REVISION OF OLD CONCEPTS

Transcription

1 Date: 20 Jan 2006 Book Corporate Law and Practices By Kapoor and Majumdar (Taxman Publication) REVISION OF OLD CONCEPTS What is a Corporate Any business incorporated under some law. Difference between Company and an Ownership/Partnership Firm 1. Any company is a separate legal entity. It can hold property in its own name. It can sue or be sued. 2. A company has perpetual succession unlike an ownership or partnership firm. Even in case all the directors and shareholders of a company die, the company continues. During the WW-II, a small company was having a meeting attended by the directors and all the shareholders. The building was bombed and all the shareholders and directors died. The court gave the verdict that the company will continue with legal heirs of original shareholders becoming the new shareholders and electing a Board of Directors. 3. Shareholders in a Limited Company have limited liability to the extent of unpaid share capital. However, in specific circumstances the liability of Shareholders can become unlimited. Like: - If the number of members in the company fall below the minimum stipulated (2 for Pvt Ltd Company and 7 for Public Ltd Company) Remaining members should have knowledge of above shortfall in membership The business is carried on for more than 6 months with reduced membership. Also, the liability of any individual shareholder/s can become unlimited when a company is being wound up due to fraudulent activity of that member/s. However, if the company is not being wound up, such liability is of the company and company can take action against the fraudulent members under the existing laws. 4. In a company, day to day decisions are taken by the directors and shareholders do not involve in the process. Page 1 of 67 - Business Law - II

2 What is a Private Ltd Company? A Pvt Ltd Co. has three restrictions: - No of members of such company can not exceed 50. Shares of such company can not be issued to public. Free transfer of shares is not allowed. Any member wishing to withdraw from the company has to first offer his shares for sale to the existing members and if no one is willing to purchase can he sell it to a person outside the existing membership. A Pvt Ltd company must have an authorized capital of Rs 1,00,000. What is Public Ltd Company? As per company law definition, A company that is not a Pvt Ltd Company is Public Ltd Company. Different Types of Companies 1. Company Limited by Shares A normal company as we generally find in the market. 2. Company Ltd by Guarantee Such companies do not have shareholders but only members. The members give guarantee that in case of shortfall of assets of company to meet the liabilities at the time of winding up, they would provide the sum as guaranteed by them. BSE was a company Limited by Guarantee till recently. Now it has become normal company. 3. Demutualisation 4. Company Limited by Guarantee also having Share Capital. 5. Foreign Company Company should not be incorporated in India but incorporated in some other country. Company should have place of business in India. 6. Govt Company Any company wherein minimum 50% shares are held by State/Central Govt individually or collectively. 7. Non Profit Companies Charitable companies, NGO. These companies are governed by Section 25 of the Companies Act, 1956 and therefore they are also called Section 25 companies. Page 2 of 67 - Business Law - II

3 8. Unlimited Liability Companies Liability of Shareholders of such companies is unlimited. 9. Investment Companies Principal business of such companies is dealing in trade of securities. 10. Producers Companies This is an option available to people who would otherwise form Co-operative Societies. Co-operative societies follow the concept of one member, one vote, irrespective of their contribution to the capital of society. It acts as dis-incentive for large stake holders. In Producers companies, voting rights are proportional to contribution. 11. Listed Companies Any company whose shares or debentures are listed in any recognized stock exchange of the country is called Listed company. Please note that it is not the companies which are listed in the stock exchanges but their shares and debentures are listed. It is, therefore, possible that shares of a particular company are listed but not the debentures. It is also possible that a particular series of debenture is listed but not others. 12. Illegal Association A partnership firm having more than 20 partners or a partnership banking firm having more than 10 members is illegal association. If such a firm is defrauded by some one, they can not seek a legal remedy because courts will refuse to admit existence of such company. What is the difference between Partnership Firms and Unlimited Liability Companies? In case of partnership firms, the liability is joint and several, which means that any creditor can approach the partners as group or even approach any individual partner for recovery of full amount owed to him by the partnership firm. However, in case of Unlimited liability companies, debtors can not approach the shareholders for payment of dues and will have to approach the company only. Company can then demand any sum, without any limit, from its shareholders to settle the dues. What is a Holding Company and a Subsidiary Company? A company is called a Holding company if (d) It holds more than 50% shares of other company, or Majority of directors of Holding company are also director in subsidiary company. Company can control composition of directors of other company Company can control directors of other company. Page 3 of 67 - Business Law - II

4 THIS SEMESTER S SYLLABUS Law and Procedure of Formation of a New Company Following activities are involved in the formation of new company 1. Promotion 2. Incorporation 3. Floatation 4. Commencement of Business 1. Promotion: Promotion involves feasibility study and taking steps for incorporation of new company. (d) (e) Promoter Any one involved with the process of promotion in any way, like providing the initial capital. Beginning and End of Promotion Promotion begins when promoters start acting on behalf of proposed company and ends when Board of Directors takes charge of business. Legal Position of Promoter He stands in the fiduciary capacity. Thus, he can not make any secret profits. This also means that he is allowed to make profits after due disclosure. Disclosure He has to disclose all transactions and profits earned. Status of Contracts Signed in the Pre-incorporation Period Those contracts which are necessary for bringing a company into incorporation are automatically valid. Validity of other contracts is dependent on acceptance by Board of Directors. 2. Incorporation: Steps involved in incorporation Application for Availability of Name Four choices of names are to be given to the Registrar who would check their availability to ensure that the same name is not already in use or the proposed names are not deceptively similar to any names already approved. Dos and Don ts about names: - (i) Name should be unique and not spelled or sounding like name of any existing company. Page 4 of 67 - Business Law - II

