HOW DOES A COMPANY GET RIGHTS?

Foe e.g.: Right to own property, Right to enter into contracts, Right to sue

 That company/individual should have legal capacity

DEFINITION OF A PERSON

 Section 11 of IPC – Person includes company or association or body of persons whether

incorporated or not.
 Section 2(31) of Income Tax Act - Person includes HUF, Individual, Firm, Associations,
Local Authority, Artificial Person, Company
Now as company is included under the definition of person How we conclude that
Company = Artificial Person.

BRACKET/ SYMBOLISTIC THEORY BY IHERING

We want to give a shield, a bracket and not disclose names - as in who owns the company. To
separate the management from the company’s identification.
The name given to Reliance – Artificial Person

People / Members / Shareholders of Reliance – Natural Persons

PROVIDING LEGAL CAPACITY

Just being an Artificial Person will not give you rights on your own name. Unless it gets legal
capacity and is incorporated, it won’t get rights of its own name. It has to be registered and
then be provided with corporate personality. Once it is recognised as an Artificial Person - we
get to know the rights and provide legal capacity. It can be provided in the following manner:

1. Person
2. Artificial person
3. Incorporated and registered under the Companies Act, 1956/2013
4. Legal Existence/ Capacity
5. Becomes “Body Corporate” – S. 2(11) of Companies Act
 It includes a company even incorporated outside India. For e.g.: Amazon, Coca Cola.
It is done so that the company can be sued by the shareholders or any individual.
 The bracket under which an association gets registered becomes body corporate. For
e.g.: 5 people ----- Register their association------Reliance Industries (Body Corporate)
 A company registered under Companies Act becomes a body corporate when it has its
own corporate personality and has legal existence.
6. Corporate Personality – Having a separate legal existence
 Corporate Sole – No association, A single Person
 Corporate Aggregate – Company comes under this.

CAN A COMPANY INVOKE FUNDAMENTAL RIGHT?

 Company is not a citizen (+foreign companies)

 Certain rights company can invoke (all right which use the word "person" in constitution)
For e.g. Right to equality if companies are discriminated against
 A company can be a resident and have a nationality
 Rights under Article 19 are invoked by key managerial personnel on behalf of the company
 Individuals can claim their rights under the company if it meets the criteria of State under
Article 12
 There are no laws which recognize company as citizens.
 Fundamental rights of business/corporates (in Canada and other countries)
 Infrastructure, power supply, labour laws, against corruption, tax relaxation
 Erbis Eng. Co. Ltd. vs. State of West Bengal
 Indo-China Steam Navigation Co. vs. Jasjit Singh

LEGAL PERSON:

 Has a real existence but its personality is fictitious.

 May be real or imaginary, but the law regards them as having rights and duties
 They are also called fictitious, juristic, artificial or moral
 They perform their functions through natural persons only.

Examples: corporations, companies, universities, president, secretaries, municipalities, gram

panchayats, rivers
CORPORATE AGGREGATE

Refers to the group of people who unite to form one body under special denomination. This
body has an artificial form of perpetual succession and is legally vested with the ability to act,
and in some respects, have the same right as individuals
A corporate aggregate can:

 Grant property
 Own property
 Enter into contractual obligations
 Sue and be sued
 Enjoy immunities and privileges

Examples: Chartered universities, railway corporations, municipal corporations, registered

companies

CORPORATE SOLE:

Refers to a series of successive individuals who hold the same title of public office. A
corporate sole is a single individual who within the rights and functions of office has the
ability to take, hold, grant or purchase land and other personal properties. Example: Minister
of Health and Agriculture, Postmaster General, the crown, and ecclesiastics corporations like
bishops.

BASIC CONCEPTS OF A COMPANY

 Corporate Personality

When one or more natural person acts as a single entity for legal purposes and based on a
legal name it gains certain rights, privileges, responsibilities and liabilities. For e.g. Payment
of taxes, to own separate property, right to sue a third party, etc. When an artificial person is
incorporated in accordance with law it acquires a legal/corporate personality which is a pre-
requisite to sign any contract, international documents, treaties, etc. A company registered
under the Companies Act, 1956/2013 is recognized to become a body corporate where:
 1. It acquires a legal personality of its own – separate and distinct from its members.
2. It has perpetual succession.
3. It has a common seal.

Characteristics of Corporate
Personality Separate legal entity –
The creditor can recover money only from the company and the property of the company and
cannot sue individual members. The property of the company is for the company’s benefit
and not for the personal benefit of the shareholders.

Limited liability –

It may be limited by shares or limited by guarantee. If limited by shares, the liability of the
members is limited to the value of shares.

Artificial Legal Persons –

It is not a natural person. Cannot act on its own, but through a board of directors elected by
shareholders. Exists in the eyes of law.

Perpetual succession –

A stable form of business organisation which does not depend on death, insolvency or
retirement of shareholders and directors. Members may come and go, but the company is
forever.

Common seal –

It is used for signature, with the name of the company engraved, to legally bind documents.
 Separate Legal Entity
 Salomon vs. Salomon & Co Ltd.

Salomon was a prosperous leather merchant and he was running a sole proprietor business.
He converted his business into a limited company and named it as Salomon & Co Ltd. The
company so formed consisted of Salomon, his wife and four children as members. The newly
formed company purchased the business of Salomon for 39,000 pounds. The purchase
consideration was paid in terms of 10,000 pounds worth debentures conferring a charge over
the company’s assets. Salomon became the major shareholder and a secured creditor. He got
20,000 pounds as fully paid up shares – one pound each and rest in cash. He became the
director of the company.
The company so formed, in less than a year ran into difficulties and went into liquidation.
The assets of the company were not even sufficient to discharge the secured creditors and
nothing was left for the unsecured creditors. The unsecured creditors argued that Salomon
should not get his dues as there is no difference between Salomon and his company.
Therefore, he is the owner of the company.
The Court held that separate legal personality of a company is the bedrock of corporate
democracy and thus a company can own property and deal with it the way it pleases.
Therefore, the business belonged to the company and not to Salomon because a company is
distinct from members who constitutes it. Being a majority shareholder does not take away
the right of being away the debenture holder. It is different from being the creditor of the
company. The Court said he is entitled to get the amount during the liquidation because a
company is separate from the promoter/ shareholder/ director.

 Macaura vs. Northern Assurance Co. Ltd

He owned a timber estate in northern Island, subsequently the asset was purchased by a
company where he agreed accept payment as equity shares of the company. He received
42000 equity shares of 1 pound each and became the majority shareholder of the company.
He took out a fire insurance on timber in his own name which was never transferred in the
name of the company. Shortly after sometime considerable damage was caused by fire to the
subject matter and therefore he sought to recover the damages by claiming his insurance.
However, the Court held that he had no insurable interest in the timber because his relation
was with the company
and not with the assets of the company. The Court further held that the corporator, even if he
owns majority shares is not the corporation and therefore has no legal or equitable interest in
the assets of the company.

 Lee vs. Lee’s Air Farming Co. Ltd.

Mr. Lee was the majority shareholder of Lee Farming Co. Ltd. He was also the governing
director of the company. Lee was a qualified pilot and therefore he entered into a contract of
employment with the company as a chief pilot. The contract stated that if an employee died,
his legal heirs will be entitled to compensation. Mr. Lee died in accident and therefore his
widow compensation under the contract
Issues:

1. While holding a position of the sole governing director can you be an employee of the
company?
2. Does being an employee with majority shareholding end your contractual relationship
with the company?
The Court held that the mere fact that someone was the governing director or a majority
shareholder cannot act as a barrier for him to enter into a contract of employment to serve the
company. A company is a separate legal entity and there was no reason to change the validity
of any contractual obligations which was created between the company and the deceased.
Accordingly, as Lee was the employee of the company, his widow is entitled to
compensation.

SUMMARY

1. Every member is distinct from the company.

2. Being a majority shareholder does not make you the owner of the company.
3. Being a majority shareholder does not stop you from being an employee of the company.
4. Contractual relations remain valid even when the person is the majority shareholder,
whole- time director or employee of the company.
5. No member can have any interest in the property of the company.
6. Members are not responsible for the actions taken by the company.
Exception: Lifting of Corporate Veil

The corporate existence separates a company’s identity from that of its promoters or
shareholders. It enables the company to contract in its own name with its shareholders and
third parties, to acquire a whole property in its own name and to sue and be sued in its own
name. A company has perpetual succession, its life is not co-dependent with that of its
shareholders and it remains in existence irrespective of any change in its members until it is
dissolved by liquidation. This is a fiction created by law and enables an organization of
multiple owners to function as a single identity.
There is a veil placed between the corporate legal personality of a company and its
shareholders which cannot be crossed or lifted except in exigent circumstance. In certain
situations, a court main lift or look beyond the fazed of this fictional identity to penetrate into
the inner workings of the company or shareholders beyond the entity. The corporate identity
of a company can be pierced in situation where separate identity is used as a shield masking
wrongful or illegal ends or to commit fraud. Some of these exceptions have been developed
through judicial precedents and have been identified in the statute.

The concept of lifting up of corporate veil is an exception to separate legal entity. It does not
mean that the court can anytime lift this veil but certain parameters had to be established.
When directors, or whosoever be in charge of the company, start committing frauds, or illegal
activities, or even activities outside purview of the objective/articles of the company,
principle of lifting the corporate veil is initiated. It is disregarding the corporate personality of
a company, in order to look behind the scenes, to determine who the real culprit of the
committed offence is. Thus, wherever this personality of the company is employed for the
purpose of committing illegality or for defrauding others, Courts have authority to ignore the
corporate character and look at the reality behind the corporate veil in order to ensure justice
is served.

 LIC vs. Escorts Ltd.

This is one of the first Indian cases which dealt with the issue of separate legal entity and
lifting of the corporate veil. The case dealt with a non-resident portfolio scheme which
existed under the FERA Act. The scheme allowed non-resident companies which were owned
by or in which the beneficial interest vested in a non-resident individual of Indian nationality
was at least 60%,
to invest in the shares of Indian companies. Investment was allowed to the extent of 1%-5%
of the paid up equity capital of the Indian company.

Under the scheme 13 companies all owned by CAPRO Group Ltd. invested in Escorts Ltd.,
an Indian company. The investment by 13 capro companies were challenged on the grounds
that it was an attempt to circumvent the prescribed ceiling of 5% under the scheme and Mr.
Swaraj Paul who was the beneficiary of group company had hidden motive.
The SC referring to the judgement of Salomon case established that a company once
incorporated has an independent personality distinct from its members but it also noted that in
certain exceptional circumstances, the corporate personality is to be ignored and individual
members have to be recognised for their actions. The SC also took the opportunity to set out
basic conditions, principles to be applied and various circumstances under which the
corporate veil can be pierced. Such acts would include breach of duty, evasion of tax, breach
of contracts, ultra vires acts and fraudulent conduct. In such situations, to look at the reality
and to know the real state of affairs, the corporate veil must be lifted.
In the above case the SC ruled that in the light of the facts of the case, the 13 companies who
belonged to the capro group ltd. are incorporated as separate companies and merely because
more than 60% of the shares were held by a trust of which Mr. Swaraj Paul and the members
of his family were beneficiaries will not make the investment illegal. The Court ignored the
fact that the identity of the shareholders maybe common recognising each company as an
independent juristic entity.

 State of Rajasthan vs. Gotan Limestone Khanji Udhyog Pvt Ltd.

In the present case, the lessee was a partnership firm which attempted to transfer a mining
lease allotted to it by first converting the firm into a private company. The partners of the
firm were the directors and shareholders of the newly incorporated company. The
shareholders of the company so formed subsequently sold the shareholding to a subsidiary of
Ultratech Cement Ltd. for 160 crores through a private sale of mining lease.
The SC observed that in the recent past there has been serious illegalities in the regulation of
mining lease. The mining rights vest in the State and the State has to regulate transfer of such
rights in the best interest of the people. No lessee can trade mining rights by adopting a
device of forming a private limited company and transfer the entire shareholding only with
the view
to sell the mining rights for private profits. Under S.12 of the Minerals Development &
Regulation Act 2015 it has been provided that transfer of mineral concessions can be allowed
only if granted through auction and they are strictly regulated with the doctrine of public
trust. The transformation of the real transaction done by the company cannot be ignored to
find out the substance. The State cannot overlook illegal transfers and any acquisition of
mining lease contrary to the rules is totally unreasonable.
The Company has been formed merely to avoid legal requirements for transferring of mining
lease and to facilitate private benefit to the parties which is detrimental to public interest. The
SC held that the doctrine of lifting the veil can be invoked if there is violation of law by using
the device of being a corporate entity.

What is a separate company under the group?

For E.g. Tata communications, Tata Steel, Tata chemicals under the Tata group (all
subsidiaries). Does this mean Tata chemicals and Tata communications is the same? Are all
companies in a group same or recognised by same name or is it one unit? The answer is no.

What is a subsidiary company?

Whenever a parent company has more than 50% control over another subsidiary. There may
be different sectors. It is upon the company strategy whether to make separate groups and
divisions. In order to make a segregation, sometimes companies start different subsidiaries
with different boards of directors, managers, share trading and so on. This makes each
subsidiary distinct. A subsidiary company is distinct from the holding company.

What are corporate crimes? – White collar crime.

They are committed by corporation or by individuals acting on behalf of the corporation.

There as a need for recognition of white collar crimes. A corporate fraud occurs when a
company or an entity deliberately changes and conceals sensitive information. There can be
several reasons for which companies commit such frauds like making more falsified money,
creating a false image of the company for the market scenario and misguiding Governmental
authorities for tax evasion.
The financial and corporate frauds or scams like Harshad Mehta case, Satyam fiasco, Sahara
case required the attention of law makers. Such frauds made it imperative to evaluate the
standards set in corporate governance and stringent methods were needed to be implemented
to tackle corporate frauds.

CORPORATE CRIMINAL LIABILITY

 It encompasses two elements: Mens Rea and Actus Reus.

 A company being an artificial person cannot have requisite Mens Rea. It is difficult to
identify and prove criminal intent of Juristic Person.
 Corporates cannot be imprisoned; it requires the person to go behind the bars. Physical
persons for proceedings are required.
 Therefore, the law was that a company cannot be prosecuted for offenses that require
imposition of a Mandatory Punishment.

 Iridium India Telecom Ltd. vs. Motorola Inc. & Ors.

In the present case Motorola had floated a private placement Memorandum to obtain funds
and investments to finance one of the Iridium projects. On the basis of the information and
representation made through the memorandum several financial institutions invested in the
project. The project turned out to be unviable and resulted in massive loss to the investors
which was alleged by Iridium to have been caused as a result of Motorola’s false
representation and misstatements in the Private Placement Memorandum. Iridium filed a
criminal complaint against Motorola alleged offense under S.420 and S.120(b) of IPC.
Issue: Whether a company can be prosecuted for an offense for which the mandatory
punishment prescribed is both imprisonment and fine. The Bombay HC squashed the
proceedings stating that a company being an artificial person is incapable of committing the
offense of cheating as it lacks criminal intent and only natural persons are capable of having
guilty mind to commit such offense. The SC set aside the HC findings and asserted that a
corporate body can be criminally prosecuted and they can no longer claim immunity from
criminal prosecution on the ground that they are incapable of possessing necessary Mens Rea.

Corporate bodies can be criminally prosecuted if a rational relationship between an

employer’s criminal conduct and his corporate duties is established and if the Directors, key
managerial
personals who are the officers in charge committed an offense with intention of benefitting
the corporation in some manner against the prescribed rules or with the intention of
increasing his own personal gain. Such non-disclosure of proper information would be treated
as fraud and thereby constituting a criminal offense for which the company can be held liable
and the directing mind of the company (the natural persons), by lifting the corporate veil can
be held personally liable.

Supreme Court laid down two tests:

1. Attribution Test

Whose mental element shall be attributed to the company for establishing criminal liability. It
shall depend on the person – in – charge, control and degree of authority.
2. Directing Mind and Will Test

Rigid test of Identification of the company. People named in MOA for handling the affairs of
the company. Identification of the directing minds.

VICARIOUS LIABILITY

The settled position of law is that, if a company commits a criminal offense, the liability rests
with the Director in two ways:
1. Who perpetuated an offense on behalf of the company?

The Director is made accused along with the company. If there is sufficient evidence of the
active role of the person + criminal intent, then the company as well as the director have to be
made parties.

2. When statute itself attracts the Doctrine of Vicarious Liability by providing for such
Liability.
Like laws of FEMA, Scams, IBC, PMLA, etc. There is doctrine of vicarious liability
established.
 There are cases where even though the director is not actively involved, still based on the
position is made party to the case. It is a technical problem.

FEATURES OF A COMPANY

1. Separate Legal Entity

- You have to take insurance in the name of the firm (e.g.: fire insurance)

- Liability of firm and not owners, unless triggered by fraud

- Exception: lifting of corporate veil

2. Perpetual Succession (Section 9)

Whenever you form a company, you have to register yet. S.9 talks about effect of
registration. After registration, it forms a body corporate. Members may leave the company,
but the company will go on unless and until it has not been wounded up.

3. Common Seal (Section 22 read with Section 9)

Before 2015, S.9 also included the concept of common seal. It has now been made optional.
This means that company would have a seal, but any cheques or document where you need a
signature, there are two options- use common seal or the director (or a person who has the
authority) can sign it.

A company may be formed for any lawful purpose by–

 Seven or more persons, where the company to be formed is a public company;

 Two or more persons, where the company to be formed is a private company; or
 One person, where the company to be formed is a One Person Company that is to say, a
private company,
 By subscribing their names or his/her name to a memorandum and complying with the
requirements of this act in respect of registration.
TYPES OF COMPANIES

A. Statutory Company

- Generally companies made under a statute.

- They have their own Act and do not require certain documents.

- Some of the provisions of Company Act would apply unless it is in contradiction with their
own statute. Their statute prevails.
- Generally do not require Memorandum of Association.

B. Registered Company
- We are the ones incorporating, who become promoters, to make it a corporate -
personality and give it legal existence, it needs to be registered under companies act to be
governed by it.
- Documents and forms needed, apply to registrar, get a certificate
- Have to be registered with a particular feature under the Companies Act.

1. Private Company

Private company means a company having a minimum paid-up share capital of one lakh
rupees or such higher paid-up share capital as may be prescribed. The words ‘Private
Limited’ must be added at the end of its name by a private limited company. As per section 3
(1), a private company may be formed for any lawful purpose by two or more persons, by
subscribing their names to a memorandum and complying with the requirements of this act in
respect of registration. Private company is a stock corporation whose shares of stock are not
publicly traded on the open market but are held internally by a few individuals. The
transferability of shares is restricted completely in private limited company. The scope of
private company is limited. It is not listed on stock exchange nor they are traded. It is
privately held by members only. Private companies are not regulated by SEBI. A private
company can be converted into public company and less procedure is required. If a private
company has to convert to a public company, it will make the compliances easier and a
company will exercise greater control. This means a company would no longer hold a
meeting of shareholders and pass a special resolution regarding part related transactions.
2. Public Company

A public limited company is a joint stock company. It is governed under the provisions of the
Indian Companies Act, 2013. While there is no limit on the number of members, it is formed
by the association of persons voluntarily with a minimum paid up capital of 5 lakh rupees.
Transferability of shares have no restriction. The company can invite public for subscription
of shares and debentures. The term public limited is added to its name at the time of
incorporation. It is regulated by SEBI. 25% mandatory public shareholding. Promoter is the
majority shareholder. There are more compliances required in public company to convert to
private company.

Difference between the two:

- Shareholding patterns would vary.

- Limited liability (private) and unlimited liability (public).

- Difference between control of regulators

Q. Can you convert private co. to public?

- Special Resolution

- Amend membership

- Amendment in the articles

- Have to comply with ROC's orders (Form- INC 27 to ROC)

- Private to public will have more compliances. The moment a private company goes for IPO,
they become 'deemed to be a public company'.

Q. Can you convert public co. to private? (S.14 of Companies Act)

- Altering articles

- You will have to let go off members, the shareholders, etc.

- There is a change of structure as a whole.

- All the investments made as a public company by collecting, you have to pay them off. This
could raise a doubt of fraud.

