

Articles will have to be altered to enable the company to do so.

Bonus Shares are issued to all the existing shareholders in

their shareholding proportion.

Revised Guidelines for Issue of Bonus Shares. Under the

Capital Issues (Control) Act, 1947, all the companies are
required to obtain the approval of the Controller of Capital
Issues for issue of Bonus Shares.

The revised guidelines for the examination of such

applications are given below while seeking approval under
the Capital Issue (Control) Act, 1947: Exemption limit has
been raised for Capital Issue – Capital Issue (Exemption)
order for Rs. 50 lakhs has been raised to Rs. 1 crore by
Controller of Capital Issues.

1. For capitalisation of reserves etc. to issue Bonus Shares,

there should be a specific provision in the Articles of
Association. If it is not there, a resolution should be passed
at the General Body Meeting to make such a provision in the
Articles.

2. If the issue of Bonus Shares leads to an increase in the

authorised capital and subscribed and paid-up capital
exceeds the authorized capital, a resolution should be
passed at the General Body Meeting to that effect.

3. Before making an application to the Controller of Capital

Issues, the company should furnish a resolution passed at
the General Meeting for Bonus Shares. In the resolution, the
management’s resolution in regard to the rate of dividend to
be declared in the year immediately after the bonus issue
should be indicated.

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4. The Bonus Shares can be issued out of the reserves built
out of genuine profits or the share premium collected in cash
only.

5. Reserves made out of the revaluation of fixed assets are

not permitted for capitalisation for this purpose.

6. Development Rebate Reserve/Investment Allowance

Reserve is considered as free reserve for the purpose of
calculation of residual reserves test.

7. All contingent liabilities disclosed in the audited accounts

having a bearing on the net profits shall be taken into
account in the calculation of the minimum residual reserves.

8. The volume of residual reserves after the proposed

capitalisation should be at least 40 percent of the increased
paid-up capital.

9. Thirty percent of the average profits before tax of the

company for the previous three years should yield a rate of
dividend on the expanded capital base of the company at 10
percent.

10. The declaration of bonus issue in lieu of dividend is not

allowed.

11. Further application for issue of Bonus Shares by a

company is permitted only after 36 months from the date of
sanction of an earlier bonus issue, if any, by the
Government. (Now only after 24 months from the date of
previous sanction). (CCI) (ii)/86 dated 26.12.86

12. Bonus issues are not permitted unless existing partly

paid shares are made fully paid-up.

13. No bonus issue is permitted if there is reason to believe

that the company is in default in respect of the payment of
statutory dues of employees, e.g., contribution to provident
fund, gratuity, bonus etc.
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14. Capital reserves arising as a result of revaluation of
assets or without accrual of cash resources will neither be
allowed to be capitalised nor taken into account in the
computation of the residual reserves of 40 percent for the
purpose of bonus issue.

15. The total amount permitted to be capitalised, for issue of

Bonus Shares out of free reserves at one time shall not
exceed the total amount of paid-up equity of the company.

As per Revised Guidelines issued on 18.3.85, the proviso

added is that the relaxation can be considered on merits in
respect of unlisted Non-FERA companies which have been
in existence for more than 10 years or which have been
making profits for last 5 years prior to the year in which they
seek listing under the Securities Contracts (Regulation)
Rules, 1957. This relaxation on case by case would,
however, be available to closely held companies till 31.3.86.

16. Application for issue of Bonus Shares should be made

within one month of the announcement of bonus by the
Board of Directors of the company.

17. In cases where there is default ia the payment of any

term loans outstanding to any public financial institution, a
no-objection letter from that institution in respect of the issue
on Bonus Shares should be furnished by the companies
concerned with the application for bonus Issue.

All applications for bonus issue should be signed by a person

not below the rank of director/secretary together with a
certificate indicating that the information furnished is true and
correct and that all the data required in the application form
and prescribed in the guidelines have been furnished.

The applications should be accompanied by a certificate

from the auditors indicating that these guidelines have been
fully met and that the data given in the applications are true
and correct to the best of their knowledge.
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Buyback
What is a 'Buyback'
A buyback, also known as a share repurchase, is when a
company buys its own outstanding shares to reduce the
number of shares available on the open market. Companies
buy back shares for a number of reasons, such as to increase
the value of remaining shares available by reducing the supply
or to prevent other shareholders from taking a controlling stake.

BREAKING DOWN 'Buyback'

A buyback allows companies to invest in themselves. Reducing

the number of shares outstanding on the market increases the
proportion of shares owned by investors. A company may feel
its shares are undervalued and do a buyback to provide
investors with a return. And because the company is bullish on
its current operations, a buyback also boosts the proportion of
earnings that a share is allocated. This will raise the stock price
if the same price-to-earnings (P/E) ratio is maintained.
Another reason for a buyback is for compensation purposes.
Companies often award their employees and management with
stock rewards and stock options; to make due on rewards and
options, companies buy back shares and issue them to
employees and management. This helps avoid the dilution of
existing shareholders.

How Companies Perform a Buyback

Buybacks are carried out in two ways:

1. Shareholders might be presented with a tender offer, where
they have the option to submit, or tender, all or a portion of their
shares within a given time frame at a premium to the current
market price. This premium compensates investors for
tendering their shares rather than holding onto them.
2. Companies buy back shares on the open market over an
extended period of time and may even have an outlined share
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repurchase program that purchases shares at certain times or
at regular intervals.
A company can fund its buyback by taking on debt, with cash
on hand or with its cash flow from operations.

Example of a Buyback

A company's stock price has underperformed its competitor's

stock even though it has had a solid year financially. To
reward investors and provide a return to them, the company
announces a share buyback program to repurchase 10 percent
of its outstanding shares at the current market price. The
company had $1 million in earnings and 1 million
outstanding shares before the buyback, equating to earnings
per share (EPS) of $1. Trading at a $20 per share stock price,
its P/E ratio is 20. All else equal, 100,000 shares would be
repurchased and the new EPS would be $1.11, or $1 million in
earnings spread out over 900,000 shares. To keep the same
P/E ratio of 20, shares would need to trade up 11 percent, to
$22.22.

Why would a company buy

back its own shares?
A:

Stock buybacks refer to the repurchasing of shares of stock by

the company that issued them. A buyback occurs when the
issuing company pays shareholders the market value per share
and re-absorbs that portion of its ownership that was previously
distributed among public and private investors. With stock
buybacks, aka share buybacks, the company can purchase
the stock on the open market or from its shareholders

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directly. In recent decades, share buybacks have overtaken
dividends as a preferred way to
return cash to shareholders. Though smaller companies may
choose to exercise buybacks, blue-chip companies are much
more likely to do so because of the cost involved.

 Reasons for Buybacks

Since companies raise equity capital through the sale of

common and preferred shares, it may seem counter-intuitive
that a business might choose to give that money back.
However, there are numerous reasons why it may be beneficial
to a company to repurchase its shares, including
ownership consolidation, undervaluation, and boosting its key
financial ratios.

 Unused Cash Is Costly

Each share of common stock represents a small stake in the

ownership of the issuing company, including the right to vote on
company policy and financial decisions. If a business has a
managing owner and one million shareholders, it actually has
1,000,001 owners. Companies issue shares to raise equity
capital to fund expansion, but if there are no potential growth
opportunities in sight, holding on to all that unused equity
funding means sharing ownership for no good reason.

Businesses that have expanded to dominate their industries, for

example, may find that there is little more growth to be had.
With so little headroom left to grow into, carrying large amounts

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of equity capital on the balance sheet becomes more of a
burden than a blessing.

Shareholders demand returns on their investments in the form

of dividends which is a cost of equity – so the business is
essentially paying for the privilege of accessing funds it isn't
using. Buying back some or all of the outstanding shares can
be a simple way to pay off investors and reduce the overall cost
of capital. For this reason, Walt Disney (DIS) reduced its
number of outstanding shares in the market by buying back
73.8 million shares, collectively valued at $7.5 billion, back in
2016.

 It Preserves the Stock Price

Shareholders usually want a steady stream of

increasing dividends from the company. And one of the goals of
company executives is to maximize shareholder wealth.
However, company executives must balance appeasing
shareholders with staying nimble if the economy dips into
a recession.

One of the hardest hit banks during the Great Recession was
Bank of America Corporation (BAC). The bank has recovered
nicely since then, but still has some work to do in getting back
to its former glory. However, as of the end of 2017, Bank of
America had bought back 509 million shares over the prior 12-
month period and the bank plans to return over $17 billion to
shareholders through share repurchases in 2018. Although the
dividend has increased over the same period, the bank's

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executive management has consistently allocated more cash to
share repurchases rather than dividends.

Why are buybacks favored over dividends? If

the economy slows or falls into recession, the bank might be
forced to cut its dividend to preserve cash. The result would
undoubtedly lead to a sell-off in the stock. However, if the bank
decided to buy back fewer shares, achieving the same
preservation of capital as a dividend cut, the stock price would
likely take less of a hit. Committing to dividend payouts
with steady increases will certainly drive a company's stock
higher, but the dividend strategy can be a double-edged sword
for a company. In the event of a recession, share buybacks can
be decreased more easily than dividends, with a far less
negative impact on the stock price.

 The Stock Is Undervalued

Another major motive for businesses to do buybacks: They

genuinely feel their shares are undervalued. Undervaluation
occurs for a number of reasons, often due to investors' inability
to see past a business' short-term performance, sensationalist
news items or a general bearish sentiment. A wave of stock
buybacks swept the United States in 2010 and 2011 when the
economy was undergoing a nascent recovery from the Great
Recession. Many companies began making optimistic forecasts
for the coming years, but company stock prices still reflected
the economic doldrums that plagued them in years prior. These
companies invested in themselves by repurchasing shares,

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hoping to capitalize when share prices finally began to reflect
new, improved economic realities.

If a stock is dramatically undervalued, the issuing company can

repurchase some of its shares at this reduced price and then
re-issue them once the market has corrected, thereby
increasing its equity capital without issuing any additional
shares. Though it can be a risky move in the event that prices
stay low, this maneuver can enable businesses who still have
long-term need of capital financing to increase their equity
without further diluting company ownership.

For example, let's assume a company issues 100,000 shares at

$25 per share, raising $2.5 million in equity. An ill-timed news
item questioning the company's leadership ethics causes
panicked shareholders begin to sell, driving the price down to
$15 per share. The company decides to repurchase 50,000
shares at $15 per share for a total outlay of $750,000 and wait
out the frenzy. The business remains profitable and launches a
new and exciting product line the following quarter, driving the
price up past the original offering price to $35 per share. After
regaining its popularity, the company reissues the 50,000
shares at the new market price for a total capital influx of $1.75
million. Because of the brief undervaluation of its stock, the
company was able to turn $2.5 million in equity into $3.5 million
without further diluting ownership by issuing additional shares.

 It's a Quick Fix for the Financial Statement

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Buying back stock can also be an easy way to make a business
look more attractive to investors. By reducing the number of
outstanding shares, a company's earnings per share (EPS)
ratio is automatically increased – because its
annual earnings are now divided by a lower number of
outstanding shares. For example, a company that earns $10
million in a year with 100,000 outstanding shares has an EPS
of $100. If it repurchases 10,000 of those shares, reducing its
total outstanding shares to 90,000, its EPS increases to
$111.11 without any actual increase in earnings.

Also, short-term investors often look to make quick money by

investing in a company leading up to a scheduled buyback. The
rapid influx of investors artificially inflates the
stock's valuation and boosts the company's price to earnings
ratio (P/E). The return on equity (ROE) ratio is another
important financial metric that receives an automatic boost.

One interpretation of a buyback is that the company is

financially healthy and no longer needs excess equity funding.
It can also be viewed by the market that management has
enough confidence in the company to reinvest in itself. Share
buybacks are generally seen as less risky than investing
in research and development for a new technology or acquiring
a competitor; it's a profitable action, as long as the company
continues to grow. Investors typically see share buybacks as a
positive sign for appreciation in the future. As a result, share
buybacks can lead to a rush of investors buying the stock.

 Downside of Buybacks
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A stock buyback affects a company's credit rating if it has to
borrow money to repurchase the shares. Many companies
to finance stock buybacks because the loan interest is tax-
deductible. However, debt obligations drain cash reserves,
which are frequently needed when economic winds shift
against a company. For this reason, credit reporting
agenciesview such-financed stock buybacks in a negative light:
They do not see boosting EPS or capitalizing on undervalued
shares as good justification for taking on debt. A downgrade in
credit rating often follows such a maneuver.

 Effect on the Economy

Despite the above, buybacks can be good for a company's

economics. How about the economy as a whole? Stock
buybacks can have a mildly positive effect on the economy
overall. They tend to have a much more direct and positive
effect on the financial economy, as they lead to rising stock
prices. But in many ways, the financial economy feeds into the
real economy and vice versa. Research has shown that
increases in the stock market have an ameliorative effect on
consumer confidence, consumption and major purchases, a
phenomenon dubbed "the wealth effect."

Another way improvements in the financial economy impact the

real economy is through lower borrowing costs for corporations.
In turn, these corporations are more likely to expand operations
or spend on research and development. These activities lead to
increased hiring and incomes. For individuals, improvements in

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the household balance sheetenhance chances they leverage
up to borrow to buy a house or start a business.

 What is a buyback?

A buyback is a mechanism through which a listed company

buys back shares from the market. A buyback can be done
either through open market purchases or through the tender
offer route. Under the open market mechanism, the company
buys back the shares from the secondary market while under
tender offer, shareholders can tender their shares during the
buyback offer. Historically, most companies had preferred the
open market route.

 Why does a firm go in for a buyback?

Buybacks are typically done when a company has a significant

cash reserve and feels that the shares are not fairly valued at
the current market price. Since the shares that are bought back
are extinguished, the stake of the remaining shareholders rise.
Promoters also use this mechanism to tighten their grip on the
firm.

 What are the benefits?

Since the bought back shares are extinguished, the earnings

per share (EPS) rise by default. Also, since a buyback is
usually done at a price higher than the then prevailing market
price, shareholders get an attractive exit option, especially
when the shares are thinly traded. It is also more tax-efficient
than dividends as a way to reward shareholders.

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  How can a company execute a buyback?

A company can use a maximum of 25% of the aggregate of its

free reserves and paid-up capital for a buyback. A special
resolution needs to be passed at a general meeting. However,
if the company plans to use less than 10% of its reserves then
only a board resolution is required.

 Can a firm opt for regular buybacks to boost EPS?

A company cannot do a second buyback offer within one year

from the date of the closure of the last buyback. Also, there are
time-bound limitations on further share issuances like
preferential allotment or bonus issue post a buyback. These
checks have been put in place so that companies do not
misuse the buyback mechanism.

 Do retail investors get a reservation in buy back?

The Securities and Exchange Board of India (SEBI) has

recently revised the buy back regulations that stipulate 15%
reservation for retail shareholders in a buy back offer. This
gives retail investors a fair share in the offer, which otherwise
could see large institutional investors tendering their shares
leaving little or no room for small investors.

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  Buy Back of Shares of a Company

Buy-back is one amongst the numerous provisions of the

Companies Act, 2013 that permits a company to buy its own
shares or other securities- with inherent advantages to the
corporate and its shareholders. In this article, we look at the
reasons for buy back of shares, methods of buy-back and other
necessary provisions related to share buy-back schemes.

Role of Buy-Back

A share buy-back program can help a company achieve the

following:

 Achieve a specified capital structure;

 Return surplus money to shareholders/security holders;

 Ensure the underlying price of shares/security is correctly

reflected;

 Control unwarranted fall in share or security value

Methods of Buy-Back

Funds for buy-back of shares are usually from free reserves or

securities premium account. Shares can be bought back from
existing shareholders on an impartial basis or open market
transaction.

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Pre-requisites

1. The buy-back must be permitted by Articles of

Association of the corporate.

2. A special resolution has been passed enabling the

corporate authorizing buy-back. However if the buy-back
is 100% or less of the paid Capital and Free Reserves, the
board resolution can fulfil the same.

3. The buy-back is 25% or less of the combination of paid up

capital and free reserves of the corporate. As long as the
buy-back of equity shares in any fiscal year shall not
exceed 25% of its total paid up equity capital in the fiscal
year.

4. The magnitude in relation to the combination of secured

and unsecured debts owed by the corporate and isn’t over
double the paid capital and its free reserves once the buy-
back.

5. All the shares or different given securities for buy-back are

totally paid up.

Other Necessary Provisions

1. Each buy-back ought to be completed about one year

from the date of passing of Special Resolution or Board
Resolution as the case may be.

2. Once the completion of buy-back the corporate cannot

create from now on issue of same shares for a period of
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 six months. However, there’s no prohibition for issue of
bonus shares or issue of shares within the discharge of
subsisting obligations like conversion of warrants, options,
equity or conversion of preferred stock or debentures into
equity shares.

3. The corporate that has been licensed by a special

resolution shall, before the buyback of shares, file with the
ROC a letter of offer in Form No. SH. 8.

4. File with the ROC a declaration of economic condition

signed by a minimum of one director of the corporate, one
amongst whom shall be the MD, if any, in Form No. SH. 9.

5. Provision for buy-back shall stay open for a period of not

less than fifteen days and not letter thirty days from the
date of dispatch of the letter of offer.

6. No provision of Buy-back shall be created about one year

from the closure of preceding Buy-back.

7. Extinguish and physically destroy the shares or securities

therefore bought back about seven days of the last date of
completion of buy-back.

8. Maintain a register of the shares or securities therefore

bought, where one has obtained the shares or securities
bought back, the date of cancellation of shares or
securities, the date of extinction and physically destroying
the shares or securities in Form No. SH. 10.

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 9. File with the ROC a return in Form No. SH. 11 within a
period of about thirty days of the completion of Buy-back.

Prohibitions Relating to Buy-back of Shares

A company shall not purchase its shares or different securities:

1. Through any company, together with its own subsidiary

company;

2. Through any investment trust or cluster of investment

companies;

3. If a default, is created by the corporate, within the

reimbursement of deposits accepted, interest payment on
it, redemption of debentures or preferred stock or payment
of dividend to any stockholder, or reimbursement of any
term loan or interest collectable on it to any financial
organization or financial institution. However, buy-back
isn’t prohibited, if the default is remedied and after a
period of 3 years has completed once such default has
ceased to subsist.

4. If it’s not complied with the provisions of section 92, 123,

127 and section 129 of the Companies Act, 2013.

Buy back of shares—overview

Section 68 of the Companies Act, 2013 permits a company,
both private and public, to buy back its shares or other
specified securities in accordance with the conditions
prescribed under Section 68 and the Companies (Share
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Capital and Debentures) Rules, 2014. Further, listed
companies are permitted to buy back its securities in
accordance with the conditions prescribed by the Securities
and Exchange Board of India (SEBI) (Buy-back of Securities)
Regulations, 1998 and the relevant sections of the
Companies Act.

Specified securities

The term specified securities has been defined under

Explanation I to s 68 of the Companies Act to include
employees’ stock option or other securities as may be
notified by the Central Government, from time to time.
Currently, the Central Government has not issued any
notification in this regard.

Funding for Buy back

The company is permitted to buy back its shares or other

specified securities (collectively, the Securities) from:

1. •free reserves

2. •securities premium account or

3. •proceeds of the issue of any Securities

however, no buy back of any kind of securities shall be made

out of the proceeds of an earlier issue of the same kind of
securities.

Permitted modes for buy back

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A private company and an unlisted public company may buy
back the securities:

1. •from the existing security holders on a proportionate

basis and

2. •by purchasing the securities issued to employees of the

company pursuant to a scheme of stock option or sweat
equity

A listed company may buy back the Securities:

1. •from the existing security holders on a proportionate

basis

2. •from the open market either through book-building

process or stock exchange and

3. •from odd-lot holders

Conditions for Buy back

The conditions for buy back of Securities include:

1. •quantum of buy back: the buy back should be 25% or

less of the aggregate of paid up capital and free reserves
of the company

2. •authorisation: a buy back of more than 10% of the total

paid-up equity capital and free reserves of the company
can be carried out if the buy back is authorised by the
articles of association of the company and a special
resolution is passed by the members of the company
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 authorising the buy back. These conditions are not
applicable to buy back of 10% or less of the total paid-up
equity capital and free reserves of the company and the
same can be carried out pursuant to a resolution of the
board of directors of the company

3. •time limit: the buy back is to be completed within a period

of 12 months from the date of passing the special
resolution, or the board resolution, as the case may be

4. •minimum interval: An offer of buy back shall not be made

earlier than the expiry of 1 year from the date of closure of
the preceding offer of buy back, if any

Stamp Duty

Stamp duty is payable on transfer of shares as prescribed by

the Indian Stamp Act. Since, buy back of shares does not
amount to transfer of shares, no stamp duty is payable in
case of buy For information on the key considerations for buy
back of shares, see Key considerations (compliances
including FEMA compliances) for buy-back of shares.

 Buy-Back of Shares By Private & Unlisted Public

Companies

Meaning of Buy-Back:- Buy-Back of shares generally meant

to a situation in which a company purchases its own shares
from the existing shareholders usually at a price which is higher

303
than the market price of such share. It is a strategy of re-
structuring of capital of the company by which excess paid up
share capital can be extinguished.

Reasons/Benefits of Buy-Back:- There are many reasons &

benefits to buy-back its shares by a company, some of them
are produced below:-

To Increase Earnings Per Share (EPS) of the Company;

To pay the surplus funds to the shareholders;

To prevent the company from takeover bids by holding the

capital in the hands of promoters;

To maintain the debt equity ratio;

o provide an exit route to the shareholders;

To service the equity of the company in more efficient manner;

To increase the return on capital & return on net worth;

A route to reduce the capital of the company without following

the long process of approval of Court/NCLT.

Sources of Buy-Back:- a company may purchase its shares

out of:-

(a) its free reserves;

(b) the securities premium account; or

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(c) the proceeds of the issue of any shares or other specified
securities.

However, no buy-back of any kind of shares can be made out

of the proceeds of an earlier issue of the same kind of shares.

Prohibitions on Buy-Back:-

No company shall directly or indirectly purchase its own

shares:-

 through any subsidiary company including its own

subsidiary companies;

 through any investment company or group of investment

companies; or

 if a default, is made by the company, in the repayment of

deposits accepted either before or after the
commencement of this Act, interest payment thereon,
redemption of debentures or preference shares or
payment of dividend to any shareholder, or repayment of
any term loan or interest payable thereon to any financial
institution or banking company, however, the buy-back is
not prohibited, if the default is remedied and a period of
three years has lapsed after such default ceased to
subsist.

The Company shall not buy-back its shares If the company has
not complied with the provisions of 92 (Annual Return), 123

305
(Declaration of Dividend), 127 (punishment for failure to
distribute dividend) and section 129 (Financial Statement)

Provisions for Buy-Back of Shares:-

i. Authorization for Buy-Back:- Articles of

Association (AOA) of the company Should authorize Buy-
Back, if no provision in AOA then first alter the AOA.

ii. Approval:- The Buy-back can be made with the approval of

the Board of directors at a board meeting and/or by a special
resolution (SR) passed by shareholders in general meeting,
depending on the quantum of buy back-

Approval of Board of Directors- up to 10% of the total paid-up

equity capital and free reserves of the company

Approval of Shareholders- up to 25% of the aggregate of

paid-up capital and free reserves of the company

iii. Notice of General Meeting:- The notice of the meeting at

which the special resolution is proposed to be passed shall be
accompanied by an explanatory statement in which the
particulars required to be mentioned as per section 68(3) [a to
e] and Rule 17(1) [a to n] of Companies (Share Capital and
Debentures) Rules, 2014 should be disclosed.

iv. Methods of Buy-Back:- The Buy-back of shares of private

& unlisted public companies may be –

1. from the existing shareholders on a proportionate basis;

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2. by purchasing the securities issued to employees of the
company pursuant to a scheme of stock option or sweat
equity.

v. Letter of Offer (Form SH-8):- Before the buy-back of

shares, the company shall file with the Registrar of Companies
a letter of offer in e-form SH-8 and the letter of offer shall be
dispatched to the shareholders immediately after filing the
same with the Registrar of Companies but not later than 20
days from its filing with the Registrar of Companies ensuring
the matters as prescribed in the Sub-rule 10 of Rule 17 of
The Companies (Share Capital and Debentures) Rules, 2014.

vi. Declaration of Solvency (Form SH-9):- The company shall

file with the Registrar of Companies, along with the letter of
offer, a declaration of solvency in e-Form SH-9.

vii. Offer Period:- The offer for buy back shall remain open for
a minimum period of 15 days but not more than 30 days from
the date of dispatch of letter of offer (Period may be less than
15 days if all members agreed)

viii. Debt-equity Ratio:- The ratio of the aggregate of secured

and unsecured debts owed by the company after buy-back
shall not be more than twice the paid-up capital and its free
reserves

ix. Fully Paid-up Shares:- Shares to be bought back must be

fully paid up

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x. Time limits:- Buy-back shall be completed within a period of
1 (one) year from the date of passing of SR or Board
Resolution, as the case may be. No offer of buy-back shall be
made within a period of one year from the date of the closure of
the preceding offer of buy-back, if any.

xi. Acceptance of Offer:- In case the number of shares offered

by the shareholders is more than the total number of shares to
be bought back by the company, the acceptance per
shareholder shall be on proportionate basis out of the total
shares offered for being bought back.

xii. Verification:- The company shall complete the the

verifications of the offers received within fifteen days from the
date of closure of the offer and the shares lodged shall be
deemed to be accepted unless a communication of rejection is
made within twenty one days from the date of closure of the
offer.

xiii. Separate Bank Account:- After the closure of the buy-

back offer, the company shall immediately open a separate
bank account and deposit therein, such sum, as would make up
the entire sum due and payable as consideration for the shares
tendered for buy-back.

xiv. Payment:- Within 7 days from the date of verification of the

offers:

i. Make payment of consideration in cash to those shareholders

whose shares have been accepted.

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ii. Return the share certificates to those shareholders whose
shares are not accepted at all or the balance of shares, if partly
accepted.

xv. Extinguishment of Shares:- The company shall

Extinguish and physically destroy the shares bought
back within 7 days of the last date of completion of buy back.

xvi. Prohibition on further issue of shares:- The company

shall not make a further issue of the same kind of shares
including allotment of new shares under clause (a) of sub-
section (1) of section 62 within a period of six months except
by way of a bonus issue or in the discharge of subsisting
obligations such as conversion of warrants, stock option
schemes, sweat equity or conversion of preference shares or
debentures into equity shares.

xvii. Register of Buy-Back (SH-10):- The Company shall

maintain a register of shares which has been bought back in
Form SH-10.

xviii. Return of Buy-Back (SH-11):- The Return of Buy back

with the Registrar in Form SH-11 on completion of buy back
along with the certificate in Form SH-15 certifying that the buy-
back of shares has been made in compliance with the
provisions of the Act and rules within 30 days of such
completion.

xix. Capital Redemption Reserve Account:- If the buy-back

of shares is made out of free reserves or securities premium
account a sum equal to the nominal value of the shares so
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purchased shall be transferred to the capital redemption
reserve account and details of such transfer shall be disclosed
in the balance sheet and the amount of the said reserve may
be applied by the company, in paying up unissued shares of
the company to be issued to members of the company as fully
paid bonus shares.

xx. Punishment:- If a company makes any default in

complying with the provisions of section 68, then the
punishment shall be as follows:-

Company Fine not less than one lakh rupees but which may
extend to three lakh rupees

Every Imprisonment for a term which may extend to three

officer years or with fine which shall not be less than one
lakh rupees but which may extend to three lakh
rupees, or with both

Buy Back Shares: Meaning,

Reasons, Aspects and Other
Details

Meaning of Buy Back of Shares:

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Buy-back of shares is a method of financial engineering. It can
be described as a procedure which enables a company to go
back to the holders of its shares and offer to purchase the
shares held by them.

Buy-back helps a company by giving a better use for its funds

than reinvesting these funds in the same business at below
average rates or going in for unnecessary diversification or
buying growth through costly acquisitions.

When a company has substantial cash resources, it may like to

buy its own shares from the market particularly when the
prevailing rate of its shares in the market is much lower than
the book value or what the company perceives to be its true
value.

This mode of purchase is also called ‘Shares Repurchase’. A

company can utilize its reserves to buy-back equity shares for
the purpose of extinguishing these or treasure operations. The
former option results in reduction of the paid up capital, and
consequently higher earnings and book value per share.
Naturally, the market price of equity goes up.

The reduction in share capital strengthens the promoter’s

control and enhances the equity value for shareholders. In the
latter option, companies buy their shares from open market and
keep these as ‘treasury stock’.

This enables the promoters to strengthen their control over the

shares bought back, without any investment of their own. In
case of treasure operations, there is a diversion of company’s
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funds to buy shares and reduction in the value of equity for the
shareholders.

When a company has substantial cash resources, it may like to

buy its own shares from the market particularly when the
prevailing rate of its shares in the market is much lower than
the book value or what the company perceives to be its true
value.

This mode of purchase is also called ‘Shares Repurchase’. A

company can utilize its reserves to buy-back equity shares for
the purpose of extinguishing these or treasure operations. The
former option results in reduction of the paid up capital, and
consequently higher earnings and book value per share.
Naturally, the market price of equity goes up.

The reduction in share capital strengthens the promoter’s

control and enhances the equity value for shareholders. In the
latter option, companies buy their shares from open market and
keep these as ‘treasury stock’.

This enables the promoters to strengthen their control over the

shares bought back, without any investment of their own. In
case of treasure operations, there is a diversion of company’s
funds to buy shares and reduction in the value of equity for the
shareholders.

The main aim of shares repurchase might be reduce the

number of shares in circulation in order to improve the share
price, or simply to return to the shareholders resources no
longer needed by the company.
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The shares repurchase may be by way of purchase from the
open market or by general tender offer to all shareholders
made by the company to repurchase a fixed amount of its
securities at pre-stated price.

Reasons for Buy-Back:

There are reasons why a company would opt for buy-back:

1. To improve shareholder value, since buy-back provides a

means for utilizing the companies surplus funds which have
unattractive alternative investment options, and since a
reduction in the capital base arising from buy-back would
generally results in higher earnings per share (EPS).

2. It is used as a defense mechanism, in an environment where

the threat of corporate takeovers has become real. Buy-back
provides a safeguard against hostile take-over by increasing
promoter’s holdings.

3. It would enable corporate to shrink their equity base thereby

injecting much needed flexibility.

4. It improves the intrinsic value of the shares by virtue of the

reduced level of floating stock.

5. It would enable corporate to make use of the buy-back

shares for subsequent use in the process of mergers and
acquisitions without enlarging their capital base.

6. Buy-back of shares is used as a method of financial

engineering.
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7. It is used for signaling the effects of buy-back on the share
price.

Financing Aspects of Buy-Back:

Finance is the nerve centre for the business activities and

success is more depending on the better and efficient
management of funds and finance. In order to buy-back of
shares and securities in large numbers, the company needs
huge amounts of capital and funds which may be mobilized
through one or more of the sources viz.

1. Internal sources

2. Sufficient cash position

3. Selling of temporary investment with the least possible loss

4. Raising of working capital needs

5. Raising cash by issuing fixed deposits

6. Raising by issue of debentures and loan bonds

7. Cash credit from commercial banks

8. Overdraft from commercial banks etc.

Benefits of Buy Back:

The benefits derived from share repurchase program are

as follows:

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1. Firms whose profitability was below their industry average
enjoy greater share price growth after shares are repurchased
than firms whose profitability was above their industry average.

2. Firms whose sales growth was below their industry average

enjoy greater share price growth after shares are repurchased
than firms whose sales growth was above their industry
average.

3. Profitable and growth firms that repurchase shares provide a

clear indication to the investors about the strengths of the
company.

4. Repurchasing firms with debt ratios below but sales growth

rates above their industry average experience substantially
higher share price growth after repurchasing than firms with
debt ratios above but sales growth below their industry
average.

5. Repurchasing firms with profitability and debt ratios below

their industry average demonstrate higher share price growth
after repurchasing than firms with profitability and debt ratios
above their industry average.

Drawbacks of Buy Back:

The shares repurchase is criticized for the following

reasons:

1. This could enable unscrupulous promoters to use company’s

money to raise their personal stakes.

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2. It opens up possibilities for share price manipulation.

3. It could divert away the company’s funds from productive

investments.

Legal Provision as to Buy-Back:

Buy-back enables the company to go back to its shareholders

and offers to purchase from them the share they held. With the
introduction of sections 77A, 77A A and 77B in the Companies
Act, 1956 through the Companies (Amendment) Act, 1999, now
the companies allowed buy-back shares.

They buy-back of shares are also subject to the SEBI (Buy-

back of Securities) Regulations, 1998. The said legal
provisions are summarized as follows:

1. The Sources of funds for buy-back of shares or other

specified securities of a company are:

(a) Free reserves or

(b) Securities premium account or

(c) The proceeds of issue of any shares or other specified

securities.

2. No buy-back should be made out of the proceeds of an

earlier issue of same kind of shares or same kind of other
specified securities.

3. Explanation to section 372A of the Act provides that

‘reserves’ as per the last audited Balance sheet of the company
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are to be taken as free reserves. The amounts credited after
the close of financial year to free reserves and the securities
premium account should not be utilized for buy-back.

4. The company may buy-back its own shares or other

specified securities in any of the following manner:

(1) From the existing security holders on a proportionate basis,

or

(2) From the open market, or

(3) From odd lots, or

(4) By purchasing the securities issued to employees of the

company pursuant to a scheme of stock option or sweat equity.

5. A company may buy-back its shares or other specified

securities to the extend 10% of its total paid-up equity capital
and free reserves by passing only a Board resolution.

6. If buy-back is beyond 10%, it must be approved by

shareholders resolution. In any case, buy-back of equity shares
by a company cannot exceed 25% of its total paid-up equity
capital in that financial year.

7. Where the companies buy-back its own shares, it shall

extinguish and physically destroy the securities so bought back
within seven days of the last date of completion of buy-back.

8. A company can issue bonus shares at any time after the

buy-back of shares. Regulation 19(l)(a) of the SEBI (Buy-back

317
of Securities) Regulations, 1998, a company shall not issue any
specified securities including by way of bonus till the date of
closure of the offers for buy-back made under the regulations.

8. Section 77(8) prohibits further issue of shares (including

allotment of further shares) under clause (a) of sub-section (1)
of section 81 for a period of six months except by way of bonus
shares.

9. A company can buy-back its shares every year but subject to

the satisfaction of other conditions such as debt-equity ratio,
limits of buy-back stipulated in section 77A etc. Promoters can
participate under tender offer or buy-back through book building
subject to full disclosures being made in the letter of offer.

10. A company cannot buy-back equity shares from the

promoter or person in control of the company if the buy-back is
through stock exchange.

11. Passing of resolution by a company does not create any

obligation on the company to buy-back its securities. Buy-back
becomes irrevocable only when the letter of offer is filed with
the appropriate authority or public announcement of the offer to
buy-back is made.

12. The company should pay the consideration only by way of

cash/ cheque /bank draft.

13. The cost of buy-back of securities should be taken as an

expense and charged to the Profit and Loss Account.

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14. Listed companies are required to intimate the stoke
exchange of general meeting and resolution passed thereof.

15. The buy-back shares of a private limited company are

subject to the compliance of Private Limited Company (Buy-
back of Securities) Rules, 1999.

A listed company is required to open an escrow account which

is to be used as a security for the purpose of making payment
in respect of buy-back of shares. The company should deposit
in an escrow account opened with a scheduled commercial
bank on or before the opening of the offer for buy-back of
securities, such sum as specified below:

16. Where the estimated consideration payable for buy-back

does not exceed Rs. 100 cores, 25% of the consideration
payable.

17. In case the consideration payable for buy-back exceed Rs.

100 crores, 25% up to Rs. 100 crores and 10% of the balance.

18. The companies are required to maintain a ‘Register of

Securities Bought back’ which should contain the prescribed
information. .

19. The company is required to extinguish and physically

destroy the security certificates bought back in the presence of
the Registers or Merchant Banker or Statutory Auditor within
seven days from the date of acceptance of securities. Mere
stamping ‘cancelled is not sufficient.

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20. The securities offered for buy back, if already
dematerialized, should be extinguished and destroyed in the
manner specified under SEBI (Depositories and Participants)
Regulations, 1996 and the bye-laws framed thereunder.

21. Where a company purchases its own shares out of free

reserves, then a sum equal to the nominal value of the shares
so purchased shall be transferred to the ‘Capital Redemption
Reserve’ and details of such transfer shall be disclosed in the
Balance sheet.

22. Disclosure are required to be made in Directors Report as

to reasons for failure of buy- back, if shares are not bought
back within 12 months from date of Board or Shareholders
resolution.

23. A company should not keep the offer for buy-back open for
a period exceeding 30 days.

Profit or Loss Prior to Incorporation:

A company may acquire another business from a date prior to

its incorporation, normally from the beginning of the accounting
year of the selling concern with to avoid preparation of final
accounts up to the date of acquisition.

For example, a company incorporated on May 1, 1984, may

purchase a business with effect from January 1, 1984, the date
on which the accounting year of the vendor starts.

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Suppose, the company closes its accounts on December 31
and prepares the Profit and Loss Account for the year ended
December 31, 1984, any Profit earned by the company from
January 1, 1984, to April 30, 1984 (i.e., Prior to incorporation) is
known as profit prior to incorporation and treated as capital
profit and transferred to the Capital Reserve Account.

In the same manner any loss incurred prior to incorporation is

treated as capital loss and debited to the Goodwill Account.
The profit earned by the company after the date of its
incorporation is its revenue profit and is available for dividend.

A pertinent point to be noted is that even though a public

company can earn revenue profits only after getting the
Certificate of Commencement, for all practical purposes, the
date of incorporation is taken as the basis for the calculation of
profit prior to incorporation.

Ascertainment of Profit or Loss Prior to Incorporation:

The following steps are taken to ascertain the profit earned

prior to incorporation and after incorporation.

(1) A Trading Account for the full accounting period is prepared

and Gross Profit is arrived at.

(2) Gross profit is apportioned between the two periods on the

basis of the sales in the two periods.

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(3) All fixed expenses such as rent, rates, salaries, insurance,
audit fees, etc., are allocated on a time basis as these
expenses are related to the time factor.

(4) Expenses which are directly related to sales, like discount

allowed, bad debts, commission on sales, advertising etc., are
allocated on the basis of the sales of each period.

(5) Certain expenses which are incurred by the company or

incurred only in the post- incorporation period, e.g., preliminary
expenses, debenture interest paid, directors’ fees, etc., are
charged as expenses of the post-incorporation period only.

 Buy-Back of shares

Buy-Back is a corporate action in which a company buys

back its shares from the existing shareholders usually at a
price higher than market price. When it buys back, the
number of shares outstanding in the market reduces.

BREAKING DOWN 'Buyback'

A buyback allows companies to invest in themselves. By

reducing the number of shares outstanding on the market,
buybacks increase the proportion of shares a company owns.
Buybacks can be carried out in two ways:

 Shareholders may be presented with a tender offer

whereby they have the option to submit (or tender) a
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 portion or all of their shares within a certain time frame
and at a premium to the current market price. This
premium compensates investors for tendering their shares
rather than holding on to them.

 Companies buy back shares on the open market over an

extended period of time.

The reasons for buy-back:

 To improve earnings per share;

 To improve return on capital, return on net worth and to

enhance the long-term shareholder value;

 To provide an additional exit route to shareholders when

shares are under valued or are thinly traded;

 To enhance consolidation of stake in the company;

 To prevent unwelcome takeover bids;

 To return surplus cash to shareholders;

 To achieve optimum capital structure;

 To support share price during periods of sluggish market

conditions;

 To service the equity more efficiently.