5 (ii) (iii) Name should be consistent with proposed business of company. A business intended to trade in wooden furniture can not assume names like the ones of software or technology company. For including words like International, Global, India etc, following guidelines have been promulgated: - (aa) (bb) (cc) India Should have a min Rs 50 lakh authorized capital. Global Should have min Rs 1 Cr as authorized capital. Corporation Should have min Rs 5 Cr as authorized capital. Memorandum of Association (MOA) and Article of Association (AOA) These two documents are collectively called as constitution of company. Memo defines company s relationship with outside world while Articles of Association defines internal relationships between company and the employees and among employees themselves. These documents are public documents and should be made available to any person on payment of nominal fees. In this case, the Doctrine of Constructive Notice is applicable. Doctrine of constructive notice favours the company and assumes that any other company or person dealing with the firm would have read particular document. Thus, ignorance of any clause in these documents can not be taken as refuge in case of any dispute. (i) Clauses of MOA (aa) (bb) (cc) (dd) (ee) (ff) Name Domicile Objects Capital Liability Association Above six clauses are minimum clauses to be included in a Memorandum of Association. Company is free to include any other clause. Domicile The state in which registered office is located is called the Domicile state of that company. Objects Object defines the scope of business of any company. There is no limit as to how many businesses can be listed in the object of the company. However, a company can not undertake a business that is not listed unless the objects are amended. Else, it will attract Ultra Vires clause. Company Page 5 of 67 - Business Law - II

6 is free to amend any clause or article by passing a special resolution by ¾ majority of members present in person or through proxy and voting. Association Name of the people who formed the company. They are called the subscribers of the MOA. For a private Ltd company, minimum two and for a Public Ltd Co. minimum 7 members are required. Doctrine of Indoor Management Doctrine of indoor management is exception to Doctrine of Constructive Notice. According to doctrine of constructive notice, any one who deals with the company is assumed to have read and have knowledge about the object and power of the company. If any transaction with company is later found to be out of the ambit of its MOA & AOA (Ultra Vires), the third party can not claim anything from company as matter of right. It means that, before entering into contract you must verify the memorandum of the company and check out whether company is authorised to perform this kind of act... But at the same time you are not suppose to verify the internal proceeding carried out by the company nor is company duty bound to reveal the internal proceeding to outsiders. Thus, an outsider or party to the contract can safely assume that everything required to be performed by the company or its officer as part of internal proceeding has been duly complied with. If it is revealed at a later date that some internal actions as necessitated by MOA/AOA prior signing of contract were omitted by its officials, the contract would remain valid and enforceable. (ii) Vetting of MOA and AOA - Draft copies of MOA and AOA are required to be submitted to the Registrar of the Companies office for vetting to ensure that the rules framed are within the ambit of the Company Law and nothing of substance has been omitted. Along with the MOA and AOA, following additional documents are required to be submitted: - (aa) Availability of name - Form 1A (ab) Notice of Registered Office - Form 18 (ac) Consent of persons for directorship Form 29 (ad) Particulars of directors Form 32 (ae) Statutory Declaration Letter from High Court Advocate or Company Secretary, etc, stating that he has checked the documents and they have been found to be correct. Page 6 of 67 - Business Law - II

7 Once Registrar is satisfied with above documents, he can issue Certificate of Registration (Birth of Company). Once the Certificate of Registration is issued, there is no invalidation clause which means that even if there was any error in the process, it still remains valid. 3. Floatation Raising of Capital. Capital can be raised by one of the following methods: - Public Offer Public Offer can be made only by Public Ltd Companies. Pvt Ltd companies can not make a public offer. Public Offers are governed by very stringent regulations. Issue of prospectus is necessary condition. Prospectus should include details of the company and Offer. (i) (ii) (iii) (iv) IPO Initial Public Offer First ever public issue of company is called IPO. FPO Follow-on Public Offer. Any subsequent public issue is called FPO, though popularly every public issue is called IPO by the common people. Pvt Placement When shares are offered to selected few with no clause to relinquish the offer in favour of some one else, it is called Pvt Placement. Pvt Placement is goverened by few regulations unlike Public Offers where the rules are very stringent. However, there is limit imposed as to how many people can be approached for Pvt Placement. The number can not exceed 50. This limit is imposed so that this route is not misused to disguise a public offer as Pvt Placement offer by mass mailing. Offer for Sale A company unwilling to go through the grind of Public Issue can sell all its shares to one entity who in turn can sell the shares to the public. Such an arrangement is called offer for sale. This route was used to con the public. Seller disowned the responsibility stating that he was like any other seller with no responsibility towards functioning of the company. Company also disowned the responsibility saying that it never made any promises to the public as it sold the shares to a single individual. Therefore, now same rules as Public Offer apply in case of sale of shares by such individuals also. 4. Commencement of Business A Pvt Limited Company can commence business as soon as Certificate of Incorporation is issued. However, in case of Public Ltd Companies, business can be commenced only when Certificate of Commencement of Business is issued by the Registrar. Before awarding Certificate of Commencement of Business, he needs following documents and information: - Page 7 of 67 - Business Law - II