3. One-person company

Several significant concepts have been introduced for the first time under Companies Act,
2013 and one of them being One Person Company. Section 2(62) defines one-person
company as a private company with only one director and one shareholder. However, it can
have more than one director, and up to a maximum of 15. Individual entrepreneurs doing
business as sole proprietors will now be able to avail the benefits of limited liability without a
second person to form a company.
A sole proprietorship form of business might seem very similar to one-person companies
because they both involve a single person owning the business, but they’re actually exist
some differences between them. The main difference between the two is the nature of the
liabilities they carry. Since an OPC is a separate legal entity distinguished from its promoter,
it has its own assets and liabilities.
The promoter is not personally liable to repay the debts of the company. On the other hand,
sole proprietorships and their proprietors are the same persons. So, the law allows attachment
and sale of promoter’s own assets in case of non-fulfilment of the business’ liabilities.
A single person can form an OPC by subscribing his name to the memorandum of association
and fulfilling other requirements prescribed by the Companies Act, 2013. Such memorandum
must state details of a nominee who shall become the company’s sole member in case the
original member dies or becomes incapable of entering into contractual relations.
This memorandum and the nominee’s consent to his nomination should be filed to the
Registrar of Companies along with an application of registration. Such nominee can
withdraw his name at any point in time by submission of requisite applications to the
Registrar. His nomination can also later be cancelled by the member.

Rules regulating the formation of one-person companies expressly restrict the conversion of
OPCs into Section 8 companies, i.e. companies that have charitable objectives. OPCs also
cannot voluntarily convert into other kinds of companies until the expiry of two years from
the date of their incorporation.
4. Small Companies

Small company is a special status given to companies registered under Indian Companies
Act, 2013 due to its scope of business, measured in terms of capital and turnover. The
companies enjoying the status of small company enjoy certain benefits in form of exemption
from applicability of provisions. To claim the status of the small company, it does not need to
register a company in India; rather a company already registered and fulfilling provided
conditions is known as a small company. In the Act, it is stated that the company’s paid-up
share capital should not exceed 50 lakh rupees and along with that the turnover of the
company should not exceed 2 crore rupees. Both the criteria are necessary to be fulfilled for a
company to fall into the category of small company.

5. Limited Liability Company

Limited Liability Company is another category of company registered under the Indian New
Companies Act, 2013. New Companies Act, 2013 has defined all rules and regulations
regarding incorporating and registering all limited liability companies. One should apply to
the Registrar of Companies (RoC) by giving all the details regarding company including
name of the company, name and address of board of directors, location of the company as per
the company registration services.
There are two types: By Share and By Guarantee. Limited by shares means where share
capital is present and shareholders have to pay the unpaid capital only. The shareholders have
a limited liability whereas the company has unlimited liability.
 Company limited by shares-

It is a company in which the liability of the members or shareholders is limited that is they
are only liable for the unpaid value of shares held by the member. The unpaid amount can be
called upon any time during the life time or winding up of the company. If the shares of a
member are fully paid up, then his liability will be nil.
 Company limited by guarantee-

In such a company the liability of contributor is limited up to the amount guaranteed or

invested by the contributor towards the assets of the company in the event of its being wound
up. The amount guaranteed can be only demanded at the time of its wound up, hence it is a
reserve
capital. Such companies are generally formed to promote art, science, commerce, sports etc.
and are not for profit making. They have contributors instead of shareholders.

6. Unlimited Liability Company

It is a company where the liabilities of the shareholders are unlimited. A company having no
limit on the liability of its shareholders is an unlimited company. Thus the liability may
extend to the personal property of the shareholders in case the company is not able to satisfy
its claims at the time of winding up. The liability of the members is like partnership where
they have to contribute according to the ratio of amount invested in the company. Example-
GE INDIA CO.- strike off.

7. Government Companies

Government company” means any company in which not less than fifty-one per cent of the
paid-up share capital is held by the Central Government, or by any State Government or
Governments, or partly by the Central Government and partly by one or more State
Governments, and includes a company which is a subsidiary company of such a Government
company. A Subsidiary of Government Company shall also be treated as a Government
Company. These Companies are registered as Private Limited Companies through their
management and their control vest with the Government. This is a type of organization where
both the Government and Private individuals are shareholders. Sometimes these Companies
are called as Mixed Ownership Company.
A Government Company may be formed as a Private Limited Company or Public Limited
Company. The name of all Government Companies shall end with the word “Limited”, be it
Public or a Private Company. Government company is a corporate body that is created under
the Indian Companies Act, 1956. It is governed by provisions of Companies Act. Whereas,
statutory corporation is a corporate body created by either Parliament or State Legislature by
a special act which defines its powers, duties and functions.
Examples: SAIL, BHEL, NTPC and GAIL
IMP POINTS:

 If a body is not registered under the Companies Act it is not a registered company.
 If in a registered company, the government does not have 51% stake it is not a
government company.

Public Enterprises:

1. Departmental Undertakings
2. Statutory Corporations
3. Government Companies

8. Departmental undertakings

This is the oldest form of public sector enterprises. The departmental undertaking is
considered as one of the departments of government. It has no separate existence than the
government. It functions under the overall control of one ministry or department of
government.
For example, Railways, post & telegraph, broadcasting, telephone service etc. they are under
a particular statute. It is very easy to form a departmental undertaking as no registration is
compulsory. There is direct parliamentary control. The performance of departmental
undertakings can be discussed in parliament. So there is public accountability. Powers and
function are not derived from companies’ act.
The main difference between a departmental company and a government company is A
departmental undertaking does not enjoy autonomy, whereas a Government company has
some autonomy. A departmental undertaking does not provide for mixed ownership, whereas
a Government company provides for mixed ownership. A departmental undertaking does not
have separate legal entity. But a Government company has separate legal entity.
The main difference between statutory corporation and departmental undertaking is that
departmental undertaking is established by a ministry and statutory corporation is established
by a special act of parliament. Statutory corporation has a separate legal entity while
departmental undertaking does not have separate legal entity.
9. Foreign company

A foreign company is any company or body corporate incorporated outside India which has a
place of business in India where it conducts business in India through an agent, or physically
or through electronic mode or conducts any business activity in India in any other manner. It
can invoke article 14 as well. This definition clearly states that even if the location of the
main server is outside India, it would still come within the purview of the term electronic
mode. The 2013 Act has done away with the requirement of having any sort of physical
presence in India to carry out business in order to be characterized as ‘foreign company’ as
required under the old Act. Now, the entities having any virtual presence would also come
under the ambit of the new Act.
Foreign companies controlled by Indian corporates have been mandated to comply with the
provisions of Chapter 22. If 50% shares are held by Indian citizens it will still be a foreign
company. However, compliances of other provisions will be applicable which are applicable
to Indian companies. Rules of both foreign and Indian companies will be applicable.
Company A- Incorporated outside Indian in which Indian entity hold 50% share capital and
conduct business activity in India. This is a foreign company but because of 50% share
capital provisions other than chapter 22 will also be applicable.
Company B- Indian entity hold 40% share capital- it will be foreign company- chapter 22
will be applicable.
Company C- 70% of share capital is held by Indian citizens- It will not be a foreign
company because it is outside the scope and provisions of chapter 22 will not be applicable.
Company D- No shares are held by Indian citizens and electronic mode is used to conduct
business. Therefore, it is a foreign company.

10. Holding Company and Subsidiary Company

A company shall be deemed to be a subsidiary company if:

 It has control over the composition of the board.

 It exercises control on more than 50% of voting rights.
 Together with its subsidiary it holds 50%.
Situation 1

Reliance Industries limited  Reliance Jio} Controls the Board Decision

Situation 2

Reliance Industries limited  Reliance Retail} 50% voting rights

Situation 3

Reliance Industries Limited} Holding Company and Reliance Jio} Subsidiary

JIO 30% + RIL 20%  XYZ Ltd 50% Together
In the given situations i.e. 1 and 2, It is a Horizontal Arrangement whereas in 3, It is a
vertical arrangement.

Horizontal Subsidiaries

Reliance Industries Limited

 Jio Platform – 50% share

 Retail – 50% Share
 Petroleum – Control over Board
 Network Group – Voting Rights

Vertical Arrangement Subsidiaries

Reliance Industries Limited

 Subsidiary – Jio Platform Limited – 50% share

 Step Down Subsidiary – Reliance Jio ltd. – S1
 Jio Savan or Jio mart – S2

Layers

Companies cannot have layers of subsidiaries beyond such numbers as provided. The Layer’s
Rule 2007 provides cap on layers. A wholly owned foreign company is exempted from the
Layers Rule.
1. Limited to 2 layers of subsidiaries
2. Excluding wholly owned subsidiaries

Wholly owned subsidiaries(WOS): 100% shareholding held by Parent Company

Example 1:
Reliance Industries Limited

1. JIO Platform – 100% - Layer 0 -

WOS Reliance Jio – 50% - Layer 1
Jio saavn – Layer 2

2. JIO Platform – 100% - Layer 0 -

WOS Reliance Jio – 50% - Layer 1
Jio saavn – Layer 2
XYZ – Layer 3 – Not valid

3. Reliance Jio – Layer 1

Jio Saavn – Layer 2

 Due to shell companies being engaged into illicit activities of more than 13 lakh
companies in 2016, Vertical restriction has been implemented.

Rules in Respect to Holding and Subsidiary Company

1. Holding and subsidiary companies are independent legal entities and they cannot be
treated as one single unit for business operations.
2. Holding company is not liable for any payment due of a subsidiary company.
3. The holding company is not liable for payment to the creditors of subsidiary company in
case of winding up.
4. Important- A private company which is a subsidiary of a public company is a public
company. Even when such subsidiary company continuous to be a private company - in
its articles and therefore the relaxation’s available to a private company is not applicable
to its subsidiary.
5. A holding company must contain details and particulars of subsidiary companies.
11. Associate Company
a. When 2 companies have significant influence
 If the company controls at least 20% voting power of the another company
 The company controls and participates in the business decisions of other company under
an agreement.
- Right to appoint majority directors
- Right to control the management of the company
- Right to participate in the policy decision of the company

b. When 2 companies have a joint venture

 Joint control by virtue of agreement.

c. They are not subsidiary

 Should not have more than 50% share.

12. Dormant Company

The concept of dormant company is “Invest Now and Shine Later. A company gets a
dormant status:

1. During Incorporation from ROC

From the beginning you want to show that your company has a dormant status. This means
you are not dealing or there is no business or operations and have not made any significant
transfers. You are just looking for investors or creating assets.
 Start ups
 For future projects
 Hold assets and IPR
 No significant accounting transaction

2. Either you get Dormant status later

 When company gas not filed financial statements or annual returns for 2 financial years
consecutively
 Has not been carrying on any business or operations
How long can you keep the company as a Dormant Company?

Five years – Active or Revive or else ROC will automatically strike off the name from the
record.
Can a public listed company apply for Dormant Status? – Not allowed

 Securities of any company which are not listed on any stock exchange within or outside
India can apply for dormant status.
 In case you make a significant transaction – within 7 days you need to file an e form –
your name will be removed from dormant company.

Essentials:

1. The company should have an outstanding loan whether active or inactive.

2. A company shall have such minimum number of directors and file such documents.
3. Pay such annual fee as may be prescribed to the Registrar to retain its dormant status in
the register.

What is the difference between shell and dormant company?

 Shell company is a company that exists only in paper and has no offices and no employees
 It is not recognized under companies’ act
 Used for money laundering, illegal activities, etc.

SECTION 8 - COMPANIES

Company is a company which is registered for charitable or not-for-profit purposes. This

Company is, however, similar to a Trust or Society; an exception is that a Section 8 Company
is registered under the Central Government’s “Ministry of Corporate Affairs (MCA)”
whereas the Societies and Trusts are registered under the State Government regulations. This,
however, has various advantages when it is compared to Trust or Society and it also has
higher credibility amongst the donors, Government departments, and other stakeholders.
Further, the key feature
of this Company is that the name of the Company can be incorporated without using the word
“Limited” or “Private Limited”. It is always on the satisfaction of the central government.

Promotion of certain subject or object should be the main motive of the company. Even if
some kind of income or profit is derived even those profits cannot be distributed among the
stakeholders. The profit has to be put forward for the promotional activity. There should be
intention of prohibition of dividend distribution among the shareholders. Whatever privileges
a limited company gets and whatever obligation that the private limited company is
subjected, section 8 companies are bound by the same. The company cannot alter their
memorandum or article unless on the approval of central government.

Formation of a Company with Charitable Interest:

1. Association not for Profit.

2. Generally, not having a capital share.
3. Prohibition on Payments of Dividends.
4. Prior permission of Central Government to be registered as a company under Section 8.

FORMATION OF A COMPANY

Who has the most important role in formation and incorporation of a company?

Promoter is the founding father of a company. He is the one who starts the inception and
establishes the company. As per Section 69 of Companies Act Promoter means a person -

(a) who has been named as such in a prospectus or is identified by the company in the annual
return or
(b) who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise; or

(c) in accordance with whose advice, directions or instructions the Board of Directors of the
company is accustomed to act:
Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a
professional capacity.
 What are the steps involved in Incorporation of a Company?

1. To get idea of the business.

2. Analyse the situation of the market.
3. To find out where a profitable business venture can be shelved.
4. Organise and start the process of turning an Idea into Reality.
5. Decide which type of company is required to be formed.
6. Decide an acceptable name of the company by ROC.
7. Decide where the registered office is to be situated.
8. Format the MOA and AOA.
9. Nominate Board of Directors (1st Directors) and Auditors if required.
10. File for Incorporation.

What is the process for Incorporation?

RULE 8 OF COMPANY (Incorporation Rules, 2014)

SECTION 9

Date of Incorporation. Certificate of Incorporation is like the birth certificate. These are the
effects of registration of a company:

 From the date of incorporation, the subscribers to the Memorandum and all subsequent
members of the company are a body corporate.
 A registered company can exercise all functions of a company incorporated under the
Act. Also, the company has perpetual succession with power to acquire, hold, and dispose
of property of all forms. Also, it can contract, sue and be sued by the said name.

 Further, the company becomes a legal person separate from the incorporators from the
date of incorporation. Also, a binding contract comes into existence between the company
and its members as mentioned in the Memorandum and Articles of Association. Until the
company dissolves or the Registrar removes it from the register, it has perpetual
existence.
SECTION 11

Certificate of Commencement of Business has been omitted by 2015 amendment and

therefore permitting all companies whether public or private to commence business
immediately after obtaining COI and CIN. Issued by Centre for Registrar.

ROLE OF PROMOTER

Legal Position of Promoters:

Is he an Agent? – No and Is he a Trustee? – No

Promoter means someone who has control overs the affairs of the company and can give
directions to the Board of Directors.

Fiduciary Duty:

1. Elect first directors of the company

2. File all documents
3. Proper disclosure in prospectus
4. Buy assets, lands and machinery for the benefits of the company
5. Only to disclose any conflict on interest

Liabilities:

Section 26 - Proper Disclosure of matters in prospectus

Section 34 - Omission in Properties
Section 35 - Misstatement or false statement in published document
Section 340 – For breach of trust or contract

Section 15(h) in The Specific Relief Act, 1963

When the promoters of a company have, before its incorporation, entered into a contract for
the purposes of the company, and such contract is warranted by the terms of the
incorporation,
the company: Provided that the company has accepted the contract and has communicated
such acceptance to the other party to the contract.

Types of Promoters:

1. Professional

Give back control of the company to the shareholders. It is prevalent in USA, UK and
Germany.

2. Occasional

It helps start-ups.

3. Financial

They help financial institutions.

In India we have Concentrated Ownership Pattern. Here the promoters are the controlling
head of the company.

 Emile Erlanger vs. New Sombrero Phosphate Company

Mr E was a banker who purchased an island containing phosphate mines for 55000 pounds.
In order to obtain profit on resale, he formed a company, New Sombrero Phosphate Co. The
objective of the company was to purchase the lease on an island and work in mining business.

Mr E was named as the promoter and he named 5 directors who were under the Article of
Association, empowered to adopt and carry into effect the contract for purchase, by the
company of the island. Out of 5 directors, 2 directors were abroad and remaining 3 directors
were under the complete control of Mr E.
The directors purchased the island for the company at a price of 1,10,000 pounds. The
prospectus of the company disclosed the purchased amount and nothing more than that. At an
ordinary general meeting, the shareholders raised objections about this purchase and the
matter was therefore put under investigation.
The Court held that a promoter is not prevented from selling his own property to the company
but when he does so he is bound to take care that he sells it to the company through the
medium of board of directors who can exercise independent and intelligent judgement on the
transaction
and the promoters in no case shall make secret profits in the name of the company, therefore
the company was authorised to rescind the contract and recover the amount.

 Situation 1

Mr A and Mr B originated the scheme for the formation of an Infrastructural Company, has
the Memorandum and articles prepared, executed and registered, and appointed the first
directors, settled the terms and made arrangements for advertising and circulating the
prospectus and for placing the capital.
Mr A and Mr B did not become signatory to the MOA neither they took the control of the
company as Directors. They were engaged in the pre-incorporation stage. After incorporation
of the company, it was found that the capital was raised by advertising false statements
during the time of floating the company.
Whether Mr A and Mr B can be held liable after incorporation, if they were not the directors
subsequently?
 Probir Kumar Misra vs. Ramani Ramaswamy

Law is clear that while the company which has come into existence is not bound by the
conduct of the promoter, at the same time it is entitled to make claim against such promoter
in case it was subsequently found that the conduct of the promoter was detrimental to the
interest of the company incorporated on the basis of principles of breach of trust.

MEMORANDUM OF ASSOCIATION

Section 2(56) - “Memorandum” means the memorandum of association of a company as

originally framed or as altered from time to time in pursuance of any previous company law
or of this Act.
It defines the scope of the company. It defines the constitution and the scope of powers of the
company. It is something which cannot be changed. It is the foundation on which the
company is built. It is the whole structure of the company. MOA can be framed and altered
under 2013 Act with very strict regulations. It is a binding document. You cannot go beyond
the objective of the company. For e.g. name of the company, registered office, etc.
According to Palmer, the MOA is a doc of great importance in relation to the proposed
company. It has the following things:

1. Objects for which the company is formed

2. Identifies the possible scope of its operations beyond which its actions cannot go
3. Confines the powers of the company

If anything is done beyond the powers of MOA, it will be ultra vires and therefore void.
Doctrine of ultravires was first laid down in:
 Ashbury Railway Carriage and Iron Co. vs. Riche

The object of the company provided that it was formed to make, sell or lend on hire railway
carriages to carry on the business of mechanical engineers and general contractors. The
company entered into a contract with Richie for financing the construction the construction of
a railway in Belgium. Later on, the company repudiated the contract. Richie brought week
action for damages for breach of contract.
Issues:

1. Whether the financing of construction of railways come within the expression General
Contractors
2. Whether entering into a contract of financing of construction of railways was ultra vires
the company
3. Whether subsequent unanimous ratification by the members of the company would make
ultra vires contract intra vires.
The Court held that the term General Contractors must be taken to indicate the making,
generally, of such contracts which are connected with the business of mechanical engineers.
Therefore, the financing of construction of railways is outside the purview of object clause
and cannot be included within the expression general Contractors. Thus the contract for the
same is ultra vires the company. A contract which is ultra vires the company is void an initio
and has no legal effect. Therefore, actions which are forbidden by the MOA cannot be
rendered intra vires even by unanimous consent or ratification by all the members.

Interpreting the issues, the court saw the object clause. The scope was making, selling and
hiring railway carriages. There was no incidental clause as well which was not even a concept
back then. It was held that Financing of railways was outside the scope and it was ultra vires
was held by the court. The court stated that whatever is not allowed in MOA cannot be done
by mere consenting. Ratification has no say for the purpose of MOA. It needs a strict
amendment. What was the liability of third liability? (Doctrine of constructive notice means
outsider is not protected to something which is not on the contract.)

What is the liability of third party and company according to today's scenario with a
case law?
There is no legal relationship between company and third party if the act is ultra vires. Third
party can bring personal liability against someone but not against company. Company is not
liable. Breach of trust is one such remedy.

Whether MOA is not amendable charter?

