Mgmt study material created/ compiled by - Commander RK Singh [email protected]Page 1 of 67 - Business Law - II Jamnalal Bajaj Institute of Mgmt Studies Date: 20 Jan 2006 Book – Corporate Law and Practices By Kapoor and Majumdar (Taxman Publication) REVISION OF OLD CONCEPTS What is a Corporate – Any business incorporated under some law. Difference between Company and an Ownership/Partnership Firm 1. Any company is a separate legal entity. It can hold property in its own name. It can sue or be sued. 2. A company has perpetual succession unlike an ownership or partnership firm. Even in case all the directors and shareholders of a company die, the company continues. During the WW-II, a small company was having a meeting attended by the directors and all the shareholders. The building was bombed and all the shareholders and directors died. The court gave the verdict that the company will continue with legal heirs of original shareholders becoming the new shareholders and electing a Board of Directors. 3. Shareholders in a Limited Company have limited liability to the extent of unpaid share capital. However, in specific circumstances the liability of Shareholders can become unlimited. Like: - (a) If the number of members in the company fall below the minimum stipulated (2 for Pvt Ltd Company and 7 for Public Ltd Company) (b) Remaining members should have knowledge of above shortfall in membership (c) The business is carried on for more than 6 months with reduced membership. Also, the liability of any individual shareholder/s can become unlimited when a company is being wound up due to fraudulent activity of that member/s. However, if the company is not being wound up, such liability is of the company and company can take action against the fraudulent members under the existing laws. 4. In a company, day to day decisions are taken by the directors and shareholders do not involve in the process.
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Mgmt study material created/ compiled by - Commander RK Singh [email protected]
Page 1 of 67 - Business Law - II
Jamnalal Bajaj Institute of Mgmt Studies
Date: 20 Jan 2006
Book – Corporate Law and Practices By Kapoor and Majumdar (Taxman Publication)
REVISION OF OLD CONCEPTS
What is a Corporate – Any business incorporated under some law.
Difference between Company and an Ownership/Partnership Firm
1. Any company is a separate legal entity. It can hold property in its own name. It can
sue or be sued.
2. A company has perpetual succession unlike an ownership or partnership firm. Even
in case all the directors and shareholders of a company die, the company continues.
During the WW-II, a small company was having a meeting attended by the
directors and all the shareholders. The building was bombed and all the
shareholders and directors died. The court gave the verdict that the company will
continue with legal heirs of original shareholders becoming the new shareholders
and electing a Board of Directors.
3. Shareholders in a Limited Company have limited liability to the extent of unpaid
share capital.
However, in specific circumstances the liability of Shareholders can become
unlimited. Like: -
(a) If the number of members in the company fall below the minimum
stipulated (2 for Pvt Ltd Company and 7 for Public Ltd Company)
(b) Remaining members should have knowledge of above shortfall in
membership
(c) The business is carried on for more than 6 months with reduced
membership.
Also, the liability of any individual shareholder/s can become unlimited when a
company is being wound up due to fraudulent activity of that member/s. However,
if the company is not being wound up, such liability is of the company and
company can take action against the fraudulent members under the existing laws.
4. In a company, day to day decisions are taken by the directors and shareholders do
not involve in the process.
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What is a Private Ltd Company?
A Pvt Ltd Co. has three restrictions: -
(a) No of members of such company can not exceed 50.
(b) Shares of such company can not be issued to public.
(c) Free transfer of shares is not allowed. Any member wishing to withdraw
from the company has to first offer his shares for sale to the existing
members and if no one is willing to purchase can he sell it to a person
outside the existing membership.
A Pvt Ltd company must have an authorized capital of Rs 1,00,000.
What is Public Ltd Company?
As per company law definition, “A company that is not a Pvt Ltd Company is Public Ltd
Company”.
Different Types of Companies
1. Company Limited by Shares – A normal company as we generally find in the
market.
2. Company Ltd by Guarantee – Such companies do not have shareholders but only
members. The members give guarantee that in case of shortfall of assets of
company to meet the liabilities at the time of winding up, they would provide the
sum as guaranteed by them. BSE was a company “Limited by Guarantee” till
recently. Now it has become normal company.
3. Demutualisation
4. Company Limited by Guarantee also having Share Capital.
5. Foreign Company –
(a) Company should not be incorporated in India but incorporated in some other
country.
(b) Company should have place of business in India.
6. Govt Company – Any company wherein minimum 50% shares are held by
State/Central Govt individually or collectively.
7. Non Profit Companies – Charitable companies, NGO. These companies are
governed by Section 25 of the Companies Act, 1956 and therefore they are also
called Section 25 companies.
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8. Unlimited Liability Companies – Liability of Shareholders of such companies is
unlimited.
9. Investment Companies – Principal business of such companies is dealing in trade
of securities.
10. Producers’ Companies – This is an option available to people who would
otherwise form Co-operative Societies. Co-operative societies follow the concept of
one member, one vote, irrespective of their contribution to the capital of society. It
acts as dis-incentive for large stake holders. In Producers’ companies, voting rights
are proportional to contribution.
11. Listed Companies – Any company whose shares or debentures are listed in any
recognized stock exchange of the country is called Listed company. Please note that
it is not the companies which are listed in the stock exchanges but their shares and
debentures are listed. It is, therefore, possible that shares of a particular company
are listed but not the debentures. It is also possible that a particular series of
debenture is listed but not others.
12. Illegal Association – A partnership firm having more than 20 partners or a
partnership banking firm having more than 10 members is illegal association. If
such a firm is defrauded by some one, they can not seek a legal remedy because
courts will refuse to admit existence of such company.
What is the difference between Partnership Firms and Unlimited
Liability Companies?
In case of partnership firms, the liability is joint and several, which means that any
creditor can approach the “partners as group” or even approach any individual partner for
recovery of full amount owed to him by the partnership firm. However, in case of
Unlimited liability companies, debtors can not approach the shareholders for payment of
dues and will have to approach the company only. Company can then demand any sum,
without any limit, from its shareholders to settle the dues.
What is a Holding Company and a Subsidiary Company?
A company is called a Holding company if –
(a) It holds more than 50% shares of other company, or
(b) Majority of directors of Holding company are also director in subsidiary
company.
(c) Company can control composition of directors of other company
(d) Company can control directors of other company.
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THIS SEMESTER’S SYLLABUS
Law and Procedure of Formation of a New Company
Following activities are involved in the formation of new company –
1. Promotion
2. Incorporation
3. Floatation
4. Commencement of Business
1. Promotion: Promotion involves feasibility study and taking steps for incorporation
of new company.
(a) Promoter – Any one involved with the process of promotion in any way,
like providing the initial capital.
(b) Beginning and End of Promotion – Promotion begins when promoters
start acting on behalf of proposed company and ends when Board of
Directors takes charge of business.
(c) Legal Position of Promoter – He stands in the fiduciary capacity. Thus, he
can not make any secret profits. This also means that he is allowed to make
profits after due disclosure.
(d) Disclosure – He has to disclose all transactions and profits earned.
(e) Status of Contracts Signed in the Pre-incorporation Period – Those
contracts which are necessary for bringing a company into incorporation are
automatically valid. Validity of other contracts is dependent on acceptance
by Board of Directors.
2. Incorporation: Steps involved in incorporation –
(a) Application for Availability of Name – Four choices of names are to be
given to the Registrar who would check their availability to ensure that the
same name is not already in use or the proposed names are not deceptively
similar to any names already approved. Dos and Don’ts about names: -
(i) Name should be unique and not spelled or sounding like name of any
existing company.
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(ii) Name should be consistent with proposed business of company. A
business intended to trade in wooden furniture can not assume names
like the ones of software or technology company.
(iii) For including words like International, Global, India etc, following
guidelines have been promulgated: -
(aa) India – Should have a min Rs 50 lakh authorized capital.
(bb) Global – Should have min Rs 1 Cr as authorized capital.
(cc) Corporation – Should have min Rs 5 Cr as authorized capital.
(b) Memorandum of Association (MOA) and Article of Association (AOA) – These two documents are collectively called as constitution of company.
Memo defines company’s relationship with outside world while Articles of
Association defines internal relationships between company and the
employees and among employees themselves.
These documents are public documents and should be made
available to any person on payment of nominal fees. In this case, the
Doctrine of Constructive Notice is applicable. Doctrine of constructive
notice favours the company and assumes that any other company or person
dealing with the firm would have read particular document. Thus, ignorance
of any clause in these documents can not be taken as refuge in case of any
dispute.
(i) Clauses of MOA
(aa) Name
(bb) Domicile
(cc) Objects
(dd) Capital
(ee) Liability
(ff) Association
Above six clauses are minimum clauses to be included in a Memorandum of
Association. Company is free to include any other clause.
Domicile – The state in which registered office is located is called
the Domicile state of that company.
Objects – Object defines the scope of business of any company.
There is no limit as to how many businesses can be listed in
the object of the company. However, a company can not
undertake a business that is not listed unless the objects are
amended. Else, it will attract “Ultra Vires” clause. Company
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is free to amend any clause or article by passing a special
resolution by ¾ majority of members present in person or
through proxy and voting.
Association – Name of the people who formed the company. They
are called the subscribers of the MOA. For a private Ltd
company, minimum two and for a Public Ltd Co. minimum 7
members are required.
Doctrine of Indoor Management – Doctrine of indoor management
is exception to Doctrine of Constructive Notice. According to
doctrine of constructive notice, any one who deals with the company
is assumed to have read and have knowledge about the object and
power of the company. If any transaction with company is later
found to be out of the ambit of its MOA & AOA (Ultra Vires), the
third party can not claim anything from company as matter of right.
It means that, before entering into contract you must verify the
memorandum of the company and check out whether company is
authorised to perform this kind of act.... But at the same time you are
not suppose to verify the internal proceeding carried out by the
company nor is company duty bound to reveal the internal
proceeding to outsiders. Thus, an outsider or party to the contract can
safely assume that everything required to be performed by the
company or its officer as part of internal proceeding has been duly
complied with. If it is revealed at a later date that some internal
actions as necessitated by MOA/AOA prior signing of contract were
omitted by its officials, the contract would remain valid and
enforceable.
(ii) Vetting of MOA and AOA - Draft copies of MOA and AOA are
required to be submitted to the Registrar of the Companies office for
vetting to ensure that the rules framed are within the ambit of the
Company Law and nothing of substance has been omitted. Along
with the MOA and AOA, following additional documents are
required to be submitted: -
(aa) Availability of name - Form 1A
(ab) Notice of Registered Office - Form 18
(ac) Consent of persons for directorship – Form 29
(ad) Particulars of directors – Form 32
(ae) Statutory Declaration – Letter from High Court Advocate
or Company Secretary, etc, stating that he has checked the
documents and they have been found to be correct.