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Advantages of Buy Back:

 It is an alternative mode of reduction in capital without

requiring approval of the Court/CLB(NCLT),

 To improve the earnings per share;

 To improve return on capital, return on net worth and to

enhance the long-term shareholders value;

 To provide an additional exit route to shareholders when

shares are undervalued or thinly traded;

 To enhance consolidation of stake in the company.

 To prevent unwelcome takeover bids;

 To return surplus cash to shareholders;

 To achieve optimum capital structure;

 To support share price during periods of sluggish market

condition;

 To serve the equity more efficiently.

Stock buybacks: A good thing or not?

Flush with cash, Apple Inc. (AAPL) has been repurchasing
shares of its stock as a means of trying to boost the share price
and provide shareholder value. This may also be seen as a
324
sign by some that the tech giant views the potential return on its
own stock as a better investment for its money than reinvesting
back into the business.

It's hard to argue with Apple's strategy. Shares of the tech giant
gained more than 46% last year as it continues to sell iPhones
at scale. For the quarter ending Sept. 30, 2017, Apple
recorded earnings per share (EPS) of $2.07 on revenue of
$52.6 billion. However, Apple certainly isn't the norm on Wall
Street, and analysts continue to ask the question: Are corporate
stock buybacks a good thing? (For more, see "Are Share
Buybacks Propping up the Market?")

One of Four Choices

For corporations with extra cash, there are essentially four

choices as to what to do: The firm can make capital
expenditures or invest in other ways into their existing
business; they can pay cash dividends to the shareholders;
they can acquire another company or business unit; or they can
use the money to repurchase their own shares—a stock
buyback.

Similar to a dividend, a stock buyback is a way to return capital

to shareholders. While a dividend is effectively a cash bonus
amounting to a percentage of a shareholder's total stock value,
however, a stock buyback requires the shareholder to
surrender stock to the company to receive cash. Those shares
are then pulled out of circulation and taken off the market.

Buyback Nation
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Prior to 1980, buybacks weren't all that common. More recently,
they have become far more frequent: Between 2003 and 2012,
the 449 publicly listed companies on the S&P 500 allocated
$2.4 trillion—some 54% of their earnings—to buybacks,
according to a Harvard Business Review report. And it's not just
giants like Apple and Amazon.com Inc. (AMZN); even smaller
companies are getting into the buyback game. For example,
SolarWinds Inc. (SWI) in 2015 agreed to buy back almost 10%
of its shares—just six years after its initial public offering.

In 2015, stock buybacks by U.S. companies totaled $572.2

billion – the largest sum since 2007. Activity has dipped a bit
since (to $536.4 billion in 2016), but overall, companies have
plunged nearly $4 trillion of their cash into buying back their
stock in the last decade.

According to recent Bloomberg research, more than half of

corporate profits (56%) in the U.S. go toward share buybacks.
Some economists and investors argue that using excess cash
to buy up their stock in the open market is the opposite of what
companies should be doing, which is reinvesting to facilitate
growth (as well as job creation and capacity).

The biggest social concern about this has to do with opportunity

costs: Money that goes to shareholders in a stock buyback
program could have been used for maintenance and upkeep.
On average, fixed assets and consumer durable goods in the
United States are now older than they’ve been at any point
since the Eisenhower era (the 1950s). There is a lot of attention
paid to the nation's crumbling roads and bridges, but private
326
infrastructure is also suffering neglect – it's just not talked
about. (For more, see "What Is Opportunity Cost and Why
Does It Matter?")

The scale and frequency of buybacks have become so

significant that even shareholders, who presumably benefit
from such corporate largesse, are not without worry. “It
concerns us that, in the wake of the financial crisis, many
companies have shied away from investing in the future growth
of their companies,” wrote Laurence Fink, chairman and CEO
of BlackRock Inc. “Too many companies have cut capital
expenditure and even increased debt to boost dividends and
increase share buybacks.”

Here's a simple truth (according to the Harvard Business

Review report): In 2012, the 500 highest-paid executives
named in proxy statements of U.S. public companies received,
on average, $30.3 million each; 42% of their compensation
came from stock options and 41% from stock awards. So C-
suite executives have little incentive to scale back on buybacks,
given the large positions in company stock they typically hold
and therefore amount they have to gain. By increasing the
demand for a company’s shares, open-market buybacks
automatically lift its stock price, even if only temporarily, and
can enable the company to hit quarterly EPS targets.

All that said, buybacks can be done for perfectly legitimate and
constructive reasons.

Benefits of Share Buybacks

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The theory behind share buybacks is that they reduce the
number of shares available in the market and – all things being
equal – thus increase EPS on the remaining shares, benefiting
shareholders. For companies flush with cash, the prospect of
bumping up EPS can be tempting, especially in an environment
where the average yield on corporate cash investments is
barely more than 1%.

In addition, companies that buy back their own shares often

believe:

 The stock is undervalued and a good buy at the current

market price. Billionaire investor Warren Buffett utilizes
stock buybacks when he feels that shares of his own
company, Berkshire Hathaway Inc. (BRK-A), are trading at
too low a level. However, the annual report emphasizes
that "Berkshire's directors will only authorize repurchases
at a price they believe to be well below intrinsic value."

 A buyback will create a level of support for the stock,

especially during a recessionary period or during a market
correction.

 A buyback will increase share prices. Stocks trade in part

based upon supply and demand, and a reduction in the
number of outstanding shares often precipitates a price
increase. Therefore, a company can bring about an
increase in its stock valuation by creating a supply
shock via a share repurchase.

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Buybacks can also be a way for a company to protect itself
from a hostile takeover, or signal that the company plans on
going private.

Some Buyback Cons

For years, it was thought that stock buybacks were an entirely

positive thing for shareholders. However, there are some
downsides to buybacks as well. One of the most important
metrics for judging a company's financial position is its EPS
ratio. EPS divides a company's total earnings by the number of
outstanding a shares; a higher number indicates a stronger
financial position. By repurchasing its own stock, a company
decreases the number of outstanding shares. Therefore, a
stock buyback enables a company to increase this important
ratio without actually increasing its earnings or doing anything
to support the idea that it is becoming financially stronger.

As an illustration, consider a company with yearly earnings of

$10 million and 500,000 outstanding shares. This company's
EPS, then, is $20. If it repurchases 100,000 of its outstanding
shares, its EPS immediately increases to $25, even though
its earnings have not budged. Investors who use EPS to gauge
financial position may view this company as stronger than a
similar firm with an EPS of $20, when in reality the use of the
buyback tactic accounts for the $5 difference.

Other reasons buybacks are controversial:

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  The impact on earnings per share can give an artificial lift
to the stock and mask financial problems that would be
revealed by a closer look at the company’s ratios.

 Companies will use buybacks as a way to allow

executives to take advantage of stock option programs
while not diluting EPS.

 Buybacks can create a short-term bump in the stock price

that some say allows insiders to profit, while suckering
other investors. This price increase may look good at first,
but the positive effect is usually ephemeral, with
equilibrium regaining when the market realizes that the
company has done nothing to increase its actual value.
Those who buy in after the bump can then lose money.

Criticism of Buybacks

Some companies buyback shares to raise capital for

reinvestment. This is all good and well until the money isn't
injected back into the company. In July 2017, the Institute for
New Economic Thinking published a paper titled "US Pharma’s
Financialized Business Model" on pharmaceutical companies
and their share buyback and dividend strategy. The study found
that share buybacks weren't being used in ways to grow the
company, and in many cases total share buybacks
outnumbered funds spent on research and development. "In
the name of 'maximizing shareholder value' (MSV),
pharmaceutical companies allocate the profits generated from
high drug prices to massive repurchases, or buybacks, of their

330
own corporate stock for the sole purpose of giving manipulative
boosts to their stock prices," the report said. "Incentivizing
these buybacks is stock-based compensation that rewards
senior executives for stock-price performance."

And, as mentioned above, any boost to share price from the

buyback seems to be short-lived. Along with Apple, Exxon
Mobil and IBM have made significant share repurchases.
A CNBC article in May 2017 said since the turn of the century,
total outstanding shares of Exxon Mobil have fallen 40%, and
IBM's has decreased by a whopping 60% from its peak in 1995.
The article notes that not only does this fit "financial
engineering," but it also affects overall stock indexes that are
valued on the weightings in these companies.

Buybacks Versus Dividends

As mentioned earlier, buybacks and dividends can be ways to

distribute excess cash and compensate shareholders. Given a
choice, most investors will choose a dividend over higher-value
stock; many rely on the regular payouts that dividends provide.
And for that very reason, companies can be wary of
establishing a dividend program. Once shareholders get used
to the payouts, it is difficult to discontinue or reduce them –
even when that's probably the best thing to do. That said, the
majority of profitable companies do pay dividends – two notable
exceptions are Alphabet Inc. and Berkshire Hathaway.

Buybacks do benefit all shareholders to the extent that, when

stock is repurchased, shareholders get market value, plus a

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premium from the company. And if the stock price then rises,
those that sell their shares in the open market will see a
tangible benefit. Other shareholders who do not sell their
shares now may see the price drop and not realize the benefit
when they ultimately sell their shares at some point in the
future.

The Bottom Line

Share repurchase programs have always had their advantages

and disadvantages, for company management and
shareholders alike. But, as their frequency has increased in
recent years, the actual value of stock buybacks has come into
question. Some corporate finance analysts feel that companies
use them as a disingenuous method to inflate certain financial
ratios, such as EPS under the auspices of providing a benefit to
shareholders. Stock buybacks also enable companies to put
upward pressure on share prices by affecting a sudden
decrease in their supply.

Investors shouldn't judge a stock based solely on the

company's buyback program, though it is worth looking at when
you're considering investing. A company that buys its own
shares back too aggressively might well be reckless in other
areas, while a company that repurchases shares only under the
most stringent of circumstances (unreasonably low share price,
stock not very closely held) is more likely to truly have its
shareholders’ best interests at heart. Remember to also focus
on the stalwarts of steady growth, price as a
reasonable multiple of earnings and adaptability. That way
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you'll have a better chance of participating in value creation
versus value extraction. (For more, see "How to Profit From
Stock Splits and Buybacks.")

Some experts contend that buybacks at current high market

levels cause the company to overpay for the stock and are
carried out to placate large shareholders. For clients who invest
in individual stocks, a knowledgeable financial advisor can help
analyze the longer-term prospects of a given stock and can
look beyond such short-term corporate actions to realize the
actual value of the firm.

 Share Buyback- Methods, Advantages and

Disadvantages
Share buyback, also known as share repurchase, is an action
to buy back the shares from the shareholders. There are two
parties involved in this transaction: 1) Company and 2)
Shareholders. The company buys back the shares from
interested shareholders by offering them cash. There are many
methods through which this transaction can happen. Also, there
are certain advantages and disadvantages of this process. We
will discuss them here.

METHODS OF SHARE BUYBACK

BUYING FROM OPEN MARKET

In this method of share buyback, the company buys its own

stocks from the market. This transaction happens through
company’s brokers. This repurchase program happens for an

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extended period of time as a large block of shares needs to be
bought. The company is under no obligation to conduct the
repurchase program after the announcement. The company
has the option to cancel it. Also, it can make changes in the
repurchase program according to company’s situations and
needs. If this method is effectively implemented, it can prove to
be very cost effective.

FIXED PRICE TENDER OFFER

In this method, the company makes an offer to buy a fixed no.

of share at a fixed price to its shareholders. The price offered
by the company is above the current market price. The
shareholders have the option to sell back the share or hold the
shares. Interested shareholders submit the no. of shares they
are willing to sell back to the company. If total no. of shares
exceeds the shares required by the company, shares are
bought back on a pro-rata basis. This method can be
conducted quickly but it can be costlier than buying shares
back from the open market.

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DUTCH AUCTION TENDER OFFER

This is very similar to fixed price tender offer. Instead of

specifying a fixed price, the company offers a range of prices to
the shareholders. The minimum price is above the current
market price. For example, a stock is currently trading at $100.
The company offers to buy back 2 million shares within the
range of $101 to $103. Investors will bid the no. of shares and
the minimum price at which he/she wants to sell the shares.
The company will start qualifying bids from $101 and move to
higher prices until requirement of fixed no. of shares is fulfilled.
If at $102 the requirement of 2 million shares is fulfilled, every
qualified bidder is paid $102. Bids above $102 will be rejected.
If total bidding at $101 and $102 exceeds the requirement of
shares then shares are allotted on a pro-rata basis.

REPURCHASE BY DIRECT NEGOTIATION

In this method, the company approaches only those

shareholders who have a large block of shares. They are paid a
premium above the current market price. This is more logical
335
approach as the company can directly negotiate with large
shareholders.

ADVANTAGES OF SHARE BUYBACK

FLEXIBILITY

The share buyback is flexible in nature. The share repurchase

program is conducted for an extended period of time, unlike
cash dividends which need to be paid immediately. Also, the
company is under no compulsion to conduct the repurchase
program. It can cancel it or modify it according to their needs.
The shareholders are also under no compulsion to sell back the
shares. They can choose to hold the shares if they want to.

TAX BENEFIT

Some countries have lower capital gain tax rate compared to

dividend tax rate. The share buyback will be taxed under capital
gain tax category. So, investors would prefer share buyback
over cash dividend in such countries.

SHARE BUYBACK AS A SIGNAL

Share buyback is generally a positive signal because company

perceives shares to be undervalued and it has confidence in its
growth prospects. There could also be a possibility that
company does not have profitable reinvestment opportunities
so they are buying back the shares. This could be a negative
signal for growth investors. Investors can analyze this action

336
and its purpose to understand where the company is heading
to. The idea here is that actions speak louder than words.

DISADVANTAGES OF SHARE BUYBACK

UNREALISTIC PICTURE THROUGH RATIOS

Share buyback boosts some ratios like EPS, ROA, ROE etc.
This increase in ratios is not because of the increase in
profitability but due to a decrease in outstanding shares. It is
not an organic growth in profit. Hence, the buyback will show
an optimistic picture which is away from the economic reality of
the company.

JUDGMENT ERROR IN VALUATION

Though management has better access to information of the

company, there are chances that they also can make mistakes
about valuing the company. If the buyback is undertaken with
the purpose to support the undervaluation but company
overestimated the future prospects. This mistake will make the
whole process of buyback futile.

 Borrowing Power of a Company in India

Abstract
Every company needs unexpected additional capital for its
business from time to time. The company can meet such
requirement of capital, to an extent, by the issue of share, but it
is not always possible to get the capital through the issue of

337
shares as and when it is required. As a result, the company has
to take the recourse of public loans.
Normally, most companies are empowered by their articles to
borrow money for the purpose of their business. It has been
held in the case of General Auction Estate Co. v. Smith that
even if it is not explicit in a trading company’s articles, every
company has the right to borrow money and to charge its
assets by way of security for the amount borrowed. So far as
non trading companies are concerned, they cannot seek any
public loan unless it is expressly stated in their memorandum
and articles that they are authorized to do so. A company’s
memorandum defines the maximum limit to which the company
may take loans whereas their article defines the procedure for
taking such loans. Where the memorandum of a company has
stated the limit of a company’s right to borrow money, any
borrowing beyond such limit is beyond the authority of the
company. In such a case any guarantee given the loan is
invalid, and the loan is not deemed to be a debt against the
company. Any such contract is void ab initio and cannot be
implemented even if all members of the company confirm the
contract.

 Borrowings Under The

Companies Act, 2013
I. INTRODUCTION

For running a new business effectively and successfully and

adequate amount of capital is required.[1] In some of the case

is the capital is arranged through internal sources that is by the

way of issuing equity share capital are true accumulated

338
profit.[2] Whereas in some cases external resources are also

used this can be external commercial, borrowing, debentures,

public fixed deposits, bank loans etc.[3] Borrowing can be

defined as under which money is arrange with an external

sources.[4]
II. POWER OF A COMPANY TO BORROW
Under the power of a company exercise by its directors who
cannot borrow more than the sum authorised. Under these two
company directors can only be exercised for borrowing money
by issuing debentures. Under section 179 (3) (c)[5] and (d)[6],
directors[7] have the power to pass a resolution to borrow
money.[8] However, the power to borrow money can only be
delegated by passing resolution. Under the resolution the total
amount of money which can be bothered must be
written.[9] Under section 180[10], the board of directors of the
company are restricted from borrowing a sum of money which
is obtained from temporary loans that are obtained from the
company’s banker.[11] According to Section 180, temporary
loans are the loans which are re-payable on the demand within
6 months from the date.

III. UNAUTHORISED BORROWINGS

When a company borrow something without the authority or
beyond the amount set out in the articles it is an unauthorised
borrowing. These borrowings are void. When these borrowings
take place then the contract is automatically void and the lender

339
cannot sue the company.[12] The securities which are given for
these unauthorised borrowing are void and inoperative.

IV. INTRA VIRES BORROWING BUT OUTSIDE THE SCOPE

OF AGENTS AUTHORITY
There is an always a distinction between a company’s
borrowing powers and authority of the directors to borrow. The
following which is done beyond the authority of the director is
not ultra vires where as such borrow is known as ultra
vires.[13] If the borrowing is done within the directors then the
company will be liable of such borrowing.[14]

V. TYPES OF BORROWING
There are various types of borrowing which can be categorised
as

1. Long term borrowings

Under the long term the funds are borrowed from a period
ranging from 5 years or more.[15]

2. Short term borrowings

Under the short-term borrowed for a very short period that is up

to 1 year.[16] These funds are generally borrowed so that
working capital amount can be made.[17]

3. Medium term borrowings

These are the borrowing under which the funds world from a
period of 2 to 5 years.[18]

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 4. Secured borrowing

Under the secured borrowing, if a creditor has the re-course of

assets of the company or a proprietary then a debt obligation is
considered as security.[19]

5. Unsecured borrowing

Under the unsecured borrowing the debt comprises of financial

obligations.[20]

6. Syndicated borrowing

Under the syndicated borrowing, if a borrower requires a large

fund, it is generally provided by a group of lenders.[21] Under
this one agreement is used by borrower covering the whole
group of bank and different types of facilities rather than
entering into series of separate loans.[22]

7. Bilateral borrowing

When a company makes a borrowing from a particular meaning

of financial institution it is known as bilateral Borrowing. There
is only single type of contract between the company and the
borrower in this type of borrowing.

8. Private borrowing

The private borrowing consists of bank loan obligations. Under

this the company take loan from Bank of financial
institution.[23]

9. Public borrowing
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Public borrowing consists of all the financial institutions that are
freely tradable on a public exchange.

 Borrowing Powers of a Company | Loans | Section

180(1)(c) |

A Company Borrowing Powers are defined in section like

179(3), 180(1)(c) in Companies Act 2013. A Company is

allowed to borrow funds, provided, it is exercised by the

proper authority. Also Read our earlier posts on Red Herring

Prospectus, Shelf Prospectus, Bonus Issue of Shares, Issue

of Shares with Differential Voting Rights, Section 189 of

Companies Act 2013, Reduction of Share Capital and the

concept of Right Shares under the Companies Act

2013. Why a Company need Borrowed Funds

In order to run a business effectively/successfully, adequate

amount of capital is necessary. In some cases capital

arranged through internal resources i.e. by way of issuing

equity share capital or using accumulated profit is not

adequate and the organisation is resorted to external

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resources of arranging capital i.e. External Commercial

borrowing (ECB), Debentures, Bank Loan, Public Fixed

Deposits etc. Thus, borrowing is a mechanism used whereby

the money is arranged through external resources with an

implied or expressed intention of returning money.

Power to Borrow Funds by a Company

The power of the company to borrow is exercised by its

directors, who cannot borrow more than the sum authorized.

The powers to borrow money and to issue debentures

whether in or outside India can only be exercised by the

Directors at a duly convened meeting. Pursuant to Section

179(3) (c) & (d) directors have to pass resolution at a duly

convened Board Meeting to borrow moneys.

The power to issue debentures cannot be delegated by the

Board of directors. However, the power to borrow monies

can, be delegated by a resolution passed at a duly convened

meeting of the directors to a committee of directors,

managing director, manager or any other principal officer of

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the company. The resolution must specify the total amount

up to which the moneys may be borrowed by the delegates.

Often the power of the company to borrow is unrestricted,

but the authority of the directors acting as its agents is limited

to a certain extent. For example, Section 180(1)(c) of the Act

prohibits the Board of directors of a company from borrowing

a sum which together with the monies already borrowed

exceeds the aggregate of the paid-up share capital of the

company and its free reserves apart from temporary loans

obtained from the company’s bankers in the ordinary course

of business unless they have received the prior sanction of

the company by a special resolution in general meeting.

Temporary Loans Meaning

Explanation to section 180(1)(c) provides that the expression

“temporary loans” means loans repayable on demand or

within six months from the date of the loan such as short-

term, cash credit arrangements, the discounting of bills and

the issue of other short-term loans of a seasonal character,

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but does not include loans raised for the purpose of financial

expenditure of a capital nature.

Borrowing by a Banking Company

It is further provided in proviso to Section 180(1)(c) that the

acceptance by a banking company, in the ordinary course of

its business, of deposits of money from the public, repayable

on demand or otherwise, and withdrawable by cheque, draft,

order or otherwise, shall not be deemed to be borrowing of

monies by the banking company within the meaning of

clause (c) of Sub-section (1) of Section 180. It is important at

this stage to distinguish between, borrowing which is ultra

vires the company and borrowing which is intra vires the

company but outside the scope of the director’s authority.

The provisions of Sub-section (5) of Section 180 clearly lay

down that debts incurred in excess of the limit fixed by

clause (c) of Sub-section (1) shall not be valid unless the

lender proves that he lent his money in good faith and

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without knowledge of the limit imposed by Sub-section (1)

being exceeded.

Borrowings by Private Companies

With recent exemption notification no 464(E) Private

Companies have been exempted to comply the entire

provisions of Section 180 of the Companies Act 2013,

resultantly special resolution is not required to exercise

powers under section 180.

Unauthorized or Ultra Vires Borrowing

Where a company borrows without the authority conferred on

it by the articles or beyond the amount set out in the Articles,

it is an ultra vires borrowing. Any act which is ultra vires the

company is void. In such a case the contract is void and the

lender cannot sue the company for the return of the loan.

The securities given for such ultra-vires borrowing are also

void and inoperative. Ultra vires borrowings cannot even be

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ratified by a resolution passed by the company in general

meeting.

However, equity assists the lender where the common law

fails to do so. If the lender has parted with his money to the

company under an ultra vires borrowing, and is, therefore,

unable to sue for its return, or enforce any security granted to

him, he nevertheless has, in equity, the following remedies:

Injunction and Recovery:

Under the equitable doctrine of restitution he can obtain an

injunction provided he can trace and identify the money lent,

and any property which the company has bought with it.

Even if the monies advanced by the lender cannot be traced,

the lender can claim repayment if it can be proved that the

company has been benefited thereby.

Subrogation:

Where the money of an ultra vires borrowing has been used

to pay off lawful debts of the company, he would be

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subrogated to the position of the creditor paid off and to that

extent would have the right to recover his loan from the

company. Subrogation is allowed for the simple reason that

when a lawful debt has been paid off with an ultra vires loan,

the total indebtedness of the company remains the same. By

subrogating the ultra vires lender, the Court is able to protect

him from loss, while debt burden of the company is in no way

increased.

Suit against Directors:

In case of ultra vires borrowing, the lender may be able to

sue the directors for breach of warranty of authority,

especially if the directors deliberately misrepresented their

authority [Executors v. Himphreys (1866) QBD 64].

Borrowing on Security of Property

The power to borrow includes the power to give security,

which may take the form of a mortgage, a charge,

hypothecation, lien, guarantee, pledge etc. The creditor’s

position becomes safer when security is given, for he will not

348
only be able to sue the company for the amount of money

which he has lent to it, but he will also be able to enforce his

security, i.e., claim that the property charged belongs to him

to the extent of the total amount due to him.

A loan taken by a company may be secured by any of the

following:

a. A legal mortgage of specific part of its property;

b. An equitable mortgage by deposit of title deeds;

c. A mortgage of movable property;

d. Issuing Bonds;

e. Issuing Promissory notes and bills of exchange;

f. A charge on uncalled capital

g. A charge on calls made but not paid;

h. A floating charge on the assets of the company;

i. Issuing debentures or debenture stock;

j. A mortgage of book debts (but not of book);

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k. A charge on a ship or any share in a ship;

l. A charge on goodwill or a patent or a license under a

patent, or a trade mark, or on a copyright;

m.A pledge of goods.

 Companies and Borrowing Power

Every trading company has an implied power to borrow, as
borrowing is implied in the object for which it is incorporated.
A trading company can exercise this power even if it is not
included in the Memorandum. However non-trading company
has no implied power to borrow and such power can be
taken by it implied power to borrow and such power can be
taken by it by including a clause to that effect in the
Memorandum.
Definition
The ability to borrow more funds. A person or company with
a great deal in assets and little in debt is likely to have
greater borrowing power than a person or company in the
opposite position.
Restrictions on borrowing power
• A public company can borrow only after the receipt of
Commencement Certificate. [Section 149(1)]. But a
• private company can borrow immediately after the
incorporation
The Board of Directors may borrow moneys by passing a
resolution passed at the meetings of the Board. The board
may delegate its borrowing powers to a Committee of
Directors. Such a resolution should specifically mention the
aggregate amount upto which the moneys can be borrowed
350
by the Committee, the Managing Director, Manager or any
other principal officer of the company on such conditions as it
may prescribe [Section 292 (1) (c)]
• The moneys borrowed together with the moneys already
borrowed by the company (excluding loans obtained from
banks i.e. working capital) shall not exceed the aggregate of
the paid up capital and the free reserves. [Section 293(1)(d)]
• It may be noted that a company may borrow in excess of its
paid up capital and free reserves if it is so consented and
authorized by the shareholders at a general meeting.
Transactions, which are not borrowing
• Temporary loans (repayable within six months or on
demand) obtained from the company’s banker in the ordinary
course of business.
• Borrowing of money by a banking company in the ordinary
course of business.
• Hire purchase and leasing transactions.
• Purchase of machinery on deferred payment.
Ultra Vires Borrowing
• A Company is said to resort to ultra vires borrowing if it
exceeds the authority given to it in this respect by the
Companies Act, the Memorandum and the Articles of the
company. An act of borrowing by the company may be ultra
vires (outside the power of) the company or ultra vires the
directors or ultra vires the Articles.
• Void ab initio borrowings - Where such loan is ultra vires
the company, such loan is null and void and does not create
an actionable debt. Any securities given in respect thereof
are inoperative. Thus, the lender cannot sue the company for
the return of the loan and shall be under an obligation to
return back the securities, if any.

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However, if the lender has acted in good faith that is without
any knowledge that the company borrowed the money
beyond its powers, he may have the following remedies
1.Injunction- If the company has not spent the money so
borrowed, the lender may obtain an injunction order against
the company restraining it from spending the amount and
recover the same.
2.Restitution- If the money has been invested in some
particular asset, he may claim that asset, or if such asset
cannot be ascertained he may claim that any increase in the
assets as a result of such borrowing be restored to him in the
even of a winding up.
3.Subrogation- If the money has been applied in paying off
some debts of the company, he is entitled to step into the
shoes of the creditors so paid off and can rank as a creditor
of the company to the extent of the money so applied.
4.Suit for breach of warranty- The lender may sue the
directors personally for breach of implied warranty of
authority and claim damages for the same.
5.Ratification of borrowing- If the borrowing power exercised
by the company is ultra vires the Memorandum, that is
beyond the powers given to its by the Memorandum, such
borrowing cannot be ratified afterwards in any way, even by
a unanimous resolution of the shareholders in a general
meeting.
But if the borrowing is ultra vires the Articles, but intra views
the Memorandum the act of borrowing can be ratified by the
shareholders in general meeting by altering the Articles or by
passing a resolution as per Articles.
If the borrowing is ultra vires the directors but intra vires the
Memorandum, that is within the powers given by the
Memorandum but beyond the authority of the directos, the
company in general meeting may ratify such act of the

352
directors. In that case the debt will be valid and binding on
the company.
BORROWINGS & CHARGES
Even if the borrowing is not ratified by the company, the
lender in good faith will be protected since the directors in
borrowing the money had acted as agent of the company.
However in that case the directors will be liable to indemnify
the company against the loss incurred thereby.
• Even in the case of unauthorized borrowings, the company
will be liable to repay, I it is shown that the money had gone
into company’s pocket [Lakshmi Ratan Cotton Mills Co. Ltd
v. J K Jute Mills Co; Ltd (1957) 27 Comp. Cas. 660 (All).]
CHARGES
• Borrowing has become an equally important method along
with share capital of financing projects. Corporate borrowing
has its own peculiarities. No single individual may in normal
circumstances be in a position to meet the loan requirements
of a company. Loan-money has, therefore, to be raised from
a large number of individuals very much in the same way as
share capital. Loans may have to be obtained in a sequence
one after the other.
• The problem was solved by the evolution, on the one hand,
of debentures and, on the other, of the concept of floating
charge, both being reserved only for the corporate sector.
The same assets are charged to several lenders and also to
several lenders in a series. That raises a question as to who
shall have priority. This gave rise to the concept of pari
passu ranking. Since other trade creditors have also to seek
payment only out of the company's assets, the problem had
to be tackled as to how they should know, before supplying
more credit, what assets would be available as security for
their payments?

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• The Act prescribes for registration of charges with the
Registrar of Companies, and also gives a list of assets a
charge on which must be registered. Registration of charges
identifies the assets, which are subject to the charge. It
becomes a source of knowledge, and, therefore, operates as
constructive notice and a protection, to "all classes of
persons interested in knowing the assets position of the
company. It makes the charge effective against all quarters
including the liquidator.
Types of charges
1. Fixed charge - a charge is fixed when it is made
specifically to cover definite an ascertained assets of
permanent nature such as land, building, o heavy machinery.
A fixed charge passes legal title to certain specific assets
and the company loses the right to dispose of the property
unencumbered, though the company retains possession of
the property.
2. Floating charge – it is a charge on the current assets of
the company, present or future which
changes from time to time in the ordinary course of business
e.g. stock in trade, bills receivable, cash in hand, work in
progress, goods in transit, inventory etc.
(i) When the company goes into liquidation;
(ii) When the company ceases to carry on the business;
(iii) When the creditors or the debenture holders take steps
to enforce this security e.g. by appointing receiver to take
possession of the property charged;
(iv) On the happening of the even specified in the deed.
Registration of charges[Section 125]
• The security created and charged for the following
purposes must be registered with the ROC within 30 days

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(or further period of 30 days with additional fees) after the
date of their creation:
(i) Securing any issue of debentures;
(ii) Uncalled share capital of the company;
(iii) Any immovable property;
(iv) Book debts, stock in trade or other current assets of the
company;
(v) Any movable property (not being a pledge);
(vi) Calls made but not paid;
(vii) IPRs of the company.
•The ROC shall with respect to each company maintain a
Register of charges containing all the specified particulars.
Upon registration of charge by the company, ROC shall
issue a Certificate of charges, which shall be conclusive
evidence.
Memorandum of satisfaction[Section 138-140]
• On payment or satisfaction of any charge in full, the
company must notify the fact to the ROC within 30 days from
the date of such payment or satisfaction. The ROC shall on
receipt thereof, shall record the same after send due notice
to the concerned creditor and on receipt on him being
satisfied (the creditor may issue NOC to the satisfaction)
shall register the satisfaction of the charge. A memorandum
of satisfaction shall be entered in the Register by the ROC.
The Central Government has been empowered to extend
time for registration of charge or satisfaction of charge of
issue of debenture of a series and to order that the omission
or mis-statement in the Register of Charges be rectified.

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  BRROWING POWER OF COMPANY DEBENTURE
AND CHARGE

BORROWING POWER OF COMPANY

DEBENTURE AND CHARGE
Debenture : Meaning
ü As per section 2(12) of Companies Act 1956, “Debenture
includes debenture stock, bond and any other securities of
the company whether constituting a charge on the
company’s assets or not”.
ü A Debenture is a unit of loan amount. When a company
intends to raise the loan amount from the public it issues
debentures. A person holding debenture or debentures is
called a debenture holder. A debenture is a document issued
under the seal of the company. It is an acknowledgment of
the loan received by the company equal to the nominal value
of the debenture. It bears the date of redemption and rate
and mode of payment of interest. A debenture holder is the
creditor of the company.
Features
ü Moveable property
ü Issued in the form of certificate of indebtedness
ü Creates a charge on the undertakings of the Company
ü The terms ‘pari passu’ used in the terms and condition sof
debentures means all debentures of a particular class will
receive money proportionately in case of Company’s inability
to discharge the whole obligation.
Debenture stock- A Company may create one loan fund
known as ‘debenture stock’ divisible among a class of
lenders each given a debenture stock certificate. It is

356
analogous to loan stocks of govts, local and public
authorities.
Imp= while debenture may or may not be fully paid,
debenture stock must be fully paid.

Debenture- Kinds
ü Registered Debentures: These are those debentures
which are registered in the register of the company. the
names, addresses and particulars of holdings of debenture
holders are entered in a register kept by the company. Such
debentures are treated as non-negotiable instruments and
interest on such debentures are payable only to registered
holders of debentures. Registered debentures are also called
as Debentures payable to registered holders.
ü Bearer Debentures: These are those debentures which
are not registered in the register of the company. Bearer
debentures are like a bearer check. They are payable to the
bearer and are deemed to be negotiable instruments. They
are transferable by mere delivery. No formality of executing a
transfer deed is necessary. When bearer documents are
transferred, stamp duty need not be paid. A person
transferring a bearer debenture need not give any notice to
the company to this effect. The transferee who acquires such
a debenture in due course bonafide and for available
consideration gets good title not withstanding any defect in
the title of the transfer-or. Interest coupons are attached to
each debenture and are payable to bearer.
ü Secured Debentures: These are those debentures which
are secured against the assets of the company which means
if the company is closing down its business, the assets will
be sold and the debenture holders will be paid their money.
The charge or the mortgage may be fixed or floating and
they may be fixed mortgage debentures or floating mortgage
depending upon the nature of charge under the category of
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secured debentures. In case of fixed charge, the charge is
created on a particular asset such as plant, machinery etc.
These assets can be utilized for payment in case of default.
In case of floating charge, the charge is created on the
general assets of the company.
ü The assets which are available with the company at
present as well as the assets in future are charged for the
purpose. A mortgage deed is executed by the company. The
deed includes the term of repayment, rate of interest, nature
and value of security, dates of payment of interest, right of
debenture holders in case of default in payment by the
company. The deed may give a right to the debenture holder
to nominate a director as one of the Board of Directors. If the
company fails to pay the principal amount and the interest
thereon, they have the right to recover the same from the
assets mortgaged.
ü Unsecured Debentures: These are those debentures
which are not secured against the assets of the company
which means when the company is closing down its
business, the assets will not be sold to pay off the debenture
holders. These debentures do not create any charge on the
assets of the company. There is no security for repayment of
principal amount and payment of interest. The only security
available to such debenture holders is the general solvency
of the company. Therefore the position of these debenture
holders at the times of winding up of the company will be like
that of unsecured debentures. That is they are considered
with the ordinary creditors of the company.
ü Convertible Debentures: These are those debentures
which can be converted into equity shares. These
debentures have an option to convert them into equity or
preference shares at the stated rate of exchange after a
certain period. If the holders exercises the right of
conversion, they cease to be the lender to the company and
become the members. Thus convertible debentures may be
referred as debentures which are convertible into shares at
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the option of the holders after a specified period. The rate of
exchange of debentures into shares is also decided at the
time of issue of debentures. Interest is paid on such
debentures till its conversion. Prior approval of the
shareholders is necessary for the issue of convertible
debentures. It also requires sanction of the Central
Government.
ü Non-Convertible Debentures: These are those
debentures which cannot be converted either into equity
shares or preference shares. They may be secured or
unsecured. Non-convertible debentures are normally
redeemed on maturity period which may be 10 or 20 years.
ü Redeemable Debentures: These debentures are issued
by the company for a specific period only. On the expiry of
period, debenture capital is redeemed or paid back.
Generally the company creates a special reserve account
known as "Debenture Redemption Reserve Fund" for the
redemption of such debentures. The company makes the
payment of interest regularly. Under section 121 of the Indian
Companies Act, 1956, redeemed debentures can be re-
issued.
ü Irredeemable Debentures: These debentures are issued
for an indefinite period which are also known as perpetual
debentures. The debenture capital is repaid either at the
option of the company by giving prior notice to that effect or
at the winding up of the company. The interest is regularly
paid on these debentures. The principal amount is repayable
only at the time of winding up of the company. however, the
company may decide to repay the principal amount during its
lifetime.
CHARGE
S. 124 For the purposes of registration, ‘charge includes
mortgage’

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· Fixed Charge: A fixed charge is created on certain
specified assets generally immovable such as land and
building, plant and machinery, long term investments and the
like. So it is equivalent to mortgage. When the charge is
fixed, the company can only deal with the property subject to
the charge, that is, a fixed charge allows the company to
retain possession of the assets but prevents the company
from selling, leasing etc., of the assets without the consent of
the charge holders. The property identified remains so
identified during the period for which the charge is created.
· Floating Charge : Such a charge is available only to
companies as borrower. A Floating charge does attach to
any definite property but covers the property of a circulating
and fluctuating nature such as stock-in-trade, debtors, etc. It
attaches to the property charged in the varying conditions in
which happens to be from time to time. A floating charge on
crystallization becomes a fixed charge.
Charges requiring registration : S.125

A company must file within 30 days of creation of a charge

with the Registrar complete details of the charge together
with the instrument of charge or its verified copy in respect of
certain charges. Otherwise the charge will be void. This does
not mean that the creditors cannot recover their dues. It
merely means that the benefit of the charged security will not
be available to them. The following charges are compulsorily
registrable :-
i. A charge for the purpose of securing any issue
of any debentures
ii. A floating charge
iii. A charge on uncalled share capital
iv. Charge on calls made but not paid

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 v. A charge on any immovable property
vi. A charge on ship
vii. A charge on book debts of the company
viii. A charge on goodwill or on patent or on license
under the patent or on trademark or copyright or on the
license under the copyright
ix. A charge other than a pledge on any movable
property of the company.
Effects of Registration :

Once a charge is registered, it acts as a notice to the public

at large that the charge holder has an interest in the charged
property. No person can take a defense against the charge
holder that he was not aware that a charge was created
against the property. That person will be entitled to the
property subject to the interest of the charge holder. Once
certificate of charge is issued by the Registrar, it is
conclusive evidence that the document creating the charge is
properly registered.
Consequences of Non-Registration :
1. A charge which is compulsorily registerable but which
is not registered is void. This does not mean that the
creditors cannot recover their dues. It merely means that the
benefit of the charged security will not be available to them.
2. Although the security becomes void by non-
registration, it does not affect the contract or obligation of the
company to repay the money thereby secured.
3. Omission to registrar particulars of charge is required
punishable with fine. A company or every officer of company
is in default shall be liable to fine upto Rs 500 for each day of
continuing default. A further fine of Rs. 1000 may be impose
361
on the company and every officer for other defaults relating
to registration of charges.
Modification of Charge : Wherever the terms and
conditions or the extent of the operation of any registered
charge is modified , the company is required to file the
particulars of modification within 30days thereof with the
Registrar of Companies.
Particulars to be filed with registrar
i. Date and description of investment creating
charge;
ii. Amount secured by charge;
iii. Particulars of property charged
iv. Terms and conditions and extent of operation of
charge
v. Name, address and description of investment
modifying the charges.
vi. Particulars of modification.
Government Stock and Investment Company v. Manila
railway Company

In Government Stock Investment Co. Ltd. v. Manila Railway

Co. Ltd., (1897) A.C. 81, the debentures created a floating
charge. Three months’ interest became due but the
debenture holders took no steps and so the charge did not
crystallize but remained floating. The company then made a
mortgage of a specific part of its property. Held, the
mortgagee had priority. The security for the debentures
remained merely a floating security as the debenture holders
had taken no steps to enforce their security.