8 In Case of Public Offer - (i) (ii) (iii) (iv) (v) Confirmation about minimum subscription of 90% of the offer amount. Application money is returned to the entitled applicants. Confirmation that all stock exchanges applied to by the company have agreed to list the share. In case, even one of the stock exchanges where application for listing was made refuses to list the stock for any reason what so ever, the Public Issue is null and void and entire money of applicants is to be returned. It is mandatory to list the company in the Stock Exchange nearest to the company s registered office. Proof of Directors having paid money for their shares. Declaration to the above effects is to be made by any one director or the company secretary. In Case of Pvt Placement Only conditions (iv) and (v) above are required to be complied with. Status of Provisional Contracts Before a company comes into existence, the promoters get into various contracts for IPO, Advtg, etc. What is the status of these contracts? Such contracts are called Provisional Contracts. In case the company does not get the certificate of business, these contracts are cancelled. In case the certificate is awarded, the Board of Directors will decide on the status of contracts. In case of a long term contract of pre-incorporation period, Board will decide whether such contract was necessary and in the interest of the company and can accept or reject. Page 8 of 67 - Business Law - II

9 Date: 27 Jan 2006 Share Capital What is a share? A share is a share in capital of company. Shareholders are not part owners of the company as is commonly believed. A company is a separate legal entity and thus there is no ownership in a company even if some one owns literally all the shares in the company. Any shareholder can not act on behalf of the company. A share in a company is a bundle of rights that shareholder enjoys for providing money to the company. He is more like a creditor of the company who enjoys certain rights for having provided the company with the capital. But like a bank which finances the company can not call it self to be owner of the enterprise, a shareholder can not call himself to be owner/part owner of the company. Shareholders Rights Shareholders rights can be grouped in two batches: Individual Rights 1. Right to receive notice of GBM 2. Right to receive information in the form of Annual Report. 3. Right to attend General Body meetings 4. Right to appoint proxy on his behalf for attending GBM. 5. Right to vote 6. Right to receive dividend when declared. 7. Right to inspect certain registers like membership register. (But not books of account). 8. Right of Pre-emption. (Right to be offered proportionate amount of shares corresponding to current holding before being offered to other people). 9. Right to seek remedy against any Ultra Vires act by the company. Collective Rights 1. To call for an Extra Ordinary General Meeting if a group of shareholders holding either 10% voting rights or 100 shareholders demand for it. If EGM is not conducted within stipulated period by the directors, then the group can organize the EGM itself and get the reimbursement for expenses from company account. 2. In case of any mismanagement or oppression, the shareholders can petition Central Govt (Ministry of Company Affairs) to intervene. Govt can change MOA and AOA and appoint its own directors etc. Page 9 of 67 - Business Law - II

10 Share certificate is not a share. A share certificate is merely an evidence that the holder of the certificate holds the number of shares in the company as listed in the share certificate. What is a Stock and how do you differentiate a share from a stock? When the capital of a company is divided into number of units of a definite face value, such units are called shares. When capital of the company is not split into units of any definite amount, such money is called stock. A company can not issue stock in the first instance. It has to first issue shares and later can convert them into stock. Types of Shares 1. Equity Shares Ordinary Equity Shares Equity Shares with Differential Voting rights. 2. Preferential Shares Cumulative Preferential Shares Non Cumulative Preferential Shares. The primary difference between Equity shares and preferential shareholders lies in fact that: Any dividend to Equity Shareholders can be paid only after Preferential Shareholders are paid theirs. The dividend to Preferential Shareholders is paid at a pre-specified rate when given. (Declaration of dividend is not mandatory but when declared, minimum rate as pre-specified would have to be paid). Again, during winding up, Preferential Shareholders will have the first claim over the money realized from liquidation. Preferential Shareholders do not have voting rights. However, they get voting rights under following conditions: (i) (ii) Cumulative Preferential Shareholders If dividend is not paid during last two financial years. Non Cumulative Preferential Shares If dividend is not paid in three out of past six years. Page 10 of 67 - Business Law - II

