In a situation, where the company will consider increasing its subscribed capital after its incorporation, the reason behind it is that such a further issue would substantially increase its financial reserves and incentives the shareholder of the company, thereby ensuring the healthy functioning of the company. Such a company which is to increase its subscribed capital by the further issue of shares is required to work in accordance with the procedure laid down in section 62 of the companies’ act 2013. Basically, this section encapsulates a scenario where the authorized capital of the company is not exhausted and further allotment of shares is made out of the unsubscribed portion of the capital.
The power under Section 62 Companies Act, 2013 governs the issue of “Rights Shares” and states as follows-
- If at any time a company proposes to increase its subscribed capital by issuing shares of earth to share, such shares would be offered first to the existing shareholder and proportionate basis such issue of share is known as Rights issue of shares.
- A letter of offer is required to be sent to such shareholders at least three days before the Issue opens and rights issue shall remain open for a minimum period of 15 days and for a maximum period of 30 days and in which shareholders shall decide whether they wish to subscribe to the shares or not. However, if 90% of the members of a private limited company had given the concern, either in writing or through electronic means, more time limit for acceptance of offer by existing shareholder may be less than 15 days.
- the shareholder may either accept or refuse or renounce the offer made to them, provided the same is warranted by the terms of article. In case of no reply, the offer may be treated as declined.
- If the offer is given to some other persons other than the existing shareholder following condition are required to be met-
- Special resolution in the general meeting shall be passed.
- The company must obtain a valuation report from the registered valuer to determine the value of such shares.
- The provision of section 62 is applicable to all types of company except the Nidhi companies.
Further issue of share capital states that at any time a company having a share capital, proposes to increase its subscribed capital by the issuer further shares shall be offered to-
- Holders of equity- shares which at the date of the offer or holder of equity shares of the company are proportionate to the paid-up share capital of those shares by sending a letter of offer are subject to such conditions as may be prescribed.
- Employees- under a scheme of employee’s stock option subject to a special resolution passed by a company, either ordinary resolution and private company subject to such conditions as may be prescribed.
- Any person- whether or not those persons include the person referred above. If it is authorized by special resolution either for cash offer or, other than cash if the price of shares is divine whether valuation report of registered valuer to the subject of such conditions.
Topics Covered in this article
- The above provisions are not applicable in case of conversion of loans or debentures into shares of the company.
- In public interest if the government has issued direction for conversions of debentures or loans obtained from any government into shares.
Facts of the case
- The respondent company was incorporated in 1908 with an authorized capital of Rs. 10 lakhs divided into 10,000 shares of Rs. 100 each
- 5,404 shares were subscribed and Rs. 25 per share was called on each of them. 4596 shares out of the authorized capital thus remained unissued.
- A businessman incorporated in many companies, started to purchase shares of the company from the holders on to a large scale. Basically, would enhance naturally put up the price of the shares.
- A board meeting of the directors and the chairman drew attention to the attempt made by an outsider to corner the shares of the company. Regarding the resolution passed in the meeting, a circular was issued to the existing shareholders acquainting them of the true position and suggesting that they could part with their shares. A circular in consideration of it was issued with the result that two rival groups were offering to buy shares from those who were desirous of selling them. The shares of about Rs.12 or 14 were paid per annum as dividend also started quoting in the market at about Rs. 2,000 per share.
- The businessman had not submitted to the company for registration of the transfers to his name to the shares purchased by him. Also, an application was submitted by the company to the authorized examiner of Capital Issues for sanction of a fresh issue of capital. Highlighting the reasons, mentioned in that application to specify the need of the company to require additional capital. Such application had become necessary in respect of this case. The Government granted the sanction, Also, the communication was received by the company.
- At the Board meeting, the directors decided to issue the remaining 4,596 shares at a premium of Rs. 75 per share and to call Rs. 25 per share on them.
- Pursuant to this resolution a circular was issued to the shareholders on the same day with copies of the form of application and renunciation referred to in the resolution and in the circular.
- The shares were offered to the shareholders shown on the register of members in the proportion of four further shares for every five shares held by them.
- The directors and their friends applied and were allotted 1,648 shares. Also, shares were allotted to shareholders who had applied for the same.