Courts said that you can bring changes in the object of MOA. But it cannot be done without
ratification. Alteration can be done by properly following procedure to amend. Section 13 of
act states that there are various clauses which can be amended by following proper procedure.

Whether MOA is an unalterable charter?

In early times it was considered that MOA is the constitution of the company and it must be
unalterable. However, this led to number of difficulties in working of the company.
Subsequently the act was amended to provide alteration of various clauses.

SECTION 13

This section states that except capital clause (which can be altered by ordinary resolution), a
company can alter clauses by passing a special resolution and after complying with all the
procedures.
SECTION 4 – CLAUSES
NAME CLAUSE
First you should have name clause- it should be non-identical. Names which are identical,
undesirable cannot be used.

 Asiatic Government Security Life Assurance Co. vs, New Asiatic Insurance Co. Ltd.

 Vardhman Corp ltd vs Union of India

Vardhman fertilizer and seeds pvt ltd was incorporated on 9th July 1987. It was engaged in
the business of manufacturing and marketing class 1 fertilizers and micro nutrients. The
company got registered its trademark Vardhman with the trademark registry in the year 2007.
Vardhman corp pvt ltd was incorporated in 2009 and started its business of manufacturing
class 1 fertilizers and micro nutrients similar to the business of Vardhman fertilizer pvt
limited. In 2011 Vardhman fertilizer filed an application under section 22 of 1956 act (now
sec 16 of 2013 act) seeking direction to change the name of the company and remove
Vardhman from their name as it was causing great loss of business reputation.

The court held that Vardhman was a registered trademark of Vardhman fertilizers since 2007
and therefore use of the same brand name by the company Vardhman crop which was in
similar business is undesirable and therefore directed the company to remove the word
Vardhman and alter the name clause.

Alteration of Name Clause:

1. By passing a Special Resolution

2. Approval of MCA
3. In case of listed company – SEBI Compliance

The Central Government also checks – Rule 29 of Company Incorporation, 2014

 Company must have filed Annual Returns

 Company must have filed Financial Statements
 Paid deposits on time

REGISTERED OFFICE CLAUSE

1. Name of the state in which registered office of the company will be situated.
2. Address of the office as mentioned in the Certificate of Incorporation.
3. Section 12 (2017 Amendment) – Within 30 days of incorporation of the registered office,
it should be capable of receiving and acknowledging all notices.

Alteration of Registered Office Clause:

1. Within local limits of the city.

a. There has to be a board of directors’ resolution.
b. It should be informed to the registrar within 15 days from the change of address

2. Within one city to another in the same state.

a. A special resolution has to be passed.
b. Form INC 23 along with Affidavit by 2 Key Managerial personnel and the Special
Resolution has to be filled with the regional director.
c. The regional director shall confirm it within 60 days to the ROC.

3. Change of Registered Office from one state to another state.

a. Pass a special resolution.
b. Obtain consent of creditors and debenture holders.
c. File form INC 23 with Affidavit of 2 Key Managerial personnel with Special
Resolution to the MCA i.e. Central Government.
d. Once the confirmation is received, the ROC will certify it within 30 days.

OBJECT CLAUSE

 Purpose for which the company is incorporated.

 Section 3(1) (c) – Company needs to mention incidental objects or ancillary objects.
 Any contract entered by Company beyond the object clause is ultra vires. The tribunal
checks and decides whether the contract is beyond the object clause.

Object clause of the company is the third clause of MOA stating the business objectives and
purpose for which the company is incorporated and any other matter considered necessary in
furtherance thereof. Any act done by the company that is beyond the object empowered is
considered to be ultra vires making the object clause one of the most important clause.
Primarily it is important to note that the object clause of the company can be divided
into following-
1. The objects to be pursued by the company on its incorporation i.e., the main objects

2. Matters which are necessary for furtherance of the main objects i.e., incidental or ancillary
objects

Main objects of the company are the ones that enables you to focus on the primary activity of
the company, incidental or ancillary objects enables you to carry on things that you may
require in the course of business so as to attain the main objects and other objects are those
which a company may keep in store for future so that they may extend their business in
coming times.

Example-

If the main object of a company is to promote sports and provide long-term coaching for
various athletic activities, its incidental or ancillary objects may be to organise seminars,
meetings, conferences, to promote the object of the company or may be to give scholarships,
financial assistance, and grants for achieving its objectives. Its other objectives may be to
purchase, takeover, acquire, or undertake assets or properties for carrying out its business
activities suitable for the purpose of the company.

Alteration of Object Clause:

1. Alteration of objects by a company which has not issued Prospectus

A company which has not issued a prospectus may alter its objects by passing a special
resolution. The requirements of passing a special resolution is exempted for a company
having members up to 200 (Rule 22 (16) of company (management and admin) rules, 2014).
2. Alteration of objects by a company which has issued the Prospectus

A company which has raised money from public and utilized the amount so raised shall
change the object clause by passing a special resolution, but if there is unutilized amount out
of the money so raised the company has to comply with the following procedures-
a. Notice in respect of the resolution sent to the members for altering the objects shall
contain the following particulars.
 Total money received
 Total money utilized
 Unutilized amount of money for the particular objective.
 Particulars of proposed alteration
 Justification of the alteration
 Amount proposed to be utilised for the new object
 Estimated financial impact of the proposed alteration on the earnings and cash flow of the
company

b. The advertisement giving details of the resolution to be passed for alteration in the objects
shall be published in the newspapers, one English and one vernacular newspaper.
c. The advertisement shall be published simultaneously with dispatch of notices to the
shareholders.
d. Notice shall be displayed on the website of the company indicating the justification for
such change.
e. The company shall file form MGT- 14 with all other documents within 30 days of passing
the special resolution.
f. The registrar shall register the alteration and certify it that the company has duly
complied with the compliances and thus the alteration shall be deemed to be complete.

LIABILITY CLAUSE

There are two types of liabilities: Limited and Unlimited.

How can we alter this clause?

 It is a contractual agreement between the shareholders and the company.

 It must be increased by consent in writing.

CAPITAL CLAUSE

This clause indicates the amount of capital with which the company is registered i.e.
authorized capital.
It can be altered by:

 An Ordinary Resolution as the capital will be increasing over time.

 Informing ROC within 30 days.

NOMINATION CLAUSE

In case of one-person-company, in addition to all the other clauses, the Memorandum of

Association contains a clause called the Nomination Clause. This clause mentions the name
of an individual who will become the member in case the subscriber dies or becomes
incapacitated. The nominee must be an Indian citizen and resident of India i. e. he must have
been living in India for at least 182 days in the preceding year. A minor cannot be a nominee.

Module – 7

ARTICLES OF ASSOCIATION

Section 2(5) read with Section 5 and Rule 10 of Companies Incorporation Rules 2014. The
Articles of a company is an important document which is Company’s Rule Book and
contains internal details governing different aspects of the company. It defines the
responsibilities of the directors, the different means by which the shareholders may exert their
control over the Directors and the Company. While the MOA defines the objectives of the
company, the AOA lays down the rules through which the objectives are to be achieved.
Every company formed in India and registered under the Companies Act, is required to have
AOA without which a company cannot be legally formed. The Articles of a company binds
the company with its members and also binds the members to each other as the Articles
constitute a contract between them and therefore a member may sue the company and vice-
versa to enforce and restrain breach of the Articles.
Section 6 of the Companies Act states that in case the Articles are inconsistent with the
Companies Act, the Act will over ride those Articles. Therefore, articles are subsidiary to the
MOA and has to be within the ambit of the Companies Act.

CONTENTS AND FORM OF ARTICLES

Depending upon the type and applicability of the company, a company may adopt regulations
contained in the Model Articles (Schedule 1 – Table f to j). The contents of Articles include
the following information:
a. Appointment, Remuneration, Powers and Proceedings of the Board of Directors and Key
Managerial Personnel.
b. Share Capital, Rights of Shareholders, transfer of shares (voluntary), Transmission of
Shares (out of Succession), Buy Back of Shares, Forfeiture of shares, etc.
c. Includes details about Call on Shares and lien of shares.
d. Provisions relating to Manner in which meetings have to be conducted, voting rights,
proxy, etc.
e. Provisions with respect to Dividends and Powers to borrow/Loan.
f. Manners in which Books of Account are to be kept.
g. Provisions relating to the winding up of the company.

ENTRENCHMENT

Entrenchment provision in the articles is to protect the interest of minority shareholders by

ensuring that amendments of such provisions in the AOA shall be possible after obtaining
approval of all the shareholders.
An entrenchment clause is one which makes certain amendments either impossible or
difficult. These provisions are more restrictive than those whose execution or alteration
cannot be complied only by passing a special resolution. The provision for such entrenchment
clause shall only be made:
A. By private company

During the formation of a company or by an amendment agreed by all members.

B. In a public company

Either during formation of a company or amending the articles by passing a special resolution.

Extra: Recently it is said that constructive notice has a concept of presumptive title. Due to
difficulty in acquiring knowledge regarding the title of the property, there are a lot of pending
trials in the Court. Nowadays we are moving forward to secure the buyer. NITI Aayog is
preparing a draft model of Land Title Act, 2019. According to this act, Title holders to be
eligible for compensation from government. All the documents will be available digitally.
The concept of conclusive notice will come into place.

Module – 8

DOCTRINE OF CONSTRUCTIVE NOTICE

Constructive means Presumption and Notice means to give information about something.
Whenever a company is registered, all the documents are uploaded and registered. It is a very
transparent thing as we can read all the MOAs and AOAs of various companies. These
documents are public documents.
Doctrine of Constructive Notice imposes a duty on the buyer. The buyer needs to do due
diligence before purchasing any shares or investing. The buyer needs to check the documents
and scrutinize them before registering. A check on the tile is required before one enters into a
contract or any sort of investment. It is also said that this doctrine is harsh because sometimes
we cannot find out whether the title was correct or not.
Section 399 of the Companies Act provides that MOA and AOA when registered with the
ROC becomes public documents. Any person who wishes to enter into a contract with the
company has the means of ascertaining the powers of the company and the extent of the
powers delegated to the Board of Directors. Every person dealing with the company is treated
to have actual or constructive knowledge of the contents of these documents. When a person
enters into a contract which is not permitted in the MOA and AOA, the contract is void and
the company will not be liable for the same.
 Kotlas Venkatswany vs. Ram Murthy and Ors.

In this case, the Articles required that all the documents should be signed by the MD, CS and
the Working Director on behalf of the company. A mortgage deed was executed in the favour
of the mortgagee that it was only signed by the CS and the Working Director. The Mortgagee
filed a case on the company for foreclosure of the property which was mortgaged against the
loan.
The Court held that no claim would stay under such contract because the mortgagee must
have examined the Articles before lending the money as every person dealing with the
company is presumed to have read and understood the MOA and AOA in their true
perspective. Therefore, applying the rule of constructive notice the company must be
protected against the outsider.

DOCTRINE OF INDOOR MANAGEMENT

This is an exception to the concept of Constructive Notice. The Rule of Constructive Notice
proved to be inconvenient for business transactions particularly where the Directors or other
officers of the company were empowered under the Article to exercise certain powers subject
to prior approval or sanctions of the shareholders. Whether these approvals had actually been
obtained could not be ascertained because the investors, creditors and other outsiders does not
form part of internal resolution. Therefore, Doctrine of Indoor Management protects outsiders
against the company. This is also known as the Turquand Rule.

 Royal British Bank vs. Turquand

The Rule of Indoor Management was first laid down in this case. The Directors of the
company were authorised by the Articles to borrow funds by issuing bonds and the amount of
money was to be decided in the General Meeting by a resolution. The Directors issued bonds
and borrowed funds from Royal British Bank without passing any resolution. In an action by
the Bank against the company on non-payment of the money, the company argued that there
has been no resolution passed authorising the Directors to borrow such amount of money and
therefore the company shall not be held liable for repayment of the amount. The Court held
that outsiders dealing with the company are required to read the Memorandum and Articles of
the company but they need not enquire into the regularities of internal proceedings. The Bank
had the right to infer that necessary resolutions must have been passed as it was part of
internal functioning of the company. Therefore, the company is not protected in such cases
and shall be held liable for repayment of the loan along with interest.

SUBSCRIBER TO MEMORANDUM AND ARTICLES

Rule 13 - Company’s Incorporation Rules.

Whoever has subscribed to the company when it was form are subscriber to memorandum
and articles. Whenever you form the company, the first shareholders have to sign the articles
and memorandum.

Module – 9

PROSPECTUS

According to Section 2(70) - Any document through which you raise funds, any notice,
circular, documents which is published and reach to the public at large + any kind of appeal
to the public to invest in their company. Any prospectus is an invitation to offer since your
bid can be denied. The allotment might happen or not.
Essentials:

 The document should invite the subscription to public share or debentures, or it should
invite deposits.

 Such an invitation should be made to the public.

 The invitation should be made by the company or on the behalf company.

 The invitation should relate to shares, debentures or such other instruments.

SECTION 23 – Methods of Fund Raising

In case you are a private or public unlisted company, you cannot issue a prospectus since
there is no public shareholding in the company. There can be no advertisement for investment
to the public. For raising funds,
1. Private Placement Offer but has a limited number of offering
2. Auctions in the company for bonus issue. The company can provide bonus shares.
3. Right Issue – Selling of shares at a discounted rate.

In case you are a public or listed company, you can issue a prospectus. You can have a huge
amount of authorised capital. For raising funds,
1. Through Public by issuing prospectus
2. Private Placement
3. Right Issue
4. Bonus Issue

SECTION 24 – Powers of SEBI

In case of a Public Company, SEBI has powers in a company -

a. Which is Listed
b. Which intends to be listed

SECTION 26 – Matters to be Stated in the Prospectus

According to this Section, the contents of prospectus must contain the following:

a. Name and Address of the Registered Office of the Company, Auditors, CS, CFO, Legal
Advisors, Bankers and Underwriters.
b. Dates of opening and closing of the issue of shares.
c. Declaration about issue of allotment letters and timelines for refund.
d. Statements by Directors about separate Bank account where the money received out of
the issue are to be transferred.
e. Details about underwriting of the issue and mentioning about Green Shoe Option.
f. Capital Structure of the Company
g. Main objectives of the company, Business Operation and its location along with schedule
of implementation of projects.
h. Details about Promoter’s contribution, Financial information of the company and other
reports with respect to financial information as received by SEBI in consultation with
MCA.
i. Any other material information as may be prescribed by the MCA time to time.
SECTION 32 – RED HERRING PROSPECTUS AND BOOK BUILDING PROCESS

As per this Section, a company proposing to make an offer of securities may issue a red
herring prospectus prior to the issue of a prospectus. It is basically a prospectus which is used
in the public issue to attract different investors. In simple terms a red herring prospectus
contains most of the information pertaining to the company’s operations and prospects, but
does not include key details of the issue such as its price and the number of shares offered. It
contains all other information except –
 Quantum of Securities
 Price of Securities

Why? Since the Price has not been discovered.

Red herring prospectus is issued during book building process. To understand book building
process we should first understand the journey of the company to reach this stage:

 When a company needs to start, they always stare small but it needs capital.
 Capital needs to grow, expand, diversity.
 So say initially friends and family members give you. Then you can have “Angel
Investors”. They are private individuals who invest in company’s who show a lot of
promise. There can be Private Equity investing.
 Finally, if you want to grow, you go for IPO i.e. listing our stock.
 The company offers to the Public – stock, equity and shares.

Red Herring Prospectus is a preliminary prospectus which does not contain complete
particulars of the price of securities. It is called red herring because the front page of the
prospectus displays bold red disclaimer stating that the information in the prospectus is not
complete and may be changed. A company making public issue of securities has to file a
draft red herring prospectus with SEBI through a SEBI registered merchant banker - Prior to
filing of the prospectus to ROC. SEBI reviews the draft document and may give observations
and modifications to the same. After incorporating the observations of SEBI by the company,
the document becomes red herring prospectus. The company shall file the red herring
prospectus with ROC atleast three days prior to the opening of subscription offer.
According to SEBI guidelines, Book Building is a process undertaken by the companies by
which demand for the securities proposed to be issued by a corporate body is discovered and
the price for such security is accessed for the determination of quantum of securities to be
issued by means of offer document or through the red herring prospectus. It is a method or a
way or marketing the shares or securities of a company where the quantum and price of
securities to be issued to the public during an initial public offering IPO is divided on the
basis of bids received from prospective shareholders by lead merchant bankers or investment
banker appointed by the company.

HOW DOES A COMPANY BECOME PUBLIC?

Step 1: Finding Investment Bank / Merchant Banker

They will Help the company to go public. For e.g. IDBI, SBI, ICICI

Step 2: Filing Registration Form to SEBI

The sole purpose of SEBI is to provide transparency and protect the investors.

Step 3: Red Herring Prospectus

Contains all the information a prospective investor must know. It is prepared by Investment
Bank or Merchant Bankers. A draft red herring prospectus has to be approved by SEBI.

Step 4: Advertising

 Newspaper
 TV
 Other Platforms

It helps to get good price when you list it to NSE or BSE. For e.g. Just Dial, Twitter,
Facebook, IRCTC – They had a huge advertisement. They all were oversubscribed.
Step 5: Price Bands

Price band is set up by Investment Bank. They look at the market reaction. Who all will bid?

 General Public
 Institutional Buyers
 Investors

 DLF vs. SEBI

DLF filed a draft Red Herring Prospectus with SEBI on January 2007 for raising 9187 crores
through IPO. DLF also filed the same with ROC and issued it to public on June 18,2007. The
prospectus was approved by SEBI and ROC. But there were certain transactions done by
DLF in 2006 which were not written in the Red Herring Prospectus. Mr. Sinha filed
complaint with SEBI alleging fraudulent practices by DLF group and requesting to disallow
the listing of DLF after the IPO.

SEBI investigated on the following issues:

a. Non-disclosure of material information in relation to alleged subsidiaries by DLF in

the Red Herring Prospectus.
 SEBI found that the 3 wholly owned subsidiaries of DLF – DLF Estates Limited, DLF
Housing Developer Limited and DLF Retail Limited had equity shares in Sudipti Estate
Pvt Ltd., Shalika Estate Pvt Ltd. and Felicite Pvt Ltd.
 On 29th November 2006, the entire shareholding of Felicite Pvt Ltd. held by wholly
owned subsidiary of DLF was sold to the wives of Key Managerial Personnel of DLF.
 On 30th November 2006, the wholly owned subsidiary of DLF sold their entire
shareholding in Shalika Estate Pvt Ltd.to Felicite Pvt Ltd. and on the same day sold their
entire shareholding in Sudipti Estate Pvt Ltd. to Shalika Estate Pvt Ltd.
 The wives of Key Managerial Personnel (KMP) were shareholders of Felicite until their
husbands were the KMP of DLF and when they ceased to be the KMP, the shares were
transferred to the wives of the present KMP. Hence SEBI alleged that DLF never lost
control of Sudipti, Shalika and Felicite.

b. Non-disclosure of related party transaction by DLF in the Red Herring Prospectus

c. Non-disclosure of outstanding litigation relating to alleged subsidiary of DLF as it

adversely affects the financial position of DLF.
 SEBI restrained 5 directors and the CFO of DLF from assessing the Securities Market and
prohibited them from dealing in securities for a period of three years on the ground of
 active and deliberate suppression of material information to mislead and defraud the
investors in the security market violating SEBI Act, 1992, Accounting Standards – 23,
DIP Guidelines 2000, LODR and ICDR.

The matter went to SAT where the order of SEBI was reversed observing that Mr. Sinha was
not an investor and therefore he cannot be considered as an interested party. Later on the
Supreme Court upheld the decision of SEBI stating that any third party can bring complain if
it is a question of Public Interest. Relying on the principle of Golden Rule of Framing
Prospectus, the Court referred to the observation made by Justice Kindersley in the case of
New Canada Railway and held that when companies issue any document to raise capital and
investment from public at large, the disclosures must be true, honest and must not be
misleading, false or having any omission of material facts. Breach of such non-disclosures
and misrepresentations would attract civil and criminal penalties under the Companies Act
and SEBI Regulations. (Section 34, 35, 36 read with 447)

Types of Prospectus:

1. SECTION 33 – ABRIDGED PROSPECTUS

The abridged prospectus is a summary of a prospectus filed before the registrar. It contains
all the features of a prospectus. An abridged prospectus contains all the information of the
prospectus in brief so that it should be convenient and quick for an investor to know all the
useful information in short.