11 Also, there are Participating Preference Shares. Such shares get extra dividend, over and above pre-specified rate, in case company pays dividend to its Equity Shareholders at rates higher than a pre-agreed rate. Preferential shares in India should be redeemable not exceeding 20 years. Equity Shares with Differential Voting Rights. These are the shares where, voting rights are not there, all other things remaining same. The question here is why should any one accept Differential Voting Rights? The companies offer inducement in terms of extra dividend to such Sharesholders. Most of the shareholders in any case don t attend the AGMs due to reasons like location of AGM venue (AGM can only be held in the city of Registered Office), and therefore don t exercise their right to vote. Those who do attend, can hardly make any difference against the majority shareholders. Thus, absence of voting rights does not make any material difference to small Shareholders. For the promoters and majority shareholders, it provides a safety net against hostile bids for take over through market route of acquisition of shares. Guidelines for issue of Equity Shares with Differential Voting Rights (ESDVR)- 1. First issue of shares has to be ordinary equity shares. ESDVR can be offered only on subsequent issues. 2. Proportion of ESDVR can not exceed 25%. 3. Company should have track record of divisible profit in last 3 years. (Company should be profit making. Declaration of dividend is not necessary) 4. Any company defaulting on repayment of deposits or interest can not issue ESDVR. Issue of Shares: - 1. Pvt Placement 2. Public Offer IPO FPO 3. Offer for sale Pvt Placement Issue of prospectus is not necessary. Merely filing of statement in lieu of prospectus is adequate. Offer for Sale Deal is struck with a single entity, an individual or company, who purchases all the shares on offer and pays money. Such entity is called Issue House. He sells those shares subsequently to public. As brought out earlier, this method was being used as a route to evade stringent regulations applicable in case of public issues. The rules Page 11 of 67 - Business Law - II

12 have now been made equally stringent even in cases of sale of shares by Issue House. Ever since, this method has fallen into disuse. Public Offer Appoint various entities: - (d) Merchant Bankers Appointment of Merchant Bankers, also called Lead Managers to the Issue, is mandatory as per SEBI rules. They act as advisors for the issue and carry a great deal of responsibility. They provide various services and in case of any problems, they are the ones to be held responsible along with company. Appoint Brokers Appoint Bankers For acceptance of applications and application money. Appointment of Underwriters It is not compulsory and can be done as a safety net in case management and Merchant Bankers are not certain about receiving minimum 90% subscription. Underwriters charge a certain percentage commission (max 2.5% of the amount underwritten in case of shares and 5% in case of debentures) and purchase unsubscribed portion of issue. There are two types of underwriting (aa) (ab) Hard Underwriting Buy the shares using public issue route Soft Underwriting Buy the unsubscribed portion in case of shortfall in subscription. (e) Appoint Registrars and Transfer Agent These are the people who do the back office job during the public offer. They process the applications, send allotment letters, send refund cheques, etc. Except for the Advertising Agency and Bankers, all others should be registered with SEBI. Different Kinds of Prospectus: - 1. Abridged Prospectus Abridged prospectus contains only salient points with note that full prospectus can be obtained from issuing company or Merchant Banker. 2. Shelf Prospectus In case of company coming up with multiple issues of shares or Debentures or bonds at short notices, (remember, IDBI and ICICI Infrastructure funds coming up with a new series of Tax Saving Infrastructure Bond every month???), such prospectus are issued. Every time a new issue is offered, an information memorandum about changes applicable in Shelf Prospectus is attached rather than issuing a full prospectus. This is applicable only to Banking Companies and Financial Institutions. Page 12 of 67 - Business Law - II

13 3. Red Herring Prospectus Such prospectus are issued in case of Book Building Issues. The only difference in case of regular prospectus and red herring prospectus is declaration of offer price which is not contained in the Red Herring Prospectus. All other things are common. SEBI Guidelines for Making Public Offer This is also called DIP Guidelines (Disclosure for Investor Protection) 1. General Requirements (d) Issue of Offer Document Prohibited companies can not make a public offer Make an application for listing of securities to as many stock exchanges as desired by company but mandatorily to local Stock Exchange (Region in which company s registered office is located). Enter into depository agreement. Rules are different regarding eligibility norms for companies making IPO. Unlisted Companies (i) (ii) (iii) Pre issue net worth of company should be minimum Rs 1 Cr. Track record of distributable profit for minimum 3 of last 5 years. Issue size can not exceed 5 times the net worth of the company. In case a company is not eligible by above criteria, then company can go for Book Building Issue and therein minimum 60% should be invested by QIBs (Qualified Institutional Bidders). Listed Companies In such companies only last criteria, ie issue size applies. 2. Pricing of Issues Companies are free to price their issue. They can demand any amount as long as investors are willing to purchase. In the Pre SEBI days, the price of issues was decided by SEBI s predecessor, Controller of Capital Issues. 3. Promoters Contribution Who is a promoter? Any person who is owning 10% or more shares through family and friends, except QIBs, FIs and FIIs is termed as promoter. Promoters are required to subscribe minimum 20% of the issue and such shares carry a lock-in period of 3 Page 13 of 67 - Business Law - II