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Once Registrar is satisfied with above documents, he can issue
Certificate of Registration (Birth of Company). Once the Certificate
of Registration is issued, there is no invalidation clause which means
that even if there was any error in the process, it still remains valid.
3. Floatation – Raising of Capital. Capital can be raised by one of the following
methods: -
(a) Public Offer – Public Offer can be made only by Public Ltd Companies.
Pvt Ltd companies can not make a public offer. Public Offers are governed
by very stringent regulations. Issue of prospectus is necessary condition.
Prospectus should include details of the company and Offer.
(i) IPO – Initial Public Offer – First ever public issue of company is
called IPO.
(ii) FPO – Follow-on Public Offer. Any subsequent public issue is
called FPO, though popularly every public issue is called IPO by the
common people.
(iii) Pvt Placement – When shares are offered to selected few with no
clause to relinquish the offer in favour of some one else, it is called
Pvt Placement. Pvt Placement is goverened by few regulations
unlike Public Offers where the rules are very stringent. However,
there is limit imposed as to how many people can be approached for
Pvt Placement. The number can not exceed 50. This limit is imposed
so that this route is not misused to disguise a public offer as Pvt
Placement offer by mass mailing.
(iv) Offer for Sale – A company unwilling to go through the grind of
Public Issue can sell all its shares to one entity who in turn can sell
the shares to the public. Such an arrangement is called offer for sale.
This route was used to con the public. Seller disowned the
responsibility stating that he was like any other seller with no
responsibility towards functioning of the company. Company also
disowned the responsibility saying that it never made any promises
to the public as it sold the shares to a single individual. Therefore,
now same rules as Public Offer apply in case of sale of shares by
such individuals also.
4. Commencement of Business – A Pvt Limited Company can commence business as
soon as Certificate of Incorporation is issued. However, in case of Public Ltd
Companies, business can be commenced only when Certificate of Commencement
of Business is issued by the Registrar. Before awarding Certificate of
Commencement of Business, he needs following documents and information: -
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(a) In Case of Public Offer -
(i) Confirmation about minimum subscription of 90% of the offer
amount.
(ii) Application money is returned to the entitled applicants.
(iii) Confirmation that all stock exchanges applied to by the company
have agreed to list the share. In case, even one of the stock
exchanges where application for listing was made refuses to list the
stock for any reason what so ever, the Public Issue is null and void
and entire money of applicants is to be returned. It is mandatory to
list the company in the Stock Exchange nearest to the company’s
registered office.
(iv) Proof of Directors having paid money for their shares.
(v) Declaration to the above effects is to be made by any one director or
the company secretary.
(b) In Case of Pvt Placement – Only conditions (iv) and (v) above are required
to be complied with.
Status of Provisional Contracts – Before a company comes into existence, the promoters get into
various contracts for IPO, Advtg, etc. What is the status of these contracts?
Such contracts are called Provisional Contracts. In case the company does not get the
certificate of business, these contracts are cancelled. In case the certificate is awarded, the Board of
Directors will decide on the status of contracts. In case of a long term contract of pre-incorporation
period, Board will decide whether such contract was necessary and in the interest of the company
and can accept or reject.
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Date: 27 Jan 2006
Share Capital
What is a share?
A “share” is a share in capital of company. Shareholders are not part owners of the
company as is commonly believed. A company is a separate legal entity and thus there is
no ownership in a company even if some one owns literally all the shares in the company.
Any shareholder can not act on behalf of the company.
A share in a company is a bundle of rights that shareholder enjoys for providing money to
the company. He is more like a creditor of the company who enjoys certain rights for
having provided the company with the capital. But like a bank which finances the company
can not call it self to be owner of the enterprise, a shareholder can not call himself to be
owner/part owner of the company.
Shareholders’ Rights – Shareholders rights can be grouped in two batches:
Individual Rights
Collective Rights
1. Right to receive notice of GBM
2. Right to receive information in the
form of Annual Report.
3. Right to attend General Body
meetings
4. Right to appoint proxy on his behalf
for attending GBM.
5. Right to vote
6. Right to receive dividend when
declared.
7. Right to inspect certain registers like
membership register. (But not books
of account).
8. Right of Pre-emption. (Right to be
offered proportionate amount of
shares corresponding to current
holding before being offered to other
people).
9. Right to seek remedy against any
Ultra Vires act by the company.
1. To call for an Extra Ordinary General
Meeting if a group of shareholders
holding either 10% voting rights or
100 shareholders demand for it. If
EGM is not conducted within
stipulated period by the directors,
then the group can organize the EGM
itself and get the reimbursement for
expenses from company account.
2. In case of any mismanagement or
oppression, the shareholders can
petition Central Govt (Ministry of
Company Affairs) to intervene. Govt
can change MOA and AOA and
appoint its own directors etc.
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Share certificate is not a share. A share certificate is merely an evidence that the holder of
the certificate holds the number of shares in the company as listed in the share certificate.
What is a Stock and how do you differentiate a share from a stock?
When the capital of a company is divided into number of units of a definite face value,
such units are called shares.
When capital of the company is not split into units of any definite amount, such money is
called stock.
A company can not issue stock in the first instance. It has to first issue shares and later can
convert them into stock.
Types of Shares
1. Equity Shares
(a) Ordinary Equity Shares
(b) Equity Shares with Differential Voting rights.
2. Preferential Shares
(a) Cumulative Preferential Shares
(b) Non Cumulative Preferential Shares.
The primary difference between Equity shares and preferential shareholders lies in fact
that:
(a) Any dividend to Equity Shareholders can be paid only after Preferential
Shareholders are paid theirs. The dividend to Preferential Shareholders is
paid at a pre-specified rate when given. (Declaration of dividend is not
mandatory but when declared, minimum rate as pre-specified would have to
be paid).
(b) Again, during winding up, Preferential Shareholders will have the first claim
over the money realized from liquidation.
(c) Preferential Shareholders do not have voting rights. However, they get
voting rights under following conditions:
(i) Cumulative Preferential Shareholders – If dividend is not paid during
last two financial years.
(ii) Non Cumulative Preferential Shares – If dividend is not paid in three
out of past six years.
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Also, there are Participating Preference Shares. Such shares get extra dividend, over and
above pre-specified rate, in case company pays dividend to its Equity Shareholders at rates
higher than a pre-agreed rate.
Preferential shares in India should be redeemable not exceeding 20 years.
Equity Shares with Differential Voting Rights. These are the shares where,
voting rights are not there, all other things remaining same. The question here is why
should any one accept Differential Voting Rights?
The companies offer inducement in terms of extra dividend to such Sharesholders. Most of
the shareholders in any case don’t attend the AGMs due to reasons like location of AGM
venue (AGM can only be held in the city of Registered Office), and therefore don’t exercise their
right to vote. Those who do attend, can hardly make any difference against the majority
shareholders. Thus, absence of voting rights does not make any material difference to small
Shareholders. For the promoters and majority shareholders, it provides a safety net against
hostile bids for take over through market route of acquisition of shares.
Guidelines for issue of Equity Shares with Differential Voting Rights
(ESDVR)-
1. First issue of shares has to be ordinary equity shares. ESDVR can be offered only
on subsequent issues.
2. Proportion of ESDVR can not exceed 25%.
3. Company should have track record of divisible profit in last 3 years. (Company should
be profit making. Declaration of dividend is not necessary)
4. Any company defaulting on repayment of deposits or interest can not issue ESDVR.
Issue of Shares: -
1. Pvt Placement
2. Public Offer
(a) IPO
(b) FPO
3. Offer for sale
Pvt Placement – Issue of prospectus is not necessary. Merely filing of statement in lieu of
prospectus is adequate.
Offer for Sale – Deal is struck with a single entity, an individual or company, who
purchases all the shares on offer and pays money. Such entity is called Issue House. He
sells those shares subsequently to public. As brought out earlier, this method was being
used as a route to evade stringent regulations applicable in case of public issues. The rules
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have now been made equally stringent even in cases of sale of shares by Issue House. Ever
since, this method has fallen into disuse.
Public Offer – Appoint various entities: -
(a) Merchant Bankers – Appointment of Merchant Bankers, also called Lead
Managers to the Issue, is mandatory as per SEBI rules. They act as advisors
for the issue and carry a great deal of responsibility. They provide various
services and in case of any problems, they are the ones to be held
responsible along with company.
(b) Appoint Brokers
(c) Appoint Bankers – For acceptance of applications and application money.
(d) Appointment of Underwriters – It is not compulsory and can be done as a
safety net in case management and Merchant Bankers are not certain about
receiving minimum 90% subscription. Underwriters charge a certain
percentage commission (max 2.5% of the amount underwritten in case of
shares and 5% in case of debentures) and purchase unsubscribed portion of
issue. There are two types of underwriting –
(aa) Hard Underwriting – Buy the shares using public issue route
(ab) Soft Underwriting – Buy the unsubscribed portion in case of
shortfall in subscription.
(e) Appoint Registrars and Transfer Agent – These are the people who do the
back office job during the public offer. They process the applications, send
allotment letters, send refund cheques, etc.
Except for the Advertising Agency and Bankers, all others should be registered with SEBI.
Different Kinds of Prospectus: -
1. Abridged Prospectus – Abridged prospectus contains only salient points with note
that full prospectus can be obtained from issuing company or Merchant Banker.
2. Shelf Prospectus – In case of company coming up with multiple issues of shares or
Debentures or bonds at short notices, (remember, IDBI and ICICI Infrastructure
funds coming up with a new series of Tax Saving Infrastructure Bond every
month???), such prospectus are issued. Every time a new issue is offered, an
information memorandum about changes applicable in Shelf Prospectus is attached
rather than issuing a full prospectus. This is applicable only to Banking Companies
and Financial Institutions.
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3. Red Herring Prospectus – Such prospectus are issued in case of Book Building
Issues. The only difference in case of regular prospectus and red herring prospectus
is declaration of offer price which is not contained in the Red Herring Prospectus.
All other things are common.
SEBI Guidelines for Making Public Offer – This is also called DIP
Guidelines (Disclosure for Investor Protection)
1. General Requirements –
(a) Issue of Offer Document
(b) Prohibited companies can not make a public offer
(c) Make an application for listing of securities to as many stock exchanges as
desired by company but mandatorily to local Stock Exchange (Region in
which company’s registered office is located).
(d) Enter into depository agreement.
