Exhaustive Study Notes on Chapter IV: Share Capital and Debentures

Section 62: Rights Issue of Shares

Whenever a company proposes to increase its subscribed capital by a further issue of shares, such shares must be offered to three distinct categories of recipients under specific legal conditions.

Offer Categories and Statutory Conditions

• (A) Existing Equity Shareholders:

  • Offered in proportion to the Paid-Up Equity Share Capital (PUSC) on their shares as nearly as circumstances admit.
  • Condition 1 (Offer Period): The offer must remain open for a minimum period of $15\,\text{days}$ (or such period as may be prescribed) and a maximum of $30\,\text{days}$.
  • Condition 2 (Renunciation): Unless the Articles of Association (AOA) otherwise provide, the offer includes a right exercisable by the shareholder to renounce the shares offered to them in favour of any other person, either partly or fully.
  • Condition 3 (Unsubscribed Shares): Any remaining unsubscribed shares upon the expiration of the offer period may be disposed of by the Board of Directors (BOD) in a manner that is not disadvantageous to the shareholders and is in the best interest of the company.

• (B) Employees under Employee Stock Option Plan (ESOP):

  • Offered to employees under a scheme of employees' stock option, subject to approval by passing a Special Resolution (SR) in a General Meeting (GM).
  • Exemption for Private Companies and IFSC Companies: An Ordinary Resolution (OR) passed in a General Meeting is sufficient instead of a Special Resolution.

• (C) Any Person (Preferential Allotment):

  • Offered to any person (whether or not including existing shareholders or employees) if authorised by a Special Resolution (SR) passed in a General Meeting.
  • The price/valuation of such shares must be determined by the valuation report of a Registered Valuer.

Dispatch of Offer Letter

• The rights issue offer letter/notice must be dispatched through speed post, registered post, courier, or electronic mode (email) at least $3\,\text{days}$ prior to the opening of the offer period.

Conversion of Debentures and Loans into Equity

• Voluntary Conversion: A company can convert its convertible debentures or convertible loans into equity shares, provided that prior to the issue of such debentures or raising of loans, a Special Resolution (SR) was passed in a General Meeting.
• Conversion Directed by Central Government (CG):
  • The Central Government may, if it considers it necessary in the public interest, by order direct that non-convertible or convertible debentures issued to CG or loans taken from CG be converted into equity shares on reasonable terms.
  • Right of Appeal to NCLT: If the company feels aggrieved by the order of the Central Government, it may apply to the National Company Law Tribunal (NCLT) within $60\,\text{days}$ from the date of communication of such order. The order of NCLT shall be final and binding on all parties.
  • While passing an order, the Central Government shall have due regard to the financial position of the company.
• Deemed Increase in Authorised Share Capital: Where the Central Government directs conversion of debentures or loans into equity shares, the authorised share capital of the company shall be deemed to be increased automatically by an amount equal to the nominal value of the shares so allotted.

Section 63: Bonus Issue

Bonus shares represent equity shares issued free of cost to the existing equity shareholders in proportion to their holding.

Permissible Sources for Bonus Issue

Bonus shares can be capitalized and issued only out of:

• Free Reserves
• Securities Premium Account
• Capital Redemption Reserve (CRR) Account
• Mandatory Exclusion: Revaluation reserves created by the revaluation of assets cannot be capitalized for issuing bonus shares.

Statutory Conditions for Bonus Issue

1. Articles Authorisation: Articles of Association (AOA) must authorise the bonus issue.
2. Board Recommendation: Board of Directors (BOD) must recommend the issue by passing a Board Resolution (BR) at a Board Meeting (BM).
3. Shareholder Approval: Shareholders must approve the issue by passing an Ordinary Resolution (OR) in a General Meeting (GM).
4. No Default on Debt Obligations: The company must not have defaulted in the payment of principal or interest in respect of public deposits or debt securities.
5. No Default on Employee Dues: The company must not have defaulted in respect of the payment of statutory dues of employees, such as bonus, Provident Fund (PF), and Gratuity.
6. Fully Paid Shares: Bonus shares can be issued ONLY on fully paid-up shares. Any partly paid-up shares must be converted into fully paid-up shares prior to allotment.
7. No Issue in Lieu of Dividend: Bonus shares cannot be issued in lieu of dividend.
8. Irrevocability: Once the Board of Directors has recommended a bonus issue, it cannot subsequently withdraw or revoke the recommendation.