14 years, which means that such shares can not be sold for 3 years. As said earlier, this rule is not applicable in case of Banks, Financial Institutions and Infrastructure companies. Promoters should bring their minimum 20% money before the issue opens. Promoters contribution in excess of statutory 20% will also have a lock-in period of 1 year. Public Offer of Securities Pubic Offer of Securities by unlisted companies is called Initial Public Offer (IPO) Public Offer by listed companies is called Follow on Public Offer (FPO). Any Public Offer is guided by two sets of guidelines Guidelines listed by Companies Act SEBI s guidelines. There is substantial variation in requirements stipulated by the two guidelines for each matter. Since every company has to satisfy both the authorities, more stringent of the two rules is followed. In most cases, SEBI stipulations are more stringent than Companies Act. Issues 1. Draft and Issue a Prospectus As Per Companies Act Not necessary to call it prospectus. In can be a circular, notice, letter. Two elements should be present in any such document to be construed as prospectus (i) (ii) Should invite to subscribe for Equity Shares/debentures/Public Deposit. Invitation to public (Any offer is termed private in case the offer is made to a specific person and is not transferable. Else it is called a public offer). Also a private offer to more than 50 persons is deemed to be a public offer. Every prospectus should be dated and registered with Registrar of Companies at least a day prior to offer. As Per SEBI Guidelines Company should deposit draft prospectus at least 21 days before going public through Merchant Banker. Draft Prospectus is a public document and put up on SEBI s Website for any one to raise any objections. SEBI can suggest any changes and they will have to be complied with by company and the merchant banker in final prospectus. Page 14 of 67 - Business Law - II

15 2. Contents of Prospectus Companies Act Schedule II of the Act mandates Details like what should be on cover page, back page etc. Part I General Information Part II Specific Information (i) General (ii) Financial (iii)statutory (d) Part III Explanation of terms SEBI Company s name, address, contact details First Issue Risk Issuers absolute liability (d) Issue details (e) Name and detail of lead managers. Page 15 of 67 - Business Law - II

16 Date: 03 Feb 2006 Allotment of Shares 1. General Rules. (d) (e) (f) Proper Authority Who is authorized to issue the shares? It is normally mentioned in the MOA. In case there is no mention of authority for issue of shares, then the power rests with the Board of Directors. (The Shareholders enjoy only listed privileges. Board of Directors enjoy the Residual Privileges, which means that any powers not vested with some one else will automatically fall on Board of Directors). Allotment against Written Application Any allotment of shares can be done only against written application from the applicant. No allotment of shares can be made unless a person had made a written request. Allotment of shares can be done only if it is not in contravention of any other law of the land. For example Minors are not entitled by the law of the land to enter into any contract. Since allotment of shares is against a contract, shares can not be allotted to any minor who is not eligible to enter into a contract. Any allotments made on misrepresentation of age by a minor would become null and void when the facts are discovered. Similarly, there are limitations imposed on allotment of shares to foreigners. Any allotment in violation of FEMA rules or any other rules, would be nullified. Allotment should be made within reasonable time of application. The law does not define the reasonable time and has been left to the courts to interpret on case to case basis. In a judgment, Supreme Court had ruled six months as unreasonable time. Communication of allotment of shares to allottee is mandatory condition. Even though the Board of Directors may have taken the decision to allot the shares, unless the same is communicated to the person concerned, allotment is not valid. In a particular case, the Board approved allotment of partly paid shares and same was duly minuted also. Soon after, the company went into liquidation and the person was asked to pay up the balance amount. However, he contested the demand on the ground that he never received the intimation, which was upheld. Revocation of Offer Any application for allotment of shares can be withdrawn any time before allotment of shares. However, in case of Public Offers (IPO or FPO), withdrawal is not permitted for 5 days from the issue opening date. This window period is basically a grace period given due to hectic activity level during the Public Issue days. However, this grace period to the company is not available in case any of the experts associated with the Page 16 of 67 - Business Law - II

17 prospectus withdraw his/their consent to the public issue for what so ever reason. In such situations, applicants are allowed to withdraw their application any time till the allotment of shares without the five day s window/grace period. (g) The offer should be absolute and unconditional. 2. Statutory Rules. Prospectus must be deposited with the Registrar of the Issues minimum 21 days before opening of the Public Issue. (d) (e) A minimum amount of application money should be collected along with the application. This rule is not applicable for institutional investors. As per Company Law, minimum amount is 5% of Issue Price while SEBI has stipulated minimum 25% of Issue Price. Application Money to be kept in a separate account in a scheduled bank. Money so collected as application money for allotment of shares must be kept in a separate account in a scheduled bank and can not be withdrawn unless the entire process of allotment of shares and dispatch of refund cheques is completed. For any Public Issue to be declared successful, it is mandatory that minimum 90% subscription is received (inclusive of Underwriter s purchase). In case 90% subscription is not received, no shares can be issued and all the money has to be returned to the applicants. SEBI regulations stipulate that any money due for refund should be refunded to the applicants within 8 days of becoming payable failing which, 15% pa is payable. In case of Raymonds Synthetics Ltd, the delay was claimed to be caused by fire in which all the refund cheques got burnt and thus had to be reprinted. However, court refused to give any relief on interest payment on this count and ordered payment of interest at prevailing penal rate. The money becomes payable in case of Underwritten issue on 61 st day of closure of issue as per SEBI rules and 121 st day as per CLB, and immediately in case the issue is not underwritten. Opening of Subscription List A issue should remain open for public to apply as follows: - (aa) (ab) (ac) CLB Minimum 5 days without any upper limit. SEBI Minimum 3 days and max 10 days. The combined effect of the two regulations is minimum 5 days and max 10 days. Page 17 of 67 - Business Law - II