Section33(1) of the Companies Act, 2013 also states that when any form for the purchase of
securities of a company is issued, it must be accompanied by an abridged prospectus.

It contains all the useful and materialistic information so that the investor can take a rational
decision and it also reduces the cost of public issue of the capital as it is a short form of a
prospectus. It is not used in Book Building Process.

2. SECTION 31 – SHELF PROSPECTUS

Shelf prospectus can be defined as a prospectus that has been issued by any public financial
institution, company or bank for one or more issues of securities or class of securities as
mentioned in the prospectus. When a shelf prospectus is issued then the issuer does not need
to issue a separate prospectus for each offering he can offer or sell securities without issuing
any further prospectus.
The regulations are to be provided by the Securities and Exchange Board of India for any
class or classes of companies that may file a shelf prospectus at the stage of the first offer of
securities to the registrar.
 The prospectus shall prescribe the validity period of the prospectus and it should be not be
exceeding one year. This period commences from the opening date of the first offer of the
securities. For any second or further offer, no separate prospectus is required. While filing for
a shelf prospectus, a company is required to file an information memorandum along with it.

3. SECTION 25 – DEEMED PROSPECTUS

When any company to offer securities for sale to the public, allots or agrees to allot securities,
the document will be considered as a deemed prospectus through which the offer is made to
the public for sale. The document is deemed to be a prospectus of a company for all purposes
and all the provision of content and liabilities of a prospectus will be applied upon it.
In the case of SEBI v. Kunnamkulam Paper Mills Ltd., it was held by the court that where
a rights issue is made to the existing members with a right to renounce in the favour of others,
it becomes a deemed prospectus if the number of such others exceeds fifty.

Module – 10

Initial Public Offering (IPO) – In-Depth Explanation

An Initial Public Offering (IPO) is the first sale of shares by a private company to the public.
Through an IPO, a company offers its equity shares to the general public for the first time,
typically to raise capital for expansion, debt reduction, or other business activities. Once the
IPO is completed, the company’s shares are listed on a stock exchange, and the company
becomes a public company subject to greater regulatory scrutiny, including financial
disclosure and governance standards.
An IPO is a major milestone in the life of a company, and it offers investors an opportunity to
buy shares in a company that was previously privately held. In exchange, the company gets the
necessary capital to fund its growth or to achieve other strategic objectives.

Reasons for an IPO

Companies pursue IPOs for various reasons, including:
1. Raising Capital:
o The primary reason for an IPO is to raise money. By issuing shares to the public,
a company can obtain capital to fund expansion, research and development,
acquisitions, reduce debt, or other strategic needs.
2. Improving Visibility:
o Listing on a public exchange raises the company’s visibility, brand recognition,
and credibility. This is especially valuable for attracting new customers, partners,
and top talent.
3. Liquidity for Existing Shareholders:
o IPOs provide liquidity to existing shareholders (including the company’s
 founders, early investors, and employees) by allowing them to sell their shares
on the public market.
4. Employee Stock Options:
o Going public can allow a company to offer stock options (stock option is a
contract that gives the owner the right to buy or sell a stock at a specific price) to
its employees as a form of compensation, which can help attract and retain
talent.
5. Exit Strategy for Founders and Investors:
o An IPO can be an exit strategy for private equity firms, venture capitalists, or
the company’s founders, who may want to liquidate part or all of their holdings.

IPO Process
The IPO process typically involves several phases and key steps, including preparation,
documentation, marketing, and pricing. Here’s an in-depth look at how an IPO works:

1. Decision to Go Public
The first step in the IPO process is for the company to decide to go public. This decision is
typically driven by the need to raise funds for growth or other corporate purposes. The decision
is made by the company’s board of directors and key stakeholders, including major investors.
Key Considerations for Going Public:
 Company’s Financial Position: A company needs to be financially stable and have a
track record of performance to attract investors.
 Market Conditions: Favourable market conditions, such as strong economic growth or
a bullish stock market, can make the timing of an IPO ideal.
 Valuation: The company’s ability to achieve an attractive valuation is critical in
determining the success of the IPO.

2. Appointing Advisors and Underwriters

Before moving forward with an IPO, the company hires various advisors, including merchant
bankers, legal advisors, auditors, and registrars, to help guide the IPO process.
 Merchant Bankers/Investment Banks: These professionals are responsible for
managing the IPO, including the underwriting process, due diligence, and pricing of
shares.
 Legal Advisors: The company needs legal counsel to ensure compliance with relevant
securities regulations and laws, including filing documents with the Securities and
Exchange Board of India (SEBI) or equivalent regulatory bodies in other countries.

3. Drafting the Prospectus (Offer Document)

One of the critical documents for the IPO process is the prospectus, which provides detailed
information about the company and its offering. It includes information on the company’s
financial health, management, business operations, risk factors, and the IPO details (e.g., size,
price band, and allocation).
 Red Herring Prospectus (RHP): In India, the company files a draft of Red Herring
Prospectus (RHP) with the SEBI, which is a preliminary version of the prospectus. The
SEBI reviews the document for accuracy, compliance with securities laws, and fairness
to investors.
o The RHP contains no price information or the number of shares offered. This
 will be determined later in the process.
 Prospectus: Once the final offer is ready, a prospectus is issued, which includes details
like the offer price, the number of shares, the rationale for the offering, and the
company’s financials.

4. SEBI Review and Approval

Once the Red Herring Prospectus (DRHP) is filed with SEBI, the regulator reviews it for
compliance with disclosure norms under the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2018. This review ensures that the information provided to
investors is clear, accurate, and in accordance with the law.
 If SEBI finds discrepancies or errors, it will ask the company to correct them before the
IPO can proceed.
 Once SEBI approves the RHP, the company can launch the public offer.

5. Marketing the IPO (Roadshow)

Before the IPO opens for subscription, the company (with the help of its underwriters) conducts
a roadshow. This is a series of presentations to potential institutional investors (mutual funds,
insurance companies, etc.) and retail investors.

6. Price Determination (Price Band or Book Building)

There are two primary methods for determining the price of the shares in an IPO: fixed price
and book building.
 Fixed Price: In a fixed-price IPO, the price of the shares is set in advance, and
investors know exactly how much they will pay per share at the time of applying.
 Book Building: In a book-built IPO, the price is determined based on the demand
generated by investor bids during the subscription period. The company offers a price
band (a range of prices), and investors bid within that range. The final price is decided
based on the highest price at which the entire issue can be sold.
o Price Discovery Process: Investors bid for shares within the price band. The
demand at different price levels helps the company and its underwriters
determine the final offer price.
o The process involves receiving bids from both qualified institutional buyers
(QIBs), non-institutional investors (NIIs), and retail investors (RIIs), with
each group allocated a portion of the shares.

7. IPO Subscription and Allotment

 Subscription Period: The company opens the IPO for subscription for a specified
period (usually 3-5 days).
 Allocation of Shares: After the subscription period closes, the company allocates shares
to investors based on demand and the basis of allotment.
o Oversubscription: In cases where the IPO is oversubscribed (demand exceeds
supply), shares are allocated pro-rata (in proportion to the number of shares
applied for).
o Allotment to Institutional Investors: QIBs qualified institutional buyers
generally get a larger portion of shares.
o Allotment to Retail Investors: A smaller portion (usually 35%) is allocated to
retail investors (individual investors applying for up to a specified amount).
8. Listing and Trading
Once the shares are allotted, the company’s shares are listed on the stock exchange (e.g., BSE,
NSE in India, or NYSE, NASDAQ in the U.S.), and the shares can be bought and sold by the
public.

IPO Risks and Considerations

While IPOs can be an exciting investment opportunity, they come with risks. Here are some key
considerations:
1. Market Volatility: Stock prices can fluctuate significantly after an IPO, influenced by
market conditions, investor sentiment, and the company’s performance.
2. Underpricing/Overpricing: Sometimes, IPOs are underpriced (set below the market
value to generate interest), leading to an initial surge in stock price, or they may be
overpriced, leading to a post-IPO decline in price.
3. Company Risks: The company may face challenges once it is publicly traded, including
managing investor expectations, reporting requirements, and market pressures.

Allotment Procedure of IPO

IPO Allotment Procedure – In-Depth Explanation

The allotment procedure of an Initial Public Offering (IPO) is the process by which the
company allocates shares to the investors who have applied for them. This is a crucial step in
the IPO process because it determines how the shares will be distributed among the various
categories of investors (like retail, qualified institutional buyers (QIBs), and non-institutional
investors (NIIs)).

In the case of an IPO, the number of shares applied for often exceeds the number of shares
available for allocation (i.e., oversubscription). In such cases, the company and its lead
managers (underwriters) need to determine how to allocate shares in a fair and equitable
manner. The most common methods for allotment in the case of oversubscription are pro-rata
allotment and, in some cases, lottery-based allotment.

Steps in the IPO Allotment Process

1. Application Submission: Investors apply for IPO shares either through the online
application process or through brokers. Applications are submitted during the
subscription period.
2. Subscription Period Ends: The subscription period typically lasts for 3-5 days, during
which investors can place their bids for shares in the IPO.
3. Finalization of the Basis of Allotment: After the subscription period closes, the
company and its registrar to the issue start the process of determining the final basis of
allotment. The final number of shares to be allotted to each category of investor
depends on the demand for shares and how much each investor has bid.
Key Terms in IPO Allotment

1. Oversubscription: This occurs when the demand for shares in the IPO exceeds the
number of shares being offered. For example, if a company offers 1,00,000 shares and
investors apply for 2,00,000 shares, the IPO is said to be 2x oversubscribed.
2. Under-subscription: This occurs when the number of shares applied for is less than or
equal to the number of shares available in the IPO.
3. Pro-Rata Allotment: When an IPO is oversubscribed, shares are usually allotted on a
pro-rata basis. This means that each investor is allotted a proportionate share of the
total available shares based on the number of shares they applied for compared to the
overall demand.
4. Full Allotment: If an investor’s application is fully subscribed (in cases of under-
subscription or low demand), they will be allotted the full number of shares they applied
for.

How the Allotment Procedure Works in Detail

1. Subscription Status

 Retail Investors: In most IPOs, a specific percentage (usually 35%) of the total shares
are reserved for retail individual investors. This group can apply for shares in amounts
up to a certain limit (e.g., ₹2 lakh in India).
 Qualified Institutional Buyers (QIBs): A larger portion of shares (typically 50%) is
usually allocated to institutional investors like mutual funds, insurance companies, and
foreign institutional investors.
 Non-Institutional Investors (NIIs): This group (which includes high-net-worth
individuals and corporate investors) is allocated the remaining portion of shares.

2. Oversubscription and Pro-Rata Allotment

When an IPO is oversubscribed, the company needs to decide how to allocate shares. Here’s
where pro-rata allotment comes into play.

 Pro-Rata Allotment: In this method, each investor is allotted a portion of the shares
they applied for, proportional to the demand in their category (retail, institutional, or
non-institutional).

Example:

 Suppose an IPO offers 100,000 shares, and the total demand is 200,000 shares (i.e., the
IPO is 2x oversubscribed).
 If you, as a retail investor, applied for 1,000 shares, and the total applications for retail
investors amount to 200,000 shares,
 So, your pro-rata allotment will be 500 shares (50% of your application).

In this case, you will receive only a fraction of the shares you applied for, as demand exceeded
the supply.
3. Allotment in Categories

 Qualified Institutional Buyers (QIBs): Allotment is usually based on the size of their
bids and their relationship with the company and underwriters. QIBs often receive a
substantial portion of the shares.
 Non-Institutional Investors (NIIs): Allotment is done on a pro-rata basis or lottery
system.
 Retail Investors (RIIs): Retail investors are generally allotted a fixed portion of the
shares. In the case of oversubscription, they typically receive shares on a pro-rata
basis. For example, if the retail portion is oversubscribed by 2x, each retail applicant
would receive 50% of the shares they applied for.

4. Types of IPO Allotment

There are different methods of allotting shares in an IPO:

 Pro-Rata Allotment: As explained, this is the most common method when the IPO is
oversubscribed. Shares are allocated based on the proportion of the total demand in each
category of investors.
 Lottery System: In cases of extremely high oversubscription (especially for retail
investors), a lottery-based system may be employed for allocating shares. Under this
system, the shares are randomly allocated to applicants (e.g., all applicants have an
equal chance of getting a share, regardless of the number of shares they applied for).

5. Allotment Confirmation

Once the basis of allotment is determined, investors receive confirmation regarding the status of
their application:

 Successful Allotment: Investors who have been allotted shares will receive allotment
letters (physical or electronic). Their demat accounts are credited with the shares
allocated to them.
 Refund: Investors who were not allotted shares (or were allotted fewer shares than they
applied for) will receive a refund for the unallotted amount.

6. Listing of Shares

After the IPO allotment is completed, the company’s shares are listed on the stock exchange.
The shares start trading publicly, and their market price is determined by demand and supply in
the market.
Book Building Process – Detailed Explanation

The Book Building Process is a mechanism used by companies to determine the price at which
their shares will be offered to the public during an Initial Public Offering (IPO). It is a
market-driven process that helps in price discovery, ensuring that the IPO price is set according
to investor demand.

The process involves setting a price band (a range of prices), and investors bid for shares
within this range. The final price of the shares is determined based on the demand at different
price levels. The Book Building process helps to establish the equilibrium price for the shares,
making the IPO more flexible and efficient.

Components of the Book Building Process

1. Price Band:
o The company, with the help of its lead managers or underwriters, sets a price
band for the IPO. The price band represents the minimum and maximum price
at which the shares will be offered.

2. Bidding within Price Band:

o Investors (including both retail investors and institutional investors) place bids
for shares within the price band.
o Investors can choose to bid for a specific number of shares at a specific price
(within the band), or they can choose to apply at any price within the band.

3. Price Discovery:
o The book-building process helps the company discover the market price for the
shares, which is based on the demand from investors during the bidding period.
o The final price will be determined by the highest price at which the company can
sell all the offered shares.

4. Allocation:
o After the subscription period ends, the company and its underwriters evaluate the
bids. Shares are then allocated to investors based on the demand and the price at
which they bid.
o The allocation can happen on a pro-rata basis or using a priority system (based
on investor categories).

5. Final Price Determination:

o The final offer price is determined after evaluating all the bids placed during the
subscription period. This price is set based on the demand for shares at different
levels of the price band.
Steps Involved in the Book Building Process
1. Appointment of Underwriters and Lead Managers

 Lead Managers (often investment banks or merchant bankers) are appointed by the
company to manage the IPO process, including the book-building process.
 Underwriters: These are financial institutions that help assess investor interest and
facilitate the issuance of shares. They might also agree to purchase any unsold shares (in
case of under-subscription).

2. Preparation of the Red Herring Prospectus (RHP)

 The company prepares the Red Herring Prospectus (RHP), which contains detailed
information about the business, financials, risk factors, and use of proceeds from the
IPO.
 The RHP is filed with the (SEBI) for regulatory review and approval.
 The RHP includes the price band (range) for the IPO, although the final price is not
disclosed in the RHP.

3. Setting the Price Band

 After SEBI’s approval, the company, with the help of the lead managers, sets the price
band within which investors can place their bids.
 Price Band: A minimum and maximum price are specified, for example, ₹100 to
₹120 per share.
 Investors can choose to place their bid at any price within the range ( ₹100 to ₹120).
However, they are not allowed to bid outside this range.

4. The Bidding Period

 The subscription period (or bidding period) for the IPO typically lasts 3 to 7 days.
 Investors who bid for shares are classified into three main categories:
o Retail Investors: Individual investors who apply for a small number of shares
(typically below ₹2 lakh).
o Qualified Institutional Buyers (QIBs): These include mutual funds, pension
funds, foreign institutional investors (FIIs), and banks.
o Non-Institutional Investors (NIIs): High-net-worth individuals (HNIs) and
corporate investors.

5. Determining the Price

 After the subscription period ends, the book is "closed," and the lead managers
determine the final issue price.
 The final price is the price at which the maximum number of shares can be sold, and it is
generally the highest price at which the total demand can be met.
 The final price is publicly announced after the subscription period ends. For example, if
the price band is ₹100-₹120, and demand is strong at ₹120, then ₹120 will be chosen
as the final issue price.
Advantages of the Book Building Process

1. Increased Transparency
2. Efficient Use of Capital
3. Flexibility in adjust the final price according to investor interest:
4. Broader Investor Participation process allows retail investors, institutional
investors, and high-net-worth individuals to participate:

Challenges and Considerations in Book Building

1. Oversubscription Risk High oversubscription can lead to lower allotment percentages

for investors.
2. Market Sentiment volatile market could affect investor demand and pricing.
3. Price Fluctuations Post-Listing there is always the risk that the share price may not
perform well once listed, leading to price

Role of Merchant Banker/Investment Bank

1. Role of a Merchant Banker in IPO:

In many jurisdictions (e.g., India), the term "Merchant Banker" is more commonly used to
describe firms or individuals that specialize in corporate finance, including IPOs, and are often
regulated by securities markets authorities (e.g., SEBI in India). Merchant bankers in IPOs
perform several key functions:

Key Functions:

 Due Diligence and Documentation: Merchant bankers are responsible for conducting
thorough due diligence to ensure that all the information provided to investors in the
IPO prospectus is accurate, complete, and complies with regulatory requirements. This
includes financial audits, legal verifications, and business assessments.
 Drafting and Filing of the Prospectus
 Pricing the IPO: assist in determining the IPO price.
 Marketing the IPO (Roadshow): They organize and manage roadshows, where the
company's management presents the investment opportunity to potential institutional
investors, analysts, and media. This helps generate interest and demand for the shares.
 Underwriting the IPO
 Regulatory Compliance: They ensure the IPO complies with all regulatory
requirements, including filing with securities regulators and managing the disclosure
obligations.
  Post-IPO Support: After the IPO, merchant bankers may continue to support the
company in areas like investor relations, secondary market support, and ensuring that
ongoing compliance with regulatory requirements is maintained.

2. Role of an Investment Bank in IPO:

In most international markets, Investment Banks are the primary institutions that help
companies raise capital through public offerings like IPOs. They provide a range of specialized
financial services, focusing heavily on the structuring, pricing, and selling of the offering.

Key Functions:

 Lead Underwriter and Syndication: Investment banks typically act as the lead
underwriters in an IPO, meaning they take on the primary responsibility for managing
the IPO process.
 Valuation and Pricing: analyse the company's financials, industry conditions, and
comparable market transactions to arrive at a fair price for the shares.
 Book-Building Process: Investment banks lead the book-building process, where they
collect bids from institutional investors to gauge demand for the shares at different price
levels. This allows them to set an offering price that reflects market conditions and
investor appetite.
 Market Making and Liquidity: Post-IPO, investment banks often provide market-
making services to help ensure liquidity for the newly issued shares. They may act as
intermediaries in the stock market, buying and selling shares to facilitate trading.
 Regulatory and Legal Guidance: Investment banks work closely with legal teams to
ensure compliance with securities laws and regulations. They help in filing the
necessary paperwork with the relevant regulatory bodies (e.g., the SEC in the U.S. or
SEBI in India).
 Selling the Shares: Investment banks use their network of institutional and retail clients
to sell the shares in the IPO. They often use various distribution channels to market the
IPO to potential investors, ensuring maximum reach and interest.
 Stabilization: After the IPO, the investment bank may engage in "price stabilization,"
where they step in to buy shares if the market price falls below the offering price, in an
effort to stabilize the stock and prevent excessive volatility.
 Post-IPO Analysis and Advisory: Investment banks continue to advise the company
on market trends, investor relations, and secondary offerings. They may also provide
support for future capital-raising initiatives.