Valuation and Book Value Example

• Balance Sheet Extract:
  • Equity Share Capital (ESC) ($5\,\text{lac shares} \times 10$): $50\,\text{Lac}$
  • Reserves & Surplus (R&S): $450\,\text{Lac}$
  • Total Net Worth (NW): $500\,\text{Lac}$
  • Total Equity Shares: $500\,\text{Lac shares}$
• Book Value Calculation:$\text{BV/SH} = \frac{\text{Total Net Worth}}{\text{Total Equity Shares}} = \frac{500\,\text{Lac}}{5\,\text{lac}} = 100/\text{share}$
• Reserves Ratio:$\frac{\text{R\&S}}{\text{Net Worth}} = \frac{400}{500} = \frac{4}{5}$

Section 68: Buy-Back of Shares

Buy-back refers to the re-acquisition of its own shares or other specified securities by a company.

Objectives of Buy-Back

• To use idle cash to improve Earnings Per Share (EPS):
  • Example: A company has ESC of $100\,\text{lac}$ ($1\,\text{lac shares} \times 100$) and available profit of ₹ $200\,\text{lac}$.
  • Initial Earnings Per Share:     $\text{EPS} = \frac{200\,\text{lac}}{1\,\text{lac}} = 200/\text{share}$
  • If the company was not utilizing the capital from $20,000\,\text{equity shares}$ and buys them back:     $\text{Revised EPS} = \frac{200\,\text{lac}}{80,000\,\text{shares}} = 250/\text{share}$
• To concentrate diluted control.
• To instill confidence in shareholders during periods of falling market prices.
• To increase promoter shareholding to minimize the risk of hostile takeover:
  • Example: Before buy-back, Promoters hold $40,000\,\text{shares}$ and Public holds $60,000\,\text{shares}$ (Total $1,00,000\,\text{shares}$). Promoter holding = $40\%$.
  • If company buys back $25,000\,\text{shares}$ from the public, revised public holding is $35,000\,\text{shares}$ and total share capital is $75,000\,\text{shares}$.
  • Revised Promoter holding = $\frac{40,000}{75,000} \times 100 = 53.33\%$.

Permissible Modes of Buy-Back

• From the Open Market.
• Through an Open Offer (from existing shareholders on a proportionate basis).
• From Odd Lot Shareholders.
• Under Employee Stock Option Plan (ESOP) or stock options.