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  BORROWING POWERS. The board of directors may,
from time to time, at its sole discretion, borrow or
secure any amount or amounts of money for the
Company's objects. The Company's board of directors
will be entitled to obtain or secure payment of any such
amount or amounts in such manner, on such dates and
under such conditions as it deems fit, and in particular
by the issuance of guaranties, fixed or redeemable
bonds, bond stock or any mortgage, pledge or floating
charge or any other security on the Company's
property, in whole or in part, whether in the present or
the future, including the uncalled share capital and the
share capital called up but unpaid.

 Introduction
Companies borrow money from various sources, including their
directors and shareholders, personal contacts, banks,
institutional investors, debentures and through the Stock
Exchange.
Borrowing Power
The powers of a company are determined by the memorandum
and the articles of association.
The Managing Director may from time to time with the approval
of the Board of Directors may borrow from any source either
from any commercial or schedule banks, or financing
institutions or firms any sum of money required for the purpose
of the company and secure the payment or repayment of such
money so borrowed in such manner and upon such terms and
conditions in all respects duly approved by the Board of
Directors deemed fit in particular by hypothecation or charge on
all or any part of the property of the company (both present and
future) including its uncalled capital for the time being.

363
Methods of Borrowing
Companies borrow money from various sources, including their
directors and shareholders, personal contacts, banks,
institutional investors and (PLCs only) through the Stock
Exchange.
 In most cases of borrowing a debenture is issued. A
debenture is the traditional name given to a loan
agreement where the borrower is a company.
Debentures
-A debenture is a document which shows on the face of it, that
the company has borrowed a certain sum of money from the
holder thereof upon certain terms and conditions.
-The Company Act states that a debenture, "includes debenture
stock, bonds and any other securities of a company, whether
constituting a charge on the assets of the company or not.”
Characteristics :
 Each debenture is numbered.
 Each contains a printed statement of the terms and
conditions,
 A debenture usually creates a floating charge on the
assets of the companies,
 A debenture may create a fixed charge instead of a
floating charge.
 No debenture holder is to have any voting rights in
company meetings.
 Full particulars regarding the issue of debentures in series
must be sent to the Registrar.

364
  Sometimes debenture holders are given the right to
appoint a receiver in case of non-fulfillment of the terms of
the debenture by the company.
 Sometimes a series of debentures are issued with a trust
deed by which trustees are appointed to whom some or all
the properties of the company are transferred by way of
security for the debenture holders.
Rights and remedies of debenture holders.
 If the company fails to pay interest or principal on the due
date or fails to comply with any of the terms and
conditions under which the debenture was issued, the
debenture holder can adopt any of the following remedial
measures.
1. He may file a suit for the recovery of money
2. He may file an application for the appointment of a
receiver by the court.
3. He may himself appoint a receiver if the terms of the
debenture entitled him to do so.
4. The trustees may sell the properties charged,
5. He may apply to the court for the foreclosure of the
company right to redeem the properties charged for the
payment of the money.
6. He may present petition for the winding up of the
company.
Fixed Charge
A fixed charge is a charge or mortgage secured on
particular property, e.g. land and buildings, a ship, piece of
machinery, shares, intellectual property such as copyrights,
patents, trademarks, etc.

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Floating charge
A floating charge is a particular type of security, available
only to companies. It is an equitable charge on (usually) all
the company's assets both present and future, on terms that
the company may deal with the assets in the ordinary course
of business.
- A floating charge is mortgage on an asset that changes in
quantity or value from time to time (such as an inventory), to
secure the repayment of a loan.

- A fixed charge is a mortgage on a specific fixed-asset (such

as a parcel of land) to secure the repayment of a loan. In this
arrangement the asset is signed over to the creditor and the
borrower would need the lender's permission to sell it.
Shareholders VS Debenture Holsters?
1. A share holder has a proprietary interest in the company.
A debenture holder is only a creditor of the company.
2. Every share is included in the capital of the company.
Debenture is a loan to the company
3. Debentures generally have a fixed or floating charge upon
the assets of the company. Shares do not have any charge
on the assets of the company because the shareholders are
the proprietors of the company.
4. A debenture holder is entitled to a fixed interest. Equity
holder is entitled to dividend on profit.
5. Debenture holders get priority over shareholders when
assets are distributed upon liquidation.
6. Debenture interest is a charged against profit. The
dividend on share are part of profit.

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Conclusion
Money or fund is very important for running a business
properly. Capital is not enough for running a business that’s
why a business requires borrowing to invest in the firm.
Availability and choice of alternative lender(s) will be
governed by the unique variables inherent in the needs,
capacities and credit history of the borrowing business or
individual.

What Does Going Into Administration

Mean?
Going into administration is when a company becomes
insolvent and is put under the management of Licensed
Insolvency Practitioners. The directors and the secured
lenders can appoint administrators through a court process
in order to protect the company and their position as much
as possible.
 Going into administration - a simple guide
Administration is a very powerful process for gaining control,
when a company is insolvent and facing serious threats from
creditors. The Court may appoint a licensed insolvency
practitioner as administrator. This places a moratorium
around the company and stops all legal actions.

The administration must have a purpose and the

Government encourages the use of company
rescue mechanisms after Administration.

Under the administration option, it is possible for the

company and its directors (or a creditor like the bank) to
apply to the court to put the company into administration
through a streamlined process, by applying to the High
Court.

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However, the law requires that any finance provider (like a
bank or lender), with the appropriate security, is contacted
and the aims of the administration be discussed and
approved. The finance provider must have a fixed and
floating charge (usually under a debenture) and the charge
holder will need to give permission for the process to go
ahead. Five days clear notice is required.
 How long does going into administration last?
It depends very much on the circumstances. The
administrators take on the employment contracts of the
company after 14 days so it is desirable that the business is
sold out of administration before that date. The insolvency
practitioners are not allowed to run the business at a loss
and so making the creditors position worse off. If there are
large amounts of money to collect in or substantial
realiseable assets then they may trade for longer periods.
During this time they will need to report to the creditors at
regular intervals.
Between January and March 2018, there were 367
administrations. For more insolvency statistics, please see
the latest Government statistics.
 What is a pre-pack administration or administration pre-
pack sale?
The pre packaged administration sale is currently a very
popular method,However, there is increasing media
coverage of creditors' dismay at seeing their "debt dumped"
by a former customer.
The company prepares itself to enter administration and sell
its assets to a new company ("newco") or to an existing 3rd
party company. This is a very powerful, far reaching process
that can protect the BUSINESS, but usually the old company
(oldco) is liquidated afterwards.
 What is administration followed by CVA

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 Basically the company enters administration to get protection
from creditors. The administrator then works with the
company's directors to produce his/her administration
proposals. Once these are accepted the administrator hands
control back to the company's board. This is powerful tool
despite the fact that it is expensive and directors are not in
control during the administration period. We have a more
detailed page on the administration process. It is less
common than the Government would like to see.
 What are the Different Forms of
Administration for Insolvent Companies?
While there is often the conception that there are various types
of company administrations, in reality, there is only one process
that can be used in different ways depending on the
circumstances.
 The Basics of Administration
Administration is a formal process that aims to turn around
an insolvent company. An administrator will be appointed to
manage the affairs of the company, mostly with a goal to put
the company back into a solvent position and restore it to
profitability. It is best-suited to companies that are currently
insolvent but have a good prospect of being restored to
solvency if managed in the correct manner.
It can be a very effective way of rescuing an insolvent
company because a moratorium is placed on the company
for a period. This effectively means that the company’s
creditors are not able to take legal action against the
company or file a winding up petition with the courts (which
would lead to the company being wound up) for the period.
The Company Will be Temporarily Run by an Administrator
An administrator will be appointed to the company. This marks
a significant shift within the company as they effectively take
over the running of the business from the company’s directors.
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They will be a licensed insolvency practitioner and will have
experience in turning failing companies around.
After their appointment, they will spend up to eight weeks
investigating the current position of the company and formulate
a plan for the future of the company. While the main purpose is
to promote the recovery of the company, it may be that they do
not think that this is possible and decides that it will be more
appropriate to wind the company up. Whatever their decision,
thy need to make a written statement within eight weeks of their
appointment stating what their intentions towards the company
are.
 Other Types
Pre-packaged (“Pre-pack”) Administrations
These use the same process, but it is structured differently to
allow the quick sale of a company’s business after the
appointment.
During this process, the negotiations for the sale of the
business take place before the appointment of the
administrator, with the sale occurring almost immediately after
the administrator’s appointment.
While the sale of the company’s business will be to a third
party, this third party may be a new company formed
specifically as a purchased vehicle by the existing company’s
directors. It can be an effective way of saving the profitable
parts of that company before the whole business has to be
wound up.
 Company Administration
1. What is company administration?
What is a Company Administration as opposed to any other
form of insolvency process? Company administration is
essentially designed to rehabilitate a company that is
experiencing some financial difficulty. A company placed into
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administration obtains a moratorium which means that action
cannot be taken against the company whilst the moratorium is
in place which gives the company time to reach some form of
settlement with its creditors.
2. What is the definition of a company administration
order?
What is the definition of a company administration order? A
company administration order is an order made by the court
either by making an application to court or by filing a Notice of
Appointment of an Administrator which is known as the out of
court process.
3. What are advantages and disadvantages of company
administration?
It is useful for a company experiencing financial difficulty to
know what the advantages and disadvantages of a company
going into administration.
Here are 3 examples of advantages and disadvantages which
an insolvent company may experience as a result of entering
administration.
4. What happens if a company goes into administration?
It is helpful for directors of a company to know what happens if
a company goes into administration. If a company is unable to
pay its debts, the company may be placed into administration. If
a company is placed into administration an insolvency
practitioner is appointed as an administrator of the company to
deal with and sell the business, assets, or certain parts of the
company for the benefit of the creditors of the company.

5. What does going into administration mean?

When a company is placed into administration, this effectively
means that the court has appointed an insolvency practitioner
to manage the affairs of the company.
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6. How do you put a company into administration?
Here at Francis Wilks & Jones we are often asked how to put a
company into administration? There are 2 ways in which a
company can be placed into administration. Firstly, an
application can be made to court for an administration order,
and secondly by way of an “out of court” route.

7. How long can a company be in administration?

The administration of an insolvent company automatically lasts
1 year. This can be extended by an application to the court by
the administrators with the consent of the court and or the
creditors of the insolvent company. It is however, the
responsibility of the administrator to deal with the affairs of the
company as soon as possible and if an administrator makes an
application to extend the administration of an insolvent
company, they will need to inform the court of the reasons for
extending the administration.

8. What is the difference between an administration and

winding up?
The administration of a company and the winding up of a
company both fall under the category of company insolvency
procedures, unlike bankruptcy or individual voluntary
arrangements which are personal insolvency procedures.
However, the company administration procedure is often
considered to be a rescue process, as the view is to recover
the company in order to avoid insolvency, whereas the winding
up a company is often defined as a ‘burial process’, because
this company insolvency procedure is focused on the
compulsory ending of the business affairs of the company and
terminating company obligations before liquidation, commonly
referred to as a compulsory liquidation.

372
9. What is the difference between insolvency and winding
up?
Insolvency is the generic term that refers to either a company, a
legal entity, a partnership or an individual who is unable to pay
their debts as and when they fall due. In addition, in the case of
a company and pursuant to section 123 of the Insolvency Act
1986, it can also mean that the value of the company’s assets
is less than the amount of its liabilities (taking into account its
contingent and prospective liabilities).
Winding up a company is a form of company insolvency, most
commonly used to describe ending the business affairs of the
company and terminating company obligations before
liquidation. However, there are other forms of company
insolvency procedures including, a Company Voluntary
Arrangement, an Administration and a Receivership.

10. What is a company in administration?

The company administration process is often referred to as a

rescue process because the aim is to rescue the business and
recover the company in order to avoid insolvency. When an
administration order is made, whether in court or out of court,
the company is then under the management of the
administrator appointed by either the courts, the company’s
creditors or the company directors. After the administration
order is made and the company administration procedure
commences, a moratorium also commences which puts a halt
on any action against the company during that period.

 Board of Directors (B of D)

What is a 'Board of Directors (B of D)'

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A board of directors (B of D) is a group of individuals, elected to
represent shareholders. A board’s mandate is to establish
policies for corporate management and oversight,
making decisions on major company issues. Every public
company must have a board of directors. Some private
and nonprofit organizations also have a board of directors.

BREAKING DOWN 'Board of Directors (B of D)'

In general, the board makes decisions as a fiduciary on behalf

of shareholders. Issues that fall under a board's purview
include the hiring and firing of senior executives, dividend
policies, options policies, and executive compensation. In
addition to those duties, a board of directors is responsible for
helping a corporation set broad goals, supporting executive
duties, and ensuring the company has adequate, well-managed
resources at its disposal.

General Board Structure

The structure and powers of a board are determined by an

organization’s bylaws. Bylaws can set the number of board
members, the manner in which the board is elected (e.g., by a
shareholder vote at an annual meeting), and how often the
board meets. While there is no set number of members for a
board, most range from 3 to 31 members.
Some analysts believe the ideal size is seven.
The board of directors should be a representation of both
management and shareholder interests, and consist of both
internal and external members.
An inside director is a member, who has the interest of major
shareholders, officers, and employees in mind, and whose
experience within the company adds value. An insider director
is not typically compensated for board activity as they are often
already a C-level executive, major shareholder, or other
stakeholder, such as a union representative.
Independent or outside directors are not involved in the day-to-
day inner workings of the company. These board members are

374
reimbursed and usually get additional pay for attending
meetings. Ideally, an outside director brings an objective,
independent view to goal-setting and settling any company
disputes. It is considered critical to strike a balance of internal
and external directors on a board.
Board structure can differ slightly in international settings. In
some countries in the E.U. and Asia, corporate governance is
split into two tiers: an executive board and a supervisory board.
The executive board consists of insiders elected by employees
and shareholders and is headed by the CEO or managing
officer. This board is in charge of the daily business operations
of the company. The supervisory board is chaired by someone
other than the presiding executive officer and concerns itself
with issues closer to what a U.S. board would.

Election and Removal Methods of Board Members

While members of the board of directors are elected by

shareholders, those put up for nomination are decided by
a nomination committee. In 2002,
the NYSE and NASDAQ required that the nomination
committee consist of independent directors. Ideally, directors’
terms are staggered to ensure only a few directors are up for
election in a given year.
Removal by resolution in a general meeting can present
challenges. Most bylaws allow a director to review a copy of a
removal proposal and then respond to it in an open meeting,
increasing the possibility of a rancorous split. In addition many
directors’ contracts include a disincentive for firing – a golden
parachute clause that requires the corporation to pay the
director a bonus upon being let go.
Breaking foundational rules can lead to the expulsion of a
director. These infractions include but are not limited to the
following:
 Using directorial powers for something other than the
financial benefit of the corporation
 Using proprietary information for personal profit

375
  Making deals with third parties to sway a vote at a board
meeting
 Engaging in transactions with the corporation that result in
a conflict of interest
In addition, some corporate boards have fitness-to-serve
protocols.

 What is a Board of Directors?

The board of directors is an essential part of business, what is

a board of directors? The board of directors is a corporation’s
governing body. Furthermore, it consists of a group of
individuals elected by shareholders. The board of directors are
also responsible for setting company policy and overseeing the
company’s managers.

A major theme of corporate governance is the separation of

ownership and control. The shareholders own the company, but
the managers control the operations. The board of directors is
expected to try to align the interests of shareholders and
managers. Furthermore, they need to always act in the best
interest of the company.

All publicly owned companies must have a board of directors.

Many private companiesalso have a board of
directors. Boards typically meet several times a year.
Furthermore, compensate board members for their services.
Consider members of the board insiders, for
stock trading purposes. A board often includes the following

 Inside directors
 Outside directors
 A chairperson

Inside Director vs. Outside Director

There are two types of directors on a board: inside directors

and outside directors. Inside directors are members of

376
the board and executives at the company, such as the chief
executive officer (CEO). They have a dual role, serving as
members of the governing body and working as managers at
the company.

In comparison, outside directors are not executives at

the company. They are independent individuals selected for
their experience and expertise in the relevant industry or sector.
Furthermore, outside directors serve only one role – they are
not company managers – and are thus considered the more
objective members of the board. The chairperson can be an
inside director or an outside director.

Board of Director Responsibility

The board of directors has many responsibilities that include

the following:

 Hiring top executives

 Setting executive compensation
 Monitoring the performance of executives
 Dismissing executives when necessary
 Approving stock issuance
 Declaring dividends
 Overseeing corporate governance and internal controls
 Determining other matters of company policy

 Disqualification of Director – Companies Act 2013

The Ministry of Corporate Affairs has started to strike-off

companies that are dormant and disqualify Directors of
Companies that have not filed their MCA annual return
continuously for over three years. In this article, we look at the
provisions under Companies Act 2013 relating to
disqualification of Director and its consequences.

 Section 164 of Companies Act 2013

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Section 164 of the Companies Act 2013 deals with
disqualification of Directors. According to the Companies Act
2013, the following conditions can be reasons for disqualifying
a Director.

 The Director is of unsound mind and stands so declared

by a competent court.
 The Director is an undischarged insolvent.
 The Director has applied to be adjudicated as an insolvent
and his application is pending.
 The Director has been convicted by a court of any offence,
whether involving moral turpitude or otherwise, and
sentenced in respect thereof to imprisonment for not less
than six months and a period of five years has not elapsed
from the date of expiry of the sentence. Also any person
who has been convicted of any offence and sentenced to
imprisonment for a period of seven years or more, will not
be eligible to be appointed as a director in any company.
 An order disqualifying the Director for appointment as a
director has been passed by a court or Tribunal and the
order is in force.
 The Director has not paid any calls in respect of any
shares of the company held by him, whether alone or
jointly with others, and six months have elapsed from the
last day fixed for the payment of the call.
 The Director has been convicted of the offence dealing
with related party transactions under section 188 at any
time during the last preceding five years.
 A company in which the Director is a part of the Board
has not filed financial statements or annual returns for
any continuous period of three financial years.
 The company has failed to repay the deposits accepted by
it or pay interest thereon or to redeem any debentures on
the due date or pay interest due thereon or pay any
dividend declared and such failure to pay or redeem
continues for one year or more.

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As mentioned in point 8, a person can be disqualified from
being a Director, if a company on which the person is a Director
has not filed MCA annual return for a continuous period of three
years. Hence, its important for all private limited company, one
person company and limited company to file MCA annual
return on time and maintain compliance under Companies Act,
2013.

 Consequences of Director Disqualification

Once a person is disqualified as a Director, he/she will not be

eligible for being appointed as Director of that company or any
other company for a period of 5 years from the date on which
the company failed to file annual compliance.

Until recently, the MCA has not strictly enforced this provision
of the Companies Act. However, from September 2017 the
MCA has began strictly enforcing these provisions of the
Companies Act and has published names of disqualified
Directors on its website.

Hence, its important for all persons who are Director of a

Company to ensure that compliance is maintained properly.

 Appealing Director Disqualification Order

The Companies Act 2013 states that an order disqualifying a

Director does not take effect within 30 days of conviction
resulting in sentence or order. Hence, any person who has
received an order can file the returns and appeal within 30 days
to stay the proceedings.

Once, an appeal is initiated, the person would continue to be

Director until expiry of 7 days from the date on which the
appeal or petition is disposed off. Hence, any person who has
received an order for disqualification as a Director must
immediately file an appeal and the overdue returns – to have
good chances of being able to continue to Act as Director of a
Company.

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  Types of Directors, Qualifications and
Disqualifications of Directors

Types of Directors

Following are the categories of directors who constitute ‘Board’

of a Company:

1. Ordinary directors: Ordinary directors are also referred to

as simple director who attend board meeting of a company and
participate in the matters put before the board. These directors
are neither whole time directors nor managing directors.

2. Managing Director: According to Sec.2 (54) of the Indian

Companies Act “managing director” means a director who, by
virtue of the articles of a company or an agreement with the
company or a resolution passed in its general meeting, or by its
Board of Directors, is entrusted with substantial powers of
management of the affairs of the company and includes a
director occupying the position of managing director, by
whatever name called.

3. Whole-time directors: A whole-time executive director

includes a director in the whole-time employment of the
company.

4. Alternate director: The Board Meeting may be held at a

time when a director is, absent for a period of more than three
months from the state and in such a situation, an ‘alternate
director’ is appointed. The Board of Directors can appoint the
additional director in the absence of a director if so authorized
by articles or by a resolution passed by the company in general
meeting. The alternate director shall work until the original
director return or up to the period permitted to the original
director.

380
5. Professional Directors: Any director possessing
professional qualifications and do not have any pecuniary
interest in the company are called as “professional directors”.

6. Independent directors: Sec. 2(47) defines independent

directors to mean an independent director referred to in Sec.
149(5).

7. Nominee Directors: The banks and financial institutions

which grants loans to a company generally impose a condition
as to appointment of their representative on the board of the
concerned company. These nominated persons are called as
nominee directors.

Qualifications of a Director:

As regards to the qualification of directors, there is no direct

provision in the Companies Act, 2013.But, according to the
different provisions relating to the directors; the following
qualifications may be mentioned:

1. A director must be a person of sound mind.

2. A director must hold share qualification, if the article of

association provides such.

3. A director must be an individual.

4. A director should be a solvent person.

5. A director should not be convicted by the Court for any

offence, etc.

Disqualifications of a director:

Section 164 of Companies Act, 2013, has mentioned the

disqualification as mentioned below:

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1) A person shall not be capable of being appointed director of
a company, if the director is

(a) Of unsound mind by a court of competent jurisdiction and

the finding is in force;

(b) An undischarged insolvent;

(c) Has applied to be adjudicated as an insolvent and his

application is pending;

(d) Has been convicted by a court of any offence involving

moral turpitude and sentenced in respect thereof to
imprisonment for not less than six months and a period of five
years has not elapsed from the date of expiry of the sentence;

(e) Has not paid any call in respect of shares of the company
held by him, whether alone or jointly with others, and six
months have elapsed from the last day fixed for the payment of
the call; or

(f) An order disqualifying him for appointment as director has

been passed by a court in pursuance of section 203 and is in
force, unless the leave of the court has been obtained for his
appointment in pursuance of that section;

2) Such person is already a director of a public company which:

(a) Has not filed the annual accounts and annual returns for
any continuous three financial years commencing on and after
the first day of April, 1999; or

(b) Has failed to repay its deposits or interest thereon on due

date or redeem its debentures on due date or pay dividend and
such failure continues for one year or more:

Provided that such person shall not be eligible to be appointed

as a director of any other public company for a period of five

382
years from the date on which such public company, in which he
is a director, failed to file annual accounts and annual returns
under sub-clause (A) or has failed to repay its deposit or
interest or redeem its debentures on due date or paid dividend
referred to in clause (B).

 Qualifications for or Disqualifications of a Director

2.1. Qualifications of a Director In addition to the pertinent

provisions of the Articles of Incorporation and By-Laws of the
Corporation, and qualifications for membership in the Board as
provided for in the Corporation Code, Securities Regulation
Code, and other relevant laws, the following general guidelines
shall be observed in the initial evaluation of Director-nominees
to the Board: 2.1.1. He should be a holder of at least one (1)
share of stock of the Corporation; 2.1.2. He shall be at least a
college graduate or have sufficient experience in managing the
business to substitute for such formal education; 2.1.3. He shall
be at least twenty one (21) years old; 2.1.4. He must have a
practical understanding of the business of the Corporation;
2.1.5. He shall have been proven to possess integrity and
probity; 2.1.6. He shall be diligent and assiduous in the
performance of his functions; 2.1.7. He must be a member in
good standing in relevant industry, business or professional
organizations.

2.1.8. Must have attended corporate governance training

conducted by an accredited training provider or through an
approved in-house corporate governance training or must have
issued an undertaking to attend such seminar as soon as
practicable. If exempted from attendance in such corporate
governance training, proof of such exemption must be
presented. 2.1.9. The Governance, Nomination and Election
Committee, as defined under Article III-B (3), may consider and
recommend to the Board other qualifications which are now or
may hereafter be provided in the relevant existing laws or any
amendments thereto or new law applicable to the Corporation.

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 How to Appoint Directors in the Company? (6 Ways)

Directors in the company may be appointed in the following

ways: 1. By Signatures to the Memorandum 2. By Company
in the General Meeting3. By Board of Directors 4. By Third
Parties 5. By Proportional Representation 6. By the Central
Government.

Way # 1. Appointment of Directors by Signatures to the

Memorandum:

(Sec. 254 and Clause 64 of Table A):

(i) The Articles of a company usually name the first directors

by their respective name or prescribe the method of
appointing them.

(ii) If the directors are not named in the Articles of the

Company, the number of directors and the name of the
directors shall be determined in writing by the subscribers of
the Memorandum or a majority of them. (Clause 64 of Table
A)

(iii) If the first directors are not appointed in the above

manner, the subscribers of the Memorandum who are
individuals shall be deemed to be the directors of the
company. They shall hold office until directors are duly
appointed in the first annual general meeting. [Sec. 254]

Subsequent directors shall be appointed according to the

provisions of Sec. 255 of the Act.

Way # 2. Appointment of Directors by Company in the

General Meeting:

(Secs. 255 to 257, 263 and 264):

Section 255 provides that subsequent directors shall be

appointed by the company in general meeting. In the case of
a public company or a private company which is a subsidiary
384
of a public company, unless the Articles provide for the
retirement of all directors at an annual general meeting, at
last two-thirds of the total number of directors shall be liable
to retire by rotation and shall be appointed by the company in
general meeting.

This means one-third of the total number of directors can be

permanent directors. The remaining directors in the case of
any such company and all the directors in the case of private
company not being a subsidiary of the public company may
be appointed as provided in the Articles. In the absence of
any regulation in the Articles of the company, these directors
shall be appointed by the company in general meeting.

The appointment or reappointment of directors by a

company in the general meeting is governed by the
following provisions:

First appointment:

(a) At the first annual general meeting of a public company or

a private company which is subsidiary of public company,
held after the general meeting at which the first directors are
appointed and at every subsequent annual general meeting,
one-third (or the number nearest to one-third) of such of the
directors for the time being as are liable to retire by rotation
shall retire from office. [Sec. 256(1)]

The provisions are aimed at eradicating the mischief caused

by self- perpetuating management. [Oriental Metal Pressing
Works (Pvt) Ltd., vs. B.K. Thakoor (1961) 31 Comp. 143
(S.C.).

(b) The directors to retire by rotation at every annual general

meeting of the company shall be those who have been
longest in the office since their last appointment. But as
between persons who became directors on the same day,
those who are to retire shall be determined by mutual
agreement or, in default, by lot. [Sec. 256 (2)]
385
In B.R. Kundra vs. Motion Pictures Assn. (1976) 46 Comp.
Cas, 339 (Det.), it was held that the directors cannot prolong
their tenure by not holding the annual general meeting in
time. They would automatically retire on the expiry of the
maximum permissible period within which a meeting ought to
have been held.

Reappointment:

At the annual general meeting at which a director retires by

rotation the company may fill up the vacancy by appointing
the retiring director or some other person thereto. [Sec. 256
(3)]

If the place of the retiring director is not filled up, and the
meeting has not expressly resolved not to fill the vacancy,
the meeting shall stand adjourned till the same day in the
next week at the same time and place.

If at the adjourned meeting also, the place of retiring

director is not filled up, nor expressly resolved not to fill
the vacancy, the retiring director shall be deemed to
have been reappointed at the adjourned meeting except
in the following cases:

(i) When at any previous meeting, a resolution for his

reappointment was put before the meeting, but was lost; or

(ii) When the retiring director has declined reappointment in

writing;

(iii) When he has been disqualified; or

(iv) When the reappointment will not be valid unless it is

made by passing a resolution, whether special or ordinary; or

(v) When the meeting has expressly resolved not to fill up the
vacancy. [Sec. 256(4)]

Appointment of a new director:

386
If a new director is to be appointed, a notice in writing shall
be given to the company at least 14 days before the meeting.
The notice shall be given by the person seeking appointment
as director or by some member intending to propose him as
director along with a deposit of Rs. 500. The deposit shall be
refunded to the depositor if such person succeeds in getting
elected as a director. [Sec. 257(1)]

The Companies (Amendment) Act, 1988 seeks to discourage

frivolous notice to contest for election as director of a
company by requiring a member desirous of sending a notice
to the company under Sec. 257 to deposit a sum of Rs. 500.

The company shall inform the members at least seven days

before the meeting about the candidature. It is not necessary
for the company to serve individual notices upon the
members if the company advertises such candidature not
less than seven days before the meeting, in at least two
newspapers. One of the newspapers must be in English
language and the other in the regional language of the place
where the registered office of the company is located.

This provision shall not apply to a private company unless it

is a subsidiary of a public company. [Sec. 257 (2)]

As per Sec. 64 of the Act, person who is being proposed as

a candidate for the office of a director Just sign and file with
the company his consent in writing to act as a director, if
appointed. This requirement does not apply to a director
retiring by rotation.

Notice to the Registrar:

The director must file his written consent to act as a director

with the Registrar within 30 days of his appointment.

One resolution for two or more directors:

387
Appointment of directors of a public company must be voted
individually by separate ordinary resolution, unless the
company has in general meeting unanimously so resolved.
In other words, each director shall be appointed by a
separate resolution unless it is unanimously decided at the
general meeting that more than one director may be
appointed by a single resolution.

Any resolution moved in contravention of this provision shall

be void even if no objection was raised at the time of its
being so moved. [Sec. 263]

Way # 3. Appointment of Directors by Board of Directors

(Secs. 260, 262 and 313):

In the following cases, the Board of Directors may

appoint the directors:

(i) Additional Directors:

Section 260 of the Companies Act empowers the Board to

appoint additional directors and Articles of every company
also confer this power to the Board. But the additional
director shall hold his office upto the next annual general
meeting. The number of directors including the additional
director should in no case exceed the maximum number of
directors as determined by the articles of the company.

(ii) Casual Director:

The Companies Act empowers the Board to appoint the

casual director subject to any regulation in the Articles. The
casual vacancy in the office of the director may exist due to
retirement, resignation, insolvency or any other reason. The
casual director may hold his office only upto the period to
which the original director would have his office if he had not
vacated. [Sec. 262]

(iii) Alternate Director:

388
This Board may appoint the alternate director if the article
authorises. The Board is empowered to appoint the alternate
director if the original director remains absent for more than
three months from the date on which the meeting is ordinarily
held. Such alternate director shall hold office only for the
period till the original director returns. [Sec. 313]

Way # 4. Appointment of Directors by Third Parties (Sec.

255):

The articles may permit the third parties for the appointment
of director as their nominee, but the number of directors so
appointed should not exceed one- third of the total number of
directors and they are not liable to retire by rotation. The third
party means the Vendor, Banking Company, Finance
Corporation and Debenture holders.

The idea behind the appointment is that they may have the
watch that money advanced to the company has been
utilised for same purpose for which it was lent.

Way # 5. Appointment of Directors by Proportional

Representation (Sec. 265):

Directors are appointed individually either by show of hands

or by ballot unless the Articles otherwise provide. If the
Articles permit, a system of proportional representation may
be adopted for the appointment of directors.

The appointment may be made by the single transferable

vote or by a system of cumulative voting. In this system, the
minority shareholders may become in a position to have their
representation in the Board of Directors. Such appointment is
made once in three years and the usual vacancies are filled
up according to the provisions of Sees. 262 and 265.

Way # 6. Appointment of Directors by the Central

Government (Sec. 408):

389
According to Sec. 408, the Central Government may appoint
the directors but not more than two in number and for the
period not exceeding 3 years.

The appointment of directors is made to prevent the affairs of

the company which are oppressive to any member or which
are prejudicial to the public or company’s interest.

The Central Government may appoint the director on the

application of not less than 100 members of the company or
the members holding not less than 1/10th of the total voting
rights. Such directors need not to retire annually and are also
not required to have the qualification shares.

The Companies (Amendment) Act, 1974, empowers the

Central Government to issue necessary directions to
companies where an appointment of directors is so made.
[Sec. 408 (6)]

Further, the directors so appointed are required to keep the

Central Government informed of the affairs of the company
to enable it to take such timely action as may be required by
exigencies of the circumstances. [Sec. 408 (7)]

 Appointment of Directors under the new Companies

Act, 2013

Directors of a company hold the most crucial position in

the Company. With the new Companies Act, 2013 (“New
Act“) already in force, their position has become even
more significant than ever before. They are now formally
included within the definition of “key managerial
personnel” or “KMP” under Section 2(51) of the New
Act.

New Categories and Qualifications of Directors

390
Resident Director: The new Act has made certain important
changes in the earlier regime, particularly in respect of the
appointment of directors. For instance, as per Section 149 of
the New Act, Board of Directors of a company, must have at
least one resident director, i.e. a person who has lived not
less than 182 days in India in the previous calendar
year. The second proviso added to section 149 in the New
Act requires all companies to comply with section 149 within
a year.

Woman Director: Similarly, a new provision is introduced

under section 149, which requires certain categories of
companies to have at least one woman director on the
board. Such companies are any listed company, and any
public company having-

1. paid up capital of Rs. 100 cr. or more, or

2. turnover of Rs. 300 cr. or more.

Independent Director: Independent Director is for the first

time introduced in the New Act, and has been clearly defined
as “any director other than a managing director, a whole time
director, and a nominee director.” Such a director not having
any significant pecuniary relationship with the company is
more efficient. Section 149 (4) requires that one third of the
directors should be independent directors. Section 149(6)
lists in detail the specific qualifications for an independent
director-

1. Person of integrity and relevant experience

2. Is not a promoter, nor has any relation with the promoters
or directors of the company, its holding, subsidiary or
associate company;
3. Has no pecuniary relationship with company, its holding,
subsidiary or associate company, its promoters or
directors in the preceding two years of his appointment
4. Has no relatives who have pecuniary relationship with
company, its holding, subsidiary or associate company, its

391
 promoters or directors, amounting to two percent in the
preceding two years of his appointment
5. Neither he, nor any of his relatives have held a key
managerial personnel or is or has been employee of the
company or its holding, subsidiary or associate company
in any of the three financial years immediately preceding
the financial year in which he is proposed to be appointed.
6. Neither he nor any of his relatives have been an employee
or proprietor or a partner, in any of the three financial
years immediately preceding the financial year in which he
is proposed to be appointed, of (a) a firm of auditors or
company secretaries in practice or cost auditors of the
company or its holding, subsidiary or associate company;
or (b) any legal or a consulting firm that has or had any
transaction with the company, its holding, subsidiary or
associate company amounting to ten per cent. or more of
the gross turnover of such firm;
7. Neither he nor any of his relatives hold together with his
relatives two per cent. or more of the total voting power of
the company; or
8. Neither he nor any of his relatives is a Chief Executive or
director, by whatever name called, of any nonprofit
organization that receives twenty-five per cent. or more of
its receipts from the company, any of its promoters,
directors or its holding, subsidiary or associate company
or that holds two per cent. or more of the total voting
power of the company; or
9. who possesses such other qualifications as may be
prescribed.

The appointment of independent directors has to also be

approved by the shareholders.

Additional Directors: Additional Directors may be appointed

by a company under section 161 of the New Act. The article
should confer such power on the Board of Directors of the
Company. A provision further added in 2013 with regards to
such appointment is that the proposed person should not
392
have failed to get appointed as a Director in a General
Meeting.

Nominee Director: Nominee Director is defined under an

explanation to section 149. He is a Director nominated by
any financial institution pursuant to any law for the time being
in force, or of any agreement or appointed by any
Government or any other person to represent its interest.

Alternate Directors: Alternate Directors, under section

161(2) of Companies Act, 2013, may be appointed by a
company if the articles confer such power or a decision is
passed by a resolution if an independent Director is absent
from India for not less than three months. He must be
qualified to become an independent director, but should not
hold any Directorship. An alternate Director cannot hold the
office longer than the term of the Director in whose place he
has been appointed. Additionally, he will have to vacate the
office, if and when the original Director returns to India. Any
alteration in the term of office made during the absence of
the original Director will apply to the original Director and not
to the Alternate Director.

Number of Directors

The New Act, by adding 149 (1) (b), has also increased the
maximum number of directors that a company can have from
twelve to fifteen. The number can be further increased by
passing a special resolution instead of requiring approval
from Central Government as was under the Old Act.

Appointment of Directors

Section 152 of the New Act governs the appointment of

directors. Certain specific requirements for appointment of
director as laid down in the New Act are-

 If there is no provision for appointment of Director in the

Articles (AoA), the subscribers to the memorandum, i.e.

393
 the shareholders, who are individuals shall be deemed to
be the first directors of the company until the directors are
duly appointed;
 Director to be appointed in a general meeting. If it is so
done, an explanatory statement for such appointment,
annexed to the notice for the general meeting, shall
include a statement that in the opinion of the Board, he
fulfills the conditions specified in this Act for such an
appointment;
 The proposed Director has to furnish his DIN (Director
Identification Number) mandatorily. DIN is allotted by the
Central Government on application by a person intending
to be the Director of a company. DIN can be obtained in
pursuance of section 153 and 154;
 The proposed Director has to also furnish a declaration
stating that he is not disqualified to be a director.
 Furthermore, such appointment should be with his
consent. Earlier such consent was not mandatory for
private companies.Consent implies that being appointed a
director and taking the charge of the office are two
different things;
 Consent has to be filed with the Registrar of Companies
within 30 days of appointment

The provisions for optional proportionate representation

which was earlier mandated only for public companies and
the private companies which are subsidies of a public
company, has now been extended to all private companies
also (section 163 of the Companies Act, 2013). Also, the
disqualifications for appointment and reappointment of
directors have been made applicable to the private
companies. Therefore, prior to appointing a director, a
company must tick off the various disqualifications for
appointment as director under Section 164 of the New Act.

394
  Discuss the powers of directors. Are there any
restriction on their powers?

Ans. Power of directors—The power of directors are

general’) contained in the articles and there is usually a
clause giving them the powers of management of the
company and all other powers which are otherwise dealt
therein. This clause is, however, not be construed ejusdem
generis but it has been held to cover and render valid all acts
of the tots done bona fide in the management of the
company [RePyle Merits (No. 2), (1891) 1 Ch. 173]. The
directors of a company can do whatever the company can do
subject to the restrictions imposed in the articles of the
company [Tata Iron and Steel Co. Ltd., A.I.R. 1928 Bom.
80] Directors have implied powers to do whatever is
incidental to the land:less of the Company. Though the
members in general body meeting, decide to sell out the
undertaking of the company, the directors according to
Kerala High Court have power to refuse the sale, in the
exercise of their discretionary power of the board, if they feel
that such sale is detrimental to the interest of the company.
The power of sale of assets is vested in die board of
directors and they are responsible for the proper exercise
of [Pothen v. Hindustan Trading Corporation, (1967) 37
Com. Cas. 266].