Key Differences:

 Merchant Bankers tend to focus more on corporate finance advisory, regulatory

compliance, and due diligence aspects, with a strong local/regional focus.
 Investment Banks are typically more involved in the financial structuring, valuation,
and distribution of securities, and they tend to have a more global reach in terms of
client base and expertise.
 1. Green Shoe Option

Green Shoe Option:

The Green Shoe Option (also known as an Over-Allotment Option) is a mechanism used in
Initial Public Offerings (IPOs) that gives the underwriters (usually investment banks) the right
to buy and sell additional shares beyond the original number of shares issued in the IPO . This
option helps stabilize the stock price after the IPO.

In simple terms, it allows the underwriters to "buy more shares" if the demand for the stock is
high, and sell those shares in the market to prevent excessive volatility in the stock's price
post-IPO.

How Does It Work?

1. Initial Offering:
o Let’s say a company is issuing 10 million shares in its IPO at a price of ₹100
per share.
o The Green Shoe Option allows the underwriters to issue an additional 15% (or
1.5 million shares) if they need to stabilize the price.
o The underwriters don’t automatically sell these additional shares, but they have
the option to do so if the stock price moves beyond a certain point after the IPO.

2. Exercise of the Option:

o If the demand for the stock is high and the price rises above the offering price
(₹100), underwriters can exercise the Green Shoe Option and purchase these
extra shares at the IPO price (₹100).
o They can then sell these shares at the higher market price to meet the additional
demand and maintain price stability.

3. Price Stabilization:
o If the stock price falls below the offering price ( ₹100) after the IPO,
underwriters can buy back shares from the market to prevent the price from
falling too much.
o In either case, the Green Shoe Option gives the underwriters flexibility to
manage the price and ensure liquidity for the stock in the first few days or
weeks after the IPO.

Example of Green Shoe Option:

Let’s go through a real-world example to make it clearer.

Company ABC is going public and is offering 10 million shares at ₹100 each. The
underwriters (let’s say Bank XYZ) are granted a Green Shoe Option to purchase 1.5 million
additional shares (15% of 10 million).
Scenario 1: Stock Price Goes Up

 The IPO price is ₹100, but after the IPO, the stock starts trading at ₹120 due to high
demand.
 The underwriters decide to exercise the Green Shoe Option and buy 1.5 million shares
at ₹100 (the original IPO price).
 The underwriters then sell these 1.5 million shares at ₹120 in the market, making a
profit of ₹20 per share.
 This also helps ensure that the price does not rise too quickly or spike too much, which
could lead to a market correction later.

Scenario 2: Stock Price Falls

 After the IPO, the stock starts trading below the offering price (e.g., at ₹90), which
might cause panic among investors.
 The underwriters, using their Green Shoe Option, step in to buy back shares from the
open market to stabilize the stock price.
 By purchasing shares at the lower price (₹90), they prevent the stock from falling
further and maintain investor confidence.

Key Benefits of the Green Shoe Option:

1. Stabilizes the Stock Price

2. Increases Investor Confidence
3. Helps Underwriters Manage Risk
4. Provides Additional Capital

Example of the Green Shoe Option in Practice:

A real-world example of the Green Shoe Option being used is Google’s IPO in 2004. Google
had a 15% Green Shoe Option, which allowed the underwriters to purchase additional shares
if needed. After the IPO, the stock price was initially volatile, but the Green Shoe Option helped
stabilize the price during the early days of trading.
Section 32, DIP Guidelines, and Regulation 45 of SEBI (ICDR)

Section 32 of the Companies Act, 2013: Red herring prospectus. —

(1) A company proposing to make an offer of securities may issue a red herring prospectus
prior to the issue of a prospectus.
(2) A company proposing to issue a red herring prospectus under sub-section (1) shall file it
with the Registrar at least three days prior to the opening of the subscription list and the offer.
(3) A red herring prospectus shall carry the same obligations as are applicable to a prospectus
and any variation between the red herring prospectus and a prospectus shall be highlighted as
variations in the prospectus.
(4) Upon the closing of the offer of securities under this section, the prospectus stating therein
the total capital raised, whether by way of debt or share capital, and the closing price of the
securities and any other details as are not included in the red herring prospectus shall be filed
with the Registrar and the Securities and Exchange Board.
Explanation. — For the purposes of this section, the expression "red herring prospectus"
means a prospectus which does not include complete particulars of the quantum or price of the
securities included therein.

DIP Guidelines (Disclosure and Investor Protection Guidelines): These guidelines, issued by
SEBI, outline the regulatory requirements for public offerings, including the minimum
disclosures that must be made in the offer document (like the prospectus), the process for
issuing securities, and the protections for investors. These guidelines ensure transparency,
 fairness, and protection of investor interests.

Regulation 45 of SEBI (ICDR) Regulations, 2009 (Issue of Capital and Disclosure

Requirements): This regulation deals with the procedure for the public issue of securities, the
disclosures to be made in the offer document, and other compliance requirements for issuers,
merchant bankers, and other participants in the process. It ensures that the IPO process is
conducted in a fair and transparent manner, with adequate disclosures made to investors to
help them make informed decisions.

Eg; In 2012, market analysts indicated that Facebook (Green Shoe option) is finally issuing its
long awaited IPO. The company was looking to raise around ﹩10.6 billion via 337 million
shares. Prices of stocks were in the range of ﹩28 to ﹩35. Once this news broke, it created an
enormous buzz in the market and resulted in an oversubscribed IPO. As a result, the company
took advantage of this situation. It increases the number of shares from 337 million to 421
million. Additionally, it increases the share price to ﹩34 to ﹩38 per share. Thus, Facebook and
its underwriters made the most of this situation and generated more capital and increased its
market valuation

Module – 11

Section 23 Companies act

23. Public offer and private placement. —
(1) A public company may issue securities—
(a) to public through prospectus (herein referred to as "public offer") by complying with the
provisions of this Part; or
(b) through private placement by complying with the provisions of Part II of this Chapter; or
(c) through a rights issue or a bonus issue in accordance with the provisions of this Act and in
case of a listed company or a company which intends to get its securities listed also with the
provisions of the Securities and Exchange Board of India Act, 1992 (15 of 1992) and the rules
and regulations made thereunder.
(2) A private company may issue securities—
(a) by way of rights issue or bonus issue in accordance with the provisions of this Act; or
(b) through private placement by complying with the provisions of Part II of this Chapter.
Explanation. —For the purposes of this Chapter, "public offer" includes initial public offer or
further public offer of securities to the public by a company, or an offer for sale of securities to
the public by an existing shareholder, through issue of a prospectus.
Section 42 - Offer or invitation for subscription of securities on private placement. —

(1) Without prejudice to the provisions of section 26, a company may, subject to the provisions
of this section, make private placement through issue of a private placement offer letter.

Explanation II.—For the purposes of this section, the expression— (i) "qualified institutional
buyer‘‘ means the qualified institutional buyer as defined in the Securities and Exchange Board
of India (Issue of Capital and Disclosure Requirments) Regulations, 2009 as amended from
time to time. (ii) "private placement" means any offer of securities or invitation to subscribe
securities to a select group of persons by a company (other than by way of public offer) through
issue of a private placement offer letter and which satisfies the conditions specified in this
section.

Rule 14 of the Prospectus and Allotment Rules, 2014. –

Private Placement. —

(1) For the purposes of sub-section (2) and sub-section (3) of section 42, a company shall not
make an offer or invitation to subscribe to securities through private placement unless the
proposal has been previously approved by the shareholders of the company, by a special
resolution for each of the offers or invitations:

Private Placement: Method of Fundraising, especially by Unlisted and Private Companies

Private Placement: Method of Fundraising, Especially by Unlisted and Private Companies

Private placement is a method by which companies raise capital by issuing securities (equity
shares, debentures, etc.) to a select group of investors, rather than through a public offering.
This is often an attractive option for unlisted and private companies seeking to raise funds
without the complexity, cost, and regulatory requirements associated with a public offering
(such as an IPO). Private placements offer flexibility, control, and speed, making them a
preferred choice for many small and mid-sized enterprises (SMEs) or startups.

1. Definition of Private Placement

In the context of Indian corporate law, private placement is defined under Section 42 of the
Companies Act, 2013. It involves offering or inviting subscriptions for securities (shares,
debentures, etc.) to a select group of persons, rather than to the general public. A company can
raise funds through private placement by offering securities to:

 A maximum of 200 persons in a financial year, excluding qualified institutional buyers

(QIBs) and employees under employee stock options (ESOPs).
 The company must ensure that no invitation is made to the general public.
This method is governed by a strict regulatory framework that ensures transparency,
accountability, and compliance with the law.

2. Key Features of Private Placement

2.1 Selectivity in Offering Unlike a public offering, which is open to all investors, private
placement is targeted. A company can approach specific investors such as:

 High-net-worth individuals (HNIs)

 Institutional investors
 Venture capitalists
 Private equity funds
 Family offices
 Qualified institutional buyers (QIBs)

These investors are typically sophisticated and can understand the risks associated with the
investment, making them better suited for private placements.

2.2 No Public Advertisement Since private placements are made to a select group of investors,
no public advertisement is made regarding the securities. This contrasts with a public offering,
where the company issues a prospectus and may engage in mass marketing.

2.3 Regulatory Compliance Private placements in India are governed by several laws,
including:

 The Companies Act, 2013: Section 42 outlines the procedures for private placements.
 Securities and Exchange Board of India (SEBI): For listed companies or entities that
want to issue securities to the public.
 Reserve Bank of India (RBI): In case the company is a Non-Banking Financial
Company (NBFC) or in other regulated sectors.

The company must adhere to the guidelines on disclosure, approvals, and filing requirements.

3. Process of Private Placement

The process for private placement involves several key steps that ensure compliance and
transparency:

Step 1: Board and Shareholder Approval

 The company must first obtain Board approval for the offer. This resolution should
specify the types of securities, the price at which they will be issued, and the total
amount to be raised.
 Following the Board approval, a special resolution must be passed by the shareholders
of the company. The special resolution gives authority to the company to issue securities
through private placement. The explanatory statement for the resolution must disclose
details like:
 o Types of securities being offered.
o The price of securities (including any premium).
o Basis for pricing.
o The amount to be raised and the purpose of the issue.
o Names of the investors to whom securities will be offered.

Step 2: Identifying the Investors

 Once shareholder approval is obtained, the company approaches a select group of

investors (e.g., institutional investors, high-net-worth individuals, etc.) who are willing
to invest in the company’s securities.

Step 3: Private Placement Offer Cum Application Letter

 The company issues a Private Placement Offer cum Application Letter (Form PAS-4) to
each identified investor. The letter must be personalized and sent within 30 days from
the date of recording the investor's name.

The application letter must also comply with any statutory disclosure requirements, such as
ensuring that the offer is not made to more than 200 persons in a year (excluding QIBs and
ESOPs).

Step 4: Subscription and Payment

 Investors interested in subscribing to the offered securities need to make payments as

per the terms mentioned in the private placement offer letter. Payments must come from
the investor’s bank account, ensuring that the funds are traceable and legitimate.

Step 5: Allotment of Securities

 Upon successful subscription, the company must allot the securities to the investors.
 The company needs to file a Return of Allotment (Form PAS-3) with the Registrar of
Companies (RoC) within 15 days of allotment, detailing the names, addresses, and other
particulars of the allottees.

4. Regulatory and Legal Framework

4.2 Financial Regulations and SEBI Guidelines

 If the company is publicly listed, private placement offers are also subject to the
guidelines issued by the Securities and Exchange Board of India (SEBI). For
example, SEBI regulates the issuance of securities through private placement for listed
companies under the SEBI (Issue of Capital and Disclosure Requirements) Regulations
ICDR, 2009.

4.3 Reserve Bank of India (RBI) and Sector-Specific Regulations

  If the company is in a regulated sector (e.g., banking, non-banking finance, housing
finance), it must comply with regulations set by the RBI or National Housing Bank
(NHB) for private placements.

5. Advantages of Private Placement for Unlisted and Private Companies

5.1 Faster Fundraising Process Private placements can be completed more quickly compared
to public offerings, as there are fewer regulatory hurdles and disclosures required. The company
can raise funds in a matter of weeks, making it a faster alternative to traditional fundraising
methods.

5.2 Lower Costs Private placements are typically less costly than public offerings. There are no
costs for underwriting, advertising, or listing fees. The cost of compliance is also lower, as the
regulatory requirements for private placement are simpler than those for a public offering.

5.3 Flexibility in Terms Private placements allow companies to tailor the terms of the offering
to suit the needs of both the issuer and the investors. This includes pricing, the number of
securities issued, and the rights attached to the securities.

5.4 Retaining Control Private placements allow companies to raise capital without diluting
control or ownership. Unlike public offerings, where a large number of shares are sold to the
public, private placements often involve offering shares to a small group of investors, helping
the founders and existing shareholders retain control over the company.

6. Challenges and Considerations

6.1 Limited Market Private placements are typically offered to a select group of investors,
limiting the pool of potential subscribers. This can sometimes result in difficulty in raising the
desired capital if suitable investors are not available.

6.3 Restrictions on Resale Securities issued through private placement are often subject to
restrictions on resale. Investors may face limitations on selling these securities, especially if the
company is not publicly listed. This can affect the liquidity of the securities.

SEBI vs. SAHARA {VERY IMP CASE}

Facts:

1. Sahara Ltd. is an unlisted company engaged in real estate business which raised money
from 2 lakh investors in form of Optionally Fully Convertible Debentures in the year
2016 which went on till 2017.
2. SEBI claimed that in the form of Optionally Fully Convertible Debentures, Sahara India
Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corporation
 Limited claim to have collected deposits from general public including cobblers,
labourers, artisans and peasants.
3. Around 23 million people, mostly from villages and small towns subscribed to this
scheme and invested about 24000 crores rupees. The Company targeted people from non-
financial background.
4. The matter came into light when a complaint was filed against the Company with SEBI
for violation of Section 42 of the Companies Act.

Issues and Judgement:

1. Whether SEBI has the power to investigate and adjudicate in this matter as per
Section 11 of the SEBI Act and Section 55 of 1956 Act.
Supreme Court held that SEBI does have the power to investigate and adjudicate in the matter
as SEBI Act 1992 is a special legislation bestowing SEBI with special powers to protect the
interest of the investors (Section 11) The Court laid emphasis on the legislative intent, the
statement of objective for the enactment of SEBI Act and incorporating sections under
Companies Act to delegate the special Powers to SEBI in the matter of issuance, allotment and
transfer of securities. SEBI has the power to administer public listed company and those
public companies which intends to get their securities listed on a recognised stock
exchange.

2. Whether the hybrid OFCD (Optionally Fully Convertible Debentures) falls within
the definition of Securities under the Companies Act.
OFCDs are kind of debentures which can be fully converted into shares at an expiry of a
certain period at pre-determined price if the debenture holders opt for a share. Supreme Court
held that though OFCDs issued by two companies are in nature of hybrid instrument, it does
not cease to be a security. Though the definition of securities under Section 2(h) of SCRA
Act does not contain the term hybrid instrument but it is an inclusive definition and the
interpretation of other marketable securities will include hybrid OFCDs as they were offered
to millions of people and therefore there is no question about the marketability of the
instrument.

3. Whether the issuance of OFCD to millions of people to subscribe to the issue is a

private placement so as not to fall within the pursuit of SEBI Regulation.
Supreme Court held that although the intention of the company was to make the issue of
OFCDs look like a private placement, it ceases to be so when such securities are offered to
more than the prescribed number of persons under the Companies Act. Therefore, it is breach
of Section 42 and it will be deemed to be a public offer compelling the company to comply
with SEBI regulations.

4. Whether listing provisions under the Companies Act mandatorily applies to all
Public Companies or depends upon the Company’s intention to get listed.
Sahara argued that listing requirements under the Companies Act is not Mandatory and
applies to only those companies who intends to get listed. No company can be forced to list
itself on the Stock Exchange as it will lead to violation of corporate autonomy. The SC
rejecting this contention held that as long as the law is clear and unambiguous any issue of
securities to more than the prescribed limit shows the intention of the Company to get listed.
In addition, the Court observed that the maxim Acta Exterior Indicant Interoria Secreta
applies to Sahara in all forms. Therefore, the court ordered Sahara to refund 25000 crores
with 15% interest to the investors within 3 months.

Private Placements - Recent Amendments 2018 (Only for Reading Purpose)

Module – 12

Shares, Types of Shares, Allotment of Shares, Transferability of Shares (Companies Act,

Sections 44, 46, and 47)

1. Shares and Types of Shares

Shares and Types of Shares

A share is a unit of ownership in a company that represents a portion of its capital . When a
company raises funds from the public or other investors, it issues shares in exchange for capital.
The ownership of these shares provides the shareholder with certain rights and responsibilities
in relation to the company. Shares are primarily issued as a means of raising capital, and the
type of shares issued determines the rights and privileges attached to them.
Shares are crucial for both the company and its shareholders because they define the
relationship between the company and its investors. For the company, shares represent equity
(ownership interest) and, depending on the type of share, may also provide access to financing
options, voting rights, dividends, and participation in the company’s growth.

1. What Are Shares?

Shares represent ownership in a company and entitle the holder to specific rights, such as:
 Dividends (a sum of money paid regularly/annually by a company to its shareholder out
of its profits): A share gives the holder the right to receive a portion of the company’s
profits, typically in the form of a dividend, depending on the type of shares held.
 Voting Rights: Shareholders may have the right to vote on important matters, such as
the election of directors, changes in the company’s articles of association, mergers, or
the approval of financial statements.
 Capital Appreciation: Shareholders benefit from the increase in the company’s share
price as the business grows and performs well.

Shares are generally classified into two broad categories:

1. Equity Shares (Common Shares)
2. Preference Shares

2. Types of Shares
Shares can be categorized based on their characteristics and the rights they offer. The major
types of shares include:
2.1. Equity Shares (Common Shares)
 Definition: These are the most common type of shares issued by a company. Equity
shares represent the ownership of the company and are typically issued to raise capital.
They entitle the shareholder to vote in company meetings and participate in the
company's profits through dividends and capital appreciation.
 Characteristics:
o Voting Rights: Equity shareholders have voting rights in annual general
meetings (AGMs) and other corporate decisions, such as mergers, acquisitions,
and changes in the articles of association.
o Dividend: Equity shareholders receive dividends, but only after preference
 shareholders have received their dues. The dividend is paid out of the company’s
profits and is not guaranteed, so it fluctuates depending on the company's
profitability.
o Capital Appreciation: Equity shareholders benefit from capital gains when the
share price increases due to the company’s growth and performance.
o Risk: Equity shareholders bear the highest risk because, in the event of
liquidation, they are the last to be paid after creditors and preference
shareholders.
 Example: If a company earns profits, equity shareholders are entitled to a share of those
profits. If the company is liquidated, equity shareholders are entitled to residual assets
after all debts and preferential claims are settled.

2.2. Preference Shares

 Definition: Preference shares are a class of shares that provide the holder with priority
over equity shareholders in terms of dividend payments and, in some cases, in the event
of liquidation. However, preference shareholders typically do not have voting rights.
 Characteristics:
o Preference in Dividend: Preference shareholders are paid a fixed dividend
before any dividends are paid to equity shareholders. The dividend is usually a
fixed percentage of the nominal value of the shares.
o Priority in Liquidation: In the event of liquidation, preference shareholders
have priority over equity shareholders in receiving their invested capital after the
creditors have been paid.
o Non-Voting: Preference shareholders generally do not have voting rights, except
in certain specific situations (e.g., when dividends are in arrears for a specific
period).

 Types of Preference Shares:

o Cumulative Preference Shares: must be paid in the future if not paid in the
current year.
o Non-Cumulative Preference Shares: shareholder does not have the right to
claim the missed dividend in the future.
o Convertible Preference Shares: shares can be converted into equity shares
o Non-Convertible Preference Shares: shares cannot be converted into equity
shares.

2.3. Redeemable and Irredeemable Shares

 Redeemable Shares: These shares can be repurchased by the company after a certain
period, which is specified at the time of issuance. allowing companies to buy back the
shares from shareholders after a fixed term.
 Irredeemable Shares: These shares cannot be repurchased by the company, and
shareholders are expected to hold them indefinitely, unless the company agrees to
repurchase them under certain conditions.
2.4. Bonus Shares
 Definition: Bonus shares are additional shares given to existing shareholders without
any additional cost, based on the number of shares already owned.