Pre Buy-Back Formalities and Legal Limits

1. Articles Authorisation: AOA must authorise buy-back; if not authorised, Articles must be amended by passing a Special Resolution in a General Meeting.
2. Resolutions Required:
   • Pass a Special Resolution (SR) in a General Meeting.
   • Exception: If the buy-back is up to $10\%$ of total Paid-Up Share Capital (PUSC) + Free Reserves (FR), passing a Board Resolution (BR) at a Board Meeting (BM) is sufficient.
3. Maximum Annual Limit: The maximum buy-back in any Financial Year (FY) cannot exceed $25\%$ of (PUSC + FR).
   • Explanation: In the case of buy-back of equity shares, PUSC refers strictly to Paid-Up Equity Share Capital (PUESC).
4. Debt-Equity Ratio Limit: The ratio of total secured and unsecured debts to post-buy-back paid-up share capital and free reserves cannot exceed $2:1$.    $\frac{\text{SL} + \text{USL}}{\text{PUSC} + \text{FR}} \le \frac{2}{1}$
   • Exception: For Government Companies engaged in housing finance, the debt-equity ratio limit can be up to 6:1$.\n5. **Declaration of Solvency:** The company must file a declaration of solvency in Form **SH-9** with the Registrar of Companies (ROC), signed by at least two directors, one of whom must be the Managing Director (MD), if any.\n6. **Fully Paid-Up Requirement:** Shares intended for buy-back must be fully paid up.\n\n## Numerical Example on Permissible Buy-Back Quantum\n\n- **Given Data:**\n - Equity Share Capital (ESC) (1\,\text{lac share} \times 10$):$10\,\text{Lacs}\n - Free Reserves (FR): 10\,\text{Lacs}\n - Debts (Secured + Unsecured): 38\,\text{Lacs}\n - Buy-back Offer Price = ₹ 50/\text{share}\n- **Test 1: 25% Amount Limit Test:**\n  \text{Max BB Amount} = 25\% \times (10\,\text{lac} + 10\,\text{lac}) = 5\,\text{lac}\n  \text{Max Shares under Amount Limit} = \frac{5\,\text{lac}}{50/\text{share}} = 10,000\,\text{shares}\n- **Test 2: Post Buy-Back Debt-Equity Ratio Test (2:1 Limit):**\n  \frac{38\,\text{lac}}{\text{Post PUSC} + \text{FR}} = \frac{2}{1} \implies \text{Required Post PUSC} + \text{FR} = 19\,\text{lacs}\n  \text{Maximum permissible reduction in PUSC + FR} = 20\,\text{lacs} - 19\,\text{lacs} = 1\,\text{lac}\n  \text{Max Shares under Debt-Equity Test} = \frac{1\,\text{lac}}{50/\text{share}} = 2,000\,\text{shares}\n- **Conclusion:** The maximum number of shares that can be bought back is the lower of the two tests, which equals **2,000\,\text{shares}**.\n\n## Post Buy-Back Formalities\n\n1. Maintain a Register of Buy-Back in Form **SH-10**.\n2. Submit Return of Buy-Back in Form **SH-11** accompanied by Form **SH-15** signed by at least 2 directors (one being MD, if any), certifying compliance.\n3. Extinguish and physically destroy the shares brought back within 7\,\text{days} of completion of buy-back.\n4. Observe a mandatory 6\,\text{months} cooling period during which no fresh issue of the same class of shares is permitted (however, bonus issue and conversion of debentures/preference shares are allowed).\n5. A time gap of at least 1\,\text{year} must elapse from the date of closure of the previous buy-back offer before opening another buy-back.\n6. The buy-back process must be completed within 1\,\text{year} from the date of passing the resolution authorizing the buy-back.\n\n# Section 69: Transfer to Capital Redemption Reserve (CRR)\n\n- When shares are bought back out of Free Reserves (FR) or Securities Premium (SP), an amount equal to the nominal value of the shares bought back must be transferred to the Capital Redemption Reserve (CRR) Account.\n- Disclosure of such transfer to CRR must be given in the Balance Sheet.\n- **Utilization of CRR:** The Capital Redemption Reserve account can be utilized by the company ONLY for paying up unissued shares to be issued to members as fully paid bonus shares.\n\n# Section 70: Prohibition on Buy-Back\n\n\n\n## Mandatory Prohibitions\n\nNo company shall directly or indirectly purchase its own shares:\n\n- Through any subsidiary company, including its own subsidiary.\n- Through any investment company or group of investment companies.\n- If a default is subsisting in:\n - Repayment of deposits or interest payable thereon.\n - Repayment of debentures or preference share capital, or redemption on due date, or interest/dividend payable thereon.