The Companies Act lays down specific provisions in regard

to the ‘lowers that may and may not be exercised by
directors and the manner . exorcise of such powers. Section
179 provides that the Board of I Hrectors of a company shall
be entitled to exercise all such powers and ti) do .11 such
acts and things as the company is authorised to do. The AIM
of this section is that subject to the restrictions contained in
the 801, and in memorandum and articles, the powers of
directors are co-mdensive with those of the company itself.
There are, however, two important limitations upon their
powers. Firstly, the board is not competent it) do what the
Act, memorandum and articles require to be done by the
395
4taroholders in general meeting and secondly, in the
exercise of their oow.rti the directors are subject to the
provisions of the Act, memorandum and articles and other
regulations not inconsistent therewith, made by tilt company
in general meeting. The powers, thus conferred on the
directors, are conferred collectively on the Board. An
individual director directors can exercise these powers only
by delegation by the Board, MI and when a director is
appointed as manager or managing director or apecial
committee of the board is set up to deal with some special
work.

The board shall not exercise any power or do any act or

thing which ut directed or required to be done by the
company in its general meeting. Moreover, in exercising any
such power or doing any such act or thing, the ‘board shall
be subject to the provisions contained in that behalf, in this or
any other Act or in the memorandum or articles of the
company or any other regulations. (Sec. 177)

Where under the articles, the directors enjoy full power of

managing dir business of the company, the shareholders are
not entitled, by a ..elution passed at the general meeting to
give effective direction to the directors to the effect as to how
to manage the business of the company, without altering the
articles. This even cannot overrule the decision of directors
in the conduct of the business. Consequently, the directors of
a banking company are entitled to enforce payment of a debt
even though the getieral body passes the resolution to write
off the debt [Subarban Bank Pvt. Ltd., Trichur v. Tariath
and another, (1968) 38 Com. Cas. 13].

The entity of a company is entirely separate from that of

shareholders and if a company does not possess a
fundamental right, then its shareholders cannot be allowed to
file a petition for enforcement of fundamental right on the
ground that company is nothing more than association of
shareholders and members. [Prithis Cotton Mills Ltd. v.

396
Broach Borough Municipality and others, A.I.R. 1968
Gujarat 124].

The Board shall exercise the following powers on behalf of

the Company and it shall do so, only by means of resolutions
passed at the meeting of the Board:-

(1) the power to make call on shareholders in respect of

money unpaid on their shares;

(2) the power to issue debentures;

(3) the power to borrow moneys otherwise than on

debentures;

(4) the power to invest the funds of the company; and

(5) the power to make loans. However, the Board by a

special resolution may delegate to any committee of
directors, the managing agent; secretaries and treasurers the
manager or any other principal officer of the company, the
power, specified in (c), (d) and (e) above.

Even where there was no actual resolution authorising a

director tee enter into a transaction on behalf of the company
either by the Board of Directors or by the Boaid of managing
agents a claim of creditors could not be affected if the terms
of its memorandum and articles of association authorized
such a transaction. In such cases the person negotiating with
the company is entitled to pressure that att the formalities in
connection therewith have been complied with.

Restrictions on the powers of Board.- (Section 180)

(1) The Board of Directors of a public company or of a

private company which is a subsidiary of a public company
shall not, except with the consent of such company in
general meeting-

397
 (i) sell, lease or otherwise dispose of the whole or
substantially the whole of the undertaking;

(ii) remit or give time for the re-payment of, any debt due by
a director except in the case of renewal or continuance made
by a Banking company to its director in the ordinary course
of business;

(iii) invest otherwise than in trust securities;

(iv) borrow moneys that will exceed the aggregate of the paid
up vital and the free reserves of the company;

(v) contribute to charitable, and other funds not directly

related to the business of the company or the welfare of its
employees, any amount die aggregate of which will, in any
financial year, exceed fifty thousand ‘mires or five per cent,
of its average net profits. [S. 181]. An agreement ‘only to
transfer the undertaking by directors does not violate the
section it being merely tentative, subject to final approval by
company at the Ilrnrral meeting. [S. Chakravarty and others
v. The Controller of Insurance, Government of India, A.L
R.. 1962’S.C. 1355].

 What are the Powers of a Company Director?

The directors are considered as the head and brain of a

company. When the brain functions, the company is said to
function. For the proper functioning, the directors should be
properly entrusted with some powers. The directors generally
acquire their powers from the provisions of the Articles of
Association and then from the Companies Act.

1. General Powers of a Company Director

As per Sec. 291 of the Act, the Board is entitled to exercise all
such powers and to do all such acts and things as the company
is authorized to do. The exceptions are the acts, which can be
398
done by the company only in the general meetings of the
members as required by law.

2. Specific Powers of a Company Director

1. As per Sec. 262, in the case of a public company or a private

company, which is a subsidiary of a public company, the power
to fill a casual vacancy of directors is to be exercised at a Board
meeting.

2. As per Sec. 292, the following powers of the company shall

be exercised by the Board by means of resolution passed at
the meeting of the Board –

1. to make calls,
2. to issue debentures,
3. to borrow moneys by other means,
4. to invest the funds of the company, and
5. to make loans.

The last three powers cannot be delegated to the Manager or

to a Committee of Directors but must be exercised only at a
Board meeting.

3. Powers of Director subject to the Consent of the

Company

The directors of a public company or of a private company can

exercise the following powers, which is a subsidiary of a public
company only with the consent of the company in the general
meeting:

1. To sell, lease or otherwise dispose of the undertaking of the

company.

2. To remit or give time for repayment of any debt due to the

company by a director.

3. To invest the sale proceeds of any property of the company

in securities other than trust securities.
399
4. To borrow moneys where the moneys already borrowed
(other than temporary) exceeds the total of the paid-up capital
and free reserves of the company.

5. To contribute to charities and other funds not directly relating

to the business of the company or to the welfare of the
employees in any year in excess of Rs.50,000 or 5% of the
average net profits of the three preceding financial years
whichever is greater.

4. Powers of Director subject to the Consent of the Central

Government

1. As per Sec. 268, any provision relating to the appointment or

reappointment of a Managing Director can be altered by the
Board with the consent of the Central Government.

2. As per Sec. 295, the Board, subject to the Central

Government’s consent, has the power to appoint a person for
the first time as a Managing Director.

3. As per Sec. 295, the Board, only with the previous approval
of the Central Government, can make any loan or give any
guarantee or provide any security in connection with a loan
made by any other person to

a. any of its directors or any director of its holding company,

or
b. any partner or relative of such director, or
c. any firm in which any such director or relative is a partner,
or
d. any private company of which any such director is a
member or director, or
e. any body corporate, 25% or more of whose total voting
power may be exercised or controlled by any such director
or two or more directors together, or
f. any body corporate, whose Board or Managing director or
Manager is accustomed to act in accordance with the

400
 directions or instructions of any director or directors of the
leading company.

4. Subject to the approval of the Government, the Board has

the power to invest in the shares of another company in excess
of the limits specified in Sec. 372.

 Legal Position/Status of Directors:

The Act does not define the position/status of directors, and it is

difficult to define the exact legal position of the directors of a
company.

Although, the directors have been referred as the trustees, or

the managing partners of the company, but in real sense they
are none of them. Directors may be considered as the agent,
trustees or managing partner for a particular moment and for
the particular purpose.

Bowen, L.J. observed, “Directors are described sometimes as

managing partners. But each of these expressions is used not
as exhaustive of their powers and responsibilities, but as
indicating useful points of view from which they may for the
moment and for the particular purpose be considered.”

The legal position of directors can be better explained in

the following manner:

1. Position of Directors as Trustees:

(i) Legally a director is not the trustee:

Legally speaking, a director is not the trustee of the company.

In the case Smith vs. Anderson, James L.J. observed, “A
trustee is a man who is the owner of property and deals with it
as principal, as owner and as master, subject only to an
equitable obligation to account to some persons to whom he
stands in relation of a trustee. The office of director is that of a
401
paid servant of the company. A director never enters into a
contract for himself, but he enters into a contract for his
principal i.e., for the company of which he is a director or for
whom he is acting.”

From this point of view, directors are not the trustees of the
company, because they are not the legal owners of the
properties of the company.

(ii) Directors as trustees of the company’s property and

money:

Although the directors are not, properly speaking, the trustees,

yet they are trustees of the company’s money and property and
they are bound to deal with capital under their control as a trust.
They must act in good faith and exercise their powers in the
interest and benefit of the company.

(iii) Directors as trustees to the powers entrusted to them:

The directors are the trustees in respect of powers entrusted to

them. They must exercise these powers bonafide and for the
benefit of the company as a whole.

Examples of such powers are as follows:

(a) The power of employing the funds of the company;

(b) The power to declare dividend in the general meeting;

(c) The power to make call;

(d) The power of forfeiting shares;

(e) The power of receiving payment of call in advance;

(f) The power of approving the transfer of shares;

(g) The power of accepting the surrender of shares;

402
(h) The power of issuing the unissued shares of the company
and making allotments thereof.

(iv) Directors not as trustees to the shareholders:

It should be noted that directors occupy a fiduciary relationship

only in relation to the company and not in relation to an
individual shareholder. They are not trustees for any particular
shareholder.

In case of Percival vs Wright, “The Directors purchased shares

from a shareholder when negotiations were being held by them
for sale of the company at a very high price. They did not
disclose this fact to the shareholder. It was held that the
shareholder could not repudiate the contract on that ground.”

(v) Directors not as trustees to the outsiders:

The directors are not as trustees to other persons entering into

any contract with the Company.

The position of directors as Trustee can be briefly stated

as under:

(i) They are not trustees in the legal sense of the term.

(ii) They occupy a fiduciary position in relation to the company

and they are considered trustees with respect to the company’s
property and money.

(iii) They are also trustees as regards powers entrusted to

them. They must exercise these powers bonafide in the interest
of the company and they are accountable for secret profits
made by them, if any.

(iv) They are not trusted of individual shareholders.

2. Position of Directors as Agents:

403
The company being an artificial person cannot manage its
affairs itself but the management of the company is entrusted to
some human agency known as directors. They are the selected
representatives of the shareholders. They run the business on
behalf of the shareholders and may be termed as the agent of
the company.

In the case of Forguson vs. Wislon, Cairns L.J. stated the

position of the directors as, “They are merely agents of the
company. The company itself cannot act in its own persons for
it has no person, it can act ‘only through directors’ and the case
is, as regards those directors, merely the ordinary case of
principal and agent, for whenever an agent is liable, those
directors would be liable. Where the liability would attach to the
principal and the principal only, the liability is the liability of the
company.”

In Great Eastern Railway vs. Turner, it was held that the

directors are agents in the transaction which they enter into on
behalf of the company.

The directors must act in the name of the company and within
the scope of their authority. If the directors enter into a contract
which is beyond their powers but within the powers of the
company, the company, like any other principal, may ratify it.

Where the directors enter into a contract which is ultra virus the
company, the company cannot ratify it and neither the company
nor the directors are liable on it. However the directors may be
held liable for breach of implied warranty of authority.

It is ‘however’ not correct to say that directors are the agents of

the company because agents are not elected but appointed
and second thing that agents have no independent power while
the directors have independent powers on certain matters.

3. Position of Directors as Managing Partner:

404
Directors have been described as the managing partners
because, on the one hand, they are entrusted with
management and control of the affairs of the company, and on
the other hand, they are usually important shareholders of the
company.

However, directors are not partners in the ordinary partnership

law sense in as much as the liability of a partner is unlimited
whereas the liability of a director as a member is limited to the
value of shares held by him (except in the case of unlimited
companies). Further unlike a partner, director has no authority
to bind the other directors and shareholders.

4. Position of Directors as Officers:

Under Sec. 2 (30) of the Companies Act, the directors are the
officers of the company. As officers, they may by held liable if
the provisions of the Companies Act have not been fully
complied with by them.

5. Position of Directors as Employees:

The directors may be considered as the employees of the

company also, because they work under a special contract of
service with the company and are paid remuneration
accordingly.

6. Position of Directors as Organs of the Company:

Directors have also been treated, in judicial decisions, organs

of the company for whose action the company is to be held
liable just as a natural person is liable for the actions of his
limbs.

In Bath vs. Standard Land Co., Neville J. stated, “The board of

directors are the brain and the only brain of the company which
is the body and the company can and does act only through
them.”

405
Considering the above discussion, Gessel said: “Directors are
described as trustees, agents or managing partners, not as
exhausting their powers or responsibilities, but as
indicating useful points of view.”

According to L.J. Bowen, “Directors are described sometimes

as agents, sometimes as trustees and sometimes as managing
partners but each of this expression is used not as exhausting
of their powers and irresponsibility’s, but as indicating useful
points of view which they may for the moment and for the
particular purpose be considered.”

Thus, it is clear from the above discussion that directors are

neither the agents, nor the trustees, nor managing partners, nor
officers, nor employees of the company but they stand in a
fiduciary position towards the company for the powers and
company’s property under their control.

 What is the legal position of a director of a

company?

(1) Directors as agents.qA company, as an artificial person,

acts through directors who are elected representatives of the
shareholders. They are, in the eyes of the law, agents of the
company for which they act (2) Directors as employees.(3)
Directors as officers. The directors are treated as officers of the
company. As such they are liable to certain penalties if the
provisions of the companies act are not strictly complied with.

Directors as trustees. Directors are treated as trustees. Of the

company's money and property ; and of the powers entrusted
to them.

Who are independent directors in a company?

Independent directors are members of the board of directors

who are not also employed by the company. The president or

406
vice-president of a company who is on the board is not an
independent director.

What qualifications does a company director need?

A director, as in "Board of Directors", needs only what

qualifications the corporation requires. They are selected
primarily for the following reasons: 1. Willingness to vote in
accordance with the person or block that appointed them. 2.
Willingness to maintain a reputation of security and
responsibility. 3. Willingness to have good ideas as to how to
grow the corporation. I listed those in order.

Under what section of the Corporations ACT 2001 does a

director of a company have the power to inspect the books
of the company for the purposes of a legal proceeding?

Section 198F(1) of the Corporations Act affords a current

director the right to inspect a company's books (other than the
companies financial records) at all reasonable times for the
purposes of a legal proceeding to which that director is a party.
Former directors also have similar inspection rights under
section 198F(2). A former director's inspection right continues
for seven (7) years after they cease to be a director.

How do you find out who is on the board of directors of a

company?

Typically, the secretary of state for each state has these

records.Companies and corporations are required to file their
bylaws, rulesof incorporation, and other corporate paperwork
with an officialstate agency. That paperwork will always include
the names andtitles of the board members (e.g., president,
vice-president,secretary, and so on). The information is a public
record, but eachstate has different procedures about how to
obtain it. You can call your secretary of state's office or visit
theirwebsite and they should have a ton of helpful information
there.

407
What is a legal position?

The legal position is a two-word term with broad meaning. It

can bedefined as what is required by law, and the abdication of
any moralresponsibility.

Can a company be the director of another company?

Yes, in some countries a company can be a director of another

company. Hong Kong is one example. However, in other
countries a director has to be an individual, and can't be a
company. Australia is an example of a country with this rule.

Can you be a director of a ltd company if you bankrupt?

Legally, yes.. However, some, if not most corp organizational

docs and policies would restrcit it.

What does an associate director do in a company?

SUMMARY : Under administrative direction, plans, organizes,

and directs the day-to-day operations of a department.
DISTINGUISHING CHARACTERISTICS: An Associate Director
typically reports to a member of executive management within
the department. TYPICAL DUTIES AND RESPONSIBILITIES:
Provides technical advice, problem-solving assistance, answers
to questions regarding program goals, and policy interpretation.
. Manages and evaluates the design, development, and
coordination of projects. . Participates in training programs and
professional development workshops and conferences. .
Supervises, hires, trains, and evaluates assigned staff. Works
with employees to correct deficiencies and recommends and
implements corrective action and discipline. . Conducts
surveys/studies relevant to organizational management .
Completes reports related to recruitment, special programs,
and professional development. . Assists the Director in
preparing and monitoring departmental goals. . Prepares or
coordinates preparation of financial and administrative reports;
analyzes and interprets statistics, financial data, and

408
management planning data for predicting resource needs and
developing long range plans. . Conducts and assists with the
development of long- and short-range goals.

How much does a director of a company get?

This depends very much on the size of the company. You can
be a managing director of your own company that just employs
you, so not as much pay as, say, the managing director of ICI.

Can a company director be a director in more than 1

companies?

Yes, He/she can be the director of more than 1 company,

Although, there is now no such thing as "managing director"
anymore within the eyes of HMRC law. You are either a
director or not. Its now just a title you can have on your
business card. The general consensus is that you can be a
director of 3 companies maximum and only if you have not
been previously disqualified within 6 years.

What is a director of an opera company called?

This depends on the house and it also varies. For example, the
Royal. Opera House, Covent Garden has a 'board of directors'
but also has a 'Musical Director'. Most opera houses /
companies have a 'Musical Director' who is usually a
conductor.

Can a company director be an employee of the company?

Absolutely. He/she is on the same payroll as the employees

they represent and direct. While a director can be an employee,
he/she represents the OWNERS (stockholders) NOT the
employees. Corportate directors direct the executives and
managers, not all employees directly.

Liability of company is not liability of director?

409
Not usually no. But it depends on the prior actions of the
director. If there is some negligence, unprofessional or illegal
activity on the part of a director in relation to the liability, then
there could be directors liability.

How do you get a director of a limited company to resign?

You will have to examine the Articles of Incorporation and the

By Laws to see if there is any provision for him being voted out,
or for him being ejected for a rule violation. Failing that, it may
be that he has broke the laws of the state in which the company
is chartered. If you find any circumstance in which he can be
terminated, then you can go to him and offer him the chance to
resign. That's known as a "forced resignation", though it is the
custom of the Western World to pretend that all resignations
are purely voluntary, even when they blatantly are not. On the
other, you could always offer him a bribe, either in a one time
payout, a retirement package, some non-voting stock options,
or other things collectively known as a "golden parachute". It's
the custom of the Western World to pretend that such payouts
and payoffs are not bribes, but "rewards for long years of good
and faithful service", even when it blatantly is not.

Can a company director sue his own company?

yes, as the company is a legal entity, and it can be sued by the

director if the shareholders of a company use the company as
the alter ego of the shareholders.

How much paymement get for director of company?

the salary of a director in a company depends on his or her

experience, what the going rate is at the time of hire, and any
special skills the director brings to the organization. It also
depends to some degree on the director's negotiating skills
when being interviewed and at performance reviews.

How much payment get for director of company?

410
The payment you would get for being the director of a company
would vary from each company. While many companies can
afford to pay large salaries, other smaller companies cannot.
The director of a company would be paid fairly based upon the
income the company has.

What position is higher than director?

Chief Executive Officer, typically. However, in my experience

with mid-size corporations, there are various types of directors
i.e., marketing/sales, operations, food service, etc. and those
positions often report to a Regional Manager, .aka Regional
"Director" who in turn reports to the CEO. So, back to my
opening statement... Chief Executive Officer is higher than a
Director. Hope this helps!

 Removal of Directors as per

Companies act 2013
Section 2(34) the Companies Act, 2013 defines the term
“director”. A director means any individual who is appointed as
the director of the Company by its board to perform such duties
and functions for/on behalf of the company in accordance with
the provisions of the Companies Act, 2013. Only an individual
can be appointed as a director of a Company. No association,
body corporate or firm can be appointed as a director of a
Company. Section 169 of the Companies Act, 2013 deals with
removal of Directors.

Section 149 of the companies act provide that a public limited

company is required to have a minimum three directors,
whereas minimum two directors are required in the case of a
private company and one director is required to be appointed in
case of a One Person Company. Maximum fifteen directors can
be appointed by a company. However, a company can appoint
more than fifteen directors only after passing a special
resolution at its general meeting.

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  Disqualifications for Appointment as Director

Sec 164 of the Companies Act, 2013 provides that a person

is ineligible for appointment as a director of a company if
he —

 Is of unsound mind
 Has been declared insolvent or has applied to be
adjudicated as an insolvent
 Has been convicted of any offense involving moral
turpitude or otherwise, and sentenced in respect thereof to
imprisonment for six months or more by a court and a
period of five years has not elapsed from the date of
expiry of a sentence. However, a person is ineligible to be
appointed to any company if, has been convicted of any
offense and was sentenced to imprisonment for a period
of seven years or more.
 Has been disqualified from appointment as a director by
any court or Tribunal
 Has failed to pay any call money in respect of any shares
of the company held by him and a period of six months
has elapsed from the day on which the call money was to
be paid;
 Has been convicted of the offense dealing with related
party transactions under section 188 in the preceding five
years;
 Does not have a DIN.

 Duties of Director

Section 166 of the Companies Act, 2013 defines the duties of

Directors. A director of a company shall : —

 He should act in accordance with the articles of the

company.
 He should always Act in good faith for promoting the
objects of the company and for the benefit of its members
and act in the best interests of the company,
shareholders, its employees and the community at large.
412
  Exercise his duties with due and diligence and should
exercise independent judgment.
 Should not involve situations which directly or indirectly
conflict with the interest of the company.
 Should not achieve or take undue gain or advantage of his
office whether for himself or for his relatives, associates or
partners.

If the director contravenes any provisions of this section, he

shall be punishable by a fine of Rs. 1,00,000 or more, which
may extend up to Rs. 5,00,000.

 Removal of Directors

Section 169 of the Companies Act, 2013 deals with removal of

Directors. A company may remove a director before the expiry
of the term of his office by passing an ordinary resolution and
after giving him a reasonable opportunity of being heard.
However, any director who has been appointed by National
Company Law Tribunal u/s 242, is not subject to the provisions
of section 169.

The provision is not applicable where the company has availed

the option to appoint not less than two – thirds of the total
number of directors in accordance with the principle of
proportional representation.

A special notice is required for any resolution, for removing a

director or for appointing any person in place of a director
removed.

On receipt of notice of a resolution under this section, the

company shall send a copy of the same to the director and the
director, irrespective of whether or not he is a member of the
company, is entitled to be heard on the resolution at the
meeting.

Where notice of a resolution to remove a director has been

given under this section and the concerned director makes a

413
representation in writing to the company and requests its
notification to members of the company, the company shall do
so, if the time permits –

 The Company shall state the fact that the representation

has been made by the director concerned, in any notice of
the resolution given to members of the company.
 A copy of the representation is required to be sent to
every member of the company to whom notice of the
meeting is sent, and if the company is unable to send the
same because of insufficient time or default, the director
has the right to be heard orally, required that the
representation shall be read out at the meeting.

However, the copy of the representation is not required to be

sent to and read out at the meeting if, an application is filed
either by the company or by any other person who is aggrieved
by it and the Tribunal is satisfied that the rights conferred by
this sub-section are being abused for unnecessary publicity
&for defamatory purposes.The Tribunal may also order the
director to pay the company’s costs on the application in whole
or in part.

The vacancy created by the removal of such director shall be

filled by appointment of another director in his place at the
meeting in which he is removed, provided that a special notice
of such appointment has been given under subsection (2).

The director who is appointed shall hold office until the date to
which his predecessor would have held office had he not been
removed.

In case such vacancy is not filled under the provisions of

subsection (5), it may be filled a casual vacancy in accordance
with the provisions of the Act provided that, the director who
was removed is not be re-appointed as a director of the Board.

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  Types of Directors

Larger businesses and organisations usually have a clear

board structure and they are as follows:

1. Chairman: He is the person who has the entire hold of the

company or an organisation.
2. Managing Director: He is often appointed by the
chairman to look after the board of directors and oversees
the working of the business.
3. Executive Directors: They are the directors who look
after some specific departments like finance, marketing,
etc.
4. Non- Executive Directors: They advise the company on
introducing new forms of strategy and they also decide the
salaries of the Executive Directors.

 Duties of a Director

According to section 166 of the Indian Companies Act, 2013,

there are several duties that he has to perform:

A director of a company should act in accordance with the

articles of the company.

 Whatever rules and regulations are mentioned in the

articles of associations and the memorandum of
associations. The director has to abide by all these.

A director should act in good faith and work towards the

interests of the company for the benefits of its members, the
employees, shareholders and all other.

 The intention of the director should be honest. He should

not do anything which is against the provisions of the
company.

A director should exercise his duties with reasonable care and

due diligence and independent judgement.

415
  A director should see that he is not being negligent in any
of his work and his judgement should not be based on the
judgements of others. It should be independent.

A director shall not involve himself in a situation where he may

have a direct or an indirect interest that conflicts with the
interests of the company.

 He shouldn’t do anything which has a direct contradiction

with the company, means he should work in the interests
of the company.

A director should not achieve or attempt to achieve any undue

advantage either to himself or to his relatives, partners or
associates. If he is found guilty of the same, he shall be liable
to pay the gain to the company which he has used for his own.

 A director should not take any disadvantage of anything in

the company. He should do everything with an honest
intention.

A director of a company cannot assign his work or an

assignment to any other person.

 He cannot assign his work to any other person. He should

perform by his own.

A director contravenes with the provisions of this act, he shall

be punishable with a fine, not less than one lakh rupees which
may extend to five lakh rupees also.

 If he acts against to whatever is given in the clauses of

section 166, he will be punishable with a fine.

 Liabilities of a Director

The liabilities of a director of a company can arise in many

cases:

Breach of fiduciary duty

416
When a director does something which is against the interests
of the company and towards the benefit of a particular
employee, it is held to be a wrongful act of a director on
account of fiduciary trust.

Ultra vires

The Directors are required to act within the parameters of the

memorandum of associations, articles of associations because
these lays down what are restrictions which are imposed upon
the directors. If any director does not act in accordance with
restrictions and act beyond the aforesaid limits is held to be
liable and his act is stated as ultra vires.

Negligence

As long as the directors are acting within the prescribed limits

of their powers with reasonable skill and diligence as a man of
ordinary prudence would do, it is okay but when they fail to
perform their duties with reasonable care and because of them
if any loss or damage is caused to the company, the directors
shall be held liable.

Mala fide acts

Directors are the trustees for money and property of the

company. If they dishonestly make the misuse of the property
and money of the company for their own interests and make
any secret profit in the performance of their duties, the directors
having no other choice will have to compensate the company
for whatever loss they have incurred to the company.

 How to fire a Director of a company

At the end of the day, we know that the power to remove a

director is in the hands of the shareholders. All the directors are
responsible to the shareholders. They can remove the director
even before his tenure his completed unless they are appointed
by the Tribunal for the prevention of oppression and

417
mismanagement or a director appointed proportional
representation.

Section 169 of the Indian Companies Act, 2013 states the

procedure for the removal of the director. Section 169 of the
Companies Act, 2013 states that the shareholders can remove
the director by passing an ordinary resolution in a general
meeting.

This right cannot be taken away by the MOA, AOA, or any

document or any agreement.

6. According to section 115 of the Companies Act, 2013, a

special notice with the intention of removing a director by
the specified no. of members of the company has to be
passed at least before 14 days before the concerned
meeting at which it has to moved excluding the day on
which the notice is served and the day of the
meeting.(Section 169)
7. The company shall immediately, after it has received the
notice should inform its members by a notice of resolution
in the same way it does at the time of a general meeting.
8. If it is not possible for the company to send notice to all
the members, it should publish it in form of an
advertisement in a newspaper having an appropriate
circulation at least before 7 days of the meeting.
9. The company should give intimation to the concerned
director about his removal by sending the copy of the
resolution which is sought to be passed. The director will
have the right to be heard on the resolution at the
meeting.
10. The director can submit his statement in writing
against his removal from the company and can also ask
the company to notify it to the other members. If the
representation of a reasonable length and has not been
too late also then the company must-

418
 o Mention in the notice of resolution that the fact of the
representation has been received at the annual
general meeting.
o Send a copy of the representation to every member
of the meeting if the representation has been
received before the notice of the meeting.
11. If the writing is not able to reach the members of the
company because it has been received too late or the
company itself made some default in sending it then the
representation must be read at the annual general
meeting, it is at the discretion of the director. In addition,
he can also make oral representation.

Provided that the copy of the representation need not be sent

out and the representations need not be read out at the
meeting if, on the application either of the company or any
other person who claims to be aggrieved, the Tribunal is
satisfied that the rights conferred by this sub-section are being
abused to secure needless publicity for defamatory matter and
the tribunal may order the company’s costs on the application
to be paid in whole or in part by the director notwithstanding
that he is a party to it.

Conclusion

In the present scenario, we see that there are a lot of

companies and for every company, it is necessary to have a
director or a board of director so that it is able to function
properly. The director has to be very disciplined and has to
make use of his powers honestly. A director has the
responsibility of the all it’s members so if a director does
anything which is in contradiction to the clauses mentioned in
Section 166 then he will liable and will be subjected to the
removal or being fired. So here I have explained the procedure
on how to fire a Director.

419
 Removal of directors
1.A company may, by ordinary resolution, remove a
director, not being a director appointed by the Tribunal
under section 242, before the expiry of the period of his
office after giving him a reasonable opportunity of being
heard:
Provided that nothing contained in this sub-section shall
apply where the company has availed itself of the option
given to it under section 163 to appoint not less than two-
thirds of the total number of directors according to the
principle of proportional representation.

1. A special notice shall be required of any resolution, to

remove a director under this section, or to appoint
somebody in place of a director so removed, at the
meeting at which he is removed.
2. On receipt of notice of a resolution to remove a director
under this section, the company shall forthwith send a
copy thereof to the director concerned, and the director,
whether or not he is a member of the company, shall be
entitled to be heard on the resolution at the meeting.
3. Where notice has been given of a resolution to remove a
director under this section and the director concerned
makes with respect thereto representation in writing to the
company and requests its notification to members of the
company, the company shall, if the time permits it to do so
a. in any notice of the resolution given to members of
the company, state the fact of the representation
having been made; and
b. send a copy of the representation to every member
of the company to whom notice of the meeting is sent
(whether before or after receipt of the representation
by the company),
and if a copy of the representation is not sent as
aforesaid due to insufficient time or for the company‘s
default, the director may without prejudice to his right

420
 to be heard orally require that the representation
shall be read out at the meeting:
Provided that copy of the representation need not be
sent out and the representation need not be read out
at the meeting if, on the application either of the
company or of any other person who claims to be
aggrieved, the Tribunal is satisfied that the rights
conferred by this sub-section are being abused to
secure needless publicity for defamatory matter; and
the Tribunal may order the company‘s costs on the
application to be paid in whole or in part by the
director notwithstanding that he is not a party to it.
4. A vacancy created by the removal of a director under this
section may, if he had been appointed by the company in
general meeting or by the Board, be filled by the
appointment of another director in his place at the meeting
at which he is removed, provided special notice of the
intended appointment has been given under sub-section
(2).
5. A director so appointed shall hold office till the date up to
which his predecessor would have held office if he had not
been removed.
6. If the vacancy is not filled under sub-section (5), it may be
filled as a casual vacancy in accordance with the
provisions of this Act:
Provided that the director who was removed from office
shall not be re-appointed as a director by the Board of
Directors
7. Nothing in this section shall be ta
a. as depriving a person removed under this section of
any compensation or damages payable to him in
respect of the termination of his appointment as
director as per the terms of contract or terms of his
appointment as director, or of any other appointment
terminating with that as director; or
b. as derogating from any power to remove a director
under other provisions of this Act.

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  PROCEDURE OF REMOVAL OF DIRECTOR
UNDER COMPANIES ACT 2013
Provisions related to removal of a director from a Company has
been prescribed under Section 169 of Companies Act 2013
specifically provides for removal of directors of a company.

Section 169 and Chapter 7 of Companies Act, 2013 Right of

Shareholders to remove a director in the General Meeting
through Ordinary Resolution is a Legal Right. This legal right
cannot be damaged or taken away by MOA, AOA or any other
documents or Agreement.

Section 169 and Chapter 7 details the procedure of removal of

director by shareholders as follows: –

A company MAY, by ordinary resolution, remove a director, Not

being a director appointed by the Tribunal under section 242,
before the expiry of the period of his office after giving him a
reasonable opportunity of being heard. The provision relating to
removal shall not apply where the company has availed itself of
the option to appoint not less than two – thirds of the total
number of directors according to the principle of proportional
representation. A special notice shall be required of any
resolution, to remove a director, or to appoint somebody in
place of a director so removed.

Shareholders of the company are empowered to remove a

director by passing an ordinary resolution at a general meeting
of the Company prior to expiry of the period of his office.
However, the following directors cannot be removed as per
said provisions of section 169 until unless otherwise stipulated
in the terms of the appointment:

1. Director appointed by Central Government under Section

408
2. Director appointed by a Financial Institution /bank in
accordance with the loan agreement

422
 3. Director of a private company holding office for life on April
1, 1952 by virtue of Articles or otherwise
4. Where company availed an option to appoint not less than
2/3rd of the total number of directors under Section 265.

 Brief Procedure to remove a Director from a

Company:

Procedure

1. A special notice under section 115 is required to be given to

the company for removal of directors, atleast 14 days before
the date of meeting at which it is to be moved exclusive of the
day on which notice is served and the day of meeting.

2. On receipt of notice of a resolution to remove a director, the

company shall forthwith send a copy thereof along with a
representation if any received from the director concerned and
if a copy of the representation is not sent as aforesaid due to
insufficient time or for the company’s default, the director shall
be entitled to be heard on the resolution at the meeting.

3. Hold and convene a general meeting to remove a director by

passing an ordinary resolution.

4. Advice the Chairman that the resolution can be moved only if

the person who has given notice of the resolution is present
and moves the same at the meeting and that the director
sought to be removed has got a right of being heard at the
meeting even if he is not a member of the company.

5. If the resolution is carried, inform the director concerned

about that fact of his removal.

6. In the case of a listed company, inform the stock exchange/s

where the securities of the company are listed about
the removal of director.

7. File Form DIR 12 within 30 days of the removal of the

director with the Registrar of Companies.
423
Provisions Contained under Companies Act 2013 and Rules
are prescribed under Section 115 andd 169 and rules as
under:

SECTION 115

RESOLUTIONS REQUIRING SPECIAL NOTICE

“Where, by any provision contained in this Act or in the articles

of a company, special notice is required of any resolution,
notice of the intention to move such resolution shall be given to
the company by such number of members holding not less than
one per cent. of total voting power or holding shares on which
such aggregate sum not exceeding five lakh rupees, as may be
prescribed, has been paid-up and the company shall give its
members notice of the resolution in such manner as may be
prescribed.”

APPLICABLE RULES

COMPANIES (MANAGEMENT AND ADMINISTRATION)

RULES, 2014

“Rule 23. Special Notice.—(1) A special notice required to be

given to the company shall be signed, either individually or
collectively by such number of members holding not less than
one percent of total voting power or holding shares on which an
aggregate sum of [not less than five lakh rupees][1] has been
paid up on the date of the notice.

(2) The notice referred to in sub-rule (1) shall be sent by

members to the company not earlier than three months but at
least fourteen days before the date of the meeting at which the
resolution is to be moved, exclusive of the day on which the
notice is given and the day of the meeting.

424
(3) The company shall immediately after receipt of the notice,
give its members notice of the resolution at least seven days
before the meeting, exclusive of the day of dispatch of notice
and day of the meeting, in the same manner as it gives notice
of any general meetings.

(4) Where it is not practicable to give the notice in the same

manner as it gives notice of any general meetings, the notice
shall be published in English language in English newspaper
and in vernacular language in a vernacular newspaper, both
having wide circulation in the State where the registered office
of the Company is situated and such notice shall also be
posted on the website, if any, of the Company.

(5) The notice shall be published at least seven days before the
meeting, exclusive of the day of publication of the notice and
day of the meeting.

SECTION 169 OF THE COMPANIES ACT:

REMOVAL OF DIRECTORS:

(1) A company may, by ordinary resolution, remove a director,

not being a director appointed by the Tribunal under section
242, before the expiry of the period of his office after giving him
a reasonable opportunity of being heard:

Provided that nothing contained in this sub-section shall apply

where the company has availed itself of the option given to it
under section 163 to appoint not less than two-thirds of the total
number of directors according to the principle of proportional
representation.

(2) A special notice shall be required of any resolution, to

remove a director under this section, or to appoint somebody in
place of a director so removed, at the meeting at which he is
removed.

425
(3) On receipt of notice of a resolution to remove a director
under this section, the company shall forthwith send a copy
thereof to the director concerned, and the director, whether or
not he is a member of the company, shall be entitled to be
heard on the resolution at the meeting.

(4) Where notice has been given of a resolution to remove a

director under this section and the director concerned makes
with respect thereto representation in writing to the company
and requests its notification to members of the company, the
company shall, if the time permits it to do so,–

(a) in any notice of the resolution given to members of the

company, state the fact of the representation having been
made; and

(b) send a copy of the representation to every member of the

company to whom notice of the meeting is sent (whether before
or after receipt of the representation by the company),

and if a copy of the representation is not sent as aforesaid due

to insufficient time or for the company’s default, the director
may without prejudice to his right to be heard orally require that
the representation shall be read out at the meeting:

Provided that copy of the representation need not be sent out

and the representation need not be read out at the meeting if,
on the application either of the company or of any other person
who claims to be aggrieved, the Tribunal is satisfied that the
rights conferred by this sub-section are being abused to secure
needless publicity for defamatory matter; and the Tribunal may
order the company’s costs on the application to be paid in
whole or in part by the director notwithstanding that he is not a
party to it.

(5) A vacancy created by the removal of a director under this

section may, if he had been appointed by the company in
general meeting or by the Board, be filled by the appointment of
another director in his place at the meeting at which he is
426
removed, provided special notice of the intended appointment
has been given under sub-section (2).

(6) A director so appointed shall hold office till the date up to

which his predecessor would have held office if he had not
been removed.

(7) If the vacancy is not filled under sub-section (5), it may be

filled as a casual vacancy in accordance with the provisions of
this Act:

Provided that the director who was removed from office shall
not be re-appointed as a director by the Board of Directors.

(8) Nothing in this section shall be taken–

(a) as depriving a person removed under this section of any

compensation or damages payable to him in respect of the
termination of his appointment as director as per the terms of
contract or terms of his appointment as director, or of any other
appointment terminating with that as director; or

(b) as derogating from any power to remove a director under

other provisions of this Act.

CASE LAWS AND JUDGEMENTS MADE BY

VARIOUS COURTS IN THE MATTER OF UNLAWFUL
REMOVAL OF DIRECTORS:

In several Judgments, the court has declared such removal as

invalid where the procedure and provisions of the Act were not
followed. Further, where the Director’s right to make a
representation, which is a statutory right of the Director, has not
been provided to the director. In such cases such removal
would be of no effect.

BHANKERPUR SIMBHAOLI BEVERAGES. VS SARABHJIT

SINGH AND ORS

427
Where the director sought to be removed is not given the
opportunity for making a representation which is his statutory
right under Section 284 the resolution passed for removal
would be of no effect. (Copy of the same is enclosed for your
kind perusal)

 What is REMUNERATION OF DIRECTORS?

Compensation of executive and non-executive director
according to policies set forth in a company’s articles of
association as approved by the shareholders. Remuneration
may consist of a salary, fees, or use of a company’s property
and may or may not be tied to company profits. Shareholders
reserve the right to approve or disapprove director
remuneration.

 Managerial remuneration under the

companies act, 2013
Managerial Remuneration – Director’s Salary as
per Companies Act
As per the Companies Act, 2013, Managerial Person means a
managing director, whole-time director or manager of
a company incorporated in India. Managerial renumeration
includes pay, compensation, or reward for work which is earned
by a managerial person. Companies Act, 2013 has certain
restrictions on pay of Managerial Renumeration. In this article,
we look at such restrictions.

Applicability

Private limited and public limited companies are both

required to comply with the regulations pertaining to payment of
managerial renumeration. Hence, its important for any person

428
becoming a Director of a company to be aware of Managerial
Renumeration, as per Companies Act, 2013.