Rules are different regarding eligibility norms for companies making
IPO.
(a) Unlisted Companies
(i) Pre issue net worth of company should be minimum Rs 1 Cr.
(ii) Track record of distributable profit for minimum 3 of last 5 years.
(iii) Issue size can not exceed 5 times the net worth of the company.
In case a company is not eligible by above criteria, then company can go for Book
Building Issue and therein minimum 60% should be invested by QIBs (Qualified
Institutional Bidders).
(b) Listed Companies – In such companies only last criteria, ie issue size
applies.
2. Pricing of Issues – Companies are free to price their issue. They can demand any
amount as long as investors are willing to purchase. In the Pre SEBI days, the price
of issues was decided by SEBI’s predecessor, Controller of Capital Issues.
3. Promoters’ Contribution –
Who is a promoter?
Any person who is owning 10% or more shares through family and friends,
except QIBs, FIs and FIIs is termed as promoter. Promoters are required to
subscribe minimum 20% of the issue and such shares carry a lock-in period of 3
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years, which means that such shares can not be sold for 3 years. As said earlier, this
rule is not applicable in case of Banks, Financial Institutions and Infrastructure
companies.
Promoters should bring their minimum 20% money before the issue opens.
Promoters’ contribution in excess of statutory 20% will also have a lock-in period
of 1 year.
Public Offer of Securities
Pubic Offer of Securities by unlisted companies is called Initial Public Offer (IPO)
Public Offer by listed companies is called Follow on Public Offer (FPO).
Any Public Offer is guided by two sets of guidelines
(a) Guidelines listed by Companies’ Act
(b) SEBI’s guidelines.
There is substantial variation in requirements stipulated by the two guidelines for each
matter. Since every company has to satisfy both the authorities, more stringent of the two
rules is followed. In most cases, SEBI stipulations are more stringent than Companies’ Act.
Issues
1. Draft and Issue a Prospectus –
(a) As Per Companies’ Act – Not necessary to call it prospectus. In can be a
circular, notice, letter. Two elements should be present in any such
document to be construed as prospectus –
(i) Should invite to subscribe for Equity Shares/debentures/Public
Deposit.
(ii) Invitation to public (Any offer is termed private in case the offer is
made to a specific person and is not transferable. Else it is called a
public offer). Also a private offer to more than 50 persons is deemed
to be a public offer.
Every prospectus should be dated and registered with Registrar of
Companies at least a day prior to offer.
(b) As Per SEBI Guidelines – Company should deposit draft prospectus at
least 21 days before going public through Merchant Banker. Draft
Prospectus is a public document and put up on SEBI’s Website for any one
to raise any objections. SEBI can suggest any changes and they will have to
be complied with by company and the merchant banker in final prospectus.
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2. Contents of Prospectus –
Companies’ Act
(a) Schedule II of the Act mandates
Details like what should be on cover
page, back page etc.
(b) Part I – General Information
(c) Part II – Specific Information
(i) General
(ii) Financial
(iii)Statutory
(d) Part III – Explanation of terms
SEBI
(a) Company’s name, address, contact
details
(b) First Issue Risk
(c) Issuers absolute liability
(d) Issue details
(e) Name and detail of lead managers.
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Date: 03 Feb 2006
Allotment of Shares
1. General Rules.
(a) Proper Authority – Who is authorized to issue the shares? It is normally
mentioned in the MOA. In case there is no mention of authority for issue of
shares, then the power rests with the Board of Directors. (The Shareholders
enjoy only listed privileges. Board of Directors enjoy the Residual Privileges, which means
that any powers not vested with some one else will automatically fall on Board of
Directors).
(b) Allotment against Written Application – Any allotment of shares can be
done only against written application from the applicant. No allotment of
shares can be made unless a person had made a written request.
(c) Allotment of shares can be done only if it is not in contravention of any
other law of the land. For example – Minors are not entitled by the law of
the land to enter into any contract. Since allotment of shares is against a
contract, shares can not be allotted to any minor who is not eligible to enter
into a contract. Any allotments made on misrepresentation of age by a minor
would become null and void when the facts are discovered. Similarly, there
are limitations imposed on allotment of shares to foreigners. Any allotment
in violation of FEMA rules or any other rules, would be nullified.
(d) Allotment should be made within reasonable time of application. The
law does not define the reasonable time and has been left to the courts to
interpret on case to case basis. In a judgment, Supreme Court had ruled six
months as unreasonable time.
(e) Communication of allotment of shares to allottee is mandatory
condition. Even though the Board of Directors may have taken the decision
to allot the shares, unless the same is communicated to the person
concerned, allotment is not valid. In a particular case, the Board approved
allotment of partly paid shares and same was duly minuted also. Soon after,
the company went into liquidation and the person was asked to pay up the
balance amount. However, he contested the demand on the ground that he
never received the intimation, which was upheld.
(f) Revocation of Offer – Any application for allotment of shares can be
withdrawn any time before allotment of shares. However, in case of Public
Offers (IPO or FPO), withdrawal is not permitted for 5 days from the issue
opening date. This window period is basically a grace period given due to
hectic activity level during the Public Issue days. However, this grace period
to the company is not available in case any of the experts associated with the
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prospectus withdraw his/their consent to the public issue for what so ever
reason. In such situations, applicants are allowed to withdraw their
application any time till the allotment of shares without the five day’s
window/grace period.
(g) The offer should be absolute and unconditional.
2. Statutory Rules.
(a) Prospectus must be deposited with the Registrar of the Issues minimum 21
days before opening of the Public Issue.
(b) A minimum amount of application money should be collected along with
the application. This rule is not applicable for institutional investors. As per
Company Law, minimum amount is 5% of Issue Price while SEBI has
stipulated minimum 25% of Issue Price.
(c) Application Money to be kept in a separate account in a scheduled
bank. Money so collected as application money for allotment of shares
must be kept in a separate account in a scheduled bank and can not be
withdrawn unless the entire process of allotment of shares and dispatch of
refund cheques is completed.
(d) For any Public Issue to be declared successful, it is mandatory that
minimum 90% subscription is received (inclusive of Underwriter’s purchase). In
case 90% subscription is not received, no shares can be issued and all the
money has to be returned to the applicants. SEBI regulations stipulate that
any money due for refund should be refunded to the applicants within 8 days
of becoming payable failing which, interest @ 15% pa is payable. In case of
Raymonds Synthetics Ltd, the delay was claimed to be caused by fire in
which all the refund cheques got burnt and thus had to be reprinted.
However, court refused to give any relief on interest payment on this count
and ordered payment of interest at prevailing penal rate. The money
becomes payable in case of Underwritten issue on 61st day of closure of
issue as per SEBI rules and 121st day as per CLB, and immediately in case
the issue is not underwritten.
(e) Opening of Subscription List – A issue should remain open for public to
apply as follows: -
(aa) CLB – Minimum 5 days without any upper limit.
(ab) SEBI – Minimum 3 days and max 10 days.
(ac) The combined effect of the two regulations is minimum 5 days and
max 10 days.
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(f) Permission of Stock Exchange – Permission to list in Regional Stock
Exchange of the area where Company’s head office is located is mandatory.
In addition, the company can opt to list its shares in any number of stock
exchanges across the country. However, permission for listing from all the
stock exchanges applied is essential for issue to be successful. In case, even
one Stock Exchange of all the stock exchanges applied-in rejects the
application for registration, the issue will be unsuccessful and money of all
the applicants would have to be returned irrespective of subscription status.
(g) Basis of Allotment (In case of over subscription) – Of late, issues are
coming with Book Building Procedure where in allotment is normally done
on pro-rata/proportionate basis. Earlier, lottery system was used.
(h) Retention of Oversubscription – Retention of oversubscription has not
been allowed by SEBI. However, up to 10% retention is allowed to cater for
proportionate allotment. In case of book building issue, 15% is allowed as
Green Shoe Option for stabilization of share prices.
(i) Consideration – Cash. Company Law permits other modes of
consideration as well such as allotment of shares against purchase of
equipment. Allotment of shares against debt is treated as equivalent of cash.
Other than cash, shares can be traded for property, goods, etc.
(j) On allotment of shares, “Return of allotment” is to be filed on separate
forms for cash and kind with copy of agreement.
3. Issue of Shares at a Premium
SEBI has allowed companies to issue shares even at IPO stage for any premium.
(TCS IPO share with face value of Re 1 was issued at a premium of Rs 849) but the
premium is to be justified in the prospectus.
Premium on shares is not profit. This money can not be distributed among Shareholders. It
is to be kept in Securities Premium Reserve.
The money realized through premium on shares can be utilized for following purposes: -
(a) Issue of Bonus Shares
(b) Write off preliminary expenses, issue expenses, discount on issue of shares
(Amortisation) (Infosys IPO shares in 1991 were issued at discount).
(c) Paying premium on redemption of preference shares.
(d) Shares buy back.
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4. Issue of Shares at a Discount
(a) First issue (IPO may not be first issue. Shares may have already been
allotted on Pvt Placement basis) has to be at premium or par.
(b) A period of one year must have elapsed from commencement of business.
(c) Should pass a resolution in General Body Meeting and approval obtained
from Central Govt.
(d) Ordinarily discount can be allowed up to 10%. However, Central Govt has
discretionary powers to increase the discount.
(e) Issue of shares should be done within 2 months of resolution passing.
5. Issue of Sweat Equity
How is sweat equity different from ESOP? Sweat Equity is issued to employees in
appreciation of their past contribution to the company. Such equity has no lock in period
and employee can leave the company very next day of receiving the equity without any
prejudice to his entitlement. ESOP is actually used as a bait to retain the employees in the
company. Employee is given an option to purchase company’s share at a pre-fixed price,
normally at a discount to the current market price, which can be redeemed after a gap of
one year or more from the offer date. However, in case the employee leaves the company
in the interim, he loses his claim on ESOP.
As per Companies’ Act for Listed Companies –
(a) Sweat equity shares should be of a class already issued.
(b) Sweat Equity can not be issued before company has completed at least one
year in the business (to be reckoned from the date of commencement).
(c) Company should pass special resolution giving details.
SEBI’s Regulations –
(a) Issue of Sweat Equity to promoters (major Shareholders) –
(i) Company should pass ordinary resolution.
(ii) Voting is to be done through postal ballot. (Postal ballot is more
participative than physical ballot in AGM where only few participate).
(iii) Beneficiary Promoters can not take part in the voting.
(b) Pricing of the Issue – Sweat Equity can be given completely free or at a
discounted price.