\n - Repayment of any term loan or interest payable thereon to any Bank or Public Financial Institution (PFI).\n - *Prohibition Window:* Buy-back is barred for a period of 3\,\text{years} from the date on which such default is remedied/corrected.\n- If the company has defaulted in complying with the provisions of:\n - Section 92 (Filing of Annual Return)\n - Section 123 (Declaration of Dividend)\n - Section 127 (Punishment for failure to distribute dividend)\n - Section 129 (Filing of Financial Statements)\n\n## Penalties for Non-Compliance with Buy-Back Provisions\n\n- **Company:** Minimum Fine = ₹ 1\,\text{lac}$; Maximum Fine = ₹$3\,\text{lac}.\n- **Officer in Default (OID):** Minimum Fine = ₹ 1\,\text{lac}$; Maximum Fine = ₹$3\,\text{lac}$; OR Imprisonment up to$3\,\text{years}; OR Both.\n\n## Companies Rules 2014: Buy-Back Through Open Offer\n\n1. File draft letter of offer with ROC in Form **SH-8**.\n2. Within 20\,\text{days}$of submission to ROC, dispatch the letter of offer to all shareholders offering an offer period of minimum$15\,\text{days}$and maximum$30\,\text{days}.\n3. The offer period may be less than 15\,\text{days}$if agreed to by$100\% of all members.\n4. Upon closure of the offer:\n - Deposit the required buy-back amount in a separate scheduled bank account designated as the **Escrow Account**.\n - Complete verification of share certificates surrendered for buy-back within 15\,\text{days}.\n - Make payment to accepted shareholders within 7\,\text{days} of completion of verification.\n - Return share certificates of shareholders whose buy-back offer was rejected within 21\,\text{days}.\n\n# Section 43: Kinds of Share Capital\n\n\n\n## Classification of Capital\n\n- **Equity Share Capital:**\n - **Ordinary Shares:** Shares carrying standard uniform voting rights (e.g., Tata Motors ordinary shares where 1\,\text{share} = 1\,\text{vote}).\n - **Differential Voting Rights (DVR) Shares:** Shares carrying differential rights as to dividend, voting, or otherwise (e.g., Tata Motors DVR shares where 1\,\text{share} = 1/10\text{th}\,\text{vote}).\n- **Preference Share Capital:** Shares that carry preferential rights over equity shares regarding dividend payment at a fixed rate and repayment of capital upon winding up.\n\n## Rule 4 of Companies Rules 2014 — Conditions for Issuing DVR Shares\n\n1. Articles of Association (AOA) must authorise the issue.\n2. Pass an Ordinary Resolution (OR) in a General Meeting (GM).\n3. **Maximum Limit:** The voting power in respect of DVR shares shall not exceed 74\% of total voting power at any point of time.\n4. **Filing Record:** No default in filing Financial Statements and Annual Returns for immediately preceding 3\,\text{financial years}.\n5. **No Regulatory Penalties:** The company must not have been penalised for violation of SEBI Act 1992, SCRA 1956, RBI Act 1934, or FEMA 1999 by any court or tribunal.\n6. **No Subsisting Defaults:** No default in payment of declared dividend, repayment of matured deposits/debentures or interest thereon, or preference shares.\n7. **Financial Default Clearance:** No default in payment of preference dividend, repayment of loan/interest to PFI/State Financial Institution/Scheduled Bank, statutory employee dues, or transfer to IEPF.\n - *Proviso:* If default occurred, a period of 5\,\text{years} must have elapsed from the date the default was corrected.\n\n# Deferred / Founder Shares and Phantom Stock\n\n- **Deferred Shares / Founder Shares:**\n - Equity shares carrying differential voting rights on which dividend and repayment of capital are made ONLY after ordinary equity shares have been fully paid.\n - Historically subscribed by promoters and founders.\n- **Phantom Stock:**\n - A cash-settled share-based incentive scheme offered to employees or Key Managerial Personnel (KMPs).\n - Employees receive a cash payout equivalent to the appreciation in share price for a designated number of target shares after a specified period, without actual allotment of equity shares.\n\n# Section 46: Share Certificate\n\n\n\n## Definition and Execution\n\n- A share certificate is a title deed issued under the common seal of the company specifying the name of the shareholder, number of shares held, and face value per share.