Managerial Renumeration

Managerial renumeration includes pay, compensation or

reward for work provided to a managerial person. The following
types of expenditure incurred by a company are also termed as
managerial renumeration.

 Expenditure incurred by the company in providing rent

free accommodation, or any other benefit or amenity, free
of charge, to any of the company’s director and manager.
 Expenditure incurred by the company in providing any
other benefit or amenity free of charge or at a
concessional rate to any of the company’s director or
manager.
 Expenditure incurred by the company in respect of any
obligation or service, which, but for such expenditure by
the company, would have been incurred by any of the
company’s director or manager.
 Expenditure incurred by the company to effect any
insurance on the life of, or to provide any pension, annuity
or gratuity for, any of the company’s director and manager
or his/her spouse and/or child.
 Expenditure incurred by the company on behalf of its
managerial person for indemnifying them against any
liability in respect of any negligence, default, misfeasance,
breach of duty or breach of trust for which they maybe
guilty in relation to the company and if such person is
proved to be guilty, the premium paid on such insurance
would be treated as part of its renumeration.
 Expenditure incurred by the company for maintenance of
vehicles pertaining to personal use by director or
manager.

Managerial Renumeration – Company Having Profit

429
A company can pay any renumeration by way of salary,
dearness allowance, perquisites, commission and other
allowances not exceeding 5% of its net profit for one
managerial person. If there are more than one managerial
person, then managerial renumeration cannot exceed 10% of
net profit for all of the managerial persons together.

 Remuneration of directors.

309. (1) The remuneration payable to the directors of a

company, including any managing or whole-time director, shall
be determined, in accordance with and subject to the provisions
of and this section, either by the articles of the company, or by
a resolution or, if the articles so required, by a special
resolution, passed by the company in general meeting [and the
remuneration payable to any such director determined as
aforesaid shall be inclusive of the remuneration payable to such
director for services rendered by him in any other capacity:

Provided that any remuneration for services rendered by any

such director in any other capacity shall not be so included if—

(a ) the services rendered are of a professional nature,

and

( b) in the opinion of the Central Government, the director

possesses the requisite qualifications for the practice of the
profession.]

[(2) A director may receive remuneration by way of a fee for

each meeting of the Board, or a committee thereof, attended by
him :

Provided that where immediately before the commencement of

the Companies (Amendment) Act, 1960, fees for meetings of
the Board and any committee thereof, attended by a director
are paid on a monthly basis, such fees may continue to be paid

430
on that basis for a period of two years after such
commencement or for the remainder of the term of office of
such director, whichever is less, but no longer.

(3) A director who is either in the whole-time employment of the

company or a managing director may be paid remuneration
either by way of a monthly payment or at a specified
percentage of the net profits of the company or partly by one
way and partly by the other :

Provided that except with the approval of the Central

Government such remuneration shall not exceed five per cent
of the net profits for one such director, and if there is more than
one such director, ten per cent for all of them together.]

[(4) A director who is neither in the whole-time employment of

the company nor a managing director may be paid
remuneration—

either

( a) by way of a monthly, quarterly or annual payment with

the approval of the Central Government ;

or

( b) by way of commission if the company by special

resolution authorises such payment :

Provided that the remuneration paid to such director, or where

there is more than one such director, to all of them together,
shall not exceed—

(i ) one per cent of the net profits of the company, if the

company has a managing or whole-time director [***] or a
manager ;

(ii ) three per cent of the net profits of the company, in

any other case :

431
Provided further that the company in general meeting may,
with the approval of the Central Government, authorise the
payment of such remuneration at a rate exceeding one per cent
or, as the case may be, three per cent of its net profits.]

(5) The net profits referred to in sub-sections (3) and (4) shall
be computed in the manner referred to in , sub-section (1).

[(5A) If any director draws or receives, directly or indirectly, by

way of remuneration any such sums in excess of the limit
prescribed by this section or without the prior sanction of the
Central Government, where it is required, he shall refund such
sums to the company and until such sum is refunded, hold it in
trust for the company.

(5B) The company shall not waive the recovery of any sum
refundable to it under sub-section (5A) unless permitted by the
Central Government.]

(6) No director of a company who is in receipt of any

commission from the company and who is either in the whole-
time employment of the company or a managing director shall
be entitled to receive any commission or other remuneration
from any subsidiary of such company.

(7) The special resolution referred to in sub-section (4) shall not

remain in force for a period of more than five years; but may be
renewed, from time to time, by special resolution for further
periods of not more than five years at a time :

Provided that no renewal shall be effected earlier than one

year from the date on which it is to come into force.

(8) The provisions of this section shall come into force

immediately on the commencement of this Act or, where such
commencement does not coincide with the end of a financial
year of the company, with effect from the expiry of the financial
year immediately succeeding such commencement.

432
(9) The provisions of this section shall not apply to a private
company unless it is a subsidiary of a public company.

 Managerial Remuneration – Director’s Salary as per

Companies Act 2013

Managerial person means a managing director, whole-time

director or manager incorporated in India as per the Companies
Act, 2013. Managerial remuneration includes pay,
compensation, or reward for work which is earned by a
managerial person. Companies Act, 2013 has certain
restrictions on the pay of Managerial Remuneration.

Applicability

Private Limited Companies and Public Limited Companies are

both required to follow with the regulations as per Companies
Act 2013 regarding the payment of managerial remuneration.
Hence, its important for any person becoming a Director of a
company to be aware of Managerial Remuneration, as per
Companies Act, 2013.

Managerial Remuneration

Managerial remuneration includes pay, compensation or

reward for work provided to a managerial person. Managerial
remuneration also includes the expenditure incurred by a
company on some specific things:

 Providing rent-free accommodation to any of

the company’s director and manager or providing any
other benefit or amenity, Expenditure incurred by the
company in this will be included.
 Providing any other benefit or amenity free of charge or at
a concessional rate to any of the company’s director or
manager, Expenditure incurred by the company in this will
be included.

433
  Expenditure incurred on any obligation or service, for any
of the company’s director or manager and paid by the
company will be included.
 Pay to effect any insurance on the life of, or to provide any
pension, annuity or gratuity for, any of the company’s
director and manager or his/her spouse and/or child,
Expenditure incurred on it will be included.
 Expenditure incurred by the company on behalf of its
managerial person for indemnifying them against any
liability in respect of any negligence, default, misfeasance,
breach of duty or breach of trust for which they may be
guilty in relation to the company and if such a person is
proved to be guilty, the premium paid on such insurance
would be treated as part of its remuneration.
 Pay for maintenance of vehicles pertaining to personal
use by the director or manager, expenditure on it will be
included.

Managerial Remuneration – Company Having profit

Remuneration by way of dearness allowance, salary,

commission, dearness, perquisites, commission and other
allowances by the company will not be exceeding 5% of its net
profit for one managerial person. The managerial remuneration
cannot exceed 10%of net profit If there is more than one
managerial person, then managerial remuneration cannot
exceed 10% of net profit for all of the managerial persons
together.

Managerial Remuneration under different sections

Managerial remuneration to be 11% maximum [Sec.197(1)]:

The total managerial remuneration payable by a public

company, to its directors, including MD and WTD, and its
manager in respect of any FY shall not exceed 11% of the net
profits( net profits for this purpose shall be computed as per
section 198) of that company for that financial year. It is
computed in the manner laid down in section 198 except that
434
the remuneration of the directors shall not be deducted from the
gross profits.

 Remuneration exceeding 11%[First Provision to

Sec.197(1)]: Provided that the company in general
meeting may, with the approval of CG, authorize the
payment of remuneration exceeding 11% of the net profits
of the company.
 Remuneration of Directors and Manager[ Second
Provision to Sec.197(1)]: The remuneration payable to
anyone MD; or WTD or manager shall not exceed 5% of
the net profits of the company. If there is more than one
such director, remuneration shall not exceed 10% of the
net profits to all such directions and manager taken
together. The remuneration payable to directors who are
neither MDs nor WTDs shall not exceed, 3% of the net
profits of the company.

Apply for Private Limited Company Registration today.

Sitting Fees [Sec.197(2) & Sec.197(5)]:

The percentages aforesaid shall not be exclusive of any fees

payable to directors. A director may receive remuneration by
way of fee for attending meetings of the Board or Committee.

The situation in case of no profits or inadequate profits

[Sec.197(3)]:

If in any financial year, a company has no profits or its profits

are inadequate, the company shall not pay to its directors,
including any MD or WTD or Manager, by way of remuneration
any sum exclusive of any fees payable to directors.

Remuneration to be determined by the articles or

GM[Sec.197(4)]:

The remuneration payable to the directors of a company,

including any MD or WTD or manager shall be determined, in

435
accordance with the provisions of this section. Either by Articles
of the company of the company, or by a resolution or, if the
articles so require, by a special resolution, passed by the
company in general meeting. And the remuneration payable to
a director determined shall be inclusive of the remuneration
payable to him for the services rendered by him in any other
capacity.

Remuneration for professional services not to be included

in ‘remuneration’ [provison to Sec.197(4)]:

Provided that any remuneration for services rendered by any

such director in other capacities shall not be so included if-

 the services rendered are of a professional nature; and

 in the opinion of

-the Nomination and Remuneration Committee, if the company

is covered under sub-section(1) of section 178, or

-the Board of Directors in other cases,

-the director possesses the requisite qualification for the

practice of the profession.

 Managerial remuneration under the

companies act, 2013
Republished with Amendments up to September 2018
Managerial Persons covered are Managing Director,
Whole-time Director, Part time Directors and managers
who shall be paid remuneration subject to and in
accordance with provisions of Section 197 of the
Companies Act, 2013. As compared to various sections
and chapters viz section 198, 309, etc of Companies Act,
1956 which deals with Managerial remunerations
separately, the new Act has solved this issue by
consolidating all provisions under a single provision of
197. Applicability of the Provisions of Section 196 to
whom: Section 196 deals with the appointment of
436
 Managerial Personnel and is applicable to private
companies and public companies both while section 197
which deals with remuneration payable to managerial
personnel is applicable to public companies only.
Schedule V is partly applicable to private companies (i.e.
in relation to Part I that deals with appointment) and partly
not applicable to private companies (i.e. Part II that deals
with remuneration)
DEFINITION AND COMPOSITION OF WORD MANAG
ERIAL REMUNERATION : The managerial remuneration
shall be payable to a person appointed within the meaning
of section 196 of the Companies Act, 2013. Under the
Companies Act, 2013 the provisions of payment of
managerial remuneration are governed by Section 197,
198, 199 and Schedule V. The word remuneration is
defined under section 2 (78) of Companies Act,
2013 which says that “remuneration”

means any money or its equivalent is given or passed to any

person for services rendered by him and includes perquisites
as defined under the Income Tax Act, 1961. Section 17(2) of
Income Tax Act, 1961 has given an inclusive definition of the
term “perquisite”. This clause comprises of eight sub-clauses
followed by two provisos, and they deal with the following
perquisites: 1. Value of rent-free accommodation provided to
the assessee by his employer. 2. Value of any concession in
respect of rent respecting any accommodation provided to
the assessee by his employer. 3. The value of any benefit or
amenity granted or provided free of cost or at a concessional
rate to employee directors; or to employees who have a
substantial interest and certain specified employees with
some exceptions. 4. Sums paid by the employer in respect
of any obligation which, but for such obligation, would have
been payable by the assessee. 5. Sums payable by the
employer to effect an assurance on the life of the assessee–
employee or to effect a contract for an annuity. 6. W.E.F
assessment year 2010-11, value of securities / sweat equity
shares allotted or transferred by the employer or former
437
employer to the employee. 7. W.E.F assessment year 2010-
11 a contribution made by an employer to an approved
superannuation fund to the extent it exceeds Rs 1 lakh. 8.
Value of any other fringe benefit or amenity as may be
prescribed. 9. The first proviso states that certain medical
benefits are not treated as perquisites in certain specific
situations. Any expenditure incurred by the Company to
affect any insurance on the life of, or to provide any pension,
annuity or gratuity for, any of the persons aforesaid or
spouse or child shall be included in managerial
remuneration. We can say that definition of remuneration, as
well as perquisites, are inclusive in nature and hence it
covers every amount that the company pays or spends for or
for the benefit of a Director, in whatever form and by
whatever name. Moreover, any remuneration for services
rendered by any such director which are of professional
nature shall not be included in the managerial remuneration.
Further, a director may receive remuneration by way of a fee
for each meeting of the Board, or a committee thereof
attended by him. Where if insurance is taken by a company
on behalf of its Key Managerial Personnel for indemnifying
against any liability in respect of any negligence, default,
misfeasance, breach of duty or breach of trust for which they
may be guilty in relation to the company, the premium paid
on such insurance shall not be treated as part of
remuneration. But if such Key Managerial Personnel is found
guilty then such insurance shall be treated as income part of
remuneration. If a manager or any director enjoys benefit or
amenity without the company incurring any expenditure
therefor, such benefit or amenity may not be included in the
managerial remuneration. An Independent director shall not
be entitled to receive stock option. However, in the case of
other directors, Stock options would be part of remuneration.

438
THREE WAYS TO MANAGERIAL REMUNERATION:

1. Automatic Route by Profits.

2. Shareholders’ Approval Route for more.

3. Shareholders’ and Central Government for even more.

REMUNERATION ALLOWED TO MANAGERIAL

PERSON: Section 197 of the Companies Act, 2013 provides
a way to pay managerial remuneration in case of Company’s
having adequate profits. A Public Company can pay
remuneration to its directors including Managing Director s
and Whole-time Directors, and its managers which shall not
exceed 11% of the net profit as calculated in a manner laid
down in section 198 of the Companies Act, 2013. Wherein a
Company in which there is one Managing Director; Whole-
time Director or manager the remuneration to be payable
shall not exceed 5% of net profits and where there are more
than one of such Directors remuneration payable shall not
exceed 11 % of the net profit.

439
 MAXIMUM REMUNERATION PAYABLE BY A COMPANY
TO ITS MANAGERIAL PERSONNEL: If a Company wants
to pay remuneration in excess of the above limit payable
then a Company shall have to follow Schedule V of the
Companies Act, 2013.

(B) No approval is required if all the conditions are

fulfilled:
- A managerial person is functioning in a professional
capacity
- Such managerial person is not having any interest in the
capital of the company or its holding company or any of its
subsidiaries directly or indirectly or through any other
statutory structures
- Such person is not having any, direct or indirect interest
or related to the directors or promoters of the company or its
holding company or any of its subsidiaries at any time during
the last two years before or on or after the date of
appointment
- Such person possesses graduate level qualification with
expertise and specialized knowledge in the field in which the
company operates.
Provided that any employee of a company holding shares of
the company not exceeding 0.05% of its paid-up share capital
shall be deemed to be a person not having any interest in the
capital of the company; A company with inadequate profit may
pay to its managing director or whole-time director 200% of the
above mentioned managerial remuneration if shareholders
have given their approval through a special resolution. Where
the managerial person who is not holding Rs 5 lacs worth of
shares or more or an employee or a director of the company
not related to any director or promoter at any time during the
two years prior to his appointment as a managerial person, In
such cases, the company can pay to him up to maximum of
2.5% of the “current relevant profits” and up to 5% with the
440
approval of shareholders by a special resolution. For the
purpose of this section, “current relevant profit” means profit
calculated under section 198 but without deducting the excess
of expenditure over income as defined in section 4(1) of section
198 relating to all usual working charges in respect of those
years during which the managerial person was not an
employee, director or shareholder of the company or its holding
and subsidiary companies.

However, Section IV Part II of Schedule V states that a

managerial person shall be eligible for the following perquisites
which shall not be included in the computation of the ceiling on
remuneration specified in Section II and Section III:—

(a) Contribution to provident fund, superannuation fund or

annuity fund to the extent these either singly or put together are
not taxable under the Income-tax Act, 1961 (43 of 1961);
(b) Gratuity payable at a rate not exceeding half a month’s
salary for each completed year of service; and
(c) Encashment of leave at the end of the tenure.
Looking at clause (a) above, it is clear that any contribution
made to provident fund, superannuation fund or annuity fund in
excess of taxable limits under IT Act, 1961 shall not be included
for the purpose of calculation of managerial remuneration in the
event of inadequate profits or nil profits. The law herein clearly
prescribes what value of perquisites shall not be considered as
part of remuneration in cases of inadequate profits. Further,
had the intent of law been to include only taxable amount of
perquisites in the definition of ‘remuneration’ under section
2(78), then this clause would have been rendered meaningless.
Thus, one can safely presume that where the intent was to
specifically cover taxable value of perquisites law has been
drafted clearly.

Therefore, to conclude, for the purpose of calculation of

remuneration:
441
i. in the event of adequacy of profits – the entire value of
perquisites as per IT Act, 1961 will have to be considered.
ii. in the event of inadequacy of profits of nil profits - only the
taxable amount of perquisites should be considered. This is
relevant only in case of managerial person. While an expatriate
managerial person shall be eligible for the following which shall
not be considered in the definition of remuneration under
ScheduleV:
a) Children’s education allowance
b) Holiday package studying outside India or family staying
outside India
c) Leave travel concession

If any of such directors receive any amount in excess of limits

mentioned under the provisions of the Act, he shall refund such
sums to the company and until such sum is refunded, hold it in
trust for the company. Further, if a Company wants to pay
remuneration exceeding Schedule V of the Act then it shall
require a Central Government approval. Section 197 of the
Company Act 2013 also does not bar a managing or whole-
time director of a company to receive compensation from its
holding company or subsidiary provided the same should be
disclosed in the director’s report.

Meaning of Effective Capital:

For the purpose of Section 197 of Companies Act’ 2013, the

term “Effective Capital” means:
• The aggregate of paid up share capital (excluding share
application money pending allotment),
• Share premium,
• Reserves and Surplus excluding Revaluation Reserve,

442
• Long term loans and deposits repayable after one year, as
reduced by –
• The aggregate of investments (except investments made by
an investment company whose principal business is dealing in
shares, stocks, debentures or any other securities),
• Accumulated losses, and • Preliminary expenses not written
off

This is also important to know as to when the effective capital

should be calculated for the purpose of payment of managerial
remuneration. In this regard, the following should be noted:
1. If the appointment of managerial person is made in the year
in which the company is incorporated, then the effective capital
should be calculated on the date of appointment of such
managerial person.
2. In case other than above, the effective capital should be
calculated on the last day of the Financial Year immediately
preceding the Financial Year in which the appointment of
managerial person is made.

PROFIT OR INADEQUATE PROFIT IN SPECIAL

CIRCUMSTANCES–
In certain special circumstances, a company suffering from no
profit or inadequate profit may pay managerial remuneration in
excess of limits specified in Section II above and that too
without the approval of Central Government. Those
circumstances are specified below:
1. 1. The company paying managerial remuneration in excess
of maximum specified limits is either a foreign company or a
company who has got approval of its shareholders in this
regard and the total managerial remuneration payable by such
company is within the permissible limits of Section 197 of
Companies Act’2013.
2. Where the company is:
443
 • A newly incorporated company and is in existence for last
seven years from the date of its incorporation, or
• A sick company in respect of which a scheme for revival and
rehabilitation has been ordered by BIFR or NCLT for a period of
five years from the date of sanction of revival scheme
• It may pay managerial remuneration up to two times of the
amount specified in Section II, given above.
3. Where such excess managerial remuneration is fixed by
BIFR or NCLT, subject to fulfilment of certain additional
conditions apart from that given in Section 197 of Companies
Act’2013

RESTRICTION ON INDEPENDENT DIRECTOR:

Section 197(5) of the Act 2013 specifically permits different
fees to be paid to Independent Directors, there is no such
enabling provision with respect to profit related commission.
This means profit related commission may be paid uniformly to
all non-executive directors. A company may pay such
commission within the limit of 1% or 3% of the net profits, as
the case may be. Further, Independent Directors cannot be
granted stock options. A company in or resident in India, to
make payment in rupees to its non WTD who is resident
outside India and is on visit to India for the company’s work and
is entitled to payment of sitting fees or commission or
remuneration, and travel expenses to and from and within
India, in accordance with the provisions contained in the
company’s MOA & AOA or in agreement entered into by it or in
any resolution passed by the company in general meeting or by
Board, provided the requirements of any law, rules, regulations,
directions applicable for making such payments are duly
complied with.

MINIMUM REMUNERATION IN CASE

OF LOSSES DURING THE TENURE OF
MANAGERIAL PERSONNEL:

444
According to Departmental Clarification regarding amendments
made by the Companies (Amendment) Act, 1988 as revised
w.e.f. 1993, the Approval of Central Government shall not be
required in case of loss or inadequacy of profit during the
tenure of Managerial Person were the appointment was made
and minimum remuneration paid was strictly in accordance with
Schedule XIII of the 1956 Act.
DEVALUATION AND MANAGERIAL
REMUNERATION:
A non-resident Indian may occupy the position of managerial
person in certain companies, it has been examined by foreign
exchange, taxation, Company Law and other aspects and was
accordingly decided as a matter of policy that, in case of
devaluation of currency there was a need to compensate such
non-resident managerial persons to maintain these remittances
at the pre-devaluation level and such increase in remuneration
is allowed even if the resultant increased remuneration exceeds
the statutory limits imposed by the Companies Act.
REMUNERATION PAYABLE TO A MANAGERIAL PERSON
IN TWO COMPANIES:

Subject to the provisions of sections I to IV, a managerial

person shall draw remuneration from one or both companies,
provided that the total remuneration drawn from the companies
does not exceed the higher maximum limit admissible from any
one of the companies of which he is a managerial person.

PENALTY CLAUSES:
If any person contravenes the provisions of section 197, he
shall be punishable with fine which shall not be less than one
lakh rupees and may extend to five lakhs rupees If a company
or any officer of a company or any other person contravenes
any of the provisions of this Act or the rules made thereunder,
the company and every officer of the company who is in default
or such other person shall be punishable with fine which may

445
extend to ten thousand rupees, and where the contravention is
continuing one, with a further fine which may extend to one
thousand rupees for every day after the first during which the
contravention continues.

446
Corporate
Legal
Environment
PART -2
Contents
SEBI: Objectives, Status, Powers, Guidelines issued by
SEBI Regarding Disclosure and Investor Protection with
Reference to Pre-issue Obligations. IP: Limited Liability
Partnership-Incorporation, Conversion, winding up

447
  Securities And Exchange Board Of India - SEBI
SEBI

What is the 'Securities And Exchange Board Of India -

SEBI'

The Securities and Exchange Board of India (SEBI) is the most

important regulatory body of the securities market in the
Republic of India.

BREAKING DOWN 'Securities And Exchange Board Of India -

SEBI'

The Securities and Exchange Board of India was established

as a non-statutory regulatory body in the year 1988, but it was
not given statutory powers until January 30, 1992, when the
Securities and Exchange Board of India Act was passed by the
Parliament of India. Its headquarters is at the business district
at the Bandra Kurla Complex in Mumbai, but it also possesses
Northern, Eastern, Southern and Western regional branch
offices in the cities of New Delhi, Kolkata, Chennai and
Ahmedabad, respectively. It also has small local branch offices
in Bangalore, Jaipur, Guwahati, Bubaneshwar, Patna, Kochi,
and Chandigarh.

The Securities and Exchange Board of India (SEBI) supplanted

the Controller of Capital Issues, which hitherto had regulated
the securities market in India, as per the Capital Issues
(Control) Act of 1947, one of the first acts passed by the
Parliament of India following its independence from the British
Empire. It is run by its own members, which consist of the
Chairman, who is elected by the Parliament of India, two
officers from the Union Finance Ministry, one member from the
Reserve Bank of India and five members who are elected by
the Parliament with the Chairman.

SEBI in India is similar to the Securities and Exchange

Commission (SEC) in the U.S.
448
Pros and Cons of SEBI

The Securities and Exchange Board of India’s stated

objective is “to protect the interests of investors in securities
and to promote the development of, and to regulate the
securities market and for matters connected therewith or
incidental thereto.” According to its charter, it is expected to be
responsible to three main groups: the issuers of securities,
investors, and market intermediaries. The body has somewhat
nebulous powers, as it drafts regulations and statutes in its
legislative capacity, passes rulings and orders in its judicial
capacity, and conducts investigation and enforcement actions
in its executive capacity.

Many criticize the regulatory body because it is insulated from

direct accountability to the public. The only mechanisms to
check its power are a Securities Appellate Tribunal, which
consists of a panel of three judges, and a direct appeal to the
Supreme Court of India. Fortunately for the people of India, the
SEBI has been mostly benevolent in its use of its authority,
issuing strong systematic reforms rapidly and aggressively with
its unchecked power. For example, after the Great Recession
of 2008 and the Satyam Fiasco, the SEBI was able to quickly
take regulatory steps to mitigate the effects of these problems,
stabilize the economy and take drastic steps to make sure such
situations never occurred again.

 Securities and Exchange Board of India

(SEBI): Purpose, Objectives and Functions
The Securities and Exchange Board of India was established
as an interim administrative body on 12 April 1988 by the
Government of India.Its main objective was to promote

449
orderly and healthy growth of securities and to provide
protection to the investors.

The Ministry of Finance of the Government of India has

overall administrative control over its functions. On 30th
January 1992, it was given a statutory status through an
ordinance, which later on was replaced by Act of Parliament
known as Securities and Exchange Board of India Act, 1992.
SEBI is considered as watchdog of the securities market.

 Reasons for the Establishment of SEBI:

During 1980s, there was tremendous growth in the capital

market due to increasing participation of public. This led to
many malpractices like Rigging of prices, unofficial premium
on new issues, violation of rules and regulations of stock
exchanges and listing requirements, delay in delivery of
shares etc. by the brokers, merchant bankers, companies,
investment consultants and others involved in the securities
market.

This resulted in many investor grievances. Because of lack

of proper penal provision and legislation, the government
and the stock i exchanges were not able to redress these
grievances of the investors. This (necessitated a need for a
separate regulatory body, and hence Securities and
Exchange Board of India was established.

 Purpose and Role of SEBI:

The main objective is to create such an environment which

facilitates efficient mobilization and allocation of resources
through the securities market. This environment consists of
rules and regulations, policy framework, practices and
infrastructures to meet the needs of three groups which
mainly constitute the market i.e. issuers of securities
(companies), the investors and the market intermediaries.

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(i) To the Issuers:

SEBI aims to provide a market place to the issuers where

they can confidently look forward to raise the required
amount of funds in an easy and efficient manner.

(ii) To the Investors:

SEBI aims to protect the right and interest of the investors by

providing adequate, accurate and authentic information on a
regular basis.

(iii) To the Intermediaries:

In order to enable the intermediaries to provide better service

to the investors and the issuers, SEBI provides a
competitive, professionalised and expanding market to them
having adequate and efficient infrastructure.

Objectives of SEBI:

Following are the main objectives of SEBI:

1. Protection:

To guide, educate, and to protect the rights and interests of

the investors.

2. Competitive and Professional:

To make the intermediaries like merchant bankers, brokers

etc. competitive and professional by regulating their activities
and developing a code of conduct.

3. Prevention of Malpractices:
To prevent trading malpractices.

4. Balancing:

To establish a balance between statutory regulation and self

regulation by the securities industry.
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5. Orderly Functioning:

To promote orderly functioning of stock exchange and

securities industry by regulating them.

Functions of SEBI

The functions of SEBI can be divided into three parts

viz:

(1) Regulatory function

(2) Development Function &

(3) Protective function.

1. Regulatory Functions:

Regulatory functions of SEBI are as follows:

(a) Registration of Brokers and Agents:

It registers brokers, sub-brokers, transfer agents, merchant

banks etc.

(b) Notifications of Rules and Regulations:

It notifies rules and regulations for the smooth functioning of

all intermediaries in the securities’ market.

(c) Levying of Fees:

It levies fees, penalties and other charges for contravening

its directions and orders.

(d) Regulator of Investment Schemes:

It registers and regulates collective investment schemes and

mutual funds.

(e) Prohibits Unfair Trade Practices:

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SEBI prohibits fraudulent and unfair trade practices.

(f) Inspection and Enquiries:

It undertakes inspection and conducts enquiries & audit of

stock exchange

(g) Performing and Exercising Powers:

It performs & exercises such powers under Securities

Contracts (Regulation) Act 1956, as have been delegated to
it by the Government of India.

2. Development Functions:

Development functions of SEBI are as under:

(a) Training to intermediaries:

It promotes training of intermediaries of the securities.

(b) Promotion of fair trade:

It promotes fair trade practices by making underwriting

optional.

(c) Research:

It publishes information useful to all market participants for

conducting research.

3. Protective Functions:

Protective Functions of SEBI are as under:

(a) Prevents Insider Trading:

It does so by prohibiting insiders such as directors,

promoters etc. to make profit through trading of securities
using confidential price sensitive information.

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(b) Prohibits Fraudulent and Unfair Trade Practices:

It prohibits fraudulent and unfair trade practices in the

security market, such as price rigging and sale or purchase
of securities through misleading statements.

(c) Promotes Fair Practices:

It promotes fair practices and code of conduct in the

securities market e.g. it looks after the interests of the
debenture holders in terms of any mid-term revision of
interest rates etc.

(d) Educates Investors:

It educates the investors through campaigns.

What is the Securities and Exchange Board of India?

The Securities and Exchange Board of India, also referred

to as the SEBI is similar to the United States Securities and
Exchange Commission. They are the governing body for
financial regulations in India. The SEBI is responsible for
maintaining a stable investment and financial market for
India. The board was established in 1988 but not given any
regulating abilities until 1992 when the Securities and
Exchange Board of India Act passed. The SEBI
headquarters are in Mumbai, and the board is headed by
eight members.

Organization Structure

The SEBI is a corporate structure with five departments that

have a department head. It has two advisory committees that
are responsible for primary and secondary markets. These
two committees advise the Securities and Exchange Board
of India on regulating intermediaries, issuing of securities in
the primary market, disclosure requirements of companies,
any changes in legal framework, and regulating and
developing the secondary stock exchange. While the
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committees provide advice, they cannot enforce any
changes.

Functions

The SEBI utilizes three functions to meet its

objectives, protective, developmental, and regulatory. The
primary functions have been defined in the SEBI Preamble
that states the Securities and Exchange Board of India must
'protect the interest of investors in securities and to promote
the development of, and to regulate the securities market
and matters connected there with or incidental there to.' Due
to malpractice in the stock market, the SEBI was formed to
regulate and prevent any further fraudulent activities that are
not in the best interest of the investors. Below are a few
examples of some of SEBI's functions:

 Regulating the business in stock exchanges and other

securities exchange markets.
 Registering and regulating the work of stock brokers and
other intermediaries that may have an association with
securities markets.
 Prohibit fraudulent and unfair trade activities within the
securities market.

 What are the Main Objectives of SEBI?

The main objectives of SEBI are:
(1) Regulation of Stock Exchanges:
The first objective of SEBI is to regulate stock exchanges so
that efficient services may be provided to all the parties
operating there.
(2) Protection to the Investors:
The capital market is meaningless in the absence of the
investors. Therefore, it is important to protect the interests of
the investors.

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The protection of the interests of the investors means
protecting them from the wrong information given by the
companies in their prospectus, reducing the risk of delivery
and payment, etc. Hence, the foremost objective of the SEBI
is to provide security to the investors.
(3) Checking the Insider Trading:
Insider trading means the buying and selling of securities by
those people’s directors Promoters, etc. who have some
secret information about the company and who wish to take
advantage of this secret information.
This hurts the interests of the general investors. It was very
essential to check this tendency. Many steps have been
taken to check inside trading through the medium of the
SEBI.
(4) Control over Brokers:
It is important to keep an eye on the activities of the brokers
and other middlemen in order to control the capital market.
To have a control over them, it was necessary to establish
the SEBI.
 Objectives of SEBI
SEBI (Securities And Exchange Board of India) is the
regulator for the securities market in India. The
key objective of SEBI is to encourage healthy and
organised growth of the securities market in India and to
provide investor protection. It was formally set up by The
Government of India in 1988 and given statutory powers in
1992.
What are the Main Objectives of SEBI?
Investor Protection
Without active investors, the capital market is worthless. For
that reason, it is essential to safeguard the interests of the
investors. The protection of the interests of investors implies
shielding them from erroneous information provided by the
businesses, lowering the likelihood of default, etc. Thus, the

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top objective of the SEBI (Securities And Exchange Board of
India) is to offer security to the investors.
Regulation of Stock Markets
SEBI regulates the stock markets to ensure that effective
services are offered to all the parties involved like brokers,
merchant bankers, and other intermediaries to promote
professionalism. Moreover, it also has to ensure fair
practices.
Checking for Insider Trading
Insider trading means the trading of a company’s securities
by individuals (like directors, promoters, etc) with access to
non-public information about the company. These people
have access to secret information about the company. This
harms the interests of the common investors. In a number of
countries insider trading is illegal. The reason being that it is
unfair to other investors who do not have access to the
information. Quite a few steps have already been taken to
check insider trading by SEBI.
Control over Financial Intermediaries
It is essential to keep close track of the activities of the
brokers and other intermediaries in order to regulate the
capital markets.
Since its creation, SEBI (Securities And Exchange Board
of India) has been working towards the achievement of its
objectives with commendable zeal. The advancements in the
securities markets like capitalization
requirements, margining, establishment of clearing
organizations etc. has decreased the risk of default.
In a nutshell, we can say that the objectives of SEBI are to
protect the investors, regulate stock exchanges & financial
intermediaries and encourage healthy growth and
development of capital market in India.
SEBI is identical to the U.S. SEC and is an important
element in strengthening the quality of the stock markets in

457
 India. SEBI has relished good results as a regulator by
driving organized reforms. It is acknowledged for fast
movement towards making the stock markets electronic and
paperless. It has additionally been a key player in taking fast
and useful steps in light of the international turmoil and the
Satyam disaster.
In October 2011, it improved the level and amount of
disclosures to be made by Indian businesses. Considering
the worldwide crisis, it liberalised the takeover code to aid
investments. It has raised the application limit for retail
individuals to Rs 2 lakh, from Rs 1 lakh at the moment.

SEBI : Functions, Powers and

Objectives
SEBI (Securities and Exchange Board of India) is an apex
institution for investment in India. Let's know about functions
of SEBI :

Functions of SEBI:
We can classify the functions of SEBI into three categories:-

1. Protective functions
2. Developmental functions
3. Regulatory functions
1. Protective Functions:
As the name suggests, the main focus of this function of SEBI
is to protect the interest of investor and security of their
investment

As protective functions SEBI performs following functions:

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(i) SEBI checks Price Rigging:
Price Rigging means some people manipulate the prices of
securities for inflation or depressing the market price of
securities. SEBI prohibits such practice to avoid fraud and
cheating which can happen to any investor.

(ii) SEBI prohibits Insider trading:

Any person which is connected with a company such as
directors, promoters, workers etc is called Insiders. Due to
working in the company they have sensitive information which
affects the prices of the securities.Such information is not
available to people at large but Insider gets this key full
knowledge by working in such company. Insider can use this
information for their personal benefits or make a profit from it,
such process is known as Insider Trading.

For Example - Managers or Directors of a company may know

that company will issue Bonus shares to its shareholders at a
particular time and they purchase shares from market to make
a profit with bonus issue.

SEBI always restricts these types of practices when

Insiders are buying securities of the company and take strict
action to avoid this in future.

(iii) SEBI prohibits fraudulent and Unfair Trade Practices:

SEBI always restricts the companies which make misleading
statements which are likely to induce the sale or purchase of
securities by any other person.

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(iv) SEBI sometimes educate the investors so that become able
to evaluate the securities and always invest in profitable
securities.

(v) SEBI issues guidelines to protect the interest of debenture

holders.

(vi) SEBI is empowered to investigate cases of insider trading

and has provision for stiff fine and imprisonment.

(vii) SEBI has stopped the practice of allotment of preferential

shares unrelated to market prices.

(vii) SEBI has stopped the practice of making a preferential

allotment of shares unrelated to market prices.

2. Developmental Functions:
Under developmental categories following functions are
performed by SEBI:

(i) SEBI promotes training of intermediaries of the securities

market.

(ii) SEBI tries to promote activities of stock exchange by

adopting a flexible and adaptable approach in following way:

(a) SEBI has permitted internet trading through registered stock

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brokers.

(b) SEBI has made underwriting optional to reduce the cost of

issue.

(c) An Even initial public offer of primary market is permitted

through the stock exchange.

3. Regulatory Functions:
These functions are performed by SEBI to regulate the
business in stock exchange. To regulate the activities of stock
exchange following functions are performed:

(i) SEBI has framed rules and regulations and a code of

conduct to regulate the intermediaries such as merchant
bankers, brokers, underwriters, etc.

(ii) These intermediaries have been brought under the

regulatory purview and private placement has been made more
restrictive.

(iii) SEBI registers and regulates the working of stock brokers,

sub-brokers, share transfer agents, trustees, merchant bankers
and all those who are associated with stock exchange in any
manner.

(iv) SEBI registers and regulates the working of mutual funds

etc.

(v) SEBI regulates takeover of the companies.

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(vi) SEBI conducts inquiries and audit of stock exchanges.

Other Functions
1. Registering and regulating the working of stock brokers, sub-
brokers, share transfer agents, bankers to issue, trustees of the
trust deed, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment adviser and such
other intermediaries who may be associated with securities
markets in any manner.

2. SEBI also perform the function of registering and regulating

the working of depositories, custodians of securities. Foreign
Institutional Investors, credit rating agencies etc.

3. Registering and regulating the working of Venture Capital

Funds and collective investments schemes including mutual
funds.

4. Promoting and regulating self - regulatory organizations.

5. Calling for information form, undertaking inspection,

conducting inquiries and audits of the stock exchange, mutual
funds and intermediaries and self - regulatory organizations in
the securities market.

6. Calling for information and record from any bank or any other
authority or boars or corporation established or constituted by
or under any Central, State or Provincial Act in respect of any
transaction in securities which are under investigation or inquiry
by the Board.

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7. Conduct research on any matter described if any.

8. Calling information from any agency, institution, banks etc.

 What is SEBI?
In 1980’s there were huge malpractices and frauds emerging in
the stock market of India. This was due to huge sudden cash
flow in the market. Everyone wanted to get rich very quickly by
finding loopholes in the system. Most prominent of these frauds
was price rigging. Insult to the injury was that there was no
authority to listen to grievances of traders and investors. This
situation created a grey-area and forced many traders and
investors shirk from the stock market. Union Government of
India noticed this decrease of figures and decided to form an
organization which can help recover the decrease in the
financial market of India.

Securities and Exchange Board of India (SEBI) was established

in 1988. Primary role at that time was to observe the market but
SEBI had no power to control anything. It was a non-statutory
body. To give it powers, Union Government of India passed
SEBI Act 1992. On 12 April 1992 SEBI became an autonomous
body with statutory powers.

Organizational Structure of SEBI

There are main 9 (nine) members on the SEBI Board.

1. One chairman appointed by Government of India

2. Two members are officers from Union Finance Ministry
3. One member from Reserve Bank of India (RBI)
4. Five members are appointed by Union Government of
India. Out of these five, three are whole-time members

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Objectives of SEBI

1. To provide a transparent and healthy platform for

corporates to raise funds from the financial market
2. To create and enforce bye-laws for corporates and
financial intermediaries
3. To protect the rights of investors and ensure the safety of
their investment
4. Listen and provide a support system for investor
grievances
5. Promote and develop the financial market of India

What is the main role of SEBI in financial market of India?

SEBI was established to regulate the financial market of

India. To achieve this objective, it takes care of three most
important entities of financial market viz.

1. Issuers of securities

These are corporate entities which raise funds from the

financial market. SEBI ensures that they get a transparent
and healthy environment for their needs.