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(i) In case the equity is being given for a price, lowest price to be
charged is higher of either - Avg of weekly High/Low for last six
months, or – Avg of weekly High/Lows for last 2 weeks. The data to
be used for this purposes is of 30 days prior to conduct of AGM.
(ii) Valuation – If given free then Merchant Banker would assess the
know how/intellectual capital contributed.
(iii) Sweat Equity has a lock-in period of 3 years.
(iv) Listing of Sweat Equity is allowed only if all the regulations of SEBI
have been followed.
(c) Sweat Equity to Full Time Directors – If they have generated any know
how which can be taken to Balance Sheet, then it is not counted towards
their remuneration. Else, cost of such equity would be counted within limit
of 11% of profits on Directors’ remuneration.
(d) In case sweat equity is issued without any tangible assets being generated
which can be taken to Balance Sheet, then the cost of equity is taken to
Profit and Loss A/c.
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Date: 10 Feb 2006
ESOP & ESPS
What is the difference between ESOS and ESPS?
ESOS – Employee Stock Option Scheme – ESOS evolved as a form of incentive for
employee retention as well as to motivate them to work towards maximizing shareholders’
value. Employees are offered a specified number of shares at a fixed price which may be at
a discount to the prevailing market. He has one year (minimum statutory time for ESOS) or more
(as decided by the company) to convey his acceptance of the offer. Once accepted, he can pay
the money and purchase those shares at offer price. In case the employee leaves the
company before acceptance of the ESOS, he loses his right to purchase those shares. Thus,
it is a bait for the employees to desist them from leaving company within short period.
Being owner/potential owner of the shares, it is in employees’ interest that company’s
shares perform well in the stock market to maximize their personal gains. Once the shares
are accepted, there is no lock-in period and can be sold immediately.
Eligibility –
(a) Employees and directors of the company, holding company and subsidiary
companies. However, as per SEBI guidelines, Promoters can not be allotted
ESOS. Further, any director who holds 10% or more shares directly or
through friends and family can not be offered ESOS.
(b) Company is required to form a compensation committee of which majority
of the members should be independent directors. This committee will decide
the terms and conditions of ESOS. Committee will ensure that all terms and
conditions of SEBI are complied with.
(c) The terms and conditions framed by the committee should then be approved
by shareholders through a special resolution.
(d) Vesting Period (interval between offer and acceptance date) can not be
reduced below one year. Committee may decide to increase though.
(e) Terms of allotment of ESOS can be altered at a later date if they are not
against the interest of the employee. Like offer price may be reduced in case
of drop in share price.
ESPS – While ESOS is an incentive to stay with the company and work towards
maximizing shareholders wealth, ESPS is a reward for good work. There is no vesting
period or acceptance involved in this case. However, unlike ESOS, there is a lock-in period
of one year in this case. Shares so allotted can not be traded in stock exchanged for one
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year. These shares can be awarded to employees either as part of the public issue or in a
separate issue for employees. Balance regulations are same as in case of ESOS.
Buy Back of Securities
When a company purchases its own shares and extinguishes the liability, it is called buy
back of securities. Buy Back of securities was not allowed for a long time and was
permitted only a few years back.
Source of Funds for Buy Back – Any single or combination of following funds can
be used to fund the buy back -
(a) Free Reserves
(b) Securities Premium Account
(c) Through fresh issue of securities (other than class of security being bought
back)
In case of use of Free Reserves, an amount equal to used for funding of Buy Back is
required to be transferred to Capital Redemption Reserves.
Rules –
(a) Buy back should be authorized by Articles of Association.
(b) If Buy Back is less than or equal to 10% of the outstanding securities, same
can be approved by passing a Board Resolution.
(c) In case buy back exceeds 10% but is less than or equal to 25%, a special
resolution is required to be passed by the shareholders.
(d) Buy back of more than 25% of the outstanding shares in a year is not
allowed.
(e) Post buy back, Debt Equity Ratio should be less than or equal to 2.
(f) Partly paid up shares can not be bought back.
(g) In case of special resolution, Shareholders are to be notified through a
declaration or disclosure, the intent and purpose of buy back.
(h) Buy back of shares results in reduced capital as well as reduced liquidity and
therefore can be detrimental towards fulfilling liabilities of the company.
Therefore, a declaration of solvency is to be made to the Registrar of the
companies showing how debtors’ interests are going to be safeguarded.
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(i) All shares bought back should be physically destroyed (in case of physical
shares) within 7 days of Buy Back.
(j) Once a particular security has been bought back, same class of security can
not be reissued within 6 months.
(k) Advertisement regarding Buy Back should be placed at least in two news
papers, one local vernacular and other English along with Record Dates of
Buy Back. (Only Shareholders as on record date are eligible to sell shares
back to the company).
(l) Shareholders should be given 21 days’ notice.
(m) A register of details regarding buy back like person, quantity, date, rate, etc
should be maintained.
(n) Return regarding buy back should be submitted to the Registrar.
Methods
1. By inviting tender from Shareholders.
2. Purchase from Stock Market
(a) Company should announce the period of Buy Back from open market.
(b) The period can not be less than 15 days and can not be more than 30 days.
Company should disclose price and number of shares bought back on daily
basis (It is not specified as to whom declaration is to be made).
(c) Shares can not be bought back from the promoter group.
(d) Promoters should declare their holding of securities pre and post Buy Back
period.
(e) During Buy Back period, company can not issue further shares.
3. Book Building Route
Restrictions
1. Can not buy through subsidiary companies
2. Can not buy through investment companies.
3. Companies having defaulted in payment of principal or interest of public deposit
are not allowed to buy back.
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4. Any company defaulting on any other provision of Companies’ Act is not allowed.
Reduction of Share Capital (Old Provision)
This is the alternate route for Buy Back of shares. Before provisions for Buy Back were
introduced few years back, this was the only route available for Buy Back of shares. As per
court judgment, Buy Back and Reduction of Share Capital are parallel routes and company
can choose either route.
In case of Reduction of Share Capital, a special resolution should be passed by
shareholders which should be approved by Company court. This was the route utilized by
Sterlite Industries.
Various methods used for reduction of share capital are –
1. Writing off of uncalled money in case of partly paid shares. In such cases, the face
value of share reduces by the uncalled amount.
2. Return of excess money (Capital)
3. Return excess capital with call option.
4. Combination of above options.
Procedure –
Special resolution has to be passed and then approved by the company court. In order to
approve the resolution, court requires:
(a) Advertisement in two News Papers regarding reduction of capital specifying
the method.
(b) Court will invite objections and decide on the objections on the merit.
(c) Court gives the company following options regarding the objections
received from creditors –
(i) Negotiate with creditors
(ii) Settle their dues
(iii) In case above two options are not possible, then company has to
satisfy the court as to how creditors’ interest are going to be
safeguarded.
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Rights Issue – In case of fresh issue, the Shareholders enjoy two rights: -
(a) Right of Pre-emption – Existing shareholders have the first right over the
fresh issue of shares.
(b) Right to renounce the right to some other person.
(c) Advertisement in news paper.
Exemptions –
(a) If an issue is floated within 2 years of incorporation or within one year of
first allotment, then Rights Issue is not necessary.
(b) Special Resolution is passed by the shareholders relinquishing rights issue.
There are SEBI regulations also governing Rights Issue but they are applicable only
for listed companies.
In case Issue size is Rs 50 Cr or more, a merchant banker has to be appointed.
In case of Rights Issue, request for allotment of shares once made can not be
withdrawn.
Issue of Bonus Shares
Issue of Bonus shares can be funded out of free reserves or share premium account. Bonus
shares should be fully paid up shares.
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Membership of a Company
Generally all Shareholders are members. But there are exceptions when this may not be
true.
1. There may be a company where share capital may not be there, like a company
limited by Guarantee. In such companies, Guarantors are the members.
2. If a shareholder sells all his shares and the new shareholder has not got himself
registered with the company as the new shareholder.
3. A person who died is not a member but continues to remain shareholders till his
heirs get the shares transferred to their names.
4. In case of insolvency, Receiver becomes the shareholder but not the member.
A person can become member by –
1. Subscription to Memorandum of Association. People who signed the MOA are
members of the company even though they may not be holding any shares.
2. By applying in writing. Company may accept application by way of allotting fresh
shares or transfer of shares.
(Company has to maintain register of members in case of physical shares. All persons listed
in the register are members. However, in case of DEMAT shares only depository participant’s name
is there. The list of Beneficial Owners of shares is held by the Depository Participant).
Who can be a member?
1. A minor can not be member because he can not be party to a contract as per our
law. All members are party to the contract in the form of Articles of Association
(AOA).
2. Partnership firms can not be members because they are not legal entities.
3. Foreigners can become members.
4. Societies, registered under Societies Registration Act can become members.
Rights and Liabilities of Members
We have discussed the rights, individual as well as collective, in lecture notes dated 27 Jan
06 on page 9. Liabilities are as under:
1. In case of partly paid up shares, balance amount is to be paid up when called.
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2. Liability is unlimited in case it is discovered during winding up of the company that
shareholder had indulged in fraudulent acts causing losses to the company.
3. Liability is also unlimited in case all of the following three conditions are satisfied:
(a) Membership of the company falls below the statutory minimum.
(b) The member was aware of the membership having fallen below minimum.
(c) Company continues to operate with deficient membership for over six
months
Contributory Clause
Instances came to light where-in owners of partly paid shares, having got information about
impending insolvency of the company, transferred the shares in the name of their domestic
help or relatives who had no assets. Thus, they escaped paying up balance money. In order
to plug this loophole, contributory clause was incorporated in the regulations. Thus, if a
company is liquidated within 12 months of a person ceasing to be member and new
member not being able to fulfil the claim, then the previous owner of such shares is liable
to pay.
Joint Ownership
1. In case of joint ownership of shares, there can not be more than three joint holders
and the three would be counted as single member (single vote)
2. In case of transfers of shares, all joint owners should sign the document.
3. Any notice would be sent to only the first named person.
4. Joint members are liable jointly and severally. It means they can be asked to pay to
fulfil liability against shares as a group or individually without proportionate
division of liability.
Can a company expel a member?
No. Any company can not expel any member under any count. This permission has not
been given else it can be misused to eject vocal minority shareholder. But a member can
surrender his shares and cease to be member.
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Date: 24 Feb 2006
Corporate Borrowings
Contrary to popular notion and belief, companies in general do not have implicit power to
borrow money. Only Trading companies have implicit power to borrow money. Other
companies in order to be able to borrow money, from any source, have to have explicit
powers vested through MOA.
If MOA gives the power to borrow money, there is no cap on borrowing unless the MOA
itself imposes restriction of maximum borrowings.