\n- Issued in Form **SH-1**.\n- If the company has a common seal, it must be affixed to the share certificate.\n- **Signing Authority:**\n - Signed by at least 1\,\text{Company Secretary (CS)}$and$1\,\text{Director}$. If no CS is appointed, signed by at least$2\,\text{Directors}.\n - In One Person Company (OPC): Signed by 1\,\text{CS}$or$1\,\text{Director}.\n\n## Duplicate Share Certificate Rules\n\n- If original share certificate is lost, destroyed, or mutilated, shareholder may apply for a duplicate certificate.\n- Upon receiving necessary supporting documents and an indemnity bond, company shall issue duplicate share certificate within:\n - **3\,\text{months}** for Unlisted Companies.\n - **45\,\text{days}** for Listed Companies.\n- Register of Duplicate Share Certificates must be maintained in Form **SH-2**.\n\n# Section 47: Voting Rights\n\n\n\n- **Equity Shareholders:** Right to vote on all matters placed before General Meetings.\n - *Special Restriction for Nidhi Company:* If any shareholder holds more than 5\%$of Paid-Up Equity Share Capital, voting rights are restricted to a maximum cap of$5\% total voting power.\n- **Preference Shareholders:** Right to vote ONLY on resolutions directly affecting their rights, namely:\n - Capital reduction resolutions.\n - Winding up of the company.\n - *Cumulative Voting Trigger:* If preference dividend remains unpaid for 2\,\text{years} or more, preference shareholders automatically obtain full voting rights on ALL matters identical to equity shareholders.\n\n# Section 48: Variation of Shareholders' Rights\n\n- **Modes of Variation:** Rights attached to any class of shares may be varied either:\n - By obtaining written consent of shareholders holding at least \frac{3}{4}\text{th} of issued shares of that class, OR\n - By passing a Special Resolution (SR) at a separate class meeting.\n- **Pre-requisite:** Such variation must be permitted by MOA/AOA, or not prohibited by terms of issue of that class.\n- **Impact on Other Classes:** If variation of one class affects rights of another class, approval from members of that other class must also be obtained.\n- **Rights of Dissenting Shareholders:** Dissenting shareholders holding at least 10\%$of issued shares of that class may apply to NCLT within$21\,\text{days} of variation to get it cancelled.\n- Copy of NCLT's order must be submitted to ROC within 30\,\text{days} of receipt.\n\n# Section 49 & 50: Calls on Shares and Calls-in-Advance\n\n- **Section 49 (Uniform Calls):** Calls on partly paid shares of the same class must be made uniformly across all shares of that class.\n- **Section 50 (Calls-in-Advance):** Company may accept calls-in-advance if permitted by Articles of Association.\n - *Restriction:* Calls-in-advance carry NO voting rights and NO dividend rights.\n\n# Section 51: Dividend Payment\n\n- Company may pay dividend in proportion to paid-up capital on each share if authorised by Articles.\n- Paid-Up Share Capital Calculation:\n  \text{PUSC} = \text{Called Up Share Capital} - \text{Calls-in-Arrear}\n\n# Section 52: Securities Premium\n\n\n\n## Permissible Uses of Securities Premium\n\nSecurities Premium Account can be utilized ONLY for 5 prescribed purposes:\n\n1. Issuing fully paid bonus shares to members.\n2. Funding buy-back of shares/securities.\n3. Writing off securities issue expenses, underwriting commission, or discount allowed on issue of shares/debentures.\n4. Writing off preliminary expenses of the company.\n5. Writing off premium payable on redemption of preference shares or debentures.\n- *Note:* Companies complying with Accounting Standards under Section 133 have restricted applications for securities premium.\n\n# Section 53: Issue of Shares at Discount\n\n- **General Rule:** Issuance of shares at a discount is strictly prohibited. Any shares issued at discount shall be void.\n- **Exceptions:**\n - Sweat Equity Shares issued under Section 54.\n - Issue of shares at discount to creditors under debt restructuring scheme of RBI or statutory resolution plan.\n- **Illustration:** ESC = 100\,\text{Lac}$, Reserves =$(40)\,\text{Lac}$accumulated loss, Net Worth =$60\,\text{Lac}$, Book Value = ₹$60/\text{share}$. Creditors will not accept shares at ₹$100$face value when book value is ₹$60, justifying discount allowed under restructuring plans.