2. Investor

These are the ones who keep the financial market alive. They
earn from these markets thus it is the responsibility of SEBI to
ensure that investors don’t fall prey to any manipulation or
fraud in the market.

3. Financial Intermediaries

These intermediaries act as a mediator in the financial

market. Their presence brings smoothness and safety in
financial transactions.
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⇯

SEBI Functions

SEBI’s Preamble describes in detail the functions and powers

of the board. Its Preamble states that SEBI must “protect the
interests of investors in securities and to promote
the development of, and to regulate the securities market and
for matters connected there with or incidental there to.”

Its functions can be divided in three parts viz

1. Protective functions

SEBI performs the following functions to provide a safe and

transparent environment for investors, who keep the financial
market alive. These protective functions are –

i. Prevent price rigging

One of the most important objectives behind the

establishment of SEBI was to stop manipulated huge
fluctuations in the financial market. Fluctuations are actually
the basis to trade and earn money in the financial market for
traders/investors. In-fact by studying historical fluctuations,
several theories have emerged to predict the trend. These
theories are collectively called as Technical Analysis (TA) and
today very popular among traders. Usually, these fluctuations
are natural but sometimes sudden fluctuations are fixed
already by a group of the corporates leading to a huge loss
for investors/traders. These fixed fluctuations are called price
rigging/price fixing/collusion. SEBI keeps strict surveillance to
prevent such price riggings. Introduction of circuits is one of
them. A circuit is defined as a threshold with respect to
previous day closing. If a security price goes beyond this

465
defined circuit (threshold), a circuit breaker comes into action
and trading on that security is halted for some time or the
whole day.

ii. Prohibit insider trading

This can be seen as a part to prevent price rigging. A

company’s stock price fluctuation is highly affected by any
public news/announcement about that company. Obviously,
any forthcoming public news/announcement is already
accessible by some persons in the company. What if they
take advantage of this coming news/announcement by buy-
sell company’s security beforehand. This is called insider
trading. To prevent insider trading, SEBI has barred trusts of
listed companies and employee welfare schemes from
purchasing their own shares from the secondary
markets. SEBI also asks listed companies to disclose all their
existing employee benefit schemes involving the stock
purchase and align them in accordance with its ESOS and
ESPS guidelines within a given timeframe.

iii. Financial education for Investors

SEBI conducts various online and offline seminars through

various mediums to educate the traders and investors. This
education starts from basics of financial market and covers
money management as well.

i. SEBI guidelines

There are several other unfair practices which can be used by

the corporates and others to manipulate security markets.
SEBI makes sure that these are prevented beforehand by
enforcing its bye-law guidelines.

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 2.Developmental functions

Developmental functions refer to the SEBI initiatives which

bring fresh breathe and innovations in Indian financial
market. Developmental functions include but not limited to

1. Introduction of electronic platform for financial market

2. DEMAT form of securities

3. Introduction of Discount brokerage

4. Training for financial intermediaries

5. Buy-sell mutual funds directly from AMC through a broker

6. Underwriting is optional to reduce the cost of issue

7. IPO is permitted through exchange

3.Regulatory functions

Regulatory functions refer to enforcement of SEBI bye-laws

to financial intermediaries and corporates. This ensures
that stock market will run smoothly with transparency. This
function includes –

1. SEBI has designed guidelines and code of conduct that

are enforced to financial intermediaries and corporates.
2. SEBI registers all the intermediaries, share transfer
agents, trustees and all those who are associated
with the stock exchange in any manner.
3. SEBI registers and regulates the functioning of
mutual funds.
4. SEBI regulates takeover of companies.
5. Conduct inquiries and audit of exchanges.

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  Powers of Central Government (SEBI) over
Stock exchanges
1. Periodical Returns: All recognized stock exchanges have to
submit periodical returns with regard to its activities to SEBI.

2. Preservation of Books of Accounts: Books of Accounts,

for a period of 5 years have to be preserved by members as
well as Stock exchanges.

3. The Books of Accounts can be inspected by SEBI at any

time.

4. Any information can be sought: SEBI can call for

additional information or explanation from any stock exchange
or any member with regard to any matter.

5. SEBI can appoint one or more persons for making

enquiry regarding the affairs of the governing body of stock
exchange or any member of the stock exchange and submit a
report within the specified time.

6. During such enquiry, every individual in the stock exchange

will have to submit documents pertaining to the stock
exchange and furnish whatever information called for.

7. Stock exchanges should furnish a copy of its annual

report to SEBI.

8. Restriction of voting rights: Any restrictions imposed on

the voting rights of the members or any regulation in the voting
rights or any restriction in the right of any member by the Stock
exchange will be valid only when it is approved by SEBI.

9. SEBI can direct all or any particular stock exchanges to

make rules or amend rules after an inquiry being conducted on
the affairs of the stock exchange.

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10. When a stock exchange fails to comply with the orders of
SEBI, then the government may stipulate time for
complying with the conditions.

 SEBI: Powers and Functions to regulate

Security Market in India
The Securities and Exchange Board of India is the regulatory
body for dealing with all matters related to the development
and regulation of securities market in India. It was
established on 12th of April in 1988. It is headquartered in
Mumbai. SEBI was declared a constitutional body in 1992. At
present, Ajay Tyagi is the Chairperson of SEBI.

Organizational Structure of SEBI

SEBI is managed by the six members-one chairman

(nominated by the chairman), two members from office of
central ministries, one from RBI, and remaining to members
are nominated by the central government.

The main functions of SEBI are summarized below

1. To protect the interests of investors and to make

regulations to drive the capital market.
469
2. To regulate the share markets and other security
exchanges.
3. To control the working of share brokers, sub brokers,
share transfer agents, merchant bankers, underwriters,
portfolio managers etc. and also to make their registration.
4. To guide the employees and individuals related with the
security exchanges and to encourage healthy competition in
the security markets.
5. To eliminate corruption in the security markets.
6. To register the mutual fund securities and keep an eye on
their activities in the market.
7. To arrange training programmes for new investors. (also
printing of training booklets)
8. To eliminate the insider trading activities.
9. To supervise the working of various organizations trading
n the security market and also to ensure systematic
dealings.
10. To increase research and investigation in order to
achieve above objectives.

Microfinance Institutions in India

Powers of SEBI

1. For the discharge of its functions efficiently, SEBI has

been vested with the following powers:
2. To approve by−laws of stock exchanges.
3. To require the stock exchange to amend their by−laws.
4. To inspect the books of accounts and call for periodical
returns from recognized stock exchanges.
5. To inspect the books of accounts of financial
intermediaries.
6. To compel certain companies to list their shares in one or
more stock exchanges.
7. Registration of brokers.

So it can be conclude that all statutory powers for regulating

Indian capital market are vested with SEBI itself. SEBI

470
releases its annual guidelines for the all participants of the
security market so that fair and smooth functioning of the
security market can be ensured.

 SEBI: What is SEBI, Powers, Role and

Functions of SEBI
For every stock market across the world, there is a watchdog
which keeps a close eye on the market activities to ensure
that the interests of every participants are not impacted by
frivolous activities of any other participants. In India, SEBI
has been created to ensure that the market activities are free
and fair.

The following article tries to answers following questions

usually posed by readers:

 Introduction on SEBI & What is SEBI

 When was SEBI established

 Full form of SEBI and Meaning of SEBI

 SEBI Chairman and Organization Structure

 Role and Functions of SEBI

 Powers of SEBI

Introduction on SEBI & What is SEBI:

SEBI is a market regulator which tries to create a balance in
the day to day stock market activities and for this there are
regulatory frameworks established by SEBI. There are 17
exchanges currently operational in Indiaand all exchanges,
including NSE and BSE are regulated by SEBI guidelines.
Securities and exchange Board of India has headquarters in
Mumbai, and has regional offices in New Delhi, Kolkata,

471
Chennai and Ahmedabad. SEBI has also opened local
offices in Jaipur, Bangalore, Guwahati, Bhubaneswar, Patna,
Kochi and Chandigarh.
SEBI has also commenced regulating the commodity
derivatives market under the Securities Contract Regulation
Act (SCRA) 1956 with effect from September 28 2015, and
the Forward Contracts Regulation Act (FCRA) 1952 got
replaced with effect from September 29 2015.

When was SEBI established:

SEBI was established in the year 1988 and subsequently
was given the constitutional validity on 30th January 1992 by
Government of India by passing the SEBI Act, 1992 in the
parliament of India.

Full form of SEBI and Meaning of SEBI:

Full form of SEBI is Securities and Exchange Board of
India and the existence of SEBI means that any unwanted
market activities won’t be allowed to occur so easily.

Who is the current chairman of SEBI and SEBI

Organization Structure:

Ajay Tyagi was appointed as the chairman on 10th January

2017 and took over as the head on 1st March 2017 by
replacing U.K. Sinha.

The SEBI has 7 board members with following structure.

 The Chairman who is nominated by the Union

Government of India.

 Two members from the Union Finance Ministry

 One member from the Reserve Bank of India

 The remaining 5 members are nominated by the Union

Government of India, out of them

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SEBI has to be responsive to 3 groups which constitute the
market:

 The issuer of securities

 The investor

 The market intermediaries

Powers of SEBI:

 To regulate and approve by-laws of stock exchanges

 Inspect the books of accounts of recognized stock

exchanges and call for periodical returns

 Inspect the books of financial Intermediaries.

 Compel certain companies to get listed on one or more

stock exchanges

 To handle the registration of brokers

Role and Functions of SEBI:

 Primary Markets: SEBI has regulated the primary market

through

1. The regulation of issuers’ access to market

2. Regulation of information production at the time of issue

3. Regulation of processes and procedures relating to

issuance of securities

 Disclosure: Disclosure standards are not limited to

accounting information but was extended to other issue
related communications such as advertisements.

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  Corporate Governance: SEBI has made a constant effort
to improve the standards of Corporate Governance in
India.

 Settlement Systems

 Dematerialization of securities

 Institutionalization of Trading and ownership of

securities

 Market Integrity and Insider Trading

 To help in developing the capital market so that the

business activities doesn’t get hampered

 To bring companies and organizations under its regulation

so that the interests of investors are not harmed

 To curtail unethical trading which includes insider trading

also

 To get done the registration of Mutual Funds and

Systematic Investment Plans(SIPs) and all such funds
comply with laid down rules and regulations of Mutual
funds and SIPs

 To impart training to market participants on regular basis

Powers of SEBI - Securities and Exchange Board of

India
Powers of SEBI

1. Powers relating to stock exchanges & intermediaries

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SEBI has wide powers regarding the stock exchanges and
intermediaries dealing in securities. It can ask information from
the stock exchanges and intermediaries regarding
their business transactions for inspection or scrutiny and other
purpose.

2. Power to impose monetary penalties

SEBI has been empowered to impose monetary penalties

on capital marketintermediaries and other participants for a
range of violations. It can even impose suspension of their
registration for a short period.

3. Power to initiate actions in functions assigned

SEBI has a power to initiate actions in regard to functions

assigned. For example, it can issue guidelines to different
intermediaries or can introduce specific rules for the protection
of interests of investors.

4. Power to regulate insider trading

SEBI has power to regulate insider trading or can regulate the

functions of merchant bankers.

5. Powers under Securities Contracts Act

For effective regulation of stock exchange, the Ministry of

Finance issued a Notification on 13 September, 1994
delegating several of its powers under the Securities Contracts
(Regulations) Act to SEBI.

SEBI is also empowered by the Finance Ministry to nominate

three members on the Governing Body of every stock
exchange.

6. Power to regulate business of stock exchanges

475
SEBI is also empowered to regulate the business of stock
exchanges, intermediaries associated with the securities
market as well as mutual funds, fraudulent and unfair trade
practices relating to securities and regulation of acquisition of
shares and takeovers of companies.

POWERS OF SEBI :
(1) Powers relating to stock exchanges and intermediaries:
SEBI has wide powers
regarding the stock exchanges and intermediaries dealing in
securities. It can ask
information from the stock exchanges and intermediaries
regarding their business
transactions for inspection/scrutiny and other purposes.
(2) Powers relating to monetary penalties: SEBI’ has been
empowered to impose
monetary penalties on capital market intermediaries and other
participants for a
range of violations. It can even impose suspension of their
registration for a short
period.
(3) Powers to initiate actions relating to functions assigned:
SEBI has a power to
initiate actions in regard to functions assigned. For example, it
can issue guidelines to
different intermediaries or can introduce specific rules for the
protection of interests of
investors.
(4) Powers relating to insider trading: SEBI has power to
regulate insider trading or
can regulate the functions of merchant bankers.
(5) Powers under Securities Contracts (Regulation) Act : For
effective regulation of
stock exchanges, the Ministry of Finance issued a Notification
on 13 September,
1994 delegating several of its powers under the Securities
Contracts (Regulation) Act
to SEBI. SEBI is also empowered by the Finance Ministry to
476
nominate three
members on the Governing Body of every stock exchange
instead of earlier practice
of government making such nominations.
(6) Powers to regulate business of stock exchanges : SEBI is
empowered to regulate
the business of stock exchanges, intermediaries associated
with the securities
market as well as mutual funds, fraudulent and unfair trade
practices relating to
securities and regulation of acquisition of shares and takeovers
of companies.

 Securities and Exchange Board of India:

Organisation, Functions and Regulations
Securities and Exchange Board of India (SEBI) was initially
constituted on 12th April, 1988 as a non-statutory body through
a resolution of the Government for dealing with all matters
relating to the development and regulation of securities market
and investor protection and to advices the Government on all
these matters. SJEBI was given statutory status and powers
through an ordinance promulgated on January 30, 1992.

The statutory powers and functions of SEBI were strengthened

through the promulgation of the Securities Laws (Amendment)
ordinance on January 25, 1995 which was subsequently
replaced by an Act of parliament.

In terms of this Act, SEBI has been vested with regulatory

powers over corporates in the issuance of capital, the transfer
of securities and other related matters. Besides, SEBI has also
been empowered to impose monetary penalties on capital
market intermediaries and other participants for a range of
violation.

Organisation and Management:

477
SEBI is managed by six members—one chairman (nominated
by Central Government), two members, (officers of Central
Ministries), one member (from RBI) and remaining two
members are nominated by Central Government. The office of
SEBI is situated at Mumbai with its regional offices at Kolkata,
Delhi and Chennai.

In 1988 the initial capital of SEBI was Rs. 7.5 crore which was
provided by its promoters (IDBI, ICICI, and IECI). This amount
was invested and with its interest amount, the day-to-day
expenses of SEBI are managed. All statutory power for
regulating Indian Capital Market are vested with SEBI itself.

Functions of SEBI:

The important functions of SEBI are given below:

(i) Registering and regulating the working of stock brokers, sub-

brokers, share transfer agents, bankers to an issue, trustee of
trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such
other intermediaries who may be associated with securities
markets in any manners.

(ii) Registering and regulating the working of the depositories,

participants, custodians of securities, foreign institutional
investors, credit rating agencies and such other intermediaries
as the Board may, by notification, specify in this behalf.

(iii) Registering and regulating the working of venture capital

funds and collective investment schemes including mutual
funds.

(iv) Helping the business in stock exchanges and any other

securities market.

(v) Promoting and regulating self-regulatory organisations.

478
(vi) Prohibiting fraudulent and unfair trade practices relating to
securities market.

(vii) Promoting investors education and training of

intermediaries of securities markets.

(viii) Prohibiting insider trading in securities.

(ix) Regulating substantial acquisition of shares and takeover of

companies.

(x) Supervise the working of various organisations trading in

security market and also to ensure systematic dealings.

(xi) Conducting research and investigations for ensuring the

attainment of above objectives.

SEBI Regulations:

SEBI has adopted a number of regulations and

revolutionary steps to re-establish the credit of capital
market, which includes the following:

1. Share Price and Premium Determination:

According to the latest directions of SEBI, Indian companies

are now free to determine their share prices and premium on
those shares. But determined price and premium amount will
he equally applicable to all without any discrimination.

2. Control on Share Brokers:

Under the new rules every broker and sub-broker has to obtain
registration with SEBI and any stock exchange in India.

3. Control on Utilizing ‘Application Amount’ having no

Interest by Companies Releasing Public Issues:

At the instance of SEBI, Commercial banks introduced Stock

Investment Scheme under which investor has to submit stock-

479
invests, purchased from banks, with their shares application. If
the investor is allotted shares/debentures, the required amount
is transferred in concerned company’s account by the bank
issuing ‘stock invest’.

In other case (if share/debenture is not allotted), investor gets a

predetermined interest rate on invested capital. This step of
SEBI ensured interest earning to the investor until he got
share/debenture allotment. It also ensures the refund of
invested amount to the investor in case shares are not allotted.

4. Underwriters:

The minimum asset limit has been fixed to be Rs. 20 lakh to

work as underwriter. Besides, SEBI has warned underwriters
that their registration can be cancelled if any irregularity is
found in the purchase of unsubscribed part of the share issue.

5. SEBI’s Control on Mutual Fund:

SEBI (Mutual funds) Regulation 1993, help to take over direct

control of all mutual funds of government and private sector
(excluding UTI). Under this new rule, the company floating a
mutual fund should possess net assets of Rs. 5 crore which
should consist of atleast 40% contribution from promoter’s side.

6. Control over Foreign Institutional Investors:

SEBI has made it compulsory for every foreign institutional

investor to get registered with SEBI for participating in Indian
Capital Market. SEBI has issued directions in this regard.

7. Insider Trading:

Companies and their employees usually adopt malpractice in

Indian Capital Market to variate share prices. To check this type
of insider trading, SEBI introduced SEBI (insider Trading)
Regulations, 1992, which will ensure honesty in the capital

480
market and will develop a feeling of faith among investors to
promote investments in capital market in the long-run.

 What are SEBI Disclosures and Investor

protection guidelines?
The primary issuances are governed by SEBI in terms of SEBI
(Disclosures and Investor protection) guidelines. SEBI framed
its DIP guidelines in 1992. Many amendments have been
carried out in the same in line with the market dynamics and
requirements. In 2000, SEBI issued "Securities and Exchange
Board of India (Disclosure and Investor Protection) Guidelines,
2000" which is compilation of all circulars organized in chapter
forms. These guidelines and amendments thereon are issued
by SEBI India under section 11 of the Securities and Exchange
Board of India Act, 1992. SEBI (Disclosure and investor
protection) guidelines 2000 are in short called DIP guidelines. It
provides a comprehensive framework for issuances buy the
companies.

 SEBI Guidelines for protecting interest of

investors
The main object of SEBI is not only to regulate stock
markets but also to protect the interest of investors. For
this purpose, SEBI has given following guidelines:

1. SEBI has been encouraging investor-education. For this

purpose, certain investors’ associations have been
registered.
2. Companies raising public deposits as well as huge capital
must undergo credit rating. Credit rating by an authorized
authority gives a fair view about the financial strength of

481
 the organization. For this purpose, there are four credit
rating agencies. They are:
 CRISIL
 ICRA
 CARE and
 Duff and Phelps Credit Rating India Pvt. Ltd.
3. SEBI has taken the responsibility of disclosing fair and
adequate information for investors for the purpose
of investment decisions.
4. For the benefit of the investors, company has to disclose
its capacity utilization, adverse events and material
changes of key personnel.
5. Disclosure on market prices for listed company.
6. Arrangement for disclosing investors grievances and
redressal system.
7. Compulsory disclosure in the prospectus.
8. Contribution by promoters whose name figure in the
prospectus.
9. In case of over subscription of any company issue, SEBI
representatives will be present there to look into the
allotment process.
10. Setting up of investors grievances cell for handling
complaints of investors.
11. SEBI has right to cancel registration of any
underwriter who fails to furnish business details to SEBI.
12. SEBI has made it mandatory for Merchant bankers to
attach diligence certificate with the prospectus for
extending their accountability to the investors. The
diligence certificate gives a detailed position of the issue
of shares. Only by such a certificate, the investor can file a
case of incorrect statement in the prospectus on erring
companies.
13. There is an advertisement code by SEBI which has
to be followed by companies or investors.
14. To avoid any malpractice in allotment process, SEBI
has appointed its representatives to look into allotment

482
 process which boosts the confidence of individual
investors.
15. Underwriters, registrar to issue and share transfer
agent and portfolio managers have been brought under
SEBI for the first time.
16. Even the mutual funds have been brought under
SEBI and they have to disclose NPV (Net present value)
of units every day which benefits investors.
17. For the benefit of the individual investors, a new
scheme called stock invest account has been introduced
in banks. From this stock invest account, the new issue of
shares will be applied. In that, the investor will intimate the
stock invest account to the company issuing the shares.
18. In case of allotment, the company will inform the
banker as per SEBI guidelines, and funds will be released
from the stock invest account to the bank.

 Disclosure and Investor Protection

Guideline, 2000 issued by SEBI (DIP
Guidelines)
The primary issuances are governed by SEBI in terms of
SEBI (Disclosures and Investor protection)
guidelines. SEBI framed its DIP guidelines in 1992. Many
amendments have been carried out in the same in line
with the market dynamics and requirements. In 2000,
SEBI issued "Securities and Exchange Board of India
(Disclosure and Investor Protection) Guidelines, 2000"
which is compilation of all circulars organized in chapter
forms. These guidelines and amendments thereon are
issued by SEBI India under section 11 of the Securities
and Exchange Board of India Act, 1992. SEBI (Disclosure
and investor protection) guidelines 2000 are in short called
DIP guidelines. It provides a comprehensive framework for
issuances buy the companies.

483
The Primary function of Securities and Exchange Board of
India under the SEBI Act, 1992 is the protection of the
investors’ interest and the healthy development of Indian
financial markets. No doubt, it is very difficult and
herculean task for the regulators to prevent the scams in
the markets considering the great difficulty in regulating
and monitoring each and every segment of the financial
markets and the same is true for the Indian regulator also.
But what are the responsibilities of the regulators to set
the system right once the scam has taken place,
especially the responsibility of redressing the grievances
of the investors so that their confidence is restored? The
redressal of investors’ grievances, after the scam, is the
most challenging task before the regulators all over the
world and the Indian regulator is not an exception. One of
the weapons in the hand of the regulators is the collection
and distribution of disgorged money to the aggrieved
investors. SEBI had issued guidelines for the protection of
the investors through the Securities and Exchange Board
of India (Disclosure and Investor Protection) Guidelines,
2000. These Guidelines have been issued by the
Securities and Exchange Board of India under Section 11
of the Securities and Exchange Board of India Act, 1992.

Before proceeding further we need to be well informed

about few important definitions as stated under the
guidelines, to start with is; Issuer Company- means a
company which has filed offer documents with the Board
for making issue of securities in terms of these guidelines ,
Listed Company- means a company which has any of its
securities offered through an offer document listed on a
recognised stock exchange and also includes Public
Sector Undertakings whose securities are listed on a
recognised stock exchange , Merchant Banker- means an
entity registered under Securities and Exchange Board of
India (Merchant Bankers) Regulations, 1992 , Offer
Document- means Prospectus in case of a public issue or
offer for sale and Letter of Offer in case of a rights issue ,
484
Offer for Sale- means offer of securities by existing
shareholder(s) of a company to the public for subscription,
through an offer document.

The Zeal For Investor’s Protection

Now let’s traverse through some important guidelines that

are offered by the SEBI dedicated to the cause of
investor’s protection.

„«Eligibility Norms For Companies Issuing Securities:-

Provisions regarding this are enshrined in Chapter-II of the
said guidelines. No company shall make any issue of a
public issue of securities, unless a draft prospectus has
been filed with the Board, through an eligible Merchant
Banker, at least 21 days prior to the filing of Prospectus
with the Registrar of Companies (ROCs). Provided that if,
within 21 days from the date of submission of draft
Prospectus, the Board specifies changes, if any, in the
draft Prospectus (without being under any obligation to do
so), the issuer or the Lead Merchant banker shall carry out
such changes in the draft prospectus before filing the
prospectus with ROCs.

No listed company shall make any issue of security

through a rights issue where the aggregate value of
securities, including premium, if any, exceeds Rs.50 lacs,
unless the letter of offer is filed with the Board, through an
eligible Merchant Banker, at least 21 days prior to the
filing of the Letter of Offer with RSE. Provided that if,
within 21 days from the date of filing of draft letter of offer,
the Board specifies changes, if any, in the draft letter of
offer, (without being under any obligation to do so), the
issuer or the Lead Merchant banker shall carry out such
changes before filing the draft letter of offer. No company
shall make an issue of securities if the company has been
prohibited from accessing the capital market under any
order or direction passed by the Board.

485
„«Pricing By Companies Issuing Securities:-

These provisions are being dealt in the Chapter-III of the

guidelines. A listed company whose equity shares are
listed on a stock exchange, may freely price its equity
shares and any security convertible into equity at a later
date, offered through a public or rights issue. An unlisted
company eligible to make a public issue and desirous of
getting its securities listed on a recognised stock
exchange pursuant to a public issue, may freely price its
equity shares or any securities convertible at a later date
into equity shares. An eligible company shall be free to
make public or rights issue of equity shares in any
denomination determined by it in accordance with Sub-
section (4) of Section 13 of the Companies Act, 1956 and
in compliance with the following and other norms as may
be specified by SEBI from time to time:

In case of initial public offer by an unlisted company, if the

issue price is Rs. 500/- or more, the issuer company shall
have a discretion to fix the face value below Rs. 10/- per
share subject to the condition that the face value shall in
no case be less than Rs. 1 per share; and, if issue price is
less than Rs. 500 per share, the face value shall be Rs.
10/- per share; The disclosure about the face value of
shares (including the statement about the issue price
being “X” times of the face value) shall be made in the
advertisement, offer documents and in application forms in
identical font size as that of issue price or price band.)

„«Pre- Issue Obligations:-

The pre issue obligations are provided in Chapter-V, they

are as follows:-
• The lead merchant banker shall exercise due diligence.
• The standard of due diligence shall be such that the
merchant banker shall satisfy himself about all the aspects

486
of offering, veracity and adequacy of disclosure in the offer
documents.
• The liability of the merchant banker shall continue even
after the completion of issue process.
No company shall make an issue of security through a
public or rights issue unless a Memorandum of
Understanding has been entered into between a lead
merchant banker and the issuer company specifying their
mutual rights, liabilities and obligations relating to the
issue.

„«Contents Of Offer Document:-

In addition to the disclosures specified in Schedule II of

the Companies Act, 1956, the prospectus shall also
contain all material information which shall be true and
adequate so as to enable the investors to make informed
decision on the investments in the issue. The prospectus
shall also contain the information and statements specified
in this chapter and shall as far as possible follow the order
in which the requirements are listed in this chapter and
summarised in Schedule VIIA.

„«Consequence Of Non-Observance Of The Guidelines

SEBI in case of non-observance of these guidelines

(Section 11B) as it seems to be a bar from doing such
things which may prejudice the interest of the investors
the board can give the following directions:-
Direct the persons concerned to refund any money
collected under an issue to the investors with or without
requisite interest, as the case may be, direct the persons
concerned not to access the capital market for a particular
period, direct the stock exchange concerned not to list or
permit trading in the securities, direct the stock exchange
concerned to forfeit the security deposit deposited by the

487
issuer company, any other direction which the Board may
deem fit and proper in the circumstances of the case.

Provided that before issuing any directions the Board may

give a reasonable opportunity to the person concerned.
Provided further that if any interim direction is sought to be
passed, the Board may give post decisional hearing to
such person.

Future Overcast Of The Investors

SEBI being a premiere institution for dealing with the

problems relating to securities has advanced a long way
towards protecting the investors from the hazards of the
predators existing in the market. As already stated before
it has compiled a great bunch of guidelines dedicated to
this cause. But the real scenario which came as a
consequence was that only the big fishes could escape
the net and the small ones were still striving to uphold
their existence. In this matter, according to a daily
newspaper it has become clear that SEBI had already
received suggestion and advice regarding the need for a
separate enactment concerning the small investors. As far
as it is concerned, the Government has thought of
introducing an independent legislation on investor
protection to safeguard the interests of small investors. A
separate legislation had also been recommended in the
report prepared by Mr. Mitra, who was commissioned by
the Finance Ministry to draw up the terms of reference for
a new Bill. A debate has been on over the need for a
separate legislation for protecting the interests of small
investors, considering that there are multiple agencies
involved in policing companies that raise funds from the
public be it public listed companies, or NBFCs (Non
Banking Financial Companies). These include the capital
markets regulator, SEBI, the banking regulator, RBI, and
the Department of Company Affairs (DCA) which is
responsible for regulating unlisted companies. SEBI has

488
been in favour of a separate regulatory agency for the
protection of small investors. The regulator had earlier
submitted a proposal to the Finance Ministry, outlining the
need for a new Act. The setting up of a comprehensive
fund for the protection of investors has also been
recommended by Mr. Mitra which we see in reality to have
been already existing today. In fact, the report has
suggested that the existing Investor Protection Fund, the
corpus of which is to come from unclaimed dividends,
should be merged with the new fund.

Conclusion
SEBI, if not 100%, than for sure it has been near to 100%
success as far as the protections of the investors are
concerned. As we have seen that via different guidelines it
had made it sure that no stone remains unturned in the
path of the mission of protecting the investors. But at
present the two greatest challenges are the scams relating
to mutual fund and the disgorgement of money.

As regards to the mutual fund problem, according to a

current issue in a newspaper it had become clear that, the
Capital market regulator SEBI is concerned about the kind
of service mutual funds are providing to their investors and
wants the industry to focus on the hassle-free redemptions
and also conduct an investor survey, in their own interest.
Furthermore Mr.C.B. Bhave while pointing towards the
mutual fund institutions commented that, “Take up
investor survey to find out what they feel about your
products, why do they like certain products……….”,
“Focus on what the client wants, as this will be in your
interest,” he added. He also assured that SEBI would be
having an advisory committee for the MF institutions. The
SEBI Chairman also suggested setting up of a depository
that will maintain database of all mutual fund investors
across the country, much in line with the depositories for
the equity market. SEBI is also planning to hold a
workshop for the trustees to get their feedback and to
489
know their requirements. The regulator has also decided
to set up a mutual fund advisory committee to address the
issues faced by the industry.

In India, the position is not so well and hence the picture is

not clear as to how the disgorged money is to be treated.
Generally, the payments received by way of penalties are
deposited in Consolidated Fund of India. In its first ever
disgorgement order on 21st November, 2006, in Karvey
case, SEBI directed NSDL, CDSL and eight depository
participants (DPs) to return Rs115.81 crore in six months.
The DPs include Karvey, HDFC Bank, Khandwala
Securities, IDBI Bank, Jhavei Securities, ING Vysya Bank,
PR Stock Broking and Pratik Stock Vision. On the issue of
disgorgement, in the order passed in the Karvey case,
SEBI said, “It is well established worldwide that the power
to disgorge is an equitable remedy and is not a penal or
even a quasi- penal action. Thus it differs from actions like
forfeiture and impounding of assets or money. Unlike
damages, it is a method of forcing a defendant to give up
the amount by which he or she was unjustly enriched. The
point of importance here is that the order was passed with
the need felt to restore confidence about the market
process in the minds of investors who were deprived of
their entitlement to shares under the IPO as a result of
illegal cornering of shares by some financiers. The
Wadhwa Committee report of December 2007
recommended making good deprived investors in money
terms, which, it seems, went well with the SEBI, as
understood from its order of disgorgement.

 ISSUE MANAGER AND SEBI

Issue Managers are required to be registered with SEBI to
carry on their Issue Management activities, since setting
up of SEBI. SEBI has formulated Rules and Regulations

490
for merchant bankers which bring out the requirements for
Registration of issue managers apart from prescribing the
conduct rules for them. In terms of these regulations,
issue managers are required to mainly comply with the
following requirements for registration: l Issue manager
should be a corporate body, not being a Non Banking
Financial Company (as per RBI). l He should have
necessary infrastructure like adequate office space,
equipments and manpower to effectively discharge his
activities. l He should have minimum two persons who
have the experience to conduct the business of Merchant
Banking. l He should fulfill capital adequacy requirements
i.e. should have a minimum net worth of Rs.5 crores. l He
should have professional qualification from an institute
recognized by government in Law, Finance or Business
Management. Under SEBI guidelines, a public/rights issue
cannot be floated without the association of a Merchant
Banker. Merchant banker, like pilots of air-crafts are
repositories of special skills required to execute the
management of issues. Thus, Issue manager is an
indispensable pilot. He is a financial architect as one of
the important areas of Issue Management relates to
capital structuring, capital gearing and financial planning
for the company. While performing these activities,
Merchant Bankers act as Financial Architects. He is an
Investors as well as an underwriter since Merchant
Bankers also underwrite (Annexure 1) and invest in the
Issues lead managed by them. Companies consider the
issue managers as their Co-traveller, as Merchant bankers
also sometimes act as market makers in the Issues lead
managed by them. They invest, continue to hold and offer,
buy and sell quotes for the scrips of the companyafter
listing. Thus, as market makers, their association is not
merely restricted to management of issue but continues
like co-traveller with the company. Under SEBI guidelines,
every Merchant Banker while managing a Capital Issue is
expected to perform Due Diligence (Annexure 2) and

491
furnish a Due Diligence Certificate to SEBI in a prescribed
format. Association of Merchant Bankers of India (AMBI)
has prescribed detailed due diligence guide to its
members to facilitate their performance of due diligence.
While managing issues they are required to interact and
file offer documents with SEBI. They are also required to
file a number of reports related to Issues being managed
by them, with SEBI. In a nut shell, merchant banker
necessarily revolves around SEBI while managing an
Issue and thus can be called as a satellite of SEBI.

It will not be out of context if we term issue manager as

Zubin Mehta because while managing an Issue, a
Merchant banker is required to co-ordinate with a large
number of institutions and agencies. Merchant banker, like
an able conductor of orchestra, has to ensure that all the
players complete their jobs timely and with proper co-
ordination, so as to produce the end result effectively.
Marketing of an Issue is an essential and perhaps the
most important component of issue Management.
Merchant banker makes number of promises and
commitments to the prospective investors which puts him
in the shoes of a dream merchant Under SEBI Guidelines,
each Public Issue and Rights Issue with size exceeding
Rs. 50 lakhs is required to be managed by a Merchant
Banker, registered with SEBI. Since setting up of SEBI,
Issue Managers are required to be registered with SEBI.
SEBI (Merchant Bankers) Regulations 1992 has laid down
the rules, regulations and conduct rules for them. They are
to be governed by the code of conduct laid down in the
regulations. SEBI Regulations have laid down restrictions
on the number of Issue Managers who can be associated
with an Issue

Pre-Issue Activities 1) Memorandum of Understanding In

terms of Regulation 18(2), before taking any issue
management, every merchant banker (lead manager)
must invariably enter into a Memorandum of
492
 Understanding (MoU) with the company making the issue
(issuer) clearly setting out their mutual rights, liabilities and
obligations relating to the issue. A draft of the MoU is
prescribed. The lead manager may adopt the draft and
incorporate such clauses as may be considered
necessary for defining his rights and obligations vis-à-vis
the issuer. While doing so, it must be ensured that neither
party should reserve for themselves any rights, which
would have the effect of diminishing in any way their
liabilities and obligations under the Companies Act, 1956
and SEBI (Merchant Bankers) Rules and Regulations,
1992. The lead manager who is responsible for drafting of
the offer documents shall ensure that a copy of the MoU
entered into with the issuer should also be submitted to
SEBI along with the offer document. 2) Obtaining
Appraisal Note After the contract for issue management is
awarded, an appraisal note is prepared either in-house or
is obtained from outside appraising agencies viz.,
Financial Institutions/ Banks etc. The appraisal note thus
prepared throws light on the proposed capital outlay on
the project and the sources of funding it. Project may be
funded either by borrowing money from outside agencies
or by injecting capital. Optimum Capital Structure is
determined considering the nature and size of the project.
If the project is capital intensive, funding is generally
biased in favour of equity funding. After the fund appraisal
a meeting of Board of Directors of the Issuing Company is
convened followed by an Extra Ordinary General Meeting
(EGM) of its members wherein various aspects related to
issue of securities are decided. If the issue of capital
include issue of shares to NRls/OCBs or FIls, then an
application to the Reserve Bank of India seeking its
permission is made.

3) Appointment of Other Intermediaries

Lead manager should ensure that the requisite intermediaries,

who are appointed, are registered with SEBI. Before advising
493
the issuer on the appointment of other intermediaries, lead
manager shall independently assess the capability and the
capacity of the various intermediaries to handle the issue.
Wherever required, the issuer shall be advised by the lead
manager to enter into a Memorandum of Understanding with
the Intermediary(ies) concerned. Lead manager should ensure
that bankers to the issue are appointed in the mandatory
collection centres. In case of public issues, there should be at
least 30 mandatory collection centres which should invariably
include the places where stock exchanges have been
established. The issuers are also permitted to appoint
authorised collection agents in consultation with the lead
manager subject to necessary disclosures. While the modalities
of selection and appointment of collection agents are left to the
discretion of the lead manager, it should be ensured that the
agents so selected are properly equipped for the purpose, both
in terms of infrastructure and manpower requirements. While
appointing Registrars to an Issue, lead manager should note
that in respect of an issue in which he is the sole/one of the
lead managers, he cannot act as Registrar to the said issue.
Similarly, where the issuer of capital is a registered Registrar to
an issue, the issuer will have to appoint an outside Registrar to
process its issue. SEBI may not object to a lead manager
acting as Registrar to an Issue where the post-issue
responsibilities rest with another lead manager, provided the
lead manager is registered with SEBI for both function. Lead
manager shall, ensure that the number of co-managers to an
issue does not exceed the number of lead managers to the said
issue and that the number of advisors to the issue is only one.
4) Issue Management Inter-se Allocation of Responsibilities
Where an issue is managed by more than one lead manager,
the responsibility of each lead manager shall be clearly
delineated, preferably as indicated in Annexure (3). In case of
under-subscription in an issue, the lead manager responsible
for tying up underwriting arrangements will be held responsible
for invoking underwriting obligations and for ensuring that the
underwriters pay the amount of development the Inter-se

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Allocation of responsibilities accompanying the Due Diligence
Certificate must specifically indicate the name of the lead
manager responsible for this. 5) Preparing Prospectus Lead
manager should ensure proper disclosures to the investors,
keeping in mind their responsibilities as per Merchant Bankers
Rules and Regulations. The lead manager should, therefore,
not only furnish adequate disclosures but also ensure due
compliance with the Guidelines for Disclosure and Investor
Protection issued by SEBI which also specifies the contents of
prospectus as well as application form. The application form
should contain necessary details and instructions to applicants
to mention the: l number of application form on the reverse of
the instruments to avoid misuse of instruments submitted along
with the applications for share/debentures in public issues. l
particulars relating to savings bank/current account number and
the name of the bank with whom such account is held, to
enable the Registrars to print the said details in the refund
orders after the names of the payees. Suitable Instructions to
investors in this behalf in the application form under the head
“How to apply” should be incorporated. 6) Submission of Draft
Offer Documents The Lead Manager shall hand over not less
than 25 copies of the draft offer document to SEBI and also to
the Stock Exchange(s) where the issue is proposed to be listed.
The Lead Manager shall submit to SEBI the Draft Prospectus in
a computer floppy. Copies of the Draft Prospectus will be made
available by the LeadManagers/Stock Exchange to prospective
investors. After a period of 21 days from the date the draft
prospectus was made public, the Lead Manager shall file with
SEBI a statement giving a list of complaints received by it form
SEBI and any amendment done in the document. The Lead
Manager responsible for drafting of the offer documents shall
ensure that the terms of the issue and the offer documents,
namely, prospectus or letter of offer are in conformity with the
SEBI Guidelines for Disclosure and Investor Protection. Due
Diligence Certificate as specified by SEBI accompanies each
draft offer document submitted to SEBI. It is to be ensured that
the format of prospectus conforms to the format prescribed by

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the Department Company Affairs. A ‘letter of offer’ is also
submitted. The format of letter of offer should conform to
disclosures prescribed in the Memorandum 2A under section
56(3) of the Companies Act, 1956, and the Guidelines issued
by the Stock Exchange Division of Ministry of Finance.
7) Launching of a Public Issue Once the legal formalities and
statutory permission for Issue of Capital are complete, the
process of marketing the Issue starts. Lead Manager has to
arrange for distribution of public issue stationery to various
collecting banks, brokers, investors, etc. Public Issue is
launched formally by conducting Press Conference, Brokers
Meets, issuing advertisements in various newspapers and
mobilising Brokers and SubBrokers. The announcement
regarding opening of Issue in the newspapers is also required
to be made by advertising (Annexure 4) in newspapers 10 days
before the Issue opens. A certificate to the effect that the
required contribution of the promoters has been raised before
opening of the Issue obtained from a Chartered Accountant is
also required to be filed with SEBI. During the currency of the
Issue, collection figures are also obtained on daily basis from
Bankers to the issue. Another announcement through the
newspapers is also made regarding the closure of the Issue. B)
Post-Issue Activities After the closure of the Issue, Lead
Manager has to manage the Post-Issue activities pertaining to
the Issue. He is to ensure the submission of the post issue
monitoring report as desired by SEBI. Finalisation of Basis of
Allotment (BOA): In case of a public offering, besides post-
issue lead-manager, registrar to the issue and regional stock-
exchange officials, association of public representative is
required to participate in the finalisation of Basis of Allotment
(Annexure 5). Data of accepted applications is finalised and
Regional Stock Exchanges are approached for finalisation of
BOA. Despatch of Share Certificates, etc.: Then follows
despatch of share certificates to the successful allottees, demat
credit, cancelled stock-invest and refund orders to unsuccessful
applicants. Issue of Advertisement in Newspapers: An
announcement in the newspaper is also made regarding BOA,

496
number of applications received and the date of despatch of
share certificates and refund orders, etc.