Any borrowings without explicit authority vested by the MOA or in excess of limits
imposed by the MOA are Ultra Vires borrowings and company has no liability to pay the
same to the lender. Company in this case is protected through the Principle of Constructive
Notice. Thus, before giving loan to any company, the lender is required to examine the
MOA with regard to powers vested by it in the company to borrow and amount of
borrowings. It also needs to examine the extent of earlier borrowing before sanctioning any
loan.
Though company in general is not responsible to pay back the Ultra Vires Loan given to it
by the lender, all is not lost for the lender. He has a few legal remedies available to him.
These are: -
(a) Injunctions
(b) Subrogation
(c) Tracing Order
(d) Suit against the directors
Injunction – If the money is still not used, the lender can approach a court to issue
Injunction against use of lent money to the company. Lender can request that the account in
which money has been kept may be frozen for operations.
Subrogation – Even if the money has already been used but it can be traced to any asset,
say a building, plant or machinery, which was purchased through borrowed money, court
can be requested to hand over the ownership of that asset to the lender.
Tracing Order – If money can be traced, it can be ordered to be refunded back. Suppose
Co. “A” borrows money from one bank to clear loan of other bank, other bank can be made
to refund this money to original bank.
Suit Against Directors - In case of Ultra Vires borrowings, the directors are responsible. It
is not necessary that only the directors who have signed the loan documents or have
approached and negotiated the loan from the agency are responsible. If it was a Board
meeting which authorized the loan, all personnel associated with entire exercise are
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responsible. Thus, suit can be filed individually against all the directors but not against the
Board of Directors.
Powers of Directors to Borrow Money – Once authorized and unless capped,
directors have powers to borrow money to a limit of - 100% of paid up capital + free
reserves. Company can increase Directors’ powers to borrow money by passing a special
resolution.
If directors exceed the cap on borrowing but not the power of the company to borrow, then
company can ratify the borrowing provided the money was used for benefit of the
company. In case the company decides not to ratify the excess borrowing, the lender can
take recourse to Principle of Indoor Management.
Creating a Charge
Most of the borrowers would demand a security against the amount they are lending. Thus,
company would have to mortgage some asset of the company to the lender called collateral
security. This process of mortgaging or providing collateral security is called “Creating a
Charge on Assets of the Company”.
Charges are of two types: -
(a) Fixed Charge – Company can not sell that asset. Such asset is called
encumbered. It can only be sold with prior permission of the lender who
may enter into some understanding with the buyer before granting
permission to sell.
(b) Floating Charge – Company may offer its current assets such as stock,
inventory, etc, as charge. Such assets are not encumbered. It is a charge on a
Class of Assets. Company is free to use the stock and trade in inventory.
Crystallisation of Floating Charges: -
This is a point of time when floating assets will get converted to fixed
Charge. It happens when company goes for liquidation or when company ceases to
carry on business or whenever lender decides to do so or as mutually agreed by the
parties (Terms of contract).
Registration of Charges: -
Any charge whenever created on the assets of the company is to be recorded
in company’s register and also registered in the office of the Registrar of the
Companies.
By Whom and When– Ideally, it should be done by borrowing Company within 30
days of creating the charge. However, it can also be done by lender.
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What is the benefit of Registration and what are the consequences
if not done?
Registration of charge makes the asset encumbered in the knowledge of the
whole world and the debtor company can not create another charge on it because
charge documents are open public documents accessible to every one. The loan
forwarded against such charge becomes a secured loan to the extent of value of the
charge. In case of non-registration of charge, such loan will be treated as an
unsecured loan and in case of liquidation of the company will have lower priority
for repayment.
In case the borrowing company fails to register the charge with Registrar of
the Companies, the loan becomes payable immediately irrespective of the terms of
contract and lender can demand repayment immediately.
Whenever, charge is modified due to say, part payment of loan, it is also to
be registered with ROC. Similarly, when the charge is completely freed/satisfied,
similar registration is done.
Debentures
Debenture is document that either creates or acknowledges debt.
There are two kinds of debenture holders:
(a) Senior Debenture Holders – The people who had invested first in the
debenture (Earlier issues only. Subscribers to the same issue are at par) have priority
for payment. In case of liquidation of the company, these holders will get
priority for payment of their dues over other debenture holders.
(b) Subordinate Debenture Holders – These debenture holders have
comparatively lower priority for payment.
Pari-Passu – When a company declares a debenture issue to be Pari-Passu, it means that
company has extinguished the distinction between the Senior Debenture Holders and
current issue subscribers. The subscribers of this issue will be treated at par with Senior
Debenture Holders for payment of their debenture owings. Once an issue is declared as
Pari-Passu, the charge created on assets earlier in favour of Senior Debenture Holders is
then registered in favour of all including the new subscribers.
Convertible Debentures at discount – Not allowed. Company is free to issue a debenture
at par, discount or premium. Company law places no restrictions in this regard. However,
courts have raised objections to issue of “Convertible Debentures” at discount since this
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can be used as escape route to issue shares at a discount greater than otherwise allowed by
law.
Debenture Trustee - On issue of a Debenture series, a trust is created and some one is
appointed as Debenture Trustee. A debenture trustee looks after the interest of debenture
holders. Debenture Trustee is to be declared in the offer documents.
Qualifications for a Debenture Trustee
1. He should not be a beneficial share holder which means that not only he should
not be holding any shares directly but also not through family and friends.
2. He should have no relationship with company
3. He should not have guaranteed any loan taken by the company.
The company is legally bound to insure and maintain the “charge” in good condition.
Trustee is to ensure that the charge is well maintained and insured. A legal mortgage is
created in favour of debenture holders. Trustee is supposed to ensure that company meets
all the terms of debenture issue. In case of any default, action is taken against the
Debenture Trustee.
Rights of Debenture Holders
1. Unsecured Debenture Holders – They have no special rights except the normal
claim on residual worth of company after all secured lenders have been satisfied.
2. Secured Debenture Holders –
(a) They can sell assets on charge.
(b) They can opt for foreclosure. In such a case, either the company pays the
money or the asset on “Charge” becomes the property of the debenture
holders which they can sell and recover their dues.
Above rules are applicable to every debenture issue, whether through public offer or
private placement basis. However, there are additional rules in the form of SEBI
guidelines in case of public offer of debentures:
1. Purpose – Company enjoys full freedom for use of Debenture money. However,
debenture money can not be used to buy shares in any company.
2. Eligibility of Company –
(a) Every Public Issue of Debentures is to be rated at least by two Credit ratings
agencies. Company is free to obtain as many credit ratings as it wishes.
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However, once a rating is obtained, company is obliged to make the rating
public. It can not choose as to which ratings it wants to make public.
(b) Company should not have been blacklisted by RBI.
(c) Company should not have defaulted in meeting any debenture obligation
(payment of interest or principal) in the last 6 months.
(d) Number of allottees should be greater than 50.
3. Disclosure norms and documents – Rules are similar to equity issue.
4. Debenture Trusty should
(a) Monitor progress of the project for which the money was raised as per the
prospectus/offer document.
(b) Monitor utilization of money that it is not being used for said purpose.
5. Debenture Redemption Reserves – Every company raising money through
debentures is required to create Debenture Redemption Reserve where part of the
profits are deposited every year to enable company to have adequate fund to meet
the payment obligation at the end of period.
6. Payment of Dividends – Dividends can be declared only after the minimum
amount has been credited into DRR. In any case, any dividend greater than 20%
should be approved by the debenture holders.
7. Conversion of Debentures into Shares – Conversion is always optional. It can not
be made compulsory.
8. Roll Over of Debentures –
Non Convertible Portion –
(a) Postponing of payment date is called Roll Over.
(b) Postponing is possible only after a resolution to the effect is passed by
minimum 75% of debenture holders through a special resolution held by
postal ballot. In case the resolution is approved, the dissenting debenture
holders should be paid over and others’ debentures can be rolled over.
(c) In case of roll over, the process is almost like issuing fresh debenture series.
Convertible Portion - Convertible portion of the debenture can be rolled over only
on receiving a positive confirmation from Debenture Holders. Non-response can not
be taken as acceptance. Clauses like “If no response is received within “X” days, it
would be construed that you have no objection to “YYYY”, are invalid in this case.
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Corporate Investments
When a company buys shares or debentures of other companies, it is called corporate
investments. Excess cash in company is often deployed in securities.
Regulations –
1. All such investments should be held in the company’s name with certain
exceptions.
Exceptions –
(a) In case of large investments, company may be eligible to nominate a
director. Other company may have clause regarding qualification shares for
directors. In such cases, nominated directors can hold minimum
qualification shares in his name to meet the legal obligations.
(b) In case of 100% subsidiary companies, parent company is the only share
holder. However, no company can be formed with only one person holding
all the shares. Minimum 2 persons for a Pvt Ltd Company and 7 persons for
a public limited company are essential. Thus to meet this legal requirement,
companies can hold shares in name of other persons.
(c) A separate register should be maintained by company of shares not held in
its own name.
Finance, Investment and banking companies are exempted from this clause of
holding all shares in company’s name due to nature of their business.
How much money can be invested as corporate investments or provided
as loans or worth of guarantees?
Corporate Investment is capped at 60% of paid-up capital plus free reserves or 100% of
free reserves which ever is higher. This cap is for cumulative investment in all three modes,
past and present. This ceiling is FIXED and can not be increased by any means like passing
a special resolution.
In case of guarantees, this limit can be exceeded by passing a Board Resolution which
would clearly state the emergency under which such action was taken. Further, such action
should be subsequently ratified by the General Body meeting.
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Date: 28 Feb 2006
Company Management
Directors
Term “Director” has not been clearly defined in the Companies Act. It merely states that
people occupying the position of a director by what ever name called.
So, duly appointed members of Board which has been given powers to control the company
and authorized by AOA to enter into contracts in the company’s name, are called directors,
even though they may be called by different names, like governors, members of governing
council, etc, and not necessary as directors. On the other hand there could be some people
appointed as directors, like marketing director, but not acting as director, are not directors.
Thus, Director is defined more by the responsibilities entrusted by the company in a person
and not by designation conferred on him.
Deemed or Shadow Director – Deemed or Shadow director is defined as a person who is
not in the Board of directors but whose directions or instructions the Board of Directors is
accustomed to follow. This provision is not a beneficial but penal provision. A deemed
director is not entitled to any perks and benefits but would be held by law for any wrong
doings.
While it is necessary for a director to be an individual, there is no such limitation in case of
Deemed or Shadow directors. A shadow director can be a body corporate also.