18 (f) (g) (h) (i) (j) Permission of Stock Exchange Permission to list in Regional Stock Exchange of the area where Company s head office is located is mandatory. In addition, the company can opt to list its shares in any number of stock exchanges across the country. However, permission for listing from all the stock exchanges applied is essential for issue to be successful. In case, even one Stock Exchange of all the stock exchanges applied-in rejects the application for registration, the issue will be unsuccessful and money of all the applicants would have to be returned irrespective of subscription status. Basis of Allotment (In case of over subscription) Of late, issues are coming with Book Building Procedure where in allotment is normally done on pro-rata/proportionate basis. Earlier, lottery system was used. Retention of Oversubscription Retention of oversubscription has not been allowed by SEBI. However, up to 10% retention is allowed to cater for proportionate allotment. In case of book building issue, 15% is allowed as Green Shoe Option for stabilization of share prices. Consideration Cash. Company Law permits other modes of consideration as well such as allotment of shares against purchase of equipment. Allotment of shares against debt is treated as equivalent of cash. Other than cash, shares can be traded for property, goods, etc. On allotment of shares, Return of allotment is to be filed on separate forms for cash and kind with copy of agreement. 3. Issue of Shares at a Premium SEBI has allowed companies to issue shares even at IPO stage for any premium. (TCS IPO share with face value of Re 1 was issued at a premium of Rs 849) but the premium is to be justified in the prospectus. Premium on shares is not profit. This money can not be distributed among Shareholders. It is to be kept in Securities Premium Reserve. The money realized through premium on shares can be utilized for following purposes: - (d) Issue of Bonus Shares Write off preliminary expenses, issue expenses, discount on issue of shares (Amortisation) (Infosys IPO shares in 1991 were issued at discount). Paying premium on redemption of preference shares. Shares buy back. Page 18 of 67 - Business Law - II

19 4. Issue of Shares at a Discount (d) (e) First issue (IPO may not be first issue. Shares may have already been allotted on Pvt Placement basis) has to be at premium or par. A period of one year must have elapsed from commencement of business. Should pass a resolution in General Body Meeting and approval obtained from Central Govt. Ordinarily discount can be allowed up to 10%. However, Central Govt has discretionary powers to increase the discount. Issue of shares should be done within 2 months of resolution passing. 5. Issue of Sweat Equity How is sweat equity different from ESOP? Sweat Equity is issued to employees in appreciation of their past contribution to the company. Such equity has no lock in period and employee can leave the company very next day of receiving the equity without any prejudice to his entitlement. ESOP is actually used as a bait to retain the employees in the company. Employee is given an option to purchase company s share at a pre-fixed price, normally at a discount to the current market price, which can be redeemed after a gap of one year or more from the offer date. However, in case the employee leaves the company in the interim, he loses his claim on ESOP. As per Companies Act for Listed Companies Sweat equity shares should be of a class already issued. Sweat Equity can not be issued before company has completed at least one year in the business (to be reckoned from the date of commencement). Company should pass special resolution giving details. SEBI s Regulations Issue of Sweat Equity to promoters (major Shareholders) (i) (ii) (iii) Company should pass ordinary resolution. Voting is to be done through postal ballot. (Postal ballot is more participative than physical ballot in AGM where only few participate). Beneficiary Promoters can not take part in the voting. Pricing of the Issue Sweat Equity can be given completely free or at a discounted price. Page 19 of 67 - Business Law - II

20 (i) (ii) (iii) (iv) In case the equity is being given for a price, lowest price to be charged is higher of either - Avg of weekly High/Low for last six months, or Avg of weekly High/Lows for last 2 weeks. The data to be used for this purposes is of 30 days prior to conduct of AGM. Valuation If given free then Merchant Banker would assess the know how/intellectual capital contributed. Sweat Equity has a lock-in period of 3 years. Listing of Sweat Equity is allowed only if all the regulations of SEBI have been followed. (d) Sweat Equity to Full Time Directors If they have generated any know how which can be taken to Balance Sheet, then it is not counted towards their remuneration. Else, cost of such equity would be counted within limit of 11% of profits on Directors remuneration. In case sweat equity is issued without any tangible assets being generated which can be taken to Balance Sheet, then the cost of equity is taken to Profit and Loss A/c. Page 20 of 67 - Business Law - II