\n- **Penalties for Illegal Issue at Discount:**\n - Fine on Company & Officer in Default = Amount raised by issuing shares at discount OR ₹ 5\,\text{lac}, whichever is lower.\n - Mandatory refund of entire amount raised along with interest @ 12\%\,\text{p.a.} from date of issue.\n\n# Section 54: Sweat Equity Shares\n\n\n\n## Statutory Conditions\n\n1. Authorised by Special Resolution (SR) passed in General Meeting.\n2. SR must specify number of shares, details of directors/employees, consideration, and market value.\n3. Listed companies must follow SEBI regulations; unlisted companies must follow Companies Rules 2014.\n4. Rank *pari passu* with other equity shares.\n\n## Rule 8 of Companies Rules 2014\n\n1. Permanent employees working in India or outside India are eligible.\n2. Directors (whole-time or part-time) are eligible.\n3. Employees/Directors of company, holding company, or subsidiary company qualify.\n4. Validity of Special Resolution = 12\,\text{months}.\n5. Mandatory lock-in period = 3\,\text{years}.\n6. Register of Sweat Equity Shares maintained in Form **SH-3**.\n7. Valuation performed by a Registered Valuer.\n8. **Annual Limit:** Maximum sweat equity shares issued in a FY cannot exceed 15\%$of Paid-Up Equity Share Capital or ₹$5\,\text{crore}, whichever is higher.\n9. **Overall Limit:** Overall cap cannot exceed 25\%$of PUESC at any time (Cap is$50\%$for Startups for up to$10\,\text{years} from incorporation).\n\n# Section 55: Preference Shares\n\n\n\n## Key Requirements\n\n1. Irredeemable preference shares CANNOT be issued.\n2. Articles must authorise redeemable preference shares.\n3. Special Resolution required prior to issue.\n4. Maximum tenure cannot exceed 20\,\text{years}$($30\,\text{years}$for infrastructure projects with minimum$10\%$annual redemption option from$21\text{st}\,\text{year}).\n5. Only fully paid preference shares can be redeemed.\n6. Nominal value of redeemed shares transferred to CRR out of free reserves.\n7. **Unredeemed Preference Shares:** If company is unable to redeem on due date, it may issue unredeemed preference shares with consent of \frac{3}{4}\text{th} preference shareholders and NCLT approval; dissenting shareholders must be paid in cash.\n\n# Section 56: Transfer & Transmission of Shares\n\n\n\n## Comparative Analysis\n\n- **Transfer:** Sale of shares; involves consideration; stamp duty payable; requires instrument of transfer (Form **SH-4**).\n- **Transmission:** Inheritance/operation of law; no consideration; no stamp duty; no transfer deed required.\n\n## Time Limits for Issuing Certificates\n\n- **Subscribers to MOA:** Within 2\,\text{months} from incorporation.\n- **Further Allotment:** Within 2\,\text{months} from allotment.\n- **Transfer/Transmission:** Within 1\,\text{month} from receipt of SH-4.\n- **Issue of Debentures:** Within 6\,\text{months} from allotment.\n- *IFSC Exemption:* IFSC Companies must issue certificates within **60\,\text{days}** in all cases.\n- Transferee must submit Form SH-4 within **60\,\text{days}** of execution.\n\n# Penalties, Appeals, and statutory Returns\n\n- **Section 57 (Impersonation):** Wrongfully acquiring share certificates carries fine of ₹ 1\,\text{lac}$to ₹$5\,\text{lac}$and imprisonment from$1\,\text{year}$to$3\,\text{years}.\n- **Section 58 (Refusal of Transfer):**\n - Private Co Refusal Appeal: Within 30\,\text{days}$of refusal notice, or$60\,\text{days} of delivery of SH-4.\n - Public Co Refusal Appeal: Within 60\,\text{days}$of refusal notice, or$90\,\text{days} of delivery of SH-4.\n - NCLT Non-Compliance Fine = ₹ 1\,\text{lac}$to ₹$5\,\text{lac}$; Imprisonment =$1\,\text{year}$to$3\,\text{years}.\n- **Section 59 (Rectification of Register):** Delay or wrongful removal allows appeal to NCLT. Non-compliance carries same fines as Section 58.\n- **Section 60 (Capital Publication):** Authorised capital mention requires subscribed and paid-up capital mention. Penalty: Company ₹ 10,000$, OID ₹$5,000\n- **Section 64 (Form SH-7 Filing):** Mandatory within 30\,\text{days}$of capital alteration, preference redemption, or CG compulsory conversion. Penalty: ₹$500/\text{day}$(Max ₹$5\,\text{lac}$for company, ₹$1\,\text{lac}$$ for OID).