2.5. Rights Shares

 Definition: Rights shares are offered to existing shareholders in proportion to their
existing holdings, giving them the "right" to purchase additional shares at a discounted
price, often during a company’s capital-raising phase.
o Pre-Emptive Rights: Rights shares give existing shareholders the first
opportunity to purchase new shares, protecting their proportionate ownership.
o Discounted Price: Typically, rights shares are offered at a price lower than the
current market value of the shares to encourage participation.
o
2.6. Sweat Equity Shares - Sweat equity shares are a type of equity share that a company
issues to its employees or directors at a discount or in exchange for something other than
cash. The term "sweat equity" refers to the idea that the employee's or director's labor adds
value to the company, similar to a monetary investment.
 Characteristics:
o Non-Cash Payment: Sweat equity shares are issued as a reward for non-cash
contributions.
o Rights and Benefits: These shares carry the same rights as equity shares,
including the right to vote and receive dividends.

3. Allotment of Shares

Allotment of Shares

The allotment of shares is a crucial process for any company raising capital. When company
issues shares, it is offering ownership stakes in the business to its investors. This process
includes determining who gets the shares, how many they will receive, and at what price. The
allotment process ensures that shareholders are properly recorded in the company’s records, and
it complies with all regulatory requirements.
In India, the process of allotment is governed by the Companies Act, 2013, along with other
regulatory rules such as the Companies (Prospectus and Allotment of Securities) Rules,
2014.

1. Initiation of Share Allotment

The allotment process begins when the company decides to issue shares, either through a
public offer, private placement, or rights issue.
Types of Share Allotment:
1. Public Issue: Shares offered to the public through an IPO or FPO (Follow-On Public
Offer).
2. Private Placement: Shares offered to a select group of investors (not exceeding 200).
3. Rights Issue: Shares offered to existing shareholders in proportion to their current
holdings.
2. Approval by the Board of Directors
Before shares can be allotted, the board of directors must approve the issue of shares. This
can happen through:
 Board Resolution: A resolution is passed by the board of directors to approve the
issuance of shares, the pricing, the number of shares to be issued, and the allotment
terms.

3. Subscription for Shares

The subscription process varies depending on the type of share issuance:
 Public Offer (IPO/FPO): Investors apply for shares by submitting their applications.
This can be done through a banking channel or an online trading platform.
 Private Placement: A specific group of investors is approached, and they subscribe to
shares by signing a private placement offer cum application letter (Form PAS-4).
 Rights Issue: Existing shareholders are given the opportunity to subscribe to the shares.
They can apply to buy additional shares in proportion to their current holdings, and the
process is done through application forms sent to shareholders.

4. Collection of Application Money

Once investors have subscribed to the shares, they are required to pay the application
money, which is the price per share multiplied by the number of shares applied for.

5. Allotment of Shares
After collecting the application money and verifying the applications, the company
proceeds with the allotment of shares. This step involves several activities:
5.1. Determining the Allotment
The company needs to decide how many shares to allot to each applicant based on the
number of shares they have applied for and the number of shares available for allotment.
5.2. Issuing Share Certificates
Once the shares are allotted, the company must prepare and issue share certificates to the
shareholders.
In modern times, dematerialized shares (held in electronic form) are more common, and a
company might not issue physical share certificates. Instead, shares are held electronically
in a demat account.
5.3. Filing with the Registrar of Companies (RoC)
The company must file a Return of Allotment (Form PAS-3) with the Registrar of
Companies (RoC) within 30 days from the date of allotment. The return must include:
 Details of the allotment (e.g., the number of shares, the name of the allottees, and the
share capital of the company).
 The amount paid up on the shares.
 The Board Resolution or special resolution approving the allotment.
This filing is essential for maintaining the company’s legal records and ensuring
transparency.
5.4. Updating Shareholder Register
The company is required to update its Register of Members with the details of the new
shareholders.
5.5. Reporting to SEBI (for Listed Companies)
For listed companies, the allotment process also involves compliance with Securities and
Exchange Board of India (SEBI) regulations.
 6. Issuing Share Certificates (Physical or Demat)
7. Issuance of Allotment Letters
The company may also issue Allotment Letters to the shareholders confirming that the
shares have been allotted. The allotment letter typically includes:
 The number of shares allotted.
 The date of allotment.
 The amount paid on the shares.

8. Post-Allotment Requirements
After the allotment is completed, the company needs to undertake the following:
 Maintain records of shareholders: The company must ensure that the Register of
Members is regularly updated and accurate.
 Dividend Declaration: Shareholders become eligible for dividends (if declared) based
on the number of shares they hold.
 Annual Reports: The company will include the updated list of shareholders and
shareholding patterns in its annual report and financial statements.

3. Transferability of Shares

Transferability of Shares:

The transferability of shares refers to the right of a shareholder to transfer their ownership
interest in a company to another person. The process and restrictions surrounding share
transfers vary significantly depending on whether the company is public or private and the
type of shares being transferred.

1. General Principle of Transferability of Shares

The general principle underlying the transfer of shares is that equity shares in a public
company are freely transferable. This means that shareholders of a public company can sell or
transfer their shares to anyone else without much restriction. In contrast, shares in a private
company are subject to certain restrictions that limit the transferability. The rules governing
the transferability of shares in India are primarily found in the Companies Act, 2013, along
with the Articles of Association (AoA) of the company.

In a private company, the restrictions are often more stringent, and the transferability of shares
is typically governed by the company’s Articles of Association and not by any public trading
mechanism. The goal is to retain control over who becomes a shareholder in the company.

2. Transferability of Shares in Public Companies

In India, the transferability of shares in public companies is governed by Section 56 of the

Companies Act, 2013, and the provisions of the Securities Contracts (Regulation) Act, 1956.
Public companies are required to follow a standardized process for share transfers, which
allows for a high degree of transparency and fairness.
  Shares Freely Transferable: The key principle in public companies is that equity
shares are freely transferable. This means that a shareholder can sell or transfer their
shares to any third party, provided the transfer complies with the company’s Articles of
Association and relevant regulations.
 Transfer Procedure: The process for transferring shares typically involves:
1. Execution of a Share Transfer Deed: A shareholder (transferor) must execute a
share transfer deed, which is signed by both the transferor and the transferee
(the person receiving the shares).
2. Stamp Duty: The share transfer deed must be affixed with the appropriate
stamp duty, as per the provisions of the Stamp Act.
3. Submission of Transfer Documents: The executed transfer deed must be
submitted to the company along with the share certificates representing the
shares being transferred.
4. Approval by the Board of Directors: In a public company, the board of
directors must approve the share transfer. Although public company shares are
typically transferable, the board may refuse to register the transfer if it violates
the company’s Articles of Association, or if the transferee is deemed undesirable
(for example, if the buyer is involved in unethical business practices).
5. Registration in the Register of Members: Once the transfer is approved by the
board, the company will update its register of members and issue a new share
certificate to the transferee.

 Completion Timeline: The company is obligated to complete the process of share

transfer within 30 days from the date of receipt of the transfer deed, provided the deed is
executed correctly and stamp duty is paid.
 Electronic Transfer of Shares: In the case of listed companies, where shares are traded
on stock exchanges, shares are often transferred electronically through the
Dematerialized (Demat) system. The shares are held in electronic form with a
Depository Participant (DP), and transactions are processed seamlessly through
electronic platforms.

Key Provisions Under Section 56 of the Companies Act, 2013:

Transfer and transmission of securities. —
(1) A company shall not register a transfer of securities of the company, or the
interest of a member in the company in the case of a company having no share
capital, other than the transfer between persons both of whose names are
entered as holders of beneficial interest in the records of a depository, unless a
proper instrument of transfer, in such form as may be prescribed, duly stamped,
dated and executed by or on behalf of the transferor and the transferee and
specifying the name, address and occupation, if any, of the transferee has been
delivered to the company by the transferor or the transferee within a period of
sixty days from the date of execution, along with the certificate relating to the
securities, or if no such certificate is in existence, along with the letter of
allotment of securities.

Explanation of section - A company can only register the transfer of securities if:

 Proper Transfer Form: The transfer must be done using a correct, stamped form signed by both the
seller and buyer, including the buyer's name, address, and occupation.
 Time Limit: The form must be submitted within 60 days from the date it’s signed.
 Documents: Along with the form, the securities certificate (or a letter of allotment if no certificate exists)
must also be provided.
3. Transferability of Shares in Private Companies

In private companies, the transfer of shares is more restricted compared to public companies.
Private companies are permitted to include provisions in their Articles of Association (AoA)
that govern the transferability of shares. These restrictions are often designed to maintain the
control of the business within a certain group of people and to prevent unwanted external
shareholders from gaining control.

Section 44 of the Companies Act, 2013 - Nature of shares or debentures. — The shares or
debentures or other interest of any member in a company shall be movable property transferable
in the manner provided by the articles of the company.

 Transferability Restrictions: Private companies may include restrictions on the

transfer of shares, provided these restrictions are stated in the company’s Articles of
Association. These restrictions typically involve the need for approval from the Board
of Directors or a specific majority of shareholders before shares can be transferred.
 Right of First Refusal (ROFR): One common provision in the Articles of private
companies is the Right of First Refusal (ROFR). Under this provision, if a shareholder
wishes to sell their shares, they must first offer the shares to existing shareholders. If the
existing shareholders do not wish to purchase the shares, only then can the shareholder
sell the shares to a third party.
 Approval of Board of Directors: In many private companies, the Articles of
Association may require that the Board of Directors approve any share transfer. The
board may exercise discretion in approving or rejecting a transfer, and such decisions
may be made based on the board's evaluation of the suitability of the proposed
transferee.

The Process for Transferring Shares in Private Companies:

The procedure for transferring shares in a private company generally follows these steps:

1. Offer Shares to Existing Shareholders: If the company’s Articles require, the

shareholder wishing to sell their shares must first offer them to existing shareholders.
The offer is usually made at market value or a price determined by the Articles of
Association.
2. Submit Share Transfer Deed: If the shares are accepted, the seller and buyer complete
a share transfer deed, which is signed by both parties.
3. Board Approval: After receiving the transfer deed, the company’s Board of Directors
must approve the transfer.
4. Payment of Stamp Duty: The stamp duty on the share transfer deed must be paid as per
the provisions of the Stamp Act.
5. Registration and Share Certificate: Once approved by the board, the transfer is
recorded in the register of members, and a new share certificate is issued to the
transferee.
  Transfer Restrictions in Articles of Association: The Articles of Association of a
private company may include specific provisions such as Pre-Emptive Rights, Board
Discretion, and Right of First Refusal (ROFR), which place certain limitations on the
transferability of shares.

Module – 13

Rights of Shareholders: Detailed Explanation

A shareholder is a person or entity that owns shares in a company. As the owner of these
shares, shareholders are granted certain rights, which are essential for protecting their interests
and ensuring they can participate in the governance and decision-making process of the
company. These rights vary depending on the type of shares held (e.g., equity shares,
preference shares) and the company’s Articles of Association.

Below is a detailed explanation of the key rights of shareholders:

1. Pre-emptive Right
Definition:

The pre-emptive right is the right of existing shareholders to purchase additional shares of the
company before they are offered to external investors. This right ensures that shareholders can
maintain their proportionate ownership in the company when new shares are issued, preventing
dilution of their holdings.

Key Features:

 Protection from Dilution: Shareholders have the first opportunity to buy new shares,
enabling them to retain their percentage of ownership even if new shares are issued.
 Exercise of the Right: The right to purchase new shares is generally offered on a pro-
rata basis, meaning that shareholders can buy shares in proportion to their existing
holdings.
 Application: The pre-emptive right is typically included in the Articles of Association
or may be granted under shareholder agreements.
 Exceptions: The pre-emptive right may not apply in cases of a rights issue or a bonus
issue where new shares are issued to existing shareholders at a ratio or for free. It may
also be waived in certain situations, such as when shares are issued to employees or
strategic investors.
2. Right to Vote
Definition:

The right to vote allows shareholders to participate in the decision-making process of the
company. Shareholders can cast their votes at general meetings (typically Annual General
Meetings (AGMs) or Extraordinary General Meetings (EGMs)) on important matters
affecting the company.

Key Features:

 Voting Rights: Generally, each shareholder has one vote per share held. However,
certain classes of shares, such as preference shares, may not carry voting rights unless
specific resolutions are proposed (e.g., matters affecting their rights).
 Types of Resolutions: Shareholders use their voting rights to vote on ordinary
resolutions (which require a simple majority) or special resolutions (which require a
special majority, usually two-thirds).
 Methods of Voting: Voting can take place in person, by proxy, or through electronic
voting (e-voting) for listed companies.
 Matters to Vote On: Important matters requiring shareholder approval include the
appointment of directors, approval of financial statements, amendments to the Articles
of Association, and major corporate transactions like mergers and acquisitions.

3. Bonus Issue
Definition:

A bonus issue (also called a scrip issue) is the issuance of additional shares to existing
shareholders without any cost. The company issues these bonus shares out of its accumulated
earnings or reserves as a way of distributing profits without paying cash dividends.

Key Features:

 No Cash Involved: Shareholders receive bonus shares in proportion to their existing

holdings (e.g., 1:1 means 1 new share for every 1 existing share).
 Impact on Share Price: While the total number of shares increases, the total value of
the shareholder's holding remains the same, although the share price may fall due to the
increased number of shares in circulation.
 Purpose: A bonus issue is typically done to reward existing shareholders, maintain a
certain market price per share, or use up accumulated reserves.
 Shareholder Consent: A bonus issue typically requires shareholder approval in the
AGM or by a special resolution.
4. Rights Issue
Definition:

A rights issue refers to an offer of additional shares made to existing shareholders in proportion
to their existing shareholding, at a discounted price or at market price. This is a method for
the company to raise capital from its current shareholders before offering it to new investors.

Key Features:

 Offer Price: The shares are offered at a discounted price to the current shareholders to
encourage participation in the issue.
 Pre-emptive Right: Existing shareholders are granted a pre-emptive right to purchase
the new shares, usually in proportion to their current holdings.
 Expiration Period: Shareholders are given a limited time frame to exercise their rights.
If shareholders choose not to participate, their rights can lapse, and the company can sell
the unpurchased shares to new investors.
 Purpose: A rights issue is typically used when a company needs to raise capital but
wants to maintain control within its existing shareholder base.

5. Buyback of Shares
Definition:

A buyback is when a company repurchases its own shares from the existing shareholders,
usually at a premium over the market price. It reduces the number of shares in circulation and is
a way for companies to return excess cash to shareholders.

Key Features:

 Reduction in Share Capital: Buybacks can reduce the number of outstanding shares,
increasing the earnings per share (EPS) and often boosting the share price.
 Method of Buyback: The company can buy back shares via the stock market or
through tender offers, where shareholders are invited to submit their shares at a
specified price.
 Legal Framework: Buybacks are regulated under Section 68 of the Companies Act,
2013 and must be done in compliance with the provisions regarding share capital,
solvency, and disclosure requirements.
 Impact: Companies use buybacks as a strategy to return surplus cash to shareholders,
increase control over ownership, or enhance shareholder value.

Section 68 of the Companies Act - Power of company to purchase its own securities.—
(1) Notwithstanding anything contained in this Act, but subject to the provisions of sub-
section (2), a company may purchase its own shares or other specified securities
(hereinafter referred to as buy-back) out of— (a) its free reserves; (b) the securities
premium account; or (c) the proceeds of the issue of any shares or other specified
securities: Provided that no buy-back of any kind of shares or other specified securities
shall be made out of the proceeds of an earlier issue of the same kind of shares or same
kind of other specified securities.
6. Sweat Equity Shares
Definition:

Sweat equity shares are shares issued by a company to its employees or directors as a reward
for their non-cash contributions, such as intellectual property, skills, or expertise, which
benefit the company. These shares are typically issued for no consideration.

Key Features:

 Non-Cash Compensation: Sweat equity is issued as compensation for services

rendered rather than cash. This can be particularly beneficial for start-ups or growing
companies with limited cash flow.
 Eligibility: The company can issue sweat equity shares to employees, directors, or
consultants who provide significant value in the form of their expertise or labor.
 Regulation: The issuance of sweat equity shares is governed by Section 54 of the
Companies Act, 2013, and the company must comply with the guidelines prescribed by
the Securities and Exchange Board of India (SEBI), particularly for listed companies.
 Vesting: In some cases, these shares may be subject to vesting periods, meaning the
recipient must stay with the company for a certain period before they fully own the
shares.

Section 54 of the Companies Act, 2013 - Issue of sweat equity shares.—(1) Notwithstanding
anything contained in section 53 company may issue sweat equity shares of a class of shares
already issued, if the following conditions are fulfilled, namely:— (a) the issue is authorised by
a special resolution passed by the company; (b) the resolution specifies the number of shares,
the current market price, consideration, if any, and the class or classes of directors or employees
to whom such equity shares are to be issued; (c) not less than one year has, at the date of such
issue, elapsed since the date on which the company had commenced business; and (d) where the
equity shares of the company are listed on a recognised stock exchange, the sweat equity shares
are issued in accordance with the regulations made by the Securities and Exchange Board in
this behalf and if they are not so listed, the sweat equity shares are issued in accordance with
such rules as may be prescribed

7. Share Certificate
Definition:

A share certificate is a physical or electronic document issued by the company to the

shareholder as evidence of their ownership in the company. The certificate specifies the number
and class of shares held by the shareholder.

Key Features:

 Proof of Ownership: The share certificate acts as a proof of ownership of the shares in
the company.
  Details Included: The certificate contains details such as the shareholder's name, the
number of shares, the class of shares (e.g., equity, preference), and the company’s name
and registration number.
 Dematerialization: In modern financial markets, share certificates are often replaced by
dematerialized (Demat) forms, which are more convenient and less prone to loss or
fraud.

8. Share Warrant
Definition:

A share warrant is a document that certifies the holder’s right to convert the warrant into
shares at a later date. It typically represents a bearer form of ownership, meaning that the
warrant holder is entitled to the shares, even if they have not been specifically registered in the
company’s books.

Key Features:

 Bearer Instrument: A share warrant is a bearer instrument, which means the holder
of the warrant is the owner of the shares.
 Transferability: Since share warrants are transferrable like currency, they can be
passed on from one person to another by simple delivery.
 Conversion: Shareholders can convert the share warrant into shares by submitting it to
the company for registration.

9. Dematerialization of Shares
Definition:

Dematerialization is the process of converting physical share certificates into electronic form.
This is done through the services of a Depository Participant (DP) and the shares are stored in
a Demat account.

Key Features:

 Paperless Trading: Dematerialization eliminates the need for physical share

certificates, reducing the risk of loss, theft, or fraud.
 Efficient Trading: Dematerialized shares can be easily traded, transferred, and settled
on electronic platforms, making transactions faster and more efficient.
 Depository System: The National Securities Depository Limited (NSDL) and the
Central Depository Services Limited (CDSL) are the two main depositories in India
that hold shares in electronic form.
 Benefits: Dematerialization simplifies record-keeping, reduces administrative costs, and
improves liquidity in the stock market.

Companies Act, Sections 2(88), 62, 63, 67, 68, and 70.
2. Relevant Sections under the Companies Act, 2013
Section 2(88) - sweat equity shares‖ means such equity shares as are issued by a company to its
directors or employees at a discount or for consideration, other than cash, for providing their
making available rights in the nature of intellectual property rights or value additions, by
whatever name called.

Section 62 - Rights Issue and Pre-emptive Rights

 Section 62(1)(a) deals with the rights issue, providing existing shareholders the pre-
emptive right to subscribe to any new shares issued by the company in proportion to
their existing shareholding. This section ensures that the proportionate ownership of
shareholders is maintained.
Section 63 - Bonus Issue
Issue of bonus shares. —
(1) A company may issue fully paid-up bonus shares to its members, in any manner whatsoever,
out of— (i) its free reserves; (ii) the securities premium account; or (iii) the capital redemption
reserve account:
(3) The bonus shares shall not be issued in lieu of dividend.