There is no concept of Chairman of Company. There is Chairman of Board of Directors
who is often called Chairman of Company which is legally not correct. As Chairman, he
has no powers. Chairman cum Managing Director concept has come in for criticism from
Corporate Governance since the two posts should be held by separate persons.
Who may be appointed as Directors?
Only individuals can be appointed as Directors. So a body corporate, association or firm
can not be appointed as Director.
Exception – Deemed or Shadow Director can be a body corporate.
What are the qualifications for appointment as Director?
No academic or professional qualifications have been laid down in Companies Act for a
person to qualify for Directorship. He need not be even member or shareholder of the
company. Articles of Association some times may provide for holding of qualification
shares. However, AOA can not stipulate holding of more than Rs 5000 worth of nominal
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value of shares or one share where Face Value of shares is higher than Rs 5000/-. In such a
case he has to obtain the shares within 2 months of his appointment.
Disqualifications – Following persons shall not be capable of appointment as directors
of any company: -
1. A person is declared to be of unsound mind by a court.
2. A person who is an un-discharged insolvent (Any insolvency is for a limited period only and
in this period he is called un-discharged insolvent).or
3. A person who has applied for insolvency.
4. A person convicted of moral turpitude and jailed for 6 months or more, is debarred
for 5 years from the date of expiry of sentence.
5. If a person has failed to pay the call money (on partly paid shares) and six months
have elapsed from the last due date of payment.
6. If a person has been debarred by any court for any economic offence.
7. Directors of a company
(a) which has failed to file Annual Returns to Registrar of Companies
continuously for three years. All the directors of such company are
disqualified to hold any directorship in any company.
(b) which has defaulted in payment of interest and principal of public deposits,
or defaulted in redemption of its shares on due date and such default
continues for one year or more. Such directors would not be eligible to be
appointed as director of any company for 5 years.
Above debarring provisions don’t apply to Directors nominated by the Govt. and Financial
Institutions.
Appointment of Directors
1. First Directors – First Directors are named in the AOA. In case, the directors are
not named in the AOA, all the individual subscribers (not the body corporates) of
AOA are deemed to be directors. In the hypothetical case of all the members being
body corporates and no directors named in the AOA, the company will have no
directors to begin with.
2. In a Public Ltd Co. two thirds of total directors are elected by the AGM and will
retire by rotation at the rate of one third of number of elected directors every year.
(Thus, tenure of each elected director is three years). Retiring directors can be re-elected if
needed.
3. Balance 1/3rd
are permanent directors and named in the AOA. Nominee Directors of
other major stake holders in the company are part of this group of permanent
directors.
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4. Minimum and Maximum No. of Directors – As per Companies Act, a Pvt Ltd
company has to have minimum 2 directors and a Public Ltd Company 3 directors.
However, there is no ceiling on maximum number of directors. It is left to
individual company to decide.
5. Govt Appointed Directors are over and above the decided size of the Board and
do not retire.
6. Election of Directors by Passing Resolution - A separate resolution is to be
passed for election of each director. Two or more directors can not be elected
through a single resolution.
7. Reappointment of Directors – A retiring director is deemed to be reappointed if
the position is not filled during the AGM and no resolution is passed specifically
stating that the position is to be kept vacant or a particular person is not to be re-
elected.
Directors are elected during AGM and retire during AGM. But what would happen
in case the retiring directors in cahoots with other directors and delay the AGM
itself to prolong their tenure?
Court has directed that in case the AGM is delayed, the directors due to retire
during the particular AGM will retire on the last day of the month in which AGM
was falling due.
All the above provisions are applicable to Public Ltd Cos. Pvt Ltd Cos are free to
frame their own rules through AOA. However, in case AOA has not framed any
rules regarding directors, these rules will apply to them also.
8. Appointment of Directors by Board of Directors – Board of Directors can
appoint directors under following situations: -
(a) Additional Directors – Additional directors, like specialists in the field, can
be appointed by Board of Directors. Their term will end on the day of next
AGM.
(b) Alternate Director – If a director is out of state in which Registered Office
of the Company is located for 3 months or more, Board of Directors can
appoint alternate director. The term of such appointment will terminate on
the day original director steps back in the state. This rule is often applied in
case of foreign directors who visit the company only once or twice a year.
(c) Casual Vacancies – Since a director can be elected only by AGM,
vacancies between AGMs arising due to death, insolvency or any other
disqualification, can be filled by the Board of Directors. Such appointments
will terminate on the day of AGM unless elected by AGM.
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(d) Appointment by Central Govt – Central Govt can appoint any number of
directors on the Board of any company in specific situations like
mismanagement of company, oppression of minority shareholders, etc.
However, such appointments are not commonplace and rarely done.
9. Nominee Directors – As per the companies Act, a director is a director and nothing
else. It does not differentiate between an elected or nominated or permanent
director. A nominee director is an internal understanding between the company and
the nominating entity. He is part of the 1/3rd
group of permanent directors. Thus,
functionally there is no distinction between nominee and other directors.
10. Small Shareholders’ Directors – Appointment of small shareholders’ director is
done in companies in case
(a) It is a Public Ltd Company, or
(b) Paid up capital of company is > 5 Cr, or
(c) There are more than 1000 small Shareholders (small shareholder is defined as
some one owning shares of Face Value not exceeding Rs 20,000).
Small Shareholders’ Director is elected by small shareholders themselves. In case
of listed company, election is done by postal ballot so that maximum number of
shareholders can participate.
11. Legal Position of a Director.
(a) As Agent of the Company – Since directors act on behalf of company on
all matters except those specifically reserved for company (read
shareholders) to act, they are agents of company. However, company, in any
manner, including through AGM, can not direct the directors to take any
particular decision. If the company is not happy with directors’ decisions, it
can change the directors during AGM or by calling EGM.
(b) Trustee of Company’s Shareholders – Directors are trustees for assets and
properties of the company. They have fiduciary relationship with company
which means that they should exhibit same amount of diligence in
company’s matters as they would do for their personal matters.
(c) Managing Partner – They are not exactly managing partner but to some
extent , Yes.
(d) Employees – Directors are normally not employees of the company but not
necessarily. There are executive directors who are employees of the
company.
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12. Powers of Directors – Directors don’t enjoy any significant power individually.
All the powers of directors have been vested with Board of which Directors are
members. Thus, power is available on collective basis and not individually.
Directors have right to inspect the books of account. Or, in case they are
incapacitated for any reason, they can also appoint someone else to inspect the books on
their behalf.
Directors also enjoy residual powers. There are certain powers explicitly given to
shareholders and Board of Directors. Residual powers, which are not conferred on any one,
rest with directors.
Can shareholders interfere with powers of directors?
Answer is NO. Else, there will always be some investors who will feel aggrieved by
Board’s decision. Their interference will severely inhibit functional capacity of the Board
of Directors. However, shareholders can interfere with Board’s power under following
situations –
(a) In case of malafide action by the Board members.
(b) If directors are wrong doers.
(c) In case of incompetence. This incompetence is not functional incompetence.
This is about legal incompetence, like in case of award of any contract, all
the directors have stake in the contract. Thus, they are not considered to be
competent enough to take a decision in the matter.
(d) Deadlock in Board. Suppose the Board of directors is divided into two
groups of exactly equal strength and thus the majority is not available for
taking any decision. There is a deadlock as each group objects to other
group’s proposal and their strength being equal, no proposal gets majority
support.
How does the Board exercise its powers?
Board exercises its powers by two methods: -
(a) By holding the Board’s meeting. Such meeting are supposed to be
conducted at least once in every quarter.
(b) Passing a resolution by Circulation. Draft proposal is circulated to all
members on a file and they give their comments/support or otherwise.
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Date: 06 Mar 2006
Occupation of Office or Place of Profit
A director, executive or independent, can not occupy any other office of profit in the same
company or any of its subsidiary companies.
Exemptions
(a) He can occupy any other office of profit if it is approved through a special
resolution by the shareholders.
(b) His relatives; partnership firm of which he is a partner; or a private firm of
which he is a member, can not get any office of profit in the same company
where he is a director. However, if the remuneration is less than Rs 10000
per month, it can be authorised by the special resolution.
(c) If remuneration is >10000 but <50000 per month, then, in addition to special
resolution, approval of Central Govt is also required.
(d) Provisions at (b) and (c) above are not applicable if the person under
consideration was already in employment with the company when the
director was appointed.
Who all are included in the relatives?
There is no ambiguity as who are to be treated as relatives. The list of people who are
considered to be relative for this Act is listed in a separate Schedule in Companies Act.
Duties of a Director
1. Fiduciary Duties (matters of confidence, trust, faith) – These are the duties which
are not explicitly defined. These are the kind of ones which a person of normal
conscience is expected to do.
(a) Good Faith
(i) Corporate Opportunities – A director is expected and enjoined to
exploit the opportunities of profit making for the company and not
his own. Courts have been very strict in this case. They have held
that even if a company decides not to exploit an opportunity of profit
making, a director still can not take up that opportunity for own
profit. This is done to ensure that directors don’t forego the
opportunities deliberately to profit themselves from them.
(ii) Not to Make Secret Profits – While Directors are allowed to make
profits by declaring the relevant facts of any transactions before the
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Board of Directors and with their consent, secret profits are not
allowed. Any secret profit, when discovered, can be recovered from
the director.
(b) Duty of Care – Directors are expected to exercise as much care and
diligence in matters of company as they would exercise in personal matters.
(c) Duty Not to Delegate – A director is chosen on the basis of his credentials
and the faith the company reposes in them. If he delegates his job to some
one else, entire exercise of selection of director by the company becomes
null and void. However, Companies Act permits some amount of delegation
by directors which should not be exceeded.
2. Statutory Duties – The list of such duties is long. Some of the most important one
are given here.
(a) Duty to Attend Meetings of Board of Directors
(b) Appoint the First Auditors – Auditors are generally appointed by the
General Body. However, appointment of auditors for the period preceding
the first General Body Meeting is done by the Directors. Cost auditors are
always appointed by the Directors and not the General Body.
(c) Report of Board of Director – The report on functioning of the company
presented at the Annual General Meeting is to be prepared by the Board of
Directors.
(d) Duty to Declare Interest – Every Director is required to declare his interest
(financial involvement) in any matter, like finalising award of a contract,
under consideration of the Board of Directors and not to participate or vote
on such issues.