 PRE- ISSUE OBLIGATIONS

5.0 The pre-issue obligations are detailed below :

5.1 The lead merchant banker shall exercise due diligence.

5.1.1 The standard of due diligence shall be such that the merchant banker shall
satisfy himself about all the aspects of offering, veracity and adequacy of
disclosure in the offer documents.

5.1.2 The liability of the merchant banker as referred to clause 5.1.1 shall continue
even after the completion of issue process.

5.2 The lead merchant banker, shall pay requisite fee in accordance with
regulation 24A of Securities and Exchange Board of India (Merchant Bankers)
Rules and Regulations, 1992 along with draft offer document filed with the Board.

5.3 Documents to be Submitted alongwith the Offer Document by the Lead

Manager

5.3.1 Memorandum of Understanding (MOU)

5.3.1.1 No company shall make an issue of security through a public or rights

issue unless a Memorandum of Understanding has been entered into between a
lead merchant banker and the issuer company specifying their mutual rights,
liabilities and obligations relating to the issue.

5.3.1.2 The MOU shall contain such clauses as are specified at Schedule I and
such other clauses as considered necessary by the lead merchant banker and the
issuer company.

Provided that the MOU shall not contain any clause whereby the liabilities and
obligations of the lead merchant banker and issuer company under the Companies
Act, 1956 and Securities and Exchange Board of India (Merchant Bankers) Rules
and Regulations, 1992 are diminished in any way. .

5.3.1.3 The Lead Merchant Banker responsible for drafting of the offer documents
shall ensure that a copy of the MOU entered into with the issuer company is
submitted to the Board along with the draft offer document.

5. 3.2 Inter-se Allocation of Responsibilities

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5.3.2.1 In case a public or rights issue is managed by more than one merchant
bankers the rights, obligations and responsibilities of each merchant banker shall
be demarcated as specified in Schedule II.

5.3.2.2 In case of under subscription at an issue, the Lead Merchant Banker

responsible for underwriting arrangements shall invoke underwriting obligations
and ensure that the underwriters pay the amount of devolvement and the same shall
be incorporated in the inter-se allocation of responsibilities (Schedule II)
accompanying the due diligence certificate submitted by the Lead Merchant
Banker to the Board .

5.3.3 Due Diligence Certificate

5.3.3.1 The Lead Merchant Banker, shall furnish to the Board a due diligence
certificate as specified in Schedule III along with the draft prospectus.

5.3.3.2 In addition to the due diligence certificate furnished alongwith the draft
offer document, the Lead Merchant Banker shall also:

i) certify that all amendments suggestion or observations made by Board have been
incorporated in the offer document;

ii) furnish a fresh "due diligence" certificate at the time of filing the prospectus
with the Registrar of Companies as per the format specified at Schedule IV.

iii) furnish a fresh certificate immediately before the opening of the issue that no
corrective action on its part is needed as per the format specified at Schedule V.

iv) furnish a fresh certificate after the issue has opened but before it closes for
subscription as per the format specified at Schedule VI.

5.3.4 Certificates Signed by the Company Secretary or Chartered Accountant,

in Case of Listed Companies Making Further Issue of Capital

5.3.4.1 The Lead Merchant Banker shall furnish the following certificates duly
signed by Company Secretaries or Chartered Accountants along with the draft
offer documents:

a. all refund orders of the previous issues were despatched within the
prescribed time and in the prescribed manner;

b all security certificates were despatched to the allottees within the

prescribed time and in
the prescribed manner;

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 c the securities were listed on the Stock Exchanges as specified in the offer
documents.

5.3.5 Undertaking

5.3.5.1 The issuer shall submit an undertaking to the Board to the effect that
transactions in securities by the `promoter' the 'promoter group' and the immediate
relatives of the `promoters during the period between the date of filing the offer
documents with the Registrar of Companies or Stock Exchange as the case may be
and the date of closure of the issue shall be reported to the Stock exchanges
concerned within 24 hours of the transaction(s).

5.3.6 List of Promoters� Group

5.3.6.1 The issuer shall submit to the Board a list of persons who constitute the
Promoters� Group and their individual shareholdings.

5.4 Appointment of Intermediaries

5.4.1 Appointment of Merchant Bankers

5.4.1.1 Merchant Banker who is associated with the issuer company as a promoter
or a director shall not to lead manage the issue of the company.

Provide that the lead merchant banker holding the securities of the issuer company
may lead manage the issue;

a. if the securities of the issuer company are listed or proposed to be listed on

the Over the Counter Exchange of India (OTCEI) and;

b the Market Makers have either been appointed or are proposed to be

appointed as per the
offer document.

5.4.2 Appointment of Co-managers

5.4.2.1 Lead Merchant Bankers shall ensure that the number of co-managers to an
issue does not exceed the number of Lead Merchant Bankers to the said issue and
there is only one advisor to the issue.

5.4.3 Appointment of Other Intermediaries

5.4.3.1 Lead Merchant Banker shall ensure that the other intermediaries being
appointed are duly registered with the Board, wherever applicable.

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5.4.3.1.1 Before advising the issuer on the appointment of other intermediaries, the
Lead Merchant Banker shall independently assess the capability and the capacity
of the various intermediaries to carry out assignment.

5.4.3.1.2 The Lead Merchant Banker shall ensure that issuer companies enters into
a Memorandum of Understanding with the intermediary(ies) concerned whenever
required.

5.4.3.2 The Lead Merchant Banker shall ensure that Bankers to the Issue are
appointed in all the mandatory collection centres as specified in clause 5.9.

5.4.3.3 The Lead Merchant Banker shall not act as a Registrar to an issue in which
it is also handling the post issue responsibilities.

5.43.4 The Lead Merchant Bankers shall ensure that;

a the Registrars to Issue registered with the Board are appointed in all public
issues and rights issues;
b in case where the issuer company is a registered Registrar to an Issue, the
issuer shall appoint an independent outside Registrar to process its issue.

The lead merchant banker shall ensure that Registrar to an issue which is
associated with the issuer company as a promoter or a director shall not act as
Registrar for the issuer company.

Where the number of applications in a public issue is expected to be large, the

issuer company in consultation with the lead merchant banker may associate one or
more Registrars registered with the Board for the limited purpose of collecting the
application forms at different centres and forward the same to the designated
Registrar to the Issue as mentioned the offer document.

The designated Registrar to the Issue shall, be primarily and solely responsible
for all the activities as assigned to them for the issue management.

5.5 Underwriting

5.5.1 The Lead merchant banker shall satisfy themselves about the ability of the
underwriters to discharge their underwriting obligations.

5.5.2 The lead merchant banker shall;

a incorporate a statement in the offer document to the effect that in the opinion of
the lead merchant banker, the underwriters' assets are adequate to meet their
underwriting obligations;

500
b obtain Underwriters� written consent before including their names as
underwriters in the final offer document.

5.5.3 In respect of every underwritten issue, the lead merchant banker(s) shall
undertake a minimum underwriting obligation of 5% of the total underwriting
commitment or Rs.25 lacs whichever is less.

5.5.4 The outstanding underwriting commitments of a merchant banker shall not

exceed 20 times its networth at any point of time.

5.5.5 In respect of an underwritten issue, the lead merchant banker shall ensure that
the relevant details of underwriters are included in the offer document.

5.6 Offer Document to be Made Public

5.6.1 The draft offer document filed with the Board shall be made public for a
period of 21 days from the date of filing the offer document with the Board.

5.6.2 The Lead Merchant Banker shall;

a. simultaneously file copies of the draft offer document with the stock
exchanges where the securities offered through the issue are proposed to
be listed.

b make copies of offer document available to the public.

5.6.3 Lead merchant banker or stock exchanges may charge an appropriate sum to
the person requesting for the copy of offer document.

5.7 Despatch of Issue Material

5.7.1 The lead merchant banker shall ensure that for public issues offer documents
and other issue materials are dispatched to the various stock exchanges, brokers,
underwriters, bankers to the issue, investors associations, etc. in advance as agreed
upon.

5.7.2 In the case of rights issues, lead merchant banker shall ensure that the letters
of offer are dispatched to all shareholders at least one week before the date of
opening of the issue.

5.7.34 [Deleted]
5.8 No Complaints Certificate

5.8.1 After a period of 21 days from the date the draft offer document was made
public, the Lead Merchant Banker shall file a statement with the Board :

501
i) giving a list of complaints received by it,
ii) a statement by it whether it is proposed to amend the draft offer document or
not, and;
iii) highlight those amendments.

5.9 Mandatory Collection Centres

5.9.1 The minimum number of collection centres for an issue of capital shall be-

a) the four metropolitan centres situated at Mumbai, Delhi, Calcutta and Chennai

b) all such centres where the stock exchanges are located in the region in which
the registered office of the company is situated.

c) the regional division of collection centres is indicated in Schedule VII.

5.9.2 The issuer company shall be free to appoint as many collection centres as it
may deem fit in addition to the above minimum requirement.

5.10 Authorised Collection Agents

5.10.1 The issuer company can also appoint authorised collection agents in
consultation with the Lead Merchant Banker subject to necessary disclosures
including the names and addresses of such agents made in the offer document.

5.10.2 The modalities of selection and appointment of collection agents can be

made at the discretion of the Lead Merchant Banker.

5.10.3 The lead merchant banker shall ensure that the collection agents so selected
are properly equipped for the purpose, both in terms of infrastructure and
manpower requirements.

5.10.4 The collection agents may collect such applications as are accompanied by
payment of application moneys paid by cheques, drafts and stock invests.

5.10.5 The authorised collection agent shall not collect application moneys in cash.

5.10.6 The applications collected by the collection agents shall be deposited in the
special share application account with designated scheduled bank either on the
same date or latest by the next working day.

5.10.7 The application forms along with duly reconciled schedules shall be
forwarded by the collection agent to the Registrars to the Issue after realisation of
cheques and after weeding out the applications in respect of cheques return cases,
within a period of 2 weeks from the date of closure of the public issue.

502
5.10.8 The applications accompanied by stockinvests shall be sent directly by the
collection agent to the Registrars to the Issue along with the schedules within one
week from the date of closure of the issue.

5.10.9 The offer documents and application forms shall specifically indicate that
the acknowledgement of receipt of application moneys given by the collection
agents shall be valid and binding on the issuer company and other persons
connected with the issue.

5.10.10 The investors from the places other than from the places where the
mandatory collection centres and authorised collection agents are located, can
forward their applications along with stockinvests to the Registrars to the Issue
directly by Registered Post with Acknowledgement Due.

5.10.11 The applications received through the registered post shall be dealt with by
the Registrars to the Issue in the normal course.

5.11 Advertisement for Rights Post Issues

5.11.1 The Lead Merchant Banker shall ensure that in case of a rights issue, an
advertisement giving the date of completion of despatch of letters of offer, shall be
released in at least in an English National Daily with wide circulation, one Hindi
National Paper and a Regional language daily circulated at the place where
registered office of the issuer company is situated at least 7 days before the date of
opening of the issue.

5.11.2 The advertisement referred to in clause 5.11.1 shall indicate the centres
other than registered office of the company where the shareholders or the persons
entitled to rights may obtain duplicate copies of composite application forms in
case they do not receive the original application form within a reasonable time
even after opening of the rights issue.

5.11.3 Where the shareholders have neither received the original composite
application forms nor are they in a position to obtain the duplicate forms, they may
make applications to subscribe to the rights on a plain paper.

5.11.4 The advertisement shall also contain a format to enable the shareholders to
make the application on a plain paper containing necessary particulars like name,
address, ratio of right issue, issue price, number of shares held, ledger folio
numbers, number of shares entitled and applied for, additional shares if any,
amount to be paid along with application, particulars of cheque, etc. to be drawn in
favour of the company Account - Rights issues.

5.11.5 The advertisement shall further mention that applications can be directly
sent by the shareholder through Registered Post together with the application

503
moneys to the company's designated official at the address given in the
advertisement.

5.11.6 The advertisement may also invite attention of the shareholders to the fact
that the shareholders making the applications otherwise than on the standard form
shall not be entitled to renounce their rights and shall not utilise the standard form
for any purpose including renunciation even if it is received subsequently.

5.11.7 If the shareholder makes an application on plain paper and also in standard
form, he may face the risk of rejection of both the applications.

5.12 Appointment of Compliance Officer

5.12.1 An issuer company shall appoint a compliance officer who shall directly
liaise with the Board with regard to compliance with various laws, rules,
regulations and other directives issued by the Board and investors complaints
related matter.

5.12.2 The name of the compliance officer so appointed shall be intimated to the
Board.

5.13 Abridged Prospectus

5.13.1 The Lead Merchant Banker shall ensure the following:

i) Every application form distributed by the issuer Company or anyone else is

accompanied by a copy of the Abridged Prospectus.

ii) The application form may be stapled to form part of the Abridged Prospectus.
Alternatively, it may be a perforated part of the Abridged Prospectus.

iii) The Abridged Prospectus shall not contain matters which are extraneous to
the contents of the prospectus.

iv) The Abridged Prospectus shall be printed at least in point 7 size with proper
spacing.

v) Enough space shall be provided in the application form to enable the investors
to file in various details like name, address, etc.
5
5.14 Agreements with depositories

5.14.1 The lead manager shall ensure that the issuer company has entered into
agreements with all the depositories for dematerialisation of securities. He shall
also ensure that an option be given to the investors to receive allotment of
securities in dematerialised form through any of the depositories."

504
  Limited liability partnership
A limited liability partnership (LLP) is a partnership in which
some or all partners (depending on the jurisdiction) have limited
liabilities. It therefore can exhibit elements
of partnerships and corporations. In an LLP, each partner is not
responsible or liable for another partner's misconduct or
negligence. This is an important difference from the traditional
partnership under the UK Partnership Act 1890, in which each
partner has joint and several liability. In an LLP, some or all
partners have a form of limited liability similar to that of the
shareholders of a corporation. Unlike corporate shareholders,
the partners have the right to manage the business directly.[1]In
contrast, corporate shareholders must elect a board of directors
under the laws of various state charters.[1] The board organizes
itself (also under the laws of the various state charters) and
hires corporate officers who then have as "corporate"
individuals the legal responsibility to manage the corporation in
the corporation's best interest. A LLP also contains a different
level of tax liability from that of a corporation.

Limited liability partnerships are distinct from limited

partnerships in some countries, which may allow all LLP
partners to have limited liability, while a limited partnership may
require at least one unlimited partner and allow others to
assume the role of a passive and limited liability investor. As a
result, in these countries, the LLP is more suited for businesses
in which all investors wish to take an active role in
management.

In some countries, an LLP must have at least one person

known as a "general partner", who has unlimited liability for the
company.

There is considerable difference between LLPs as constituted

in the U.S. and those introduced in the UK under the Limited
Liability Partnerships Act 2000 and adopted elsewhere. The UK

505
LLP is, despite its name, specifically legislated as a corporate
body rather than as a partnership.

 What Is a Limited Liability Partnership? -

Definition
Many businesses are formed as partnerships. There are
actually several different types of partnerships, including limited
liability partnerships. This lesson explains the advantages and
disadvantages of limited liability partnerships.

Limited Liability Partnership

Partnerships are the most common business structure for

businesses that have more than one owner. Many businesses,
ranging from retail stores to accounting firms, are structured as
partnerships. A business partnership is a for-profit business
established and run by two or more individuals. There can be
any number of partners involved in the business, as long as
there are at least two. A business partner is a co-owner of the
business.

Most business partnerships are general partnerships,

meaning that all partners have responsibility for the business
and unlimited liability for the financial obligations of the
business. This means that general partners share both the
benefits and the detriments of the business.

However, some types of partnership allow at least one owner

limited personal liability for the business' financial obligations,
such as debts and court judgments. One common structure is
the limited liability partnership, or LLP. A limited liability
partnership is a newer form of business partnership where all of
the owners have limited personal liability for the financial
obligations of the business.

506
There are no general partners in a limited liability partnership,
but an LLP is similar to a general partnership. Each limited
liability partner contributes to the everyday business operations.
However, each partner enjoys limited personal liability for the
other partners' acts. All states allow some form of LLP, though
state laws vary. Note that some states only allow LLP status for
professional partnerships, like accountants, lawyers or
architects. In all states, limited liability partnerships can only be
formed by registering with the appropriate state office.

Let's use an example. Let's say that Ben, Bob and Brandi are
all lawyers. They decide to form a law firm as partners. They
each contribute $50,000 to form a limited liability partnership.
They will each work at the law firm and earn money for the firm.

 Limited Liability Company - LLC

What is a 'Limited Liability Company - LLC'

A limited liability company is a corporate structure whereby the

members of the company are not personally liable for the
company's debts or liabilities. Limited liability companies are
hybrid entities that combine the characteristics of a corporation
and a partnership or sole proprietorship. While the limited
liability feature is similar to that of a corporation, the availability
of flow-through taxation to the members of an LLC is a feature
of partnerships.

BREAKING DOWN 'Limited Liability Company - LLC'

Although LLCs have some attractive features, they also have

several disadvantages, especially in relation to the structure of
a corporation. An LLC has to be dissolved upon the death
or bankruptcy of a member, unlike a corporation, which can
exist in perpetuity. Also, an LLC may not be a suitable option
when the founder's objective to become a publicly listed
company, eventually.
507
The primary reason business owners opt to take the LLC
route is to limit the principals' personal liability. Many view an
LLC as a blend of a partnership, which is a simple business
formation of two or more owners under an agreement, and a
corporation, which has certain liability protections. An LLC is a
more formal partnership arrangement requiring articles of
organization to be filed with the state. An LLC is much easier to
set up than a corporation, and it provides more flexibility along
with the protection. However, creditors may still pierce the
corporate veil of an LLC in cases of fraud or when a company
hasn't met legal and reporting requirements.

Differences between a Partnership and a Limited Liability

Company

The primary difference between a partnership and an LLC is

that an LLC separates the business assets of the company
from the personal assets of the owners, which insulates the
owners from the LLC's debts and liabilities. An LLC functions
similar to a partnership in that the profits of the company pass
through to owners’ tax return. Losses can be used to offset
other income, but only up to the amount invested. The LLC only
files an informational tax return.

In terms of the sale or transfer of the business, a business

continuation agreement is the only way to ensure the smooth
transfer of interests when one of the owners leaves or dies.
Without a business continuation agreement, the remaining
partners must dissolve the LLC and create a new one is a
partner files bankruptcy or dies.

 An Overview of Limited Liability Partnership

(LLP) in India
A Limited Liability Partnership (LLP) is a partnership in
which some or all partners (depending on the jurisdiction)
have limited liability. It therefore exhibits elements of
partnerships and corporations. In an LLP, one partner is
not responsible or liable for another partner's misconduct

508
or negligence. This is an important difference from that of
an unlimited partnership. In an LLP, some partners have a
form of limited liability similar to that of the shareholders of
a corporation. In some countries, an LLP must also have
at least one "General Partner" with unlimited liability.
Origin The Limited Liability Partnership was formed in the
early 1990s in United States in the consequence of the
collapse of real estate and energy prices in Texas in the
1980s. This collapse led to a large wave of bank and
savings and loan failures. Because the amounts
recoverable from the banks were small, efforts were made
to recover assets from the lawyers and accountants who
had advised the banks in the early 1980s. The reason was
that partners in law and accounting firms were subject to
the possibility of huge claims which would bankrupt them
personally, and the first LLP laws were passed to shield
innocent members of these partnerships from liability.
Apart from India Many Countries like Canada, China
Germany, Greece, Japan, Kazakhstan, Poland, Romania,
and Singapore have felt the need to recognize LLPs in
their country. Limited Liability Partnership in India Preface
In India, The Limited Liability Partnership Act, 2008 was
published in the official Gazette of India on January 9,
2009 and has been notified with effect from 31 March
2009. The first LLP was incorporated in the first week of
April 2009. Some sections relating to conversion of
existing partnership firms and private as well as public
unlisted companies into LLP have been brought into force
on 31-5-2009 At present, there are about 10,000 LLPs
formed and registered under the Limited Liability
Partnership Act. Salient features of an LLP a. An LLP is a
body corporate and legal entity separate from its partners.
It has perpetual succession. b. Being the separate
legislation (i.e. LLP Act, 2008), the provisions of Indian
Partnership Act, 1932 are not applicable to an LLP and it
is regulated by the contractual agreement between the
partners. c. Every Limited Liability Partnership shall use

509
the words “Limited Liability Partnership” or its acronym
“LLP” as the last words of its name. d. It contains
elements of both ‘a corporate structure’ as well as ‘a
partnership firm structure’. e. Every LLP shall have at least
two designated partners being individuals, at least one of
them being resident in India and all the partners shall be
the agent of the Limited Liability Partnership but not of
other partners. f. LLP agreement is not mandatory but in
the absence of LLP agreement, mutual rights and
liabilities of partners shall be determined as provided
under Schedule I to the LLP Act. Advantages of forming
an LLP a. LLP form is a form of business model which is
organized and operates on the basis of an agreement. b.
Liability of partners is limited to their agreed contribution in
the LLP and no partner is liable on account of the
independent or un-authorized actions of other partners,
thus individual partners are protected from joint liability
created by another partner’s wrongful business decisions
or misconduct. c. LLP has more flexibility and lesser
compliance requirements as compared to a company. d.
Simple registration procedure, no requirement of minimum
capital, no restrictions on maximum limit of partners. e. It
is easy to become a partner or leave the LLP or otherwise.
f. It is easier to transfer the ownership in accordance with
the terms of the LLP Agreement. g. As a juristic legal
person, an LLP can sue in its name and be sued by
others. The partners are not liable to be sued for dues
against the LLP. h. No restriction on limit of the
remuneration to be paid to the partners like companies,
but the remuneration must be authorized by the LLP
agreement and it cannot exceed the limit prescribed under
the agreement. i. The Act also provides for conversion of
existing partnership firm, private limited Company and
unlisted public Company into an LLP by registering the
same with the Registrar of Companies (ROC). j. No
exposure to personal assets of the partners except in case
of fraud. Disadvantages of forming an LLP a. Any act of

510
 the partner without the consent of other partners, can bind
the LLP. b. Under some cases, liability may extend to
personal assets of the partners. c. An LLP are not allowed
to raise money from Public. d. Because of the hybrid form
of the business, it is required to comply with various rules
& regulations and legal formalities. e. It is very difficult to
wind up the business in case of exigency as there are a lot
of legal compliances under Limited Liability Partnership
(Winding Up and Dissolution) Rules and it is very lengthy
and expensive procedure. How to Form of an LLP?
Any two or more persons can form an LLP. Even a limited
Company, a foreign Company, a LLP, a foreign LLP or a
non-resident can be a partner in LLP. Although, there is
no specific mention, a HUF represented by its Karta and a
Minor can also be partner in LLP. An Incorporation
document (similar to memorandum) and LLP agreement
(similar to articles of association) is required to be filed
electronically. The Registrar of Companies (ROC) shall
register and control LLPs.

 Process : 6 Steps to Incorporate a Limited

Liability Partnership(LLP)
Limited Liability Partnership (LLP) is a new form
organization. It is a hybrid form of organization. It
combines the benefits of Partnership firms along with the
corporate identity of Companies. LLPs are governed by
Limited Liability Partnership Act, 2008. Many
entrepreneurs have registered for the same, since its
introduction. Besides, Startups are highly recommended
to form an LLP rather than Private Limited Companies
owing to certain advantages.
Key Advantages of Forming a Limited Liability
Partnership
 It is a legal entity separate from its owners.
 The cost of formation is very low.

511
 The partner’s liability in the LLP is limited to their capital
contribution.
 The partners can decide the terms of partnership just like
partnership firm.
 The compliances and cost of maintenance are much lower
than a Private Limited Company.
Related:6 Steps to Incorporate a Private Limited
Company
Step by Step Procedure to Register a Limited Liability
Partnership
Step 1 – Obtain Directors’ Identification Number (DIN)
Every applicant who would become the designated
partner of the LLP must have a DIN. Application for DIN
can be made online through Ministry of Corporate Affairs
(MCA) website. The applicant can submit E-form DIR-3 to
apply for DIN. A nominal fee of Rs. 100/- has to be paid
for each application. There is no physical submission, and
the entire process is online. Following are some important
points in this regard –
 Proof of Identity – In case of Indian Nationals – PAN card,
while in case of Foreign Nationals – Passport
 Proof of Residence – Passport, Election (Voter identity)
card, Ration card, Driving license, Electricity bill,
Telephone bill or Bank account statement. The telephone
bill, electricity bill or bank account statement should not
older than two months in the case of Indian Nationals and
one year in the case of Foreign Nationals.
 Affidavit as per Annexure 1 of DIN Rules has to be made
by applicants on Stamp Papers, which shall also be
notarized.
Step 2 – Register Digital Signature of Designated
Partners
The applicants whose signatures would be placed on the
application forms must have a Class 2 or a Class 3 Digital
Signature Certificate (DSC) from an authorized certifying
agency. This DSC has to be registered on the MCA
website.

512
 Step 3 – File Form 1 for Name Availability
Form 1 has to be filled for applying for Name availability.
The applicants can place 6 choices for names in the form
which should be unique. On MCA portal, one can freely
search the names of existing companies or LLPs. Details
of at least 2 proposed designated partners are required
while filing this form. This form has a nominal fee of Rs.
200/- To upload this form, one has to register on the MCA
Website. Once the approval for reservation of name is
obtained, one may proceed to next steps.
Step 4 – File Form 2 for Incorporation of LLP
This form requires details of the partners, the monetary
value of their contribution, details of nominees, details of
witnesses, their signatures, address proof of registered
office of LLP, etc. Consent letter from each individual
becoming partner in the LLP has to be attached along with
Form 2. The fee for this form is dependent on the
monetary value of contribution being made by the
partners. In case, the business belongs to a regulated
sector, then appropriate approval from the concerned
regulatory body is also required to be attached along with
this form.
Step 5 – Drafting LLP agreement
LLP agreement has to be drafted in consonance with LLP
Act. It is not mandatory to file LLP agreement immediately
at the time of registration, and it can also be filed within 30
days from the date of registration. The designated
partners will be responsible for acts of the LLP, and so it is
important to draft LLP agreement carefully. The following
are the relevant clauses that are generally added in an
LLP agreement –
 Name & Object of the LLP
 Registered office of the LLP
 Initial contribution by the partners
 Method adopted to value Non-monetary contribution
 Ratio of sharing Profits and Losses
 Details of the Designated Partners

513
 Remuneration payable to partners
 Interest, if any, payable on Capital contributed.
 Maintenance of Accounts
 Rights & duties of the partners
 Rights & functions of the designated partners
 Goodwill and indemnity clause
 Procedure for change in name
 Procedure for appointment of auditor
 Procedure for admission of New Partner, Meetings,
Cessation of existing Partners.
 Process for winding up of LLP, amending the LLP
agreement, etc.
 The extent of liability of LLP and of partners in LLP.
Step 6 – File Form 3 for LLP Agreement
The LLP agreement has to be uploaded. On approval of
the same, the LLP is legally incorporated, and the
registration procedure is completed.

 Incorporation of an LLP
The LLP Act, 2008 inter area, provides for incorporation
of LLP's as a business vehicle. Two or more individuals
or organizations, by subscribing their names to an
"Incorporation document" and by giving details
pertaining to the name of LLP, proposed business,
address of the registered office, name, address &
photographs of the proposed partners of the LLP, and
name and address of the persons who are named as
"Designated Partners" for compliance with the legal
provision of the Act. Such an LLP can be formed to
carry on any lawful business and to make profits.

In terms of minimum number of partners required, the

provision of LLP is analogous to a private limited
company under the Companies Act, 1956 (Companies
Act).. There is no limit on the maximum number of
partners unlike in the Partnership Act.

514
 The incorporation document together with the
partnership agreement, if any, between the partners
should be delivered to the Registrar of Companies
(ROC). A statement of compliance with the LLP Act
duly signed by an Advocate or Company Secretary or
Chartered Accountant, who is in whole time practice is
also required to be delivered to the ROC.

The ROC on receiving the documents aforesaid and if

satisfied with the documents, will register the LLP and
issue an "Incorporation certificate". The certificate is the
conclusive proof that all the statutory requirements of
the Act have been complied with and the LLP has been
incorporated by the name stated in the Incorporation
Certificate.

 Limited Liability Partnership (LLP) Registration

Limited Liability Partnership (LLP) was introduced in India by
way of the Limited Liability Partnership Act, 2008. The basic
premise behind the introduction of Limited Liability Partnership
(LLP) is to provide a form of business entity that is simple to
maintain while providing limited liability to the owners. Since, its
introduction in 2010, LLPs have been well received with over 1
lakhs registrations so far until September, 2014.
The main advantage of a Limited Liability Partnership over a
traditional partnership firm is that in a LLP, one partner is not
responsible or liable for another partner's misconduct or
negligence. A LLP also provides limited liability protection for
the owners from the debts of the LLP. Therefore, all partners in
a LLP enjoy a form of limited liability protection for each
individual's protection within the partnership, similar to that of
the shareholders of a private limited company. However, unlike
private limited company shareholder, the partners of a LLP
have the right to manage the business directly.

515
LLP is one of the easiest form of business to incorporate and
manage in India. With an easy incorporation process and
simple compliance formalities, LLP is preferred by
Professionals, Micro and Small businesses that are family
owned or closely-held. Since, LLPs are not capable of issuing
equity shares, LLP should be used for any business that has
plans for raising equity funds during its lifecycle.
IndiaFilings is the market leader in LLP registration services in
India. In addition to LLP registration, IndiaFilings also offers a
variety of business registration services like private limited
company registration, one person company registration, Nidhi
Company Registration, Section 8 Company Registration,
Producer Company Registration and Indian Subsidiary
registration. The average time taken to complete a LLP
registration is about 15 - 20 working days, subject to
government processing time and client document submission.
Get a free consultation on LLP registration and business setup
in India by scheduling an appointment with an IndiaFilings
Advisor.
Reasons to Register a Limited Liability Partnership

Separate Legal Entity

A LLP is a legal entity and a juristic person established under
the Act. Therefore, a LLP has wide legal capacity and can own
property and also incur debts. However, the Partners of a LLP
have no liability to the creditors of a LLP for the debts of the
LLP.
Uninterrupted Existence
A LLP has 'perpetual succession', that is continued or
uninterrupted existence until it is legally dissolved. A LLP being
a separate legal person, is unaffected by the death or other
departure of any Partner. Hence, a LLP continues to be in
existence irrespective of the changes in ownership.
Easy Transferability

516
The ownership of a LLP can be easily transferred to another
person by inducting them as a Partner of the LLP. LLP is a
separate legal entity separate from its Partners, so by changing
the Partners, the ownership of the LLP can be changed.

Audit NOT Required

A LLP does not require audit if it has less than Rs. 40 lakhs of
turnover and less than Rs.25 lakhs of capital contribution.
Therefore, LLPs are ideal for startups and small businesses
that are just starting their operations and want to have minimal
regulatory compliance related formalities.
Owning Property
A LLP being an artificial judicial person, can acquire, own,
enjoy and sell, property in its name. No Partner can make any
claim upon the property of the LLP - so long as the LLP is a
going concern.

Documents reqired for Limited Liability Partnership

Identity and Address Proof
Identity and address proof will be required for all partners of the
LLP to be incorporated. In case of Indian nationals, PAN is
mandatory. For foreign nationals, apostilled or notarised copy
of passport must be submitted mandatorily. All documents
submitted must be valid. Residence proof documents like bank
statement or electricity bill must be less than 2 months old.
Registered Office Proof
All LLPs must have a registered office in India. To prove access
to the registered office, a recent copy of the electricity bill or
property tax receipt or water bill must be submitted. Along with
the utility bill, rental agreement or sale deed and a letter from
the landlord with his/her consent to use the office as a
registered office of a company must be submitted.

 Incorporation of an LLP
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Limited Liability Partnerships have gotten quite popular in the
last few years. In this article, we will focus on the process and
steps along with the elements essential for the incorporation of
an LLP (limited liability partnership). The guidelines are
provided by the Limited Liability Partnership Act (LLP Act),
2008.
Elements Essential for the Incorporation of an LLP
According to the LLP Act, 2008, the following elements are
essential for the incorporation of an LLP in India:
 Complete and submit the Incorporation document in the
prescribed form, with the Registrar electronically.
 Have at least two partners, either individual or body
corporate
 Have a registered office in India for sending and receiving
communication
 Appoint at least two individuals as designated partners.
They will be responsible for doing all acts, matters, and
things as required to be done by the LLP. Also, the
designated partners should be resident in India.
 Each designated partner should hold a Designated
Partner Identification Number (DPIN) allotted by the
Ministry of Corporate Affairs (MCA).
 Execute the agreement between the partners or between
the LLP and its partners. Further, if an agreement is not
present, the provisions in the First Schedule of the LLP
Act, 2008 are applied.
 Name of the LLP. It is important to note that the name
should be distinct. The LLP cannot have a name which
another LLP or Partnership firm or Company is currently
using.
Process for the Incorporation of an LLP
The following things need to be ensured for the
incorporation of LLP:
 Appoint/nominate partners and designated partners.

518
 Obtain the DPINs and Digital Signature Certificates
(DSCs)
 Register a unique LLP name (applicant can indicate up to
6 choices)
 Draft the LLP Agreement
 File the required documents, electronically
 Apply for the Certificate of Incorporation along with LLPIN
(Limited Liability Partnership Identification Number)
The contents of an LLP agreement
 Name of the LLP
 Names and addresses of the partners and designated
partners
 The form of contribution and interest on contribution
 Profit sharing ratio
 Remuneration of partners
 Rights and duties of partners
 The proposed business
 Rules for governing the LLP
Steps for the Incorporation of an LLP
 Reserve the name of the LLP. Applicant files e-Form 1 to
ascertain the availability and register the name of the LLP.
Once the Ministry approves the name, it reserves it for the
applicant for a period of 90 days. Also, if the LLP is not
incorporated within that time frame, the reservation is
removed and the name is made available to other
applicants.
 Incorporation of a new LLP. Applicant files e-Form 2 which
contains the details of the proposed LLP along with details
of the partners and designated partners
 Consent of the partners and designated partners to act in
the said role.
 File the LLP Agreement with the Registrar within 30 days
of incorporation of the LLP. Applicant files e-Form 3.

519
According to Section 23 of the LLP Act, 2008, execution of
LLP Agreement is mandatory.
On obtaining an approval of the LLP Agreement, the
process of Incorporation of LLP is complete.
Solved Question for You
Q1. What is the mandatory requirement with respect to
designated partners for the incorporation of LLP?
Answer: The applicant has to appoint at least two
individuals as designated partners. They should be
resident in India. Also, they are responsible for doing all
acts, matters, and things as per the requirements of an
LLP.

 LLP Formation Procedure

Limited Liability Partnership (LLP) is a newly introduced
corporate entity type in India aimed at small and medium
sized businesses. A LLP provides many of the benefits of
a Private Limited Company while being easier to maintain
compliance. Low registration fee and easy maintenance
make LLP a first choice for many of the small businesses
in India. In this article, we look at the LLP
formationprocedure and the documents required.
LLP Formation Procedure
The procedure for formation of a LLP is very similar to that
of a Private Limited Company incorporation procedure.
A minimum of two Partners are required to start the LLP
formation procedure and a registered office location is
required within India. It is important to remember that FDI
in LLP is allowed only with the prior approval of the
Reserve Bank of India (RBI). Therefore, it is
recommended that NRI’s and Foreign National promoters
opt to incorporate a Private Limited Company,
where 100% FDI is allowed under the automatic route.
LLP Formation Documents Required

520
 To register a LLP in India, the following documents are
required:
 PAN Card of the Partners
 Address Proof of the Partners
 Utility Bill of the proposed Registered Office of the LLP
 No-Objection Certificate from the Landlord
 Rental Agreement Copy between the LLP and the
Landlord
The PAN Card of the Partners and the Address Proof the
the Partners is required to start the LLP formation
procedure. The documents pertaining to the Registered
Office of the LLP can be submitted after obtaining name
approval for the LLP from the Registrar of Companies.
Step #1: Obtain Digital Signature Certificate (DSC) for
the Partners
For obtaining DIN (Director Identification Number or
Designated Partner Identification Number) for the Partners
of the LLP, a Digital Signature Certificate (DSC) is
required. Therefore, a Digital Signature Certificate for the
proposed Partner must first be obtained. The DSC can be
obtained within one day of filing of the DSC Application
with IndiaFilings. Digital Signatures usually have a validity
of one or two years and can be used during that time for
filing of Income Tax documents online or Ministry of
Corporate Affairs (MCA) documents online.
Step #2: Obtaining Director Identification Number for
the Partners
Once, Digital Signatures are obtained for the Partners,
application for Director Identification Number (DIN) can be
made. DIN registration usually happens immediately and
in rare cases, additional documents must be submitted to
the DIN Cell for approval of the DIN application. DIN and
DPIN are synonymous and can be used interchangeably.