21 Date: 10 Feb 2006 ESOP & ESPS What is the difference between ESOS and ESPS? ESOS Employee Stock Option Scheme ESOS evolved as a form of incentive for employee retention as well as to motivate them to work towards maximizing shareholders value. Employees are offered a specified number of shares at a fixed price which may be at a discount to the prevailing market. He has one year (minimum statutory time for ESOS) or more (as decided by the company) to convey his acceptance of the offer. Once accepted, he can pay the money and purchase those shares at offer price. In case the employee leaves the company before acceptance of the ESOS, he loses his right to purchase those shares. Thus, it is a bait for the employees to desist them from leaving company within short period. Being owner/potential owner of the shares, it is in employees interest that company s shares perform well in the stock market to maximize their personal gains. Once the shares are accepted, there is no lock-in period and can be sold immediately. Eligibility (d) (e) Employees and directors of the company, holding company and subsidiary companies. However, as per SEBI guidelines, Promoters can not be allotted ESOS. Further, any director who holds 10% or more shares directly or through friends and family can not be offered ESOS. Company is required to form a compensation committee of which majority of the members should be independent directors. This committee will decide the terms and conditions of ESOS. Committee will ensure that all terms and conditions of SEBI are complied with. The terms and conditions framed by the committee should then be approved by shareholders through a special resolution. Vesting Period (interval between offer and acceptance date) can not be reduced below one year. Committee may decide to increase though. Terms of allotment of ESOS can be altered at a later date if they are not against the interest of the employee. Like offer price may be reduced in case of drop in share price. ESPS While ESOS is an incentive to stay with the company and work towards maximizing shareholders wealth, ESPS is a reward for good work. There is no vesting period or acceptance involved in this case. However, unlike ESOS, there is a lock-in period of one year in this case. Shares so allotted can not be traded in stock exchanged for one Page 21 of 67 - Business Law - II

22 year. These shares can be awarded to employees either as part of the public issue or in a separate issue for employees. Balance regulations are same as in case of ESOS. Buy Back of Securities When a company purchases its own shares and extinguishes the liability, it is called buy back of securities. Buy Back of securities was not allowed for a long time and was permitted only a few years back. Source of Funds for Buy Back Any single or combination of following funds can be used to fund the buy back - Free Reserves Securities Premium Account Through fresh issue of securities (other than class of security being bought back) Rules In case of use of Free Reserves, an amount equal to used for funding of Buy Back is required to be transferred to Capital Redemption Reserves. (d) Buy back should be authorized by Articles of Association. If Buy Back is less than or equal to 10% of the outstanding securities, same can be approved by passing a Board Resolution. In case buy back exceeds 10% but is less than or equal to 25%, a special resolution is required to be passed by the shareholders. Buy back of more than 25% of the outstanding shares in a year is not allowed. (e) Post buy back, Debt Equity Ratio should be less than or equal to 2. (f) (g) (h) Partly paid up shares can not be bought back. In case of special resolution, Shareholders are to be notified through a declaration or disclosure, the intent and purpose of buy back. Buy back of shares results in reduced capital as well as reduced liquidity and therefore can be detrimental towards fulfilling liabilities of the company. Therefore, a declaration of solvency is to be made to the Registrar of the companies showing how debtors interests are going to be safeguarded. Page 22 of 67 - Business Law - II

23 (i) (j) (k) (l) (m) (n) All shares bought back should be physically destroyed (in case of physical shares) within 7 days of Buy Back. Once a particular security has been bought back, same class of security can not be reissued within 6 months. Advertisement regarding Buy Back should be placed at least in two news papers, one local vernacular and other English along with Record Dates of Buy Back. (Only Shareholders as on record date are eligible to sell shares back to the company). Shareholders should be given 21 days notice. A register of details regarding buy back like person, quantity, date, rate, etc should be maintained. Return regarding buy back should be submitted to the Registrar. Methods 1. By inviting tender from Shareholders. 2. Purchase from Stock Market (d) (e) Company should announce the period of Buy Back from open market. The period can not be less than 15 days and can not be more than 30 days. Company should disclose price and number of shares bought back on daily basis (It is not specified as to whom declaration is to be made). Shares can not be bought back from the promoter group. Promoters should declare their holding of securities pre and post Buy Back period. During Buy Back period, company can not issue further shares. 3. Book Building Route Restrictions 1. Can not buy through subsidiary companies 2. Can not buy through investment companies. 3. Companies having defaulted in payment of principal or interest of public deposit are not allowed to buy back. Page 23 of 67 - Business Law - II

24 4. Any company defaulting on any other provision of Companies Act is not allowed. Reduction of Share Capital (Old Provision) This is the alternate route for Buy Back of shares. Before provisions for Buy Back were introduced few years back, this was the only route available for Buy Back of shares. As per court judgment, Buy Back and Reduction of Share Capital are parallel routes and company can choose either route. In case of Reduction of Share Capital, a special resolution should be passed by shareholders which should be approved by Company court. This was the route utilized by Sterlite Industries. Various methods used for reduction of share capital are 1. Writing off of uncalled money in case of partly paid shares. In such cases, the face value of share reduces by the uncalled amount. 2. Return of excess money (Capital) 3. Return excess capital with call option. 4. Combination of above options. Procedure Special resolution has to be passed and then approved by the company court. In order to approve the resolution, court requires: Advertisement in two News Papers regarding reduction of capital specifying the method. Court will invite objections and decide on the objections on the merit. Court gives the company following options regarding the objections received from creditors (i) (ii) (iii) Negotiate with creditors Settle their dues In case above two options are not possible, then company has to satisfy the court as to how creditors interest are going to be safeguarded. Page 24 of 67 - Business Law - II