Issue in the case
A suit was instituted against the company and the directors by two of the shareholders of the company for the following reliefs:
A declaration that the offer of shares and the provisions of section 105-C of the Indian Companies Act, 1913, and resolution of the directors were ultra vires and illegal;
- A declaration that the offer of shares were not made bona fide or were not in interest of the company and was therefore illegal; and
- Restrain defendants from allotment of any shares in pursuance of their offer.
The appellants are two shareholders of the company. The appellants had filled the suit, for themselves and all other aggrieved shareholders of the company. The defendants included the company and eight directors. It is stated in the plaint that the whole issue of these further shares and the idea of maximizing the capital of the company were mala fide. Also, the object of retaining the control and management of the company was in the hands of defendants. It is further stated that the resolution of the directors and the offer of shares contained in the circular letter were in contradiction to Section 105-C of the Indian Companies Act. It was stated that the company was not in need of capital. Therefore, the issue of further shares was not made bona fide for the betterment of the company but had been made with the object of retaining or securing the defendant control of the over company.
On behalf of the respondents three answers were submitted as follows-
- The first was that the section deals with the case of increase of capital by the directors beyond the authorized limit and as in the present case, the new shares were issued within the limit of authorized capital, therefore, the section has no application.
- The second was that the terms of the section should be construed in a practical way and there was no difference between Regulation 42 in regard to the Companies Act and Section 105-C in regard to the scheme to offer also, with the proportion of shares to the existing shareholders. It was highlighted that the directors had complied with the requirements of the section and therefore their action was not illegal.
- The third answer was that in fact the directors had not committed any breach of the terms of Section 105-C up to now and therefore their action cannot be held to be illegal.
Summary of court decision and Judgment
The evidence was led in the trial Court on the question of bona fides. The trial Court granted that the issue of new shares was bona fide and the appellate Court has also come to the conclusion that the object of the directors in issuing the new shares was not merely with the object of retaining or securing to the defendant company. It was held that the company was in need of capital. The suit was ultimately dismissed and that decision was affirmed by the High Court on appeal.
The decision of the appellate Court has been challenged on both grounds. The counsel appearing for the appellants did not contest the finding of fact of both the lower Courts to the effect that the company was in need of capital. Moreover, they urged on their behalf that as the issue of these shares, although not admitted in the written statement but admitted in the course of evidence, it was for the purpose of preventing the control of the company, the directors had not acted bona fide and solely in the interest of the company. The contention of the appellants on this issue was correctly rejected by both the lower Courts and that contention failed. It leaves a question in consideration, whether the issue of these shares was in contravention of Section 105-C of the Indian Companies Act. That leaves a question whether the issue of these shares was in relation with section 105-C of the Indian Companies Act. That section runs as follows:-
“Where the directors decide to maximize the capital of the company by issuing further shares, the shares shall be offered to the members in proportion to the existing shares held by member and offer would be made by notice which specifies the number of shares to which the member is entitled, and also limiting a time period under which the offer, if not acknowledged, would be considered to be declined; and after the lapse of time, or on receipt of a suggestion from the part to whom, such notification.” is given that he rejects to accept the shares offered, the directors may dispose of the same in such manner as they think most beneficial to the company.”
Basically, the section deals with the case of increase of capital by the directors beyond the authorized limit and as in the present case, the new shares were issued within the actual limit of capital, the section would have no application. Also, the terms of the section should be construed in a practical way and there was no difference between Regulation 42 of the Companies Act and Section 105-C in consideration to the scheme to offer the proportion of shares to the present shareholders.
It was argued that they were offered “as nearly as circumstances admit” the director did in accordance with the requirements of the section and therefore their action was not illegal. The directors had not committed any wrong of the terms of section 105-C up to now and therefore. For the reasons stated above, the Courts were right and no ground has been made out for interfering with the same. The result, therefore, is that this appeal is dismissed with costs, and their action cannot be held to be illegal.
The issue of further shares by the directors, whether in contravention of the provisions of Section 105-C of the Indian Companies Act, and is the issue not made bona fide. The issues were taken in favour of the respondents by the High Court.