Liabilities of Directors
1. Liability to the Company
(a) Breach of fiduciary duties
(b) Ultra Vires Acts
(c) Negligence
(d) Malafide Acts
2. Liability to Outsiders
(a) Prospectus
(b) Allotment
(c) Unlimited Liability
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3. Breach of Statutory Duties
4. Criminal Liabilities
5. Liability for acts of co-directors.
Liability to Company – In case of most of liabilities like breach of fiduciary duties or
Ultra Vires Acts or Malafide acts, company can recover the costs from the directors. But
who can file a case against the directors on behalf of company, when they themselves are
the sole authority to approach courts on behalf of company; and shareholders are expressly
prohibited from filing law suits on behalf of company?
Such situations are exceptions when shareholders can approach court with prayer to be
allowed to file law suit against director. However, in cases of successful appeal, the
damages awarded by the court will go to the company and plaintiffs will get nothing for
fighting the case.
Liability to Outsiders – Directors are personally responsible in case of any mis-
information contained in the prospectus of company or delay in allotment of shares or
refund of balance application money. In case of delay beyond statutory period attracting
interest, directors can be asked to pay interest to applicants. Offence like mis-statement in
prospectus invite a penalty of up to 2 years imprisonment and false Directors’ report can
lead to 6 months imprisonment. Even bouncing of cheques can lead to jail.
But such harsh punishments are applicable only when the error is of commission
(deliberate) and not of omission (innocent mistake). If a cheque was issued when the
director was fully aware about inadequacy of funds in the account, it will invite jail term.
It is to be noted here that while criminal cases are decided on the basis of incontrovertible
(undeniable) evidence, civil cases are decided on the balance of probabilities. Most of the
director’s responsibilities and duties fall under civil offence.
Directors’ liability can be increased to unlimited amount but only with the consent of that
director.
Relief to Directors by Courts
(a) Courts have discretionary powers in matters of punishment.
(b) Courts can grant relief it is proved that Directors acted honestly and fairly
under the prevailing circumstances.
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Managing Director
Managing Director is defined as a person (necessarily one of the directors) who has been
conferred with substantial powers of management which are not otherwise exercisable by
him as director.
He is the only director who has individual powers of management. Rest of the directors
have only collective powers of management. They can take any decision as Board of
Directors but nothing in individual capacity of director. Board of Directors decides the
exact powers conferred on the Managing Director.
While private limited companies have no compulsion to appoint a Managing Director,
Public Ltd Cos with paid up capital of Rs 5 Cr or more have to have a Managing Director.
Mode of Appointment
A Managing Director can be appointed either by Company’s resolution or Board of
Directors resolution, or MOA or AOA provided it is approved by Central Govt.
With more than 5000 companies listed on stock exchanges, and many more elsewhere, it
would be a Herculean task to accord approval for appointment of each Managing Director.
Therefore, Schedule XIII of the Companies Act was incorporated. If an appointment
complies with terms of this schedule, no approval of Central Govt is required.
Disqualification
1. Absolute – No waiver even by Govt can be accorded against disqualification under
these clauses. That is why they are called “Absolute” clauses.
(a) Insolvent – If a person was declared insolvent ever in the past, he is not
qualified to become Managing Director. (Please note that disqualification in case
of insolvency for Director is only for 5 years but here it is life-long).
(b) Settlement with Creditors – It is something like insolvency only. If a
person pleads his inability to pay back loans and negotiates concessions in
interest or principal amount repayment with his lender, such person is
disqualified from becoming Managing Director for his life time.
(c) Conviction for offence involving moral turpitude.
2. Can be Condoned by Central Govt
(a) Convicted for offences under corporate or tax laws.
(b) Detention under COFEPOSA (Conservation of Foreign Exchange and
Prevention of Smuggling Act, 1974). It was a draconian act under which a
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person could be detained for long periods without even being presented to a
judge or trial. Please note that only detention is condonable and not
conviction.
3. Condonation by Passing a Special Resolution – A Managing Director’s age
should be between 25 and 70. Company can condone this age limit (but not below 18,
else he would be a minor) by passing a special resolution.
Term of Managing Director – A Managing Director can be appointed for a max period
of 5 years. However, he is eligible for reappointment/election. But reappointment
resolution can be passed by the company only in the last two years of the running term and
not earlier than that.
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Manager
A manager is a person who under the superintendence, control and directions of Board of
Director has the whole or substantially whole of management of the company.
A company will have either the Manager or the Managing Director.
CEO is something like Manager. Primary difference between a Manager and a Managing
Director is that a Manager is not a director. The disqualification clauses are same for
Manager as that of Managing Director.
Managerial Remunerations – These rules apply to only Directors, MD and Managers and
no one else. These appointments are entitled to
(a) Periodic Payments
(b) Commission
(c) Perks
Sitting fees of directors is not included in Managerial Remuneration. But there is a cap of
Rs 20000/- per sitting. Directors per say do not have any right to get any remuneration.
Therefore, there should be a separate contract for remuneration.
Since the directors run the company and therefore can manipulate to get undue advantage
of the control they exercise on the company, there is a need to put limits on their
remunerations.
(a) Overall Limit - The maximum amount that can be paid to all the directors
can not exceed 11% of the profits of company in that year.
(b) For Executive Directors
(i) In case there is only one executive Director – max 5% of Net Profits
(ii) In case there is a group of Executive Directors – Max 10% of Net
Profits
(c) For Non Executive Directors
(i) Periodic Salary – Normally no salary is paid to non Executive
directors but same can be paid with prior approval of Central
Government.
(ii) Commission – Commission be authorised to them through a special
resolution.
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(iii) Payments to Non Executive Directors is restricted to 1% of NP in
case the company has an MD. In case of absence of MD, maximum
3% of NP can be paid to them.
Above conditions are applicable when a company generates enough profits. What happens
when the company is running into loss or just about in the black. (profits inadequate to pay
decent remuneration to directors). Again Schedule XIII comes to the rescue. Max payments
to each director are laid down based on effective capital of the company.
EFFECTIVE CAPITAL MAX MONTHLY REMUNERATION PER DIRECTOR
Less than 1 Cr Rs 75000
1 – 5 Cr Rs 100000
5-25 Cr Rs 125000
25-50 Cr Rs 150000
50 – 100 Cr Rs 175000
More than 100 Cr Rs 200000
Effective Capital does not include Revaluation reserves. Effective date for applicability of
capital is the last audited balance sheet. In case of a new set up company, where there is no
balance sheet available, Effective capital as on date of appointment of a new Director is
taken
Exceptions
Above limits can be doubled by passing a special resolution provided the company has not
defaulted in payment of interest or capital of public deposits.
Above limits are not applicable to units located in SEZ. Max salary of Rs 20 lacs can be
paid if public issue is not involved and company is not making any profits.
Companies can also pay extra for following to expatriates
(a) Allowance for Children education
(b) Holiday to home country with family.
(c) Leave travel concession.
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Date: 10 Mar 06
Board of Directors’ Report
Board of Directors’ Report is submitted in every Annual General Body Meeting.
Companies Act prescribes a format for same. Accordingly, a Board of Directors’ Report
should contain following details:
I
1. General
(a) State of Affairs – General details of the happening in the company are
included in this head.
(b) Transfer to Reserves – Amount proposed to be transferred to Reserves and
Surplus and normally justification for the same is also included under this
head.
(c) Dividend Recommended.
(d) Material Changes – Book Closure date is 31 Mar while it normally takes
up to 6 months to conduct Annual General Meeting. Some important
changes may have taken place in company in the intervening long duration.
Such changes are to be placed in the Board of Directors’ Report.
(e) Others
(i) Conservation of Foreign Exchange – Efforts taken by company to
conserve the foreign exchange are to be included in the report. This
Act was written in 1975 and therefore some of the archaic
regulations are still in place.
(ii) Technology Absorption – Report about how much of technology
absorption of the imported technology has been achieved. Again an
archaic regulation.
2. Significant Changes – The report has to include various significant changes taken
place at various levels: -
(a) Company
(b) Subsidiaries
(c) Industry
3. Employees – Report has to include details of employees who are drawing high
salaries for shareholders to know that largesses are not being showered on unworthy
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people as a favour. Thus, these details are to be included under following three
heads
(a) Annual Salary more than 24 lakhs
(b) Monthly Salary more than Rs 2 lakhs in case of employees who may not
have worked for full year.
(c) Other employees who are drawing salary more than Managing Director and
also hold 1% or more of the voting rights. In this case, there is no qualifying
amount of Rs 2 lakhs per month /Rs 24 lakhs per annum.
4. Director’s Responsibility Statement
5. Report on failure to buyback as to why did the buy back of securities attempt not
succeed.
6. Response to Auditors’ Objections – Most of the time, auditors pass the balance
sheet with some observation. Thus, clarifications to auditors’ observations are to be
included in the BoDs’ Report.
7. Composition of audit committee is to be declared in the documents.
II
SEBI Requirement – SEBI’s guide lines in this regard are not elaborate. As per SEBI,
BoDs’ Report should contain complete details about ESOPs and ESPS (Employees Stock
Option Plan and Employees Stock Purchase Scheme. Refer Page 21), like policy, basis for
allotment, number of stocks allotted, how many employees exercised the option, etc.
III
Listing Agreement – As per listing agreement, Clause 49, the BoDs’ report should include
(a) Management discussion and analysis
(b) Compliance Report on Corporate Governance – All the actions are to be
quantified as to how many meetings held, how many independent directors
are there on the board, etc.
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Board Meetings
Following are the important aspects of Board Meeting
1. Authority to Convene – Any meeting should be convened by a person who has the
authority, else meeting would be null and void. Any director is empowered to call
the meeting.
2. Notice – Nothing is specified in the Companies Act about notice period. It is also
silent about forwarding of agenda. Even though secretarial standards (Company
Secretary) state that agenda for the meeting should be issued, law does not make it
compulsory. Notice should be sent to all directors in India as per their available
address. In case of other directors notice can sent by any communication medium,
including email and post. There is no format, no duration, and no mode specified.
However, individually companies are allowed to include such details in the Articles
of Association.
3. Frequency – Board meetings should be held minimum once in every quarter (3
months) and minimum 4 times in a year. Initially there were no constraints about
interval between two meeting. Thus, if a meeting was held on 01 Jan of first quarter
and the second meeting was held on 30 Jun of second quarter, it was perfectly valid
because a meeting was held in every quarter. But the gap between meetings was
effectively 6 month. As per the latest amendment by SEBI, a stipulation regarding
gap between two meetings not exceeding 4 months has been introduced.
4. Quorum – Quorum for a Board meeting is 1/3rd
of Board strength or 2 directors,
whichever is more. But it does not include any INTERESTED directors. Another
important point to note is that in case of Board Meetings, quorum is required to be
present through out meeting unlike AGM where it was required only to commence
the meeting and thereafter its depletion had no bearing on validity of the decisions
taken during the meeting.