25 Rights Issue In case of fresh issue, the Shareholders enjoy two rights: - Right of Pre-emption Existing shareholders have the first right over the fresh issue of shares. Right to renounce the right to some other person. Advertisement in news paper. Exemptions If an issue is floated within 2 years of incorporation or within one year of first allotment, then Rights Issue is not necessary. Special Resolution is passed by the shareholders relinquishing rights issue. There are SEBI regulations also governing Rights Issue but they are applicable only for listed companies. In case Issue size is Rs 50 Cr or more, a merchant banker has to be appointed. In case of Rights Issue, request for allotment of shares once made can not be withdrawn. Issue of Bonus Shares Issue of Bonus shares can be funded out of free reserves or share premium account. Bonus shares should be fully paid up shares. Page 25 of 67 - Business Law - II

26 Membership of a Company Generally all Shareholders are members. But there are exceptions when this may not be true. 1. There may be a company where share capital may not be there, like a company limited by Guarantee. In such companies, Guarantors are the members. 2. If a shareholder sells all his shares and the new shareholder has not got himself registered with the company as the new shareholder. 3. A person who died is not a member but continues to remain shareholders till his heirs get the shares transferred to their names. 4. In case of insolvency, Receiver becomes the shareholder but not the member. A person can become member by 1. Subscription to Memorandum of Association. People who signed the MOA are members of the company even though they may not be holding any shares. 2. By applying in writing. Company may accept application by way of allotting fresh shares or transfer of shares. (Company has to maintain register of members in case of physical shares. All persons listed in the register are members. However, in case of DEMAT shares only depository participant s name is there. The list of Beneficial Owners of shares is held by the Depository Participant). Who can be a member? 1. A minor can not be member because he can not be party to a contract as per our law. All members are party to the contract in the form of Articles of Association (AOA). 2. Partnership firms can not be members because they are not legal entities. 3. Foreigners can become members. 4. Societies, registered under Societies Registration Act can become members. Rights and Liabilities of Members We have discussed the rights, individual as well as collective, in lecture notes dated 27 Jan 06 on page 9. Liabilities are as under: 1. In case of partly paid up shares, balance amount is to be paid up when called. Page 26 of 67 - Business Law - II

27 2. Liability is unlimited in case it is discovered during winding up of the company that shareholder had indulged in fraudulent acts causing losses to the company. 3. Liability is also unlimited in case all of the following three conditions are satisfied: Membership of the company falls below the statutory minimum. The member was aware of the membership having fallen below minimum. Company continues to operate with deficient membership for over six months Contributory Clause Instances came to light where-in owners of partly paid shares, having got information about impending insolvency of the company, transferred the shares in the name of their domestic help or relatives who had no assets. Thus, they escaped paying up balance money. In order to plug this loophole, contributory clause was incorporated in the regulations. Thus, if a company is liquidated within 12 months of a person ceasing to be member and new member not being able to fulfil the claim, then the previous owner of such shares is liable to pay. Joint Ownership 1. In case of joint ownership of shares, there can not be more than three joint holders and the three would be counted as single member (single vote) 2. In case of transfers of shares, all joint owners should sign the document. 3. Any notice would be sent to only the first named person. 4. Joint members are liable jointly and severally. It means they can be asked to pay to fulfil liability against shares as a group or individually without proportionate division of liability. Can a company expel a member? No. Any company can not expel any member under any count. This permission has not been given else it can be misused to eject vocal minority shareholder. But a member can surrender his shares and cease to be member. Page 27 of 67 - Business Law - II

28 Date: 24 Feb 2006 Corporate Borrowings Contrary to popular notion and belief, companies in general do not have implicit power to borrow money. Only Trading companies have implicit power to borrow money. Other companies in order to be able to borrow money, from any source, have to have explicit powers vested through MOA. If MOA gives the power to borrow money, there is no cap on borrowing unless the MOA itself imposes restriction of maximum borrowings. Any borrowings without explicit authority vested by the MOA or in excess of limits imposed by the MOA are Ultra Vires borrowings and company has no liability to pay the same to the lender. Company in this case is protected through the Principle of Constructive Notice. Thus, before giving loan to any company, the lender is required to examine the MOA with regard to powers vested by it in the company to borrow and amount of borrowings. It also needs to examine the extent of earlier borrowing before sanctioning any loan. Though company in general is not responsible to pay back the Ultra Vires Loan given to it by the lender, all is not lost for the lender. He has a few legal remedies available to him. These are: - (d) Injunctions Subrogation Tracing Order Suit against the directors Injunction If the money is still not used, the lender can approach a court to issue Injunction against use of lent money to the company. Lender can request that the account in which money has been kept may be frozen for operations. Subrogation Even if the money has already been used but it can be traced to any asset, say a building, plant or machinery, which was purchased through borrowed money, court can be requested to hand over the ownership of that asset to the lender. Tracing Order If money can be traced, it can be ordered to be refunded back. Suppose Co. A borrows money from one bank to clear loan of other bank, other bank can be made to refund this money to original bank. Suit Against Directors - In case of Ultra Vires borrowings, the directors are responsible. It is not necessary that only the directors who have signed the loan documents or have approached and negotiated the loan from the agency are responsible. If it was a Board meeting which authorized the loan, all personnel associated with entire exercise are Page 28 of 67 - Business Law - II