The Supreme Court while dealing with this provision in the case laid down that the company must give the first option to existing shareholders before favoring anyone else. The Companies Act, 1956 and the Companies Act, 2013 also provides for a preemptive right of the shareholders in consideration to new shares of the company. The Supreme Court also in the landmark case of Sahara India Real Estate Corporation v. SEBI held that Section 81 gives powers a preemptive right in consideration to the existing shareholders to the new issue of shares. Thus, it is obvious that an organization which is in further issue of offers should offer it to its current investors prior to preferring any other person. This is a recognized principle in India as well as other jurisdictions as well.
In consideration to it,Section 81 (corresponding to section 62 of the companies act 2013), it is intended to cover cases where the director decides to increase the capital by issuing for shares within the authorized shares because it is within that limit that the director can decide to issue for the shares unless, of course they are precluded from doing that by the article of Association of company according to section applicable only when the director decide to increase the capital within the authorized limit by issue of further shares.
The above judgment was followed by the Supreme Court in Needle Industrial Limited v. Needle Industry Newey Holding Ltd. The court pointed out that directors of the company must exercise the power for the benefit of the company and the directors are officially positioned and if they do not exercise powers for the benefit of the company, the court will interfere and prevent the director from doing so. But as in this case the director was acting on behalf of the company and for the benefit of the company itself, so the appeal would be rejected and the case falls in respect to the respondent only.
Keeping in consideration further issue of sharing, some changes have been made in the legislature in relation to it. As in the Companies Act, 2013, under Companies Act, 1956, a company follows the procedure prescribed in Section 81 (including preemptive rights of the existing shareholders) only if the company has been in existence for two years or at the time after the expiry of one year of the allotment of shares. A company should issue well-laid out procedures prescribed under Section 81 of the Companies Act, 1956. If the shares are allotted within two years of formation, this would basically include a scenario where a company could reject the preemptive rights of the shareholders if it allotted shares within two years of its formation. The Legislature realizing the backdrop has updated the section and it now obligates any company who issues further shares at any time within the ambit of Section 62 of the Companies Act, 2013. This is a great step to ensure complete compliance with the procedure prescribed under the legislature.
The manner of exercise of such right has been a bone of issue in many situations. The manner of exercise of the director’s power was taken under the case by Supreme Court in the case of Needle Industries (India Ltd) v. Needle Industries Newey (India) Holding Ltd. In this case, the Court did not restrain the act of director since he not only acted in a bona fide manner for the benefit of the company, but also acted without any motive to promote the cause for it. The Court also held that the exercise of director’s discretion would be for an improper motive if it is only done for their own benefit. Thus, the court added another standard (Proper Purpose) apart from the requirement of the director to act in a bona fide manner.
The landmark case which applied the principle of proper purpose and bone fide requirement was in the decision of Supreme Court in Shri V.S Krishnan and Ors v. Westford Hi-Tech Hospital Ltd and Ors. Therefore, it is clear from this that the court standard for analyzing the manner of exercise of the director’s discretion has shifted from a mere bona fide requirement to a modified principle of bona fide andproper purpose. This is the right standard for the discretion of the director in further issue of shares. Keeping in consideration that Companies Act does not provide any guidance on the aspect of the director’s discretion in issuing further shares adopting these modified principles leads to the possibility of a director to exercise his discretion in an irregular manner is reduced to the maximum extent. In India, such a situation was dealt with by the Supreme Court In this case, the appellants contended that the director’s exercise of discretion in issuing further shares was male fide in nature as it was done for betterment of the company. Court dealing with this issue held that since the directors exercised their power in a bona fide manner for the betterment of company, mere incidental benefits to the directors would not interference in the further issue of share is possible.
The court concluded that director’s power of discretion in issuing further shares was mala fide in nature as it was done in good faith of the company. The Court, while dealing with this issue held that as the directors exercised their power in a bona fide manner for the betterment of the company, and mere incidental benefits to directors would not grant interference in the further issue of shares. Keeping in consideration the existing shareholders have a preemptive right to the new stock of shares, the scope of interference in the director’s discretion is limited. Only in exceptional situations the further issue of shares is restrained. Dealt with Section 62 of the Companies Act, 2013 which contains provisions on “further issue of capital”, and enacts the principle of pre-emptive rights of shareholders of a company to subscribe to new shares of the company.On the aspect of the fiduciary duties of the director, even though there is no mention of the same in the companies act, judicial pronouncements of the court indicates that the director is required to act in a bona fide manner with a proper purpose.