5. Attendance – If a director is absent from three consecutive meetings or three
months at a stretch without leave of absence from the Board, then he is
automatically unseated from the Board membership. Attendance is taken at every
Board meeting to comply with this provision.
6. Chairman – Chairman is usually named in the Articles of Association. Else, Board
members can elect their own chairman. Chairman is responsible for orderly conduct
of the meeting and is authorised to sign the minutes of meeting.
7. Minutes of the Meeting – Summary of meeting is to be accurately recorded in the
minutes of meetings. Chairman has discretion to remove any matter which he does
not deem fit. Minutes should be written in the Minutes Book within 30 days of the
meeting.
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Divisible Profits
Part of the net profits allowed to be distributed to shareholders is called divisible profits.
Entire net profits are often not allowed to be distributed among shareholders. Before profits
are distributed, company may have obligation to apportion part of profits to certain
reserves. Also, generally, only revenue profits are allowed to be distributed and capital
profits are not allowed. Thus, divisible profits are those which the company can finally
distribute to shareholders.
Divisible profits can come from any of the following sources: -
(a) Current Profits
(b) Reserves
(c) Money provided by the Govt.
Part of the profits are required to be compulsorily transferred to reserves as follows
Dividend Proposed
(of Face Value of Share)
Min Transfer to Free Reserves
(% of profits)
Less than 10% Nil
10 – 12.5% 2.5%
12.5 – 15% 5%
15 – 20% 7.5%
More than 20% 10%
In case a company wants to transfer more than 10% of profits to reserves, it has to maintain
dividend payout of previous years. The base for payout ratio is dependent upon whether
company had issued bonus shares in the previous year:
(a) If Bonus Shares Were Issued – Then the company has to maintain the
absolute amount (in Rupees terms) of payout (average of last 5 years
payout) as dividend. (If average payout over the last 5 years was Rs 2 per share, then
company has to pay minimum Rs 2 as dividend to shareholders before it can transfer more
than 10% into the reserves).
Exception – This condition may not be maintained in case the company’s
profits have fallen by 20% or more in this year.
(b) If No Bonus Shares Were Issued – Company has to maintain payout of
average of last 5 years in percentage terms. (If average payout was 8 % during past
5 years, and suppose company came up with a public issue in the past year instead of bonus
issue, it will have to first payout minimum 8% as dividend on enhanced capital before it can
transfer more than 10% into the reserves).
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Payment from Reserves – Even though dividend is mostly paid from current profits,
company can draw into the reserves to pay dividend in certain cases. However, certain
conditions have to be fulfilled:
(a) Max Payment – Max dividend payout will be lower of
(i) Average rate of dividend payment over last 5 years,
(ii) 10% dividend.
(b) Amount drawn can not exceed 10% of reserves.
(c) Balance of reserves should not fall below 15% of Paid-up Capital.
2. Dividend on Preference Shares – Preference shares are cumulative unless
expressly declared to be non-cumulative. But dividend on preference shares is payable only
when declared (along with arrears if cumulative). Shareholders can not claim it as right. In
a bizarre situation, where a company goes for liquidation/wound-up and has balance
amount left after meeting the obligatory payments, balance will go to ordinary equity
shareholders and not to the outstanding dividends on preference shares.
Dividend on Participating Preference Share – Participating preference shares are
entitled to get extra dividend in case dividend on ordinary equity share exceeds a pre-
specified percentage.
3. Difference Between Final Dividend and Interim Dividend – Final dividend is
proposed by the Board and approved by the General Body at Annual General Meeting.
Once it is approved, it becomes obligatory on Company to pay the amount. (The decision can
not be rescinded later). It becomes kind of loan on company. Any shareholder can sue the
company, if payment is not received within specified period.
Interim dividend is decided by the Board of Directors in case they feel that
company is making enough profits and has liquidity to payout. Till some time back, interim
dividend could be cancelled after declaration in case there is sudden change in fortunes of
company like cancellation of some major order. However, now it can not be revoked. It is
now at par with Final dividend for all practical purposes.
4. Payment of Dividend –
(a) To Whom – Earlier, eligibility was based on book closure date but now it
has been amended to discretionary Record Date to be decided by the Board.
All shareholders on the record date are eligible to receive dividend on pro-
rata basis.
(b) Mode of Payment – Dividend can not be paid in kind. A textile company
can not offer cloth as dividend. It has to be paid in cash/cheque/demand
draft. Bonus shares are not considered as dividend.
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(c) Default - Company can not pay dividend if it has defaulted on redemption
of preferential share on due date.
(d) Time – Dividend should be paid within 30 days of declaration, else 12%
interest is payable on amount.
(e) Separate Account – Once dividend is declared, dividend amount should be
deposited into a separate account within 5 days. This amount thereafter can
not be used by company for any other purpose.
5. Stock Exchange Requirement as per Listing Agreement.
(a) Notice of Board Meeting regarding decision on dividend payment is to be
given.
(b) Notice of Record Date is to be given at least 42 days in advance of date.
(c) Record date can be in any preceding month but has to be 1st or 16
th of the
relevant month.
(d) There has to be a gap of at least 90 days between two record dates.
(e) Proposed dividend is to be declared at least 5 days before the record date.
(f) 21 days notice is to be served for AGM.
(g) Stock Exchange is to be informed of the dividend decision within 15
minutes of AGM.
Dividend is proposed by Board of Directors but approved by Shareholders in the
AGM through an ordinary resolution. But shareholders do not have right to increase
the rate of dividend. Companies Act is silent on shareholders right to reduce the rate
of dividend.
6. Payment of Dividend Out of Capital Profits – Although Companies Act permits
payment of dividend only from revenue profits, courts judgements have permitted payment
of dividend out of capital profits also provided
(a) Profits are realised in cash through sale of assets and are not by revaluation
of assets.
(b) There is net profit after all assets and liabilities are revalued. (Selective
revaluation is not allowed).
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Public Deposits
1. What are public deposits?
2. What are not public deposits?
Public Deposits – All unsecured loans are treated as public deposits.
How do you differentiate Public deposits from loans?
Deposits are payable only after a period of time and depositor may not be permitted
to redeem the deposit prematurely. Premature redemption of deposits generally
attracts penal discount on payable interest. Loans have no such limitation or penal
discount clause. Loans can be asked to be repaid any time or even immediately.
Not Public Deposits – Following loans are not treated as public deposits
(a) Any loan given by govt.
(b) Loans given by banks and financial institutions.
(c) Inter-corporate loans.
(d) Security deposits by any one.
(e) Advances paid by buyers, selling agent, purchasing agent, etc.
(f) Security deposit paid by employees.
(g) Any amount received as subscription for shares, debentures, stocks, bonds
etc.
(h) Money provided/loaned by directors.
3. What is the difference between Debentures and public deposits?
Debentures are essentially deposits but not treated as deposits because they can be
secured or unsecured whereas public deposits are necessarily unsecured.
4. Which companies are eligible to invite public deposits?
(a) Pvt Ltd Companies are not eligible to take public deposits.
(b) Any company which has defaulted in repayment of public deposits principal
or interest on earlier occasion is not allowed.
(c) Net Owned Funds (NOF) should be greater than Rs 1 Cr. (NOF is defined as
{Paid up equity capital + Free Reserves – (accumulated losses + Deferred
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revenue expenditure + intangible assets + Investment made by company in
shares and debentures of company under the same management)}.
5. Advertisement – Obligations regarding placement of advertisement are same as in
case of prospectus.
(a) Authority – Board of Directors (They thus are responsible for accuracy of
contents of advertisement).
(b) Content – Same as prospectus
(c) It should be signed by majority of directors as against normal stipulation of
two directors in case of most transactions.
(d) Filing – Advertisement should be filed with Registrar of Companies.
(e) Validity – Till next AGM.
There is no role of SEBI in case of Public Deposits.
6. Maturity Period – Public deposits can be invited for period between 3 months to 3
years. It can not exceed maturity period of 3 years. Deposits invited for period of
less than 6 months are called small deposits and can not exceed 10% of Paid-up
capital plus Free Reserves.
7. Ceiling on Deposits – Deposits generally can not be invited for more than 25% of
Paid Up capital plus Free Reserves. In case the deposits are provided by Directors,
it can not exceed 10% of Paid Up capital plus Free Reserves.
8. Premature Withdrawal of Deposits – Company is not obliged to honour the
request for premature withdrawal. However, in case it accepts such a request,
withdrawal is to be allowed under following guidelines:
(a) For deposits less than 6 months old – No interest is payable.
(b) For deposits of more than 6 months – Rate applicable for the period deposit
was actually held with company; less 2% penal charges. (Suppose company had
offered 10% interest on deposits for 3 years and 9% on 2 years deposits. A three year
deposit is sought to be redeemed after two years. In such a case, depositor would be
entitled to get rate applicable for 2 year deposit minus 2%, ie 9% - 2% = 7%).
(c) No withdrawal is allowed within first 3 months.
Above regulations are applicable for Non Banking Non Financial Companies (NBNFCs).
Banking and NBFCs are governed by RBI guidelines.
9. Other requirements -
(a) Joint Holders – There can be up to 3 joint holders for a deposit.
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(b) Nomination – Nomination facility is available in case of public deposits.
(c) Declaration by Holders – Depositors are to give a declaration that the
amount being deposited has not been raised through loan.
(d) Interest Ceiling – As decided by RBI from time to time. Currently limit has
been set at 11%.
10. Small Depositors – Small depositor is defined as a person who has invested in a
financial year a sum not exceeding Rs 20000 in a company. Regulations governing
such deposits are far more stringent to provide them added security.
(a) If a company makes a default in payment of principal or deposits of small
depositors, it is obligatory on company to give intimation to CLB on
monthly basis starting within 60 days of such default. Details of affected
small depositors are to be forwarded to Company Law Board.
(b) In case there has been any default in payment of interest or principal of
small depositors, company is prohibited from accepting any further deposits
from small depositors. However, this clause is superfluous since Section
58A(2)(c), disallows any company to accept any further deposits from any
one in case of default, where as this section gives impression that deposits
can be accepted from other than small depositors.
(c) In case of default, every advertisement and form for accepting deposit in
future should carry information about past default.
(d) In case of raising working capital loans, same is to be first utilised for
clearing dues of small depositors.
(e) Penal interest is applicable @ 18% for the default period.
11. Maintenance of Liquid Assets - 15% of the amount of Public Deposit maturing
next year are to be kept in marketable securities like unencumbered (against which
no loan has been raised) govt