Section 67 - Restrictions on Buy-back of Shares

This section restricts companies from buying their own shares or providing financial
assistance for such purchases, with certain exceptions:
1. No Purchase of Own Shares: A company cannot buy its own shares unless share
capital is reduced as per law.
2. No Financial Assistance for Share Purchase: Public companies cannot give loans or
guarantees for share purchases.
3. Exceptions:
o Banks can lend in the usual course of business.
o Companies can fund employee share purchase schemes, subject to approval.
o Companies can offer small loans to employees (excluding directors) to buy
shares.
4. Redemption of Preference Shares: Unaffected by this section.
5. Penalties: Violations may result in fines (₹1-25 lakh) and imprisonment (up to 3 years)
for officers in default.

Section 68 - Buy-back of Shares

This section regulates a company’s buy-back of its own shares:
1. Funding: Buy-back can be funded from free reserves, securities premium, or proceeds
from new issues (not from prior issues of the same shares).
2. Conditions:
o Must be authorized by the company’s articles and a special resolution (or Board
resolution for ≤10% of capital).
o Buy-back cannot exceed 25% of paid-up capital and reserves.
o Debt-to-capital ratio after buy-back must not exceed 2:1.
3. Methods: Buy-back can be from shareholders, the open market, or employee stock
options.
4. Solvency Declaration: Directors must declare the company can meet its liabilities and
 avoid insolvency.
5. Completion: Must complete within a year, cancel shares within 7 days, and file a return
with the Registrar/SEBI within 30 days.
6. Post Buy-Back: No further issue of the same shares for 6 months, except in specific
cases (e.g., bonus issues).

Section 70 - Purchase of Own Shares

This section prohibits a company from buying back its own shares or securities in the following
situations:
1. Prohibited Methods:
o Through its subsidiaries or investment companies.
2. Prohibited if Defaults:
o If the company has defaulted on repaying deposits, interest, debentures,
preference shares, dividends, or term loans to financial institutions or banks, it
cannot buy back shares. However, if the default is cured and three years have
passed since the default was resolved, buy-back is allowed.
3. Non-Compliance:
o If the company has not complied with sections on annual return (92), dividend
distribution (123), payment of dividends (127), or financial statements (129), it
cannot buy back shares.
In short, buy-back is prohibited in cases of financial default or non-compliance with specific
legal requirements.
4o mini

Renunciation of Shares by Shareholders

 Company will give offer of Renunciation to existing shareholders in the Letter of Offer. If
shareholders want to renounce the shares offered to him then shareholder will give a letter
of renunciation in favour of other person to the Company.
 Company will receive the acceptance letter and share application money from the renounce.
 After closing of offer period company will hold a Board Meeting and allot shares to
renounce.

Module – 14

Equity Shares with Differential Rights and Superior Voting Rights

Equity shares with differential voting rights (DVRs) are a class of shares that give the holder
different voting rights or financial rights compared to the common equity shareholders.
These shares allow companies to issue equity capital while maintaining control over decision-
making with a select group of shareholders. In India, the issuance of such shares is governed by
specific regulatory provisions, and this framework is designed to ensure transparency, investor
protection, and fair governance.

Here’s an in-depth breakdown of the points to cover under the framework for the issuance of
equity shares with differential voting rights (DVRs), the SEBI guidelines, and related case
studies like Tata Group and Pantaloons Retail.

1. Equity Shares with Differential Rights

Differential Voting Rights (DVRs) are a type of share that gives certain shareholders more voting
power than others. In a company, shares usually carry one vote per share, but with DVRs, some shares
may have more votes (e.g., 10 votes per share), while others have fewer or no votes (e.g., 1 vote per
share).
Here's how DVRs work:
1. Higher Voting Rights for Certain Shares: Shares with DVRs give their holders more control
over company decisions, even if they own a smaller number of shares. For example, a
shareholder holding DVRs might control a larger proportion of the company’s votes compared
to ordinary shareholders.
2. Purpose: DVRs are typically issued to founders or promoters of a company to help them
maintain control over the business, even if they don’t own a majority of the capital. It allows
them to make key decisions without needing to own a large percentage of the shares.
3. Types of DVRs:
o Superior Voting Rights: These shares grant holders more than one vote per share.
These are generally issued to promoters or founders of a company to help them maintain
control over business decisions even after diluting ownership.
o Inferior Voting Rights: These shares grant holders fewer voting rights, typically in the
form of one vote for every 10 shares or no voting rights at all. These are typically issued
to raise capital while limiting the influence of external investors.

Example:
 If a founder holds 1,000 DVR shares with 10 votes each, they effectively have 10,000 votes,
while a regular shareholder with 1,000 normal shares would only have 1,000 votes.

Key Features:

 Voting Rights: The core difference is the number of votes attached to the shares, which
could either be superior or inferior compared to ordinary equity shares.
 Dividend Rights: Differential shares can also have varied dividend entitlements,
although in practice, the dividend rate is often the same for both equity shares and
DVRs.
 Transferability: As with regular equity shares, DVRs are transferable, but the number
of DVR shares may be subject to certain restrictions, as outlined in the company's
Articles of Association (AoA).

2. Section 47 Voting Rights – companies act

Voting rights. — (1) Subject to the provisions of section 43 and sub-section (2) of section 50,
— (a) every member of a company limited by shares and holding equity share capital therein,
shall have a right to vote on every resolution placed before the company; and (b) his voting
right on a poll shall be in proportion to his share in the paid-up equity share capital of the
company.
(2) Every member of a company limited by shares and holding any preference share capital
therein shall, in respect of such capital, have a right to vote only on resolutions placed before
the company which directly affect the rights attached to his preference shares and, any
resolution for the winding up of the company or for the repayment or reduction of its equity or
preference share capital and his voting right on a poll shall be in proportion to his share in the
paid-up preference share capital of the company:
Provided that the proportion of the voting rights of equity shareholders to the voting rights of
the preference shareholders shall be in the same proportion as the paid-up capital in respect of
the equity shares bears to the paid-up capital in respect of the preference shares:
Provided further that where the dividend in respect of a class of preference shares has not been
paid for a period of two years or more, such class of preference shareholders shall have a right
to vote on all the resolutions placed before the company.

Key Provisions of Section 47:

 Voting Rights: This section provides that every shareholder is entitled to one vote for
every share held, except for cases where differential voting rights are issued.

3. SEBI Guidelines for Issuance of DVRs

The Securities and Exchange Board of India (SEBI) has laid down detailed regulations to
ensure the transparent and responsible issuance of differential voting rights in listed
companies.

SEBI's Framework for Issuance of DVRs:

 Limit on Voting Rights: DVRs must have a minimum voting ratio of 2:1 and a
maximum of 10:1
 Total voting rights: The total voting rights of shareholders holding DVRs cannot
exceed 74%
 Transferability: DVRs cannot be transferred between promoters

4. Tata Group Case Study: DVRs Issuance

In 2007, Tata Motors, part of the Tata Group, issued Differential Voting Rights (DVRs) to
raise capital while maintaining control over its operations. This was a strategic move by the
Tata family, allowing them to retain voting power despite raising funds from the public. DVRs
are a class of shares that give the holder more or fewer voting rights than ordinary shares,
depending on the terms.
The Tata Group's primary reason for issuing DVRs was to preserve control while still
attracting external investors. By issuing DVRs, the Tata family could hold shares with 10 votes
per share, while regular shareholders received only 1 vote per share. This gave the Tata
family disproportionate control over key decisions like mergers and acquisitions, even if they
did not own the majority of the company’s equity.
The public offering of DVR shares was designed to fund Tata Motors' expansion, including the
acquisition of Jaguar Land Rover. The DVR shares were priced at a discount compared to
regular shares, making them attractive to investors looking for financial returns rather than
voting rights.
However, the move faced criticism regarding corporate governance, as it concentrated
decision-making power in the hands of a few. Regular investors in DVR shares had limited
influence over company decisions, which raised concerns about fairness and transparency.
Despite mixed reactions, the Tata Group successfully raised significant capital. This issuance
set a precedent for other companies considering DVRs but remained an exceptional case, as few
companies followed suit in the years that followed. The Tata Group's DVR issuance is seen as a
balance between capital raising and control retention, with long-term implications for
corporate governance in India.

5. Pantaloons Retail Case Study: DVRs for Capital Raising

Pantaloons Retail, a prominent Indian retail chain, utilized Differential Voting Rights (DVRs)
in 2010 to raise capital for its expansion and growth. DVRs are a mechanism in which certain
shares carry more voting rights than others, typically issued to raise funds without giving full
control to new investors. This strategy was employed by Pantaloons' parent company, Future
Group, when the retail giant sought funds for its ambitious expansion plans in the competitive
Indian retail market.
In 2010, Pantaloons Retail issued DVR shares through a public offering to attract capital from
institutional investors while maintaining control over the company. These DVRs offered lower
dividend payouts compared to regular shares but gave holders greater voting power. By doing
so, Future Group was able to ensure that existing shareholders (mainly the promoters) could
maintain control over corporate decisions, despite bringing in external investors.
The DVR structure allowed Pantaloons Retail to raise funds without diluting the decision-
making influence of the founding family, addressing concerns about losing control while still
tapping into capital markets. The capital raised was intended to support the company's
expansion strategy, including increasing its retail footprint and competing with other major
players in the market.
However, the use of DVRs also raised concerns about corporate governance and fairness, as
new investors would have less say in the company’s operations despite their financial
investment. Critics argued that this structure could lead to conflicts of interest, especially if the
interests of the promoters diverged from those of minority shareholders.

6. Regulatory Framework for Issuing DVRs

 Articles of Association: The company must have the provision for the issuance of
DVRs in its Articles of Association (AoA).
 Disclosure: Full disclosure regarding the voting rights and dividend structure of
DVRs must be made to shareholders.
 Shareholder Approval: Issuance of DVRs requires the approval of shareholders via a
special resolution. This ensures that the interests of all shareholders are considered
before making the issue.
Issue of Shares at Premium

The issue of shares at premium refers to the issue of shares at a price higher than the face
value of the share. In other words, the premium is the amount over and above the face value
of a share.
Usually, the companies that are financially strong, well- managed and have a good reputation
in the market issue their shares at a premium. For example, if a company issues a share of
nominal or face value of ₹10 at ₹11, it issues it at 10% premium.

A company may call the amount of premium from the applicants or shareholders at any stage,
i.e. at the time of application, allotment or calls. However, a company generally calls the
amount of Premium at the time of allotment.

Issue of Shares at Discount

The issue of shares at a discount means the issue of the shares at a price less than the face
value of the share. For example, if a company issues share of Rs.100 at Rs.90, then Rs.10 (i.e.
Rs 100—90) is the amount of discount.
The issue of Share at Discount is always below the Nominal Value (NV) of the shares. The
company debits it to a separate account called ‘Discount on Issue of Share’ Account.
Module – 15

Debentures:
A debenture is a type of debt instrument issued by a company to raise funds. Debentures are
essentially loans taken by companies from investors, and in return, the company promises to
pay interest over a fixed period. In addition to the principal amount, debentures often carry
specific terms and conditions, such as rights, redemption, and security.
Section 71, of the Companies act - Debentures. — (1) A company may issue debentures with
an option to convert such debentures into shares, either wholly or partly at the time of
redemption: Provided that the issue of debentures with an option to convert such debentures
into shares, wholly or partly, shall be approved by a special resolution passed at a general
meeting. (2) No company shall issue any debentures carrying any voting rights

Companies (Share Capital and Debentures) Rules, 2014.

Debentures, debenture stock, bonds, debenture trustees, and rights of debenture holders:

1. Debenture: Definition and Key Features

 Definition: A debenture is an instrument issued by a company acknowledging its debt
and providing a promise to repay the principal along with interest over a specific period.
Unlike equity shares, debentures do not give the holder voting rights or a share in the
company’s profits beyond the interest.
 Key Features of Debentures:
o Interest-bearing instrument: Debentures usually carry a fixed or floating
interest rate, which is payable periodically (e.g., annually, semi-annually).
o Secured or Unsecured: Debentures can be secured, where they are backed by
the company’s assets, or unsecured, where no specific asset backs the debt.
o Fixed Maturity: Debentures have a fixed maturity date for repayment of the
principal sum.
Convertible or Non-convertible: Some debentures can be converted into equity
shares at the option of the debenture holder (convertible debentures), while others
remain as debt (non-convertible debentures).

2. Debenture Stock
 Debenture Stock: The term debenture stock is used to refer to convertible or non-
convertible debentures that are grouped together and issued in a stock format rather
than individual debentures. It is a form of debt security that may represent a series of
debentures under one instrument, with the aggregate principal value.
o Debenture stockholders do not have specific certificates for individual
debentures, but they hold an entitlement to the principal and interest in relation
to the total stock issued.
o Transferability: Debenture stock can be transferred just like shares, providing
liquidity and ease of trading.
 Differences Between Debenture and Debenture Stock:
o Debentures: Generally issued as individual units (each with specific terms).
o Debenture Stock: Represents an aggregate value of debentures and is treated as
 a single instrument, allowing easier transfer and administration.

3. Bonds
 Bonds: Bonds are a type of debt security, essentially a loan made by an investor to a
corporation, government, or other organization. When you buy a bond, you're lending money to
the issuer in exchange for regular interest payments (called the coupon) and the return of the
principal amount (the face value) at the bond's maturity date.
 Bonds are typically issued with a fixed interest rate, although there are variations like
floating-rate bonds, where the coupon can change.
 A bond is similar to a debenture in that it is a debt instrument issued by a company, but
the term "bond" is often used in relation to larger issuances or government debt
instruments.
o They may be issued with a fixed interest rate, known as the coupon rate, which
is paid to the bondholder periodically until maturity.
 Key Differences Between Bonds and Debentures:
o Term Usage: "Bond" is more commonly used in international markets, while
"debenture" is used under Indian corporate law.
o Market: Bonds are often traded on secondary markets, and they tend to be
issued in larger denominations or by larger institutions.
o Security: Debentures may be secured or unsecured, while bonds are typically
associated with being secured by assets or a guarantee.

4. Debenture Trustee
 Role of Debenture Trustee: A debenture trustee is an independent party (usually a
bank or financial institution) who is appointed to protect the interests of the debenture
holders and ensure that the issuing company adheres to the terms and conditions of the
debenture issuance.
o Primary Duties:
 Ensuring that the company pays interest and redeems the debenture in
accordance with the terms.
 Monitoring compliance with the terms of the issue, such as covenants
related to the company’s financial health and business activities.
 Acting on behalf of the debenture holders in case of default, including
enforcing rights and taking legal action if required.
o Appointment: As per Section 71(5) of the Companies Act, a debenture trustee
must be appointed for any public offering of debentures or if the company’s
debentures are to be listed on a stock exchange.

5. Rights of Debenture Holders

Debenture holders have several rights related to the interest and principal repayment, but their
rights differ significantly from equity shareholders, particularly regarding voting rights and
company control.
Key Rights of Debenture Holders:
 Right to Interest: Debenture holders are entitled to receive interest on their investment
in the debentures, which is typically paid at a fixed rate (fixed interest) or in accordance
with a predetermined formula (floating rate).
 o Interest is paid as per the terms outlined at the time of the issue and is usually
paid annually, semi-annually, or as otherwise specified.
 Right to Repayment (Principal): Debenture holders are entitled to the repayment of
the principal amount at the end of the agreed term. For convertible debentures, this
could also include the option to convert the debenture into equity shares.
 Right to Redemption: Debentures are redeemable, which means that the issuing
company must repay the debenture holders at the maturity of the debenture. In the case
of callable debentures, the company can redeem the debentures before maturity under
specific terms.
 Priority in Payment: In case of liquidation or winding-up of the company, debenture
holders typically have a priority over equity shareholders in receiving the repayment
of principal and interest from the company’s assets.
 Right to Transfer: Debentures are generally transferable, and holders can sell their
debentures in the secondary market, unless the terms of issue restrict such

Limitations on Debenture Holders' Rights:

 No Voting Rights: Unlike equity shareholders, debenture holders do not have voting
rights in the company, except in certain circumstances (such as approval for the issuance
of new debentures).
 No Claim on Profits: Debenture holders do not share in the profits of the company
beyond the agreed interest rate, and they do not have any claim over dividends.

Companies (Share Capital and Debentures) Rules, 2014 (Rule 18):

 Rule 18 governs the issuance and regulation of debentures, including detailed
procedures regarding the issuance process, appointment of debenture trustees, and
redemption. Some key points include:
o Eligibility: Companies wishing to issue debentures must be compliant with
solvency norms, ensuring they have sufficient assets to meet debt obligations.
o Debenture Trust Deed: The issuance of debentures must be backed by a
debenture trust deed, outlining the terms and obligations of both the company
and the debenture holders.
o Minimum Subscription: There must be a minimum subscription requirement
for the debenture issue to be valid.
o Debenture Trustee’s Role: The rules specify the duties and obligations of the
debenture trustee, such as ensuring that the company complies with all
conditions of the debenture issue.

DEBENTURE

A debenture is an instrument of debt executed by the company acknowledging its obligation

to repay the sum at a specified rate and also carrying an interest. It is one of the methods of
raising the loan capital by the company. A debenture is thus like a certificate of loan or a loan
bond evidencing the fact that the company is liable to pay a specified amount with interest
and although the money raised by the debentures becomes a part of the company's capital
structure, it does not become share capital.
 In general debentures are classified into various types such as redeemable, irredeemable,
convertible, non-convertible, fully, partly, secured, unsecured, etc.
 The convertible debentures as the name suggests are those debentures which are
converted to equity shares of a company after a specified term. Such debenture earns
regular income in form of interest up to the period they are converted to equity shares of
the company.
 Non-convertible debentures ('NCDs') can be regarded as those debentures which are not
convertible to equity shares of the company after the expiry of a certain period. 
Secured debenture creates a charge on the assets of the company, thereby mortgaging the
assets of the company.
 Unsecured debenture does not carry any charge or security on the assets of the company.
 Redeemable debentures carry a specific date of redemption on the certificate. The
company is legally bound to repay the principal amount to the debenture holders on that
date.
 Irredeemable debentures, also known as perpetual debentures, do not carry any date of
redemption.

Provision under the Companies Act 2013 – Section 71 Debentures

(1) A company may issue debentures with an option to convert such debentures into shares,
either wholly or partly at the time of redemption: Provided that the issue of debentures with
an option to convert such debentures into shares, wholly or partly, shall be approved by a
special resolution passed at a general meeting.
(2) No company shall issue any debentures carrying any voting rights.

(3) Secured debentures may be issued by a company subject to such terms and conditions as
may be prescribed. (See rules)
(4) Where debentures are issued by a company under this section, the company shall create a
debenture redemption reserve account out of the profits of the company available for
payment of dividend and the amount credited to such account shall not be utilised by the
company except for the redemption of debentures.
(5) No company shall issue a prospectus or make an offer or invitation to the public or to its
members exceeding five hundred for the subscription of its debentures, unless the company
has, before such issue or offer, appointed one or more debenture trustees and the conditions
governing the appointment of such trustees shall be such as may be prescribed.

Module – 16

Convertible Securities: Convertible Shares and Debentures, SEBI Norms

Convertible Securities are financial instruments that combine characteristics of both debt and
equity. They allow the holder to convert the security into shares or equity of the issuing
company at a pre-determined price, typically after a certain period or under certain conditions.
The most common forms of convertible securities are convertible debentures and convertible
preference shares.
The Securities and Exchange Board of India (SEBI) has issued specific norms for the
issuance of convertible securities by public companies. These norms govern the process,
pricing, disclosure requirements, and regulatory compliance to ensure transparency and fairness
in the issuance of these securities.
Below, we will break down the key points to cover regarding Convertible Securities, including
Convertible Shares and Convertible Debentures, as well as the latest SEBI guidelines on the
issue of convertibles.