521
Further, once a DIN is obtained, there are no renewals
required and each person can have only one DIN.
Step #3: Obtaining Name Approval
Once two DIN’s are available, application for reservation
of name can be made to the MCA. It is important for the
promoters to keep in mind the LLP Naming
Guidelines and suggest appropriate names for the LLP in
the application, to ensure a speedy approval. Once,
the application for reservation of name is submitted to the
MCA, it will be processed by the Registrar of Companies
(ROC) in the State of Incorporation. The processing time
for name approval application differ from ROC to ROC
based on the workload.
Step #4: Filing for Incorporation
Once the name approval application is accepted by the
MCA, a LLP name approval letter will be issued to the
proposed Partners. The Partners then have 60 days to file
the required incorporation documents and register
the LLP. In case the LLP is not formed within 60 days of
name approval letter, the approval for name for the LLP
would have to be re-obtained.
While filing for formation of LLP, the documents showing
possession of the registered office would be required.
Once prepared, the registered office related documents
along with the signed subscribers sheet must be filed with
the MCA for registration of the LLP.
If the application for LLP Registration is acceptable, the
Registrar would issue the incorporation certificate. Once,
the incorporation certificate is issued, the LLP will be
considered to be registered and application for PAN for
the LLP can be made. The Partners of the LLP then have
30 days time to file the Partnership Deed of the LLP with
the MCA. In case, the LLP Partnership Deed is not filed
within 30 days, a fine will be applicable.

522
 Limited Liability Partnership (LLP) Registration in
India
Updated on Oct 01, 2018 - 05:08:25 PM
Limited Liability Partnership (LLP) has become a
preferable form of organization among entrepreneurs as it
incorporates the benefits of both partnership firm and
company into a single form of organization.
 Features of LLP
 Process of Registration as LLP
 Documents required to register as LLP
 Cost Involved in Registration Process
 Time Involved In Registration Process
Features of LLP
 It has a separate legal entity just like companies
 The liability of each partner is limited to the contribution
made by partner
 The cost of forming an LLP is low
 Less compliance and regulations
 No requirement of minimum capital contribution
The minimum number of partners to incorporate an LLP is
2. There is no upper limit on the maximum number of
partners of LLP. Among the partners, there should be
minimum two designated partners who shall be
individuals, and at least one of them should be resident in
India. The rights and duties of designated partners are
governed by the LLP agreement. They are directly
responsible for the compliance of all the provisions of LLP
Act 2008 and provisions specified in LLP agreement.
If you want to start your business with Limited Liability
Partnership, then you must get it registered under Limited
liability Partnership Act, 2008.
Form name Form purpose

523
RUN – LLP (Reserve Form for reserving a name for the
Unique Name-Limited LLP
Liability Partnership

*FiLLiP Form for incorporation of LLP

Form 5 Notice for change of name

Form 17 Application and statement for the

conversion of a firm into LLP

Form 18 Application and Statement for

conversion of a private
company/unlisted public
company into LLP
Process of Registration as LLP
Step 1: Obtain DSC
Step 2: Apply for DIN
Step 3: Name Approval
Step 4: Incorporation of LLP
Step 5: File LLP Agreement
Steps to form a limited liability partnership
Step 1: Digital Signature Certificate (DSC)
Before initiating the process of registration, you must
apply for the digital signature of the designated partners of
the proposed LLP. This is because all the documents for
LLP are filed online and are required to be digitally signed.
So, the designated partner must obtain their digital
signature certificates from government recognized
certifying agencies. Here is a list of such certified
agencies. The cost of obtaining DSC varies depending
upon the certifying agency. Also, you should obtain either
class 2 or class 3 category of DSC or you can click here &
let a ClearTax expert procure DIN for you. If you go for

524
Limited Liability Partnership company registration with
ClearTax, up to 2 DINs are covered in the plan & there is
no need to apply for DIN separately.
Step 2: Director Identification Number (DIN)
You have to apply for the DIN of all the designated
partners or those intending to be designated partner of the
proposed LLP.
The application for allotment of DIN has to be made in
Form DIR- 3. You have to attach the scanned copy of
documents (usually Aadhaar and PAN) to the form. The
form shall be signed by a Company Secretary in full- time
employment of the company or by the Managing
Director/Director/CEO/CFO of the existing company in
which the applicant shall be appointed as a director.
Step 3: Reservation of Name
LLP-RUN(Limited Liability Partnership-Reserve Unique
Name) is filed for the reservation of name of proposed
LLP which shall be processed by the Central Registration
Centre under Non-STP. But before quoting the name in
the form, it is recommended that you use the free name
search facility on MCA portal. The system will provide the
list of closely resembling names of existing
companies/LLPs based on the search criteria filled up.
This will help you in choosing names not similar to already
existing names. The registrar will approve the name only if
the name is not undesirable in the opinion of the Central
Government and does not resemble any existing
partnership firm or an LLP or a body corporate or a
trademark. The form RUN-LLP has to be accompanied
with fees as per Annexure ‘A’ which may be either
approved/rejected by the registrar. A re-submission of the
form shall be allowed to be made within 15 days for
rectifying the defects. There is a provision to provide for 2
proposed names of the LLP.
Step 4: Incorporation of LLP
525
1. The form used for incorporation is FiLLiP(Form for
incorporation of Limited Liability Partnership) which shall
be filed with the Registrar who has a jurisdiction over the
state in which the registered office of the LLP is situated.
The form will be an integrated form.
2. Fees as per Annexure ‘A’ shall be paid.
3. This form also provides for applying for allotment of DPIN,
if an individual who is to be appointed as a designated
partner does not have a DPIN or DIN.
4. The application for allotment shall be allowed to be made
by two individuals only.
5. The application for reservation may be made through
FiLLiP too.
6. If the name that is applied for is approved, then this
approved and reserved name shall be filled as the
proposed name of the LLP
Get your business registered under LLP
◉ Registration done in 15 working days ◉ Completely
online process
Know More
Step 5: File Limited Liability Partnership Agreement
LLP agreement governs the mutual rights and duties
amongst the partners and also between the LLP and its
partners.
 LLP agreement must be filed in form 3 online on MCA
Portal.
 Form 3 for LLP agreement has to be filed within 30 days
of the date of incorporation.
 The LLP Agreement has to be printed on Stamp Paper.
The value of Stamp Paper is different for every state.
Documents required to register as LLP
Here is a list of documents required for registration:

526
 Documents of Partners:
 PAN Card/ ID Proof of the Partners
 Address Proof of the partners
 Residence Proof of Partners
 Photograph
 Passport (in case of Foreign Nationals/ NRIs)
Documents of LLP:
 Proof of Registered Office Address
 Digital Signature Certificate
A. Documents of Partners
1. PAN Card/ ID Proof of Partners – All the partners are
required to provide their PAN at the time of registering
LLP. PAN card acts as a primary ID proof.
2. Address Proof of Partners – Partner can submit
anyone document out of Voter’s ID, Passport, Driver’s
license or Aadhar Card. Name and other details as per
address proof and PAN card should be exactly same. If
spelling of own name or father’s name or date of birth is
different in address proof and PAN card, it should be
corrected before submitting to RoC.

527
3. Residence Proof of Partners – Latest bank statement,
telephone bill, mobile bill, electricity bill or gas bill should
be submitted as a residence proof. Such bill or statement
shouldn’t be more than 2-3 months old and must contain
the name of partner as mentioned in PAN card.
4. Photograph – Partners should also provide their
passport size photograph, preferably on white
background.
5. Passport (in case of Foreign Nationals/ NRIs) – For
becoming a partner in Indian LLP, foreign nationals and
NRIs have to submit their passport compulsorily. Passport
has to be notarized or apostilled by the relevant authorities
in the country of such foreign nationals and NRI, else
Indian Embassy situated in that country can also sign the
documents.
Foreign Nationals or NRIs have to submit a proof of
address also which will be a driving license, bank
statement, residence card or any government issued
identity proof containing the address.
If the documents are in other than the English language, a
notarized or apostilled translation copy will be also be
attached.
B. Documents of LLP
1. Proof of Registered Office Address
Proof of registered office has to be submitted during
registration, or within 30 days of its incorporation.
If the registered office is taken on rent, rent agreement
and a no objection certificate from the landlord has to be
submitted. No objection certificate will be the consent of
the landlord to allow the LLP to use the place as
‘registered office’.
Besides, anyone document out of utility bills like gas,
electricity, or telephone bill must be submitted. The bill
should contain complete address of the premise and

528
owner’s name and the document shouldn’t be older than 2
months.
2. Digital Signature Certificate
One of the designated partners needs to opt for a digital
signature certificate also since all documents and
applications will be digitally signed by the authorized
signatory.
Cost Involved in Registration Process
Below is the government fees for filing forms:
Step Cost

Step 1 – DSC Around Rs. 1500-2000 for 2

partners(varies depending on the
agency)

Step 2 – DIN Rs. 1000 for 2 partners

Step 3 – Name Rs. 200

Reservation

Step 4 – Depends on capital contribution.

Incorporation Contribution up to Rs. 1 lakhs – Rs.
500,
Contribution between Rs. 1 and 5
lakhs – Rs. 2000

Step 5 – LLP Depends on capital contribution.

Agreement Contribution up to Rs 1 lakhs – Rs 50
for filing Form 3
and stamp duty based on the state
where LLP is formed
Time Involved In Registration Process

529
 LLP formation starting from obtaining DSC to Filing Form
3 takes approximately 15 days subject to availability of all
the documents.
Now, get your business registered as a Limited Liability
Partnership using ClearTax’s CA & Legal Services.
Let our experts manage your taxes and business
compliances, while you do what you do best!

 Conversion of Partnership into LLP

 The first thing you need to do while conversion of a
partnership into an LLP is to get a DSC (Digital
Signature Certificate). All the partners will require a digital
signature.
 Then, obtain a DPIN (Designated Partner Identification
Number). It is again mandatory for at least two partners in
order to proceed with the conversion. It is a one-time
number. There is no renewal or anything associated.
 Next, apply for name approval. It is one tricky part. The
name should be selected carefully. Limited Liability
Partnership will be used at the end of the company’s
name.
 Finally, file LLP Form 17, LLP Form 2 and LLP form 3 for
the conversion. Certain documents are required along with
the form. Documents include:
 Address proof of registered office,
 Approval by regulatory authority,
 Details of partnership (including details of partners and
directors)
 Consent of all the partners,
 Copy of the latest income tax return (can be
acknowledgment),
 No Objection Certificate from tax authorities,
 List of creditors and their consent, and

530
 List of certified liabilities and assets.
 After the successful filing of all the documents along with
prescribed fees, verification will take place. After which, a
certificate will be issued to you. Hence, completing the
conversion of your partnership into a Limited Liability
Partnership successfully.
Conversion of Partnership into a Private Limited
Company:
 When you want to convert your Partnership
registration into a Pvt limited company you need to
ensure that you have:
 A minimum of seven partners.
 A minimum share capital of Rupees one lakh.
 The authorized capital should be divided into units or
shares.
 Object Clause of your Memorandum of Association (which
will be drafted while conversion) should permit the
company to be formed to acquire the assets and liabilities
of the existing firm.
 Other than that, you will again require DSC (Digital
Signature Certificate) for the directors as well as DIN
(Director Identification Number).
 Memorandum of Association and Articles of
Association has to be drafted. And the application for
name approval is to be filed. The name will bear Private
Limited Company at the end.
 Filing of form 18, 37, 32, 39, 40 and 41 along with identity
proof, address proof of registered office and a No-
objection certificate from the landlord.
 All these documents are filed along with prescribed fees,
upon which a certificate is issued. Hence, completing the
conversion successfully.
 Conversion to an LLP

531
 This is a unique feature of the LLP Act. It provides for
conversion of a firm, a private company and unlisted
public company into a LLP, in accordance with the
procedure laid down in the Second, Third & the Fourth
schedules to the LLP Act. The advantages of
conversion, lies in the organisation flexibility for each of
it partners to carry on the business of LLP as its agent
and not the agent of other partners. The equation of
partners with LLP is on one to one basis

The Second Schedule provides for detailed procedure

for conversion of a firm into an LLP, subject to the
condition that all the existing partners of a firm should
be partners of the LLP and no one else. The procedure
for conversion starts with the presentation of certain
information to the Registrar, containing: (i) A statement
by all the partners containing the name & registration
no. of the firm, if applicable; (ii) The date on which the
firm was registered under the Indian Partnership Act,
1932 or any other law, as may be applicable. (iii)
Incorporation document containing - (a) the name of the
LLP, (b) the proposed business of the LLP, (c) the
address of the registered office, (d) the name & address
of each of the persons who are to be partners of the
LLP, on incorporation, (e) the name & address of the
persons who are to be Designated Partners of the LLP,
on incorporation.

On receiving the documents referred to above, the

Registrar will register the documents and issue a
certificate of registration stating that the Firm is, on and
from the date specified therein, registered under the
LLP Act. The LLP, within 15 days of its incorporation,
inform the Registrar of Firms about the conversion into
an LLP.

532
 The effects of registration into an LLP are as under:-

a) All tangible property (movable & immovable) as well

as intangible property vested in the firm, all assets,
interests, rights, privileges, liabilities, obligations relating
to the firm and the whole of the undertaking of the firm
are transferred to and vest in the LLP without further
assurance, act or deed, and

b) The firm is deemed to be dissolved and if registered

under the Indian Partnership Act, 1932 removed from
the record maintained under that Act.

c) All proceedings by or against the firm, every

agreement, deeds, contract including employment
contracts, appointments of the firm etc are enforceable
against LLP.

d) Notwithstanding what is stated above, every partner

of a firm that has been converted into LLP will continue
to be personally liable for the liabilities and obligations
of the firm, incurred prior to the conversion.
e) If any partner discharges any liability as aforesaid, he
shall be entitled to be indemnified by the LLP, subject to
the terms of any agreement.

f) The LLP is required to ensure that for a period of 12

months commencing not later than 14 days of the
registration, every official communication of the LLP
should bear a statement that it was converted from firm
into LLP, together with the name and registration of the
firm from which it was converted.

Conversion of a Private Company into an LLP

The Third Schedule provides for conversion of a private

533
company into LLP if and only if (a) there is no security
interest subsisting in force at the time of application for
conversion, and (b) the partners of the LLP consist of
the shareholders of the private company and no one
else. All other procedures as mentioned above in the
case of a firm are also applicable in the case of a
private company except that the conversion of private
company into LLP and dissolution of the private
company should be informed to the Registrar of
Companies.

Conversion of an unlisted public company into an

LLP

The Fourth Schedule to the LLP Act provides for

conversion of unlisted public company into an LLP. The
procedure detailed above and applicable in the case of
a private company is equally applicable in the case of
unlisted public company.

Foreign Limited Liability Partnership

Section 59 of the LLP Act empowers the Central

Government to prescribe rules for the establishment of
a place of business by foreign limited partnerships
within India for the purpose of carrying on business.
This may be done by applying or incorporating, with
such modifications, as may be appropriate under the
Companies Act, 1956 or with such regulatory
mechanism as may be prescribed.

Other matters

The LLP Act also provides for the following:-

a) Compromise, Arrangement or Reconstruction of

534
 LLP's

b) Winding up & Dissolution of LLP's

c) Investigation into the affairs of LLP.

The Central Government is empowered by the LLP Act
to direct that any of the provisions of the Companies
Act, 1956 as specified in the notifications shall apply to
LLP or shall apply to any LLP with such exception,
modification and adaptation as may be specified.

Conclusion

It is expected that a number of firms, private and

unlisted public companies will get the benefit of limited
liability and the flexibility it offers for internal
management of business by the LLP Act. In particular,
professionals and small entrepreneurs will find the LLP
model an ideal opportunity to regulate their business
under the LLP Act and make best use of the protective
umbrella that the statue offers. All these will result in
faster expansion of business and add a new dimension
to the economic growth of Indian economy.

 What Is The Procedure To Convert A Company

Into Limited Liability Partnership
Benefits of Converting a Company into LLP
One of the major benefits of converting the company into
LLP is that in a company there are a lot of forms that need
to be filled while the company is being incorporated for
example Regular – MGT – 14, 23AC, 23ACA, 20B, GNL
– 2 etc. Whereas, in the case of establishing an LLP, only
two forms need to be filled i.e. Regular-E-Form 8 and E-
Form 11.

535
 In the company form of business organisation, members
can transfer their shares only through court order once it is
decided that the company is to be wound up whereas, in
an LLP, transfer of shares is possible.
In companies, it is essential that during the stage of
incorporation, the minimum capital contribution is Rs.
1,00,000 in the case of private companies and Rs.
5,00,000 in the case of public companies. Whereas, in the
case of LLP, there is no minimum capital requirement for
incorporating a limited partnership.
According to the Companies Act, 2013 companies are
bound by the obligation of maintaining a statutory record.
There is no such obligation or requirement of maintenance
of statutory records. Moreover, at the end of financial
periods, it is compulsory to conduct audits. Whereas LLPs
have to conduct audits only if their contribution exceeds
40 lakhs or their contribution is above 25 lakhs.
Other benefits in the Income tax include no payment of
taxes like dividend distribution tax, MAT tax and income
tax which is due to interests and remuneration payable to
partners as salary payable to directors.
Cost to be incurred in case the company gets
converted into an LLP
In case if a company gets converted into an LLP, then
following are the cost that the company shall have to bear:
1. If any of the conditions mentioned under (i) to (vi) of
clause (xiiib) of section 47 are not met then the
Unabsorbed Depreciation and Accumulated Loss will not
be carried over;
2. Payment of stamp duty, if any, in case of transfer of
immovable assets;
3. Cost related to transfer of brand name, patent, trademark;
4. Cost of formation of LLP;

536
5. Since LLPs do not have a concept of MAT, therefore, the
amount of the credit of MAT will have to be given up. The
succeeding LLP shall not be entitled to hold the preceding
company’s credit of MAT.
Points to be ensured before getting converted into
LLP
1. The company that wishes to be converted into an LLP
shall have its shareholders as its partners and no one
else.
2. Income tax returns have to be up to date as per the
provisions of Income Tax Act, 1961
3. Every designated partner shall have to obtain a DIN from
the Central Government.
4. Since all the forms that need to be filled up for the purpose
of establishing an LLP are to be filled electronically, it
becomes impossible to sign them manually. In such a
case, the designated partners are required to obtain a
Digital Signature Certificate from government recognised
DSAs
5. There should be no proceeding against the company in
any court or tribunal;
6. In cases where the company has certain creditors, then
obtaining an NOC from all unsecured creditors;
7. Subsistence of any conviction, rule or order by a court or
tribunal should be checked.
Process of Conversion of a Company into an LLP
Following are the steps that need to be followed for
converting a company into LLP:
1. Obtain DIN – DIN acronyms for Director Identification
number. Earlier instead of DIN, DPIN was to be obtained.
Nowadays DIN is required to be obtained by those
designated partners who do not possess one.
2. Board Meeting – The second step for conversion of a
company into LLP is that a meeting of all board of

537
 directors is to be called for. In the meeting, a resolution for
the conversion of the company into LLP is to be passed.
Apart from this, another resolution that needs to be
passed is for authorising any director to apply for the
name of LLP. After passing of such a resolution, an
application for name availability is to be filled i.e. e-form
LLP- 1 with the Registrar of Companies. Along with such
application, the board resolution regarding conversion also
needs to be attached.
3. After submission of such an application, the approval
certificate needs to be obtained from the Registrar of
Companies.
4. Drafting the LLP agreement – An LLP agreement needs
to be drafted. A basis contents in each LLP agreement
contain Name of the LLP, Name of the partners and
designated partners, form of contribution, profit sharing
ratio, rights, duties and liability of each of the partners,
proposed business activity that the partners would carry
on and the rules that the shall govern the LLP. All these
details need to be filled in e-form 3 within 30 days of
incorporation. It is desirable that all the partners sign this
agreement in order to avoid disputes.
5. Filling of Incorporation Documents – For the purposes
of incorporation, e-form 2 is to be filled up by attaching
documents like proof of address of registered office of
LLP, subscription sheet signed by the partners, notice of
consent and appointment of designated partners along
with their personal details and the detail of LLP.
6. Filling of application for Conversion – E-Form 18 needs
to be filled with the registrar of companies. Following
attachments need to be put with this form:
 Statement of shareholders.

 Incorporation Documents & Subscribers Statements in

Form 2 filed electronically.

538
 Statement of Assets and Liabilities of the company duly
certified as true and correct by the auditor.
 List of all the Secured creditors along with their consent to
the conversion.
 Approval of the governing council (In case of
professional private limited companies)
 NOC from Income Tax authorities and Copy of
acknowledgement of latest income tax return.
 Approval from any other body/authority as may be
required.
 Particulars of pending proceedings from any
court/Tribunal etc
7. After filling of all the above documents and approval of the
same from the registrar and ministry, the registrar would
issue a certificate of registration in form no. 19 for the
conversion. This certificate shall be the conclusive
evidence of conversion into LLP.
8. Filling of e-form 14 – After receiving the certificate of
conversion, within 15 days of the date of registration, the
partners need to intimate the registrar of companies about
the acceptance. The attachments to be made with e- form
14 are a copy of the certificate of incorporation of
formation of LLP and copy of incorporation.
How to Close a LLP – Winding Up of LLP
LLP or Limited Liability Partnership is a new form of
business entity introduced in India through the LLP Act,
2008. LLP enjoys audit exemption, if the annual turnover
of the LLP is less than Rs.40 lakhs and/or the capital
contribution is less than Rs.25 lakhs. This feature has
made LLP popular amongst many entrepreneurs.
However, due to a number of reasons, it may be
necessary to close a LLP or windup a LLP. In this article,
we cover the procedure for voluntary wingding up of LLP
in India.

539
  LLP Winding up Overview
A LLP winding up can be initiated voluntarily or by a
Tribunal. If a LLP is to initiate winding up voluntarily, then
the LLP must pass a resolution to wind up the LLP with
approval of at least three-fourths of the total number of
Partners. If the LLP has lenders, secured or unsecured,
then the approval of the lenders would also be required for
winding up of the LLP.
Winding up of LLP by Tribunal
Winding up of LLP can be initiated by a Tribunal for the
following reasons:
1. The LLP wants to be wound up.
2. There are less than two Partners in the LLP for a period of
more than 6 months.
3. The LLP is not in a position to pay its debts.
4. The LLP has acted against the interests of the sovereignty
and integrity of India, the security of State or public order.
5. The LLP has not filed with the Registrar Statement of
Accounts and Solvency or LLP Annual Returns for any
five consecutive financial years.
6. The Tribunal is of the opinion that it is just and equitable
that the LLP should be wound up.

Winding Up of LLP Procedure

To begin the process for winding up of LLP, a resolution
for winding up of LLP must be passed and filed with the
Registrar within 30 days of passing of the resolution. On
the date of passing of resolution of winding up of LLP, the
voluntary winding up shall be deemed to commence.
Once, the resolution for winding up of LLP is filed with the
Registrar, the majority of Partners (not less than two) shall
make a declaration verified by an Affidavit to the effect
that the LLP has no debt or that it will be in a position to
pay its debts in full within a period, as mentioned in the
540
 declaration, but not exceeding one year from the date of
commencement of winding up of LLP. Along with the
Affidavit signed by the majority Partners, the following
documents must be filed with the Registrar within 15 days
of passing of the resolution for winding up of LLP:
 Statement of assets and liabilities for the period from last
accounts closure to date of winding up of LLP attested by
atleast two Partners
 Report of valuation of the assets of the LLP prepared by a
valuer, if there are any assets in the LLP.
Winding up of LLP with Creditors
If a LLP under winding up has any secured or unsecured
creditors, then before taking any action for winding up of
LLP, the approval for winding up of LLP must be
requested from the creditors. Creditors are required to
provide their opinion on winding up of LLP within 30 days
of receipt of request for approval for winding up. If it is in
the interest of all partners and all creditors that the LLP be
wound up, then the LLP can proceed with voluntary
winding up procedure.
Appointment of LLP Liquidator
A LLP Liquidator must be appointed within thirty days of
passing of resolution of voluntary winding up through a
resolution. In case there are any creditors, then the
appointment of LLP Liquidator shall be valid only if it is
approved by two thirds of the creditors in value of the LLP.
It is then the duty of the LLP Liquidator to perform the
functions and duties for winding up of LLP. The LLP
Liquidator would settle the creditors and adjust the rights
of the partners, as the case may be. While discharging his
duties, the LLP Liquidator is required to maintain proper
books of accounts pertaining to the winding up of the LLP.
Filing of Winding Up Report by LLP Liquidator

541
Once, the affairs of the LLP is fully wound up, the LLP
Liquidator would prepare a report stating the manner in
which the winding up of LLP has been conducted and
property of the LLP has been disposed off. If two thirds of
the number of Partners and Creditors in value are satisfied
with the winding up report prepared by the LLP Liquidator,
then a resolution for winding up of accounts and
explanation for dissolution must be passed by the
Partners.
The LLP Liquidator must then send the LLP winding up
report along with the resolution to the Registrar and file an
application with the Tribunal.
Dissolution of the LLP
If the Tribunal is satisfied that procedures have been
followed in winding up of the LLP, then the Tribunal would
pass an order that the LLP shall stand dissolved. The LLP
Liquidator is required to file the copy of the order from the
Tribunal with the Registrar for winding up of LLP. The
Registrar on receiving the copy of the order passed by the
Tribunal for winding up of LLP would publish a notice in
the Official Gazette that the LLP stands dissolved.
For more information about Private Limited Company
Registration, LLP Registration or LLP Winding Up,
visit IndiaFilings.com or talk to an IndiaFilings
Business Advisor.
LLP Winding Up
A LLP winding up can be initiated voluntarily or by striking
off or by a Tribunal. If a LLP is to initiate winding up
voluntarily, then the LLP must pass a resolution to wind up
the LLP with approval of at least three-fourths of the total
number of Partners. If the LLP has lender's, secured or
unsecured, then the approval of the lenders would also be
required for winding up of the LLP.
To begin the process for winding up of LLP, a resolution
for winding up of LLP must be passed and filed with the
542
Registrar within 30 days of passing of the resolution. On
the date of passing of resolution of winding up of LLP, the
voluntary winding up shall be deemed to commence.
IndiaFilings can help you wind up your LLP quickly and
easily.
Voluntary Winding Up
LLPs can also be wound-up easily with the approval of
3/4th of the partners. To start the liquidation process for a
LLP, a greater part of the designated partners, will have to
make a declaration that the LLP has no debt or that it will
be competent to pay the debts in full within a period of not
more than 1 year from the start of winding up. Further, the
LLP partners must declare that the LLP is not being
wound up to defraud any person or persons. This
declaration for winding up of the LLP must be prepared
along with a statement of assets and liabilities until the
most recent practicable date right before the making of
declaration for winding up. A valuation of the assets
related to the LLP prepared by a valued must also be
submitted, if there are assets in LLP. Voluntary winding up
will be deemed to start on the date of passing of resolution
for the reason of voluntary winding up. (Know more)
Striking Off
The Ministry of Corporate Affairs has recently amended
Limited Liability Partnership Rules, 2009 by introducing
the Limited Liability Partnership (Amendment) Rules, 2017
with effect from 20th May, 2017. With this amendment,
LLP Form 24 has been introduced by the MCA and it is
now possible to easily close a LLP by making an
application to the Registrar for striking off name of LLP.
Before the introduction of the Limited Liability Partnership
(Amendment) Rules, 2017, the procedure for winding up a
LLP used to be long and cumbersome. However, with the
introduction of LLP Form 24, the procedure has been
made easy and simple. (Know more)

543
 Winding Up by Tribunal
Winding up of LLP can be initiated by a Tribunal for the
following reasons:
1. The LLP wants to be wound up.
2. There are less than two Partners in the LLP for a period of
more than 6 months.
3. The LLP is not in a position to pay its debts.
4. The LLP has acted against the interests of the sovereignty
and integrity of India, the security of State or public order.
5. The LLP has not filed with the Registrar Statement of
Accounts and Solvency or LLP Annual Returns for any
five consecutive financial years.
6. The Tribunal is of the opinion that it is just and equitable
that the LLP should be wound up.
(Know more)
Reasons to Wind Up LLP

Avoid Compliance
A LLP is a legal entity and a juristic person requiring
regular maintenance of compliance throughout its
lifecycle. LLP winding up can be used close a LLP that is
not active and avoid compliance responsibilities.
Avoid Fines
A LLP that doesn't file its compliance on time incurs fines
and penalty, including debarment of the Partners from
starting another LLP or Company.

Low Cost
LLPs can be wound up easily through IndiaFilings for just
Rs.15899. On the other hand, a dormant LLP or non-
compliant LLP could potentially acquire more penalty, if
compliance is not maintained every year.
Easy to Close

544
 The formalities for winding up of a dormant LLP are
relatively simple and easy to complete. Hence, its best to
close an inactive LLP at the earliest.
Easy Process
The Ministry of Corporate Affairs has simplified the
process for liquidation or winding up of LLP through
various initiatives. Hence, akin to incorporation, a LLP can
be wound up easily with minimal procedural requirement.

 How to Close a LLP – LLP Winding Up

Procedure
LLP Winding up procedure has been simplified by the
MCA. In this article, we understand the meaning of LLP
and will discuss the winding up / dissolution process of the
LLP.
A Limited Liability Partnership being an artificial person
cannot die a natural death. It comes into existence
through legal proceedings and hence ceases to exist in
the same manner.
Winding up means closing up of a company’s concerns,
which may be by reason of insolvency or otherwise, by the
realization of assets, payment of liabilities and distribution
of surplus if any amongst the partners of LLP.
The winding up of an LLP may be either Voluntary or by
Tribunal and LLP, so wound up may be dissolved.
Dissolution is an event wherein the name of LLP is
removed from the register of LLP’s and the fact is notified.
Dissolution puts an end to the existence of a company.

Four Reasons Why LLP Winding-Up is Required?

1. To avoid compliance and filing responsibilities for the
LLP’s which are not active.
2. To avoid fines and penalty for late filing, it is better to
officially Wind Up LLP’s which are inactive.
545
 3. When compared to maintaining compliance for Dormant
LLP, it might actually be cheaper to Wind Up and
incorporate again when the time is right.
4. It makes easy for inactive LLP’s that have NIL assets and
liabilities to close down or Wind Up.
Modes of Winding Up of LLP
Voluntary Winding Up of LLP
LLP may initiate winding up voluntarily, then the LLP must pass
a Partners resolution to wind up the LLP with the approval of at
least three-fourths of the total number of Partners. If the LLP
has lenders, secured or unsecured, then the approval of the
lenders would also be required for winding up of the LLP by
adopting the following procedure.
1. Passing of Resolution
2. Declaration of solvency by designated partners
3. Approval of Creditors
4. Publication of Resolution
5. Appointment of Liquidator
6. Preparation of Final Report by the Liquidator
7. Passing on Dissolution Order
Compulsory Winding Up of LLP
The firm may also wound up by the order of the Tribune/court
and this kind of winding up is known as Compulsory Winding
up. The circumstances in which Limited Liability Partnership
1. For a period of more than six months, the number of
partners of LLP is reduced below two;
2. LLP is unable to pay its debts;
3. LLP has acted against the interests of the sovereignty and
integrity of India, the security of the State or public order;
4. LLP has made a default in filing with the Registrar the
Statement of Account and Solvency or annual return for
any five consecutive financial years; or

546
 5. Tribunal is of the opinion that it is just and equitable that
the LLP be wound up.
LLP Winding-up Procedure
1. The petition or an application for winding up of an LLP
could be filed with the tribunal by the LLP itself or by any
of its partner(s) or creditor(s) or by the Registrar or by
Central Government or by a person authorized by Central
Government.
2. The tribunal is empowered with the special powers that
can be exercised by the Tribunal as per his discretion on
presentation of the petition.
3. Once the petition for winding up of the LLP, has been
received by the Tribunal, it fixes a date for its hearing and
issued notice to the LLP to appear and justify its position
and the Tribunal gives a public notice in order to inform
everybody, particularly, the creditors and the partners,
about winding up so that their concerns or objections
could also be considered.
4. Once the Tribunal passes and communicates the
Winding-up order to the firm, the following consequences
will follow:
a) The petitioner and the LLP shall ensure that a certified copy
of the winding up order has been filed with the ROC so that the
Registrar could notify the fact in the Official Gazette.
b) The winding-up order serves as a notice of discharge to all
the employees and officers of the concerned Limited Liability
Partnership.
c) No suit or legal proceedings can be commenced against the
LLP without the leave of the court. Even a suit, which is
pending against the LLP at the date of winding up the order,
cannot be preceded unless the permission of Tribunal is
obtained.
Effect of Winding Up of LLP

547
Once the winding up process has begun, a company can no
longer pursue its business, except in order to complete the
liquidation and distribution of its assets. At the end of the
process, the company will be dissolved and will effectively
cease to exist.
Declaration of Dissolution of the LLP by the Registrar
The Registrar may, by notice in writing, declare that the
LLP is dissolved if:
1. There is no objection received from any partner or creditor
of the LLP;
2. The objection to the proposed dissolution of LLP was
subsequently withdrawn; or
3. The Registrar is the view that the objection to the
proposed dissolution is without justification.
The declaration of dissolution of the LLP shall only take effect
upon such notification is given to the Registrar and the LLP
cannot be used by the court after liquidation.
Winding up or closing a limited liability partnership (LLP)
company in India is to be made strictly as per the provisions
given in the Sections 63-65 of the Indian LLP Act of 2008.
Again, this winding up of an LLP may be voluntarily or
compulsorily (by a Tribunal or Court).
In the voluntary winding up, the partners of the LLP themselves
decide that the business operations of their firm should be
stopped, closing the LLP formally. On the other hand, an LLP
may be wound up compulsorily under certain circumstances by
the order of a tribunal (an institution with the authority to judge
and intervene or determine claims) or court. The forced winding
up of an LLP may be caused by any of the following reasons:
 The LLP desires to be wound up

 Absence of the minimum number of prescribed partners

(which is Two) for over Six months.
 The LLP is unable to pay off its debts, or is at the brink of
getting bankrupt.

548
  Failure of the LLP in filing the Statement of Accounts and
Solvency or the Annual Returns with the Registrar for any
Five consecutive Financial Years.
 The LLP being against the integrity and sovereignty of
India, or the security of State or Public Order.
 Rigorous order of a tribunal that the LLP must be wound
up based on the specified just and equitable reasons.
What Documents are Required to Close a Limited Liability
Partnership
The various documents required to close a limited liability
partnership firm in India, are the following in general:
 A Board Resolution in favor of winding up

 Consent Letter of the Creditors

 Report regarding the current valuation of the assets of the

LLP, by a recognized Valuer
 Statement of Accounts

 Statement of Assets, Liabilities, Debts, etc. of the LLP at

the time of closure
 Affidavits from the Designated Partners

 Indemnity Bonds

 How to Close an LLP Company - Procedure to

Close an LLP Company
The general procedure to close an LLP company in India,
involves the following processes or steps:
 The LLP must pass a resolution in favor of its winding up
with approval of at least 3/4th of its total number of
partners. This resolution should also be supported by at
least 2/3rd of its creditors in value.
 Within 15 days of passing such a resolution a declaration
in an affidavit duly signed by the majority of the
designated partners of the LLP, should be submitted to
the Registrar. This declaration must clarify that the LLP

549
 has no debts, or if there are some debts, the LLP is able
to pay off those in full through sale of its assets, in a
maximum of one year period, counted from the date of the
commencement of winding up. A copy of the resolution for
winding up is to be submitted to the Registrar within 30
Days of passing the same.
 Within Two Weeks of the receipt of the consent of
sufficient creditors in favor of the resolution of winding up,
the LLP is required to advertise its notice of resolution in a
newspaper which is widely read in the region where the
registered office of the LLP is located.
 Within 30 days of receiving creditors' consent, the
designated partners are then required to appoint a
Liquidator to carry out the necessary processes of winding
up, along with maintaining proper books of accounts.
Then, the Liquidator is required to submit the report
together with the resolution to the Registrar, and file an
application for winding up to the Tribunal. Submission of
other documents mentioned above, is also to be made.
 In case the Tribunal gets satisfied with the processing of
winding up and necessary accounts, then it will pass the
permission for dissolution of the LLP. Then, the liquidator
needs to file the order of Tribunal with the Registrar along
with an application requesting winding up. Finally, the
Registrar will publish a notice in the Official Gazette
regarding the dissolution of the said LLP.
LLP Form 24 – Easily Close a LLP
The Ministry of Corporate Affairs has recently amended Limited
Liability Partnership Rules, 2009 by introducing the Limited
Liability Partnership (Amendment) Rules, 2017 with effect from
20th May, 2017. With this amendment, LLP Form 24 has been
introduced by the MCA and it is now possible to easily close a
LLP by making an application to the Registrar for striking off
name of LLP. In this article, we look at LLP Form 24 and the
procedure for striking off name of LLP in detail.

550
Winding Up a LLP
The penalty for LLPs defaulting in filing of any statutory return
is Rs.100 per day, without any maximum limit. Hence, its is
often best to windup dormant LLPs so that there is no
requirement to file LLP Form 11, LLP Form 8 and Income Tax
Return for the LLP each financial year to maintain compliance
and avoid penalty.

Before the introduction of the Limited Liability Partnership

(Amendment) Rules, 2017, the procedure for winding up a LLP
used to be long and cumbersome. However, with the
introduction of LLP Form 24, the procedure has been made
easy and simple.

Hence, its best for Entrepreneurs having dormant or defaulting

LLPs that are accruing penalty to use this opportunity to close
the LLP.

Filing LLP Form 24

The following procedure can be followed for closing a LLP by
filing Form 24:

Step 1: Cease Commercial Activity

LLP Form 24 can be filed only by LLPs that never commenced
business or have ceased commercial activity. Hence, if the LLP
is operational and the promoters wish to close the LLP, the LLP
must first cease all commercial activity.

Step 2: Close Bank Account(s)

LLP Form 24 can be filed only by those LLP that have no
creditors and no open bank account. Hence, prior to filing LLP
Form 24, any bank account opened in the name of the LLP
must be closed and a letter evidencing closure of the bank

551
account in the name of the LLP must be obtained from the
Bank.

Step 3: Prepare Affidavits & Declaration

All the Designated Partners of the LLP must first execute an
affidavit, either jointly or severally, that the Limited Liability
Partnership ceased to carry on commercial activity from (Date)
or has not commenced business.

Further, the LLP Partners must also declare that the LLP has
no liabilities and indemnify any liability that may arise even after
striking off its name from the Register. The liability of the
Partners would not be extinguished even after closure of a LLP
while using Form LLP 24.

Step 4: Prepare Documents

Along with Form LLP 24 the income tax return of the LLP and
LLP deed must be enclosed. In case the LLP has not filed any
income tax return and it has not carried on any business
activity, then it is not required. Else, a copy of the
acknowledgement of the latest Income-tax return filed must be
attached with the application for closing the LLP.

Step 5: File Any Pending Documents

After incorporation of a LLP, the LLP agreement must be filed
with the MCA within 30 days of registration. In case this
compliance was missed and LLP agreement was not filed, then
the initial LLP agreement, if entered into and not filed, along
with any amendments must be filed.

Also, any overdue returns in Form 8 and Form 11 up to the end

of the financial year in which the limited liability partnership
ceased to carry on its business or commercial operations must
be filed before filing LLP Form 24. The date of cessation of
commercial operation is the date from which the Limited
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Liability Partnership ceased to carry on its revenue generating
business and the transactions such as receipt of money from
debtors or payment of money to creditors, subsequent to such
cessation will not form part of revenue generating business.

Step 6: Obtain Chartered Accountant Certificate

Once all the documents for filing of LLP Form 24 is prepared, a
statement of accounts disclosing NIL assets and NIL liabilities,
that is certified by a practising Chartered Accountant up to a
date not earlier than thirty days of the date of filing of Form 24
must be obtained.

Step 7: File LLP Form 24

The above mentioned documents along with LLP Form 24
(Download LLP Form 24) can be then filed with the MCA to
strike off name of LLP. On processing the application, if found
acceptable, the concerned Registrar of Companies would
cause a notice to be published on the MCA website announcing
the striking off of the LLP.

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