1. What are Convertible Securities?

Convertible Securities are instruments that give the holder the right (but not the obligation) to
convert them into equity shares of the issuer company at a later date. These instruments may be
in the form of Convertible Debentures (CDs) or Convertible Preference Shares (CPS).
Key Characteristics of Convertible Securities:
 Hybrid Nature: Convertible securities are a hybrid between debt and equity. Initially,
they function as debt instruments, and after conversion, they become equity instruments.
 Conversion Option: The holder has the option (but not the obligation) to convert the
debenture or preference share into equity at a pre-specified price, conversion ratio, and
time period.
 Conversion Price: This is the price at which the security can be converted into equity
shares. The conversion price is typically fixed at the time of issuance.
 Coupon Rate (in case of debentures): Convertible debentures usually have an interest
rate that is paid periodically, like regular debt instruments.
 Maturity (in case of debentures): Convertible securities, particularly debentures, may
have a maturity date. At maturity, they may either be converted into equity or redeemed
for cash.
2. Types of Convertible Securities
 Convertible Debentures (CDs):
o These are debt instruments that can be converted into equity shares at a later
date.
o Characteristics:
 Interest Payments: Convertible debentures may carry a fixed or floating
interest rate, typically paid annually or semi-annually.
 Conversion Option: Holders can convert debentures into equity at a
predetermined price after a specified period (e.g., 3-5 years).
 Hybrid Investment: Investors get fixed income (interest payments) in
the initial years but can also benefit from the potential appreciation of
equity shares once converted.
o Maturity: At the end of the tenure, the debenture either gets converted into
equity or is redeemed at face value.
 Convertible Preference Shares (CPS):
o These are shares issued by a company that can be converted into ordinary equity
shares at a later date.
 o Characteristics:
 Dividend Payments: CPS often provide a fixed dividend, similar to debt
payments.
 Conversion Rights: Investors have the option to convert CPS into equity
shares at a fixed price after a certain period.
 Priority in Liquidation: Preference shareholders have a priority claim
on the company’s assets (over common shareholders) in the event of
liquidation, but they do not typically have voting rights.
3. SEBI Norms on Issue of Convertible Securities
The Securities and Exchange Board of India (SEBI) regulates the issuance of convertible
securities by public companies. SEBI has issued specific norms and guidelines under the SEBI
(Issue of Capital and Disclosure Requirements) Regulations (ICDR Regulations), which
apply to the public issuance of convertible securities.
Some of the key SEBI guidelines on the issue of convertible securities are:
A. Pricing of Convertible Securities
 Conversion Price: SEBI mandates that the conversion price of convertible securities
(debentures or preference shares) must be determined before the issuance of the
securities. The conversion price should not be less than the fair value of the company’s
shares at the time of issuance, and it should be disclosed clearly to investors.
 Floor Price: For public offerings, the conversion price must not be lower than the floor
price of the company’s shares. The floor price is typically the average of the closing
prices of the shares for a specified number of days before the issuance.
 Pricing Formula: SEBI prescribes a formula for determining the pricing in certain
situations, such as for rights issues or issues to promoters, to avoid excessive dilution of
shareholder value.
B. Timeframe for Conversion
 Minimum and Maximum Conversion Period: SEBI mandates a clear conversion
period for convertible debentures or preference shares. The conversion period should
generally not exceed 10 years for a convertible debenture issue, and the minimum
conversion period is typically 3 years.
 Lock-in Period for Conversion: The securities issued through a public offering must
have a minimum lock-in period before they can be converted into equity. This ensures
that the investors are committed to holding the securities for a certain duration before
exercising the conversion option.
C. Regulatory Disclosures
SEBI's norms ensure transparency and proper disclosure to investors. Companies issuing
convertible securities must adhere to the following requirements:
 Offer Document: The company must file a detailed offer document, which includes
information about the terms of the convertible securities, the conversion process, the
conversion price, and the rights attached to the securities.
 Disclosures in the Offer Document:
o The conversion price or conversion ratio.
o Date of issue and conversion period.
o The valuation report (if applicable), including how the price is justified.
o Risks associated with the conversion and potential dilution of equity.
D. Treatment of Convertible Securities Post-Conversion
Once the convertible securities are converted into equity shares, they must be treated in
accordance with the ICDR Regulations for the issuance of fresh equity shares. The company
must also:
 Comply with the Listing Requirements: After conversion, the new shares must be
listed on the stock exchanges (if the company is publicly listed).
 Dilution Impact: The issuance of new equity shares may dilute the existing
shareholders' ownership, and the company must disclose the potential dilution impact to
investors.

Module – 17

Dividend:

A dividend is a portion of a company's profits distributed to its shareholders, typically in the

form of cash or additional shares. The payment of dividends is a key event for shareholders, as
it represents a return on their investment in the company. The Companies Act, 2013 provides a
detailed framework for the declaration and payment of dividends, which is primarily
governed under Section 123 to Section 125, and other relevant provisions related to dividend
distribution and investor protection. This framework also addresses issues like the Interim
Dividend, Investor Education and Protection Fund (IEPF), and the role of the Board of
Directors in declaring dividends.

1. Payment of Dividend: General Principles

Section 123 of the Companies Act, 2013: Declaration of Dividend

Section 123 is the central provision that governs the declaration and payment of dividends by
companies. The key provisions under this section include:

 Declaration by the Board of Directors:

o The Board of Directors is responsible for declaring dividends. Shareholders
cannot directly declare dividends; it must be authorized by the board.
o The board must pass a resolution at a meeting to declare a dividend.

 Conditions for Declaring a Dividend:

o The company must have sufficient profits (either from current or previous
years).
o The accumulated profits should be sufficient to cover the dividend, and there
should be no default in paying interest or repayment of loans to the
government or any financial institutions.
o The dividend should not exceed the amount recommended by the Board of
Directors.

 Solvency Test:
o The company should be solvent before declaring a dividend, i.e., it should be
able to pay its debts as they fall due.
 o The company should not declare dividends if it risks becoming insolvent or if it
compromises its ability to pay creditors.

 Reserve Requirements:
o A company is required to transfer a certain percentage of its profits to reserves
before declaring a dividend. The amount to be transferred to reserves is subject
to the company's articles of association and shareholder approval.

 Amount of Dividend:
o The Board of Directors must decide the amount of dividend to be paid to
shareholders. This can vary based on the company's performance and overall
financial health.

 Declaration in Annual General Meeting (AGM):

o The final dividend must be approved by shareholders in the Annual General
Meeting (AGM). The dividend declared by the board is subject to the approval
of the shareholders.

Key Provisions under Section 123:

 Payment from Profits: Dividends must be paid out of the profits of the company, and
not from capital. If the company does not have sufficient profits, it cannot declare
dividends.
 Interim Dividend: Companies can also declare an interim dividend before the
finalization of the annual accounts.
 Shareholder Approval: While the board declares the dividend, final approval is
generally required from shareholders (in the AGM for the final dividend).

2. Interim Dividend

An interim dividend is a dividend declared by a company's board of directors before the

annual general meeting (AGM) and before the final annual accounts are finalized. The key
points to cover about interim dividends include:

Key Features of Interim Dividend:

 Declared by Board: Unlike final dividends, which are declared at the AGM, interim
dividends are declared by the Board of Directors in the middle of the financial year.
 No Shareholder Approval Needed: Unlike final dividends, interim dividends do not
require the approval of the shareholders at the AGM. The board has the authority to
declare interim dividends, provided there are sufficient profits.
 Interim Financial Statements: The board may declare an interim dividend after
reviewing the unaudited financial statements. It does not have to wait for the full
financial year to conclude.
 Payment: Interim dividends are payable after they have been declared by the board and
are typically paid within a few weeks.
Conditions for Declaration:

 Sufficient Profits: The company must have enough profits for the period up to the
point of declaration. The board will consider interim financials (quarterly or half-yearly)
to decide on the interim dividend.
 Solvency Test: Like with the final dividend, the company must pass the solvency test
and be able to meet its debts after declaring the interim dividend.

3. Investor Education and Protection Fund (IEPF)

The Investor Education and Protection Fund (IEPF) is a fund established by the
Government of India to promote investor awareness and protect the interests of investors,
particularly in the context of unclaimed dividends. The key provisions related to IEPF include:

Section 125 of the Companies Act, 2013: Investor Education and Protection Fund

 Unclaimed Dividends: If a dividend remains unclaimed for a period of 7 years, it is

transferred to the Investor Education and Protection Fund (IEPF). This includes
unclaimed dividends, matured debentures, and other amounts related to securities that
remain unclaimed.
 Use of Funds: The IEPF is used for:
o Promoting investor education and awareness.
o Taking action for the protection of investor interests and awareness
programs.
o Reimbursing investors whose funds have been transferred to the fund (in case of
unclaimed dividends or unclaimed deposits).

 Claiming Unclaimed Dividends: Investors can reclaim their unclaimed dividends by

submitting an application to the IEPF Authority. The application process allows
investors to claim any unclaimed dividends that have been transferred to IEPF.
o Transfer to IEPF: Companies are required to transfer unclaimed dividends to
the IEPF after a period of 7 years.

 Reporting to IEPF: Companies must file periodic returns with the IEPF to report
unclaimed dividends and securities transferred to the Fund.

4. Provisions under the Companies (Share Capital and Debentures) Rules, 2014

The Companies (Share Capital and Debentures) Rules, 2014 provide specific details about
the processes, disclosures, and actions associated with the declaration and payment of
dividends.
Key Provisions:

 Declaration of Dividend: These rules prescribe the procedures for the declaration and
payment of dividends, including the documentation that must be maintained by the
company and the steps involved in declaring dividends.
 Transfer to Reserves: The rules may set out the minimum percentage of profit that
should be transferred to reserves before dividend declaration, depending on the nature
of the company.
 Dividend Distribution Policy: Companies may be required to disclose their dividend
distribution policy in the annual report (if applicable), particularly for listed
companies. The policy should indicate how the company decides on the proportion of
profit to be distributed as dividends.

5. Rights of Shareholders Regarding Dividend

Right to Receive Dividend:

 Shareholders have the right to receive dividends on their shares if declared by the
company. The dividends are usually paid in proportion to the number of shares held by a
shareholder.

Right to Receive Dividend within 30 Days:

 As per Section 123, the company must pay the declared dividend within 30 days from
the date of declaration.

Dividend in Kind:

 Although less common, dividends can also be paid in the form of assets rather than cash,
such as bonus shares or property dividends. However, this is subject to approval by
shareholders and the company’s articles of association.

DIVIDEND

1. What is the difference between profit & divisible Profit? Are divisible profits available
for distribution? S. 123, 124
2. Can dividend be claimed as matter of right? Is it different for preference shareholders &
equity shareholders?

3. Can dividend be paid out of the capital of a company? If not what are the sources out of
which dividend can be paid?
4. Can dividend once declared be revoked?

5. What is an interim dividend? Can interim dividend be revoked?

 6. What do we understand by unpaid and unclaimed dividend? Discuss the provisions for
unclaimed dividend under the Companies Act?

Sources Out of Which Dividend Can Be Paid:

According to Section 123 no dividend can be declared or paid by the company for any
financial year except out of,

1. Current profits

Dividends may be paid out of profits for the company for the current year after providing
depreciation as per schedule 2 in computing profits any amount representing unrealized
gains, revaluation of assets, liability on measurement of assets, or liability at fair value shall
be excluded.

2. Out of past reserves

According to section 2(43) past reserves mean such reserves which as per the latest audited
balance sheet of a company are available for distribution as dividend. Whenever the
dividends are declared out of the surplus the rate of dividend declared shall not exceed the
average rates at which dividend was declared in the 3 years immediately preceding that year.

3. Out of the money provided by the central government or state government

For the payment of dividend by the company (funds, grants or guarantees) + dividend shall
not be paid out of the company in any case
According to section 2(35) dividend means and includes an interim dividend. A part of profit
may be distributed before the financial statements and accounts are finally declared in the
annual general meeting thus dividend paid between two AGMs is known as interim dividend.

According to section 123 (3) The board of directors of a company may declare interim
dividend out of surplus in the profit and loss account of the financial year in which such
interim dividend is sought to be declared. In case the company has incurred losses during the
current financial year such interim dividend shall not be declared at the rate higher than the
average dividend declared by the company during the immediately preceding 3 financial
years.

Interim Dividend like final dividend shall be considered as debt for the co. & thus it is NOT
revocable except with the consent of the shareholder. Also if the dividend is declared & the
amount is credited the shareholders, it cannot be altered by any subsequent resolution.
(Kishanchand Chellam v. CIT)

UNCLAIMED DIVIDEND & IEPF (S. 124 & 125)

According to S. 124 where dividend has been declared by a co. but hasn’t been claimed
within 30 days from the date of declaration by shareholders entitled to such payment of
dividend. The company shall within 7 days from the date of expiry of the said period of 30
days. The company transfers the total amount of dividend which remains unpaid within the
said period of 30 days to a special account opened by the co. in a scheduled bank to be called
as unpaid dividend account.
The company shall within a period of 90 days of making any transfer of the amount to the
unpaid dividend A/c prepare a statement containing the name of the shareholder, their
address, the amount of dividend unclaimed & such other details as required and publish it on
the website of the company, or any other website recommended & approved by the central
government.
If any default is made in transferring the amount the company shall create an interest at the
rate of 12% per annum from the date of default. According to s. 124, if the amount
transferred to the unclaimed dividend amount remains unclaimed for a period of 7 years from
the date of such transfer then it shall be transferred by the company to refund established
under s. 125.

Section 125- purpose for which the investor education & protection fund IEPF can be
used:

The central government should constitute by notification, the authority for administration
consisting of chairperson, CEO & 6 other members. The authority shall administer the fund
in consultation with the auditor general of India for the following purposes-

1. To refund amount with respect to unclaimed dividend

2. Promotion & awareness for investors education & protection

3. Reimbursement of legal expenses incurred during class action suits

4. Any other purpose incidental to & prescribed by the central govt. time to time.
 Module – 18

Membership in a Company:

In the context of a company, membership refers to the individuals or entities that are
shareholders of the company. Membership can be acquired through the purchase or allotment of
shares and entails certain rights, duties, and liabilities.

1. Who Can Become a Member?

Under the Companies Act, 2013, the following individuals or entities can become members of
a company:

Individuals or Entities Eligible to Become Members:

 Natural Persons (Individuals): Any adult person (above 18 years) with the mental
capacity to contract can become a member by subscribing to or buying shares in the
company.
 Body Corporates (Entities): Other companies, firms, or organizations can also be
members of a company by purchasing shares in it. For example, one company may be a
shareholder (member) in another company.
 Minors: A minor (someone under the age of 18) cannot directly become a member of a
company, but a guardian or legal representative can hold shares on their behalf until
they come of age.
 Foreign Individuals or Entities: Foreign nationals or companies are permitted to
become members, subject to the provisions of the Foreign Exchange Management Act
(FEMA) and other applicable regulations, particularly for companies that are subject to
foreign investment restrictions.
 Joint Holders: Shares may be held jointly by two or more persons, and they are
considered joint members. They share rights and obligations concerning those shares.

Methods of Becoming a Member:

 Subscription to Shares: A person becomes a member of a company by subscribing to

its Memorandum of Association (MOA) during the incorporation phase, or by
purchasing shares from the market in case of listed companies.
 Allotment of Shares: A person can also become a member through the allotment of
shares by the company. In this case, the person is added to the Register of Members
maintained by the company.
 Transfer of Shares: A member may acquire shares by purchasing them from an
existing shareholder. Once the transfer is completed, the new shareholder will become a
member upon registration by the company.
2. Member vs. Shareholder: Distinction

While the terms "member" and "shareholder" are often used interchangeably, there is a
subtle distinction between the two:

Member:

 A member is someone who is registered in the company’s Register of Members as

the holder of shares.
 Membership in the company involves being a part of the company and is generally
recognized as having rights (such as voting rights and entitlement to dividends) and
obligations (such as the potential liability to pay calls on shares).
 A member may hold shares directly or may hold them as a joint holder.

Shareholder:

 A shareholder refers specifically to a person or entity holding shares in the company.

 All shareholders are members of the company, but the term "member" could also
include individuals who have rights to vote or participate in the company’s decisions but
do not hold shares (as in non-profit or membership-based organizations).
 For example, in a share transfer, the transferor of the shares ceases to be a
shareholder, but their membership status (if they were a member) will terminate upon
the transfer being registered.

Conclusion: While a shareholder holds shares, a member is an individual or entity listed in

the company’s Register of Members. In practice, however, most members are also
shareholders.

3. Registration of Membership
Register of Members:

 Section 88 of the Companies Act, 2013 mandates that every company (except a One
Person Company) must maintain a Register of Members.
 This Register records the names, addresses, and shareholding details of all the
company's members. It is an official document and must be made available for
inspection by members of the company.
 The Registrar of Companies (RoC) also receives periodic filings on the status of
members, such as share transfers and new memberships.

Process of Becoming a Member:

 When shares are allotted to a person, they are entered into the Register of Members by
the company.
 The company issues a share certificate to the person, which is proof of their
membership and ownership of shares.
  If the person acquires shares via transfer, the company registers the name of the new
shareholder in the Register of Members once the share transfer procedure is completed.

4. Rights of a Member

The rights of a member (who is also a shareholder) include a variety of entitlements and
privileges, including the following:

Basic Rights of Members:

 Right to Vote: Members typically have the right to vote in the company’s General
Meetings (AGM or EGM). Voting may be on matters such as the election of directors,
approval of financial statements, and other major company decisions.
o Types of Votes: Members can cast votes in person, by proxy, or electronically
(in case of listed companies or those subject to electronic voting).

 Right to Receive Dividend: Members are entitled to receive dividends declared by the
company in proportion to their shareholding.
 Right to Inspect Records: Members have the right to inspect certain documents, such
as the Register of Members, Minutes of General Meetings, and the company’s
financial records.
 Right to Transfer Shares: Members can transfer their shares to another person,
subject to company rules. The transfer is typically registered by the company after
verifying the transfer deed and relevant documents.
 Right to Attend and Speak at Meetings: Members have the right to attend General
Meetings (AGMs, EGMs) and can speak or raise questions during such meetings.
 Right to Participate in Surplus Distribution: In case of winding up or liquidation,
members are entitled to a share of the assets left after the company's debts have been
paid, according to the class of shares held (preference or equity).
 Right to Call a Meeting: In certain circumstances, members holding a minimum
percentage of shares can call an Extraordinary General Meeting (EGM) or propose
resolutions to be voted on in a meeting.

5. Liabilities of a Member
Limited Liability:

 The liability of a member is generally limited to the unpaid amount on the shares they
hold. In most cases, the liability of a member is limited to the nominal value of the
shares (if any) that are unpaid.
o For example, if a person holds shares with a nominal value of ₹10 but has
already paid ₹8, they are liable to pay the remaining ₹2 if the company calls for
payment.
Liabilities in Special Cases:

 In a winding-up scenario, the member's liability may extend to paying for any unpaid
amount on their shares.
 Members of companies limited by guarantee may have a higher degree of liability
(which is typically specified in the company's Memorandum of Association).

6. Termination of Membership
Voluntary Termination:

 A member may voluntarily cease to be a member by selling or transferring their shares

to another person.

Involuntary Termination:

 Forfeiture of Shares: If a member fails to pay calls on their shares (where the company
has made a call for payment of unpaid capital), the company may forfeit their shares
and terminate their membership.
 Redemption of Preference Shares: If the company issues preference shares with the
provision for redemption, the redemption of these shares terminates the member's status
as a member once the shares are redeemed and the payment is made.

Death or Insolvency:

 Upon the death or insolvency of a member, their membership may be terminated, and
their shares may be transferred to their legal heirs, assignees, or the official receiver (in
the case of insolvency).

Company’s Winding Up:

 In the event of the company being wound up, the membership of all shareholders is
terminated as part of the liquidation process, and the members’ shares are either
transferred or liquidated to pay off creditors.

MEMBERSHIP (5 MARKS)

1. Who can become a member?

a. Subscriber of memorandum
b. Registers as a member u/s. 88 and agrees in writing
c. Holding equity share capital and name is entered as beneficial owners in the record of the
depository
2. Difference between Member & Shareholders?

A company which has share capital, the shareholders are members. In companies where
companies do not have share capital, members are not shareholders
There can be situations where members are not shareholders-

a. Section 8 companies rarely have a share capital

b. Companies limited by guarantee

c. When company does not have a share capital\

d. In case of transfers

e. In case of transmission

f. Forfeiture/surrender of the share.

3. Modes of acquiring membership?

a. Subscription

b. Application and allotment

c. Transfer

d. Transmission
e. Estoppel

1. Termination of membership?

a. By an act of party

b. By operation of law

c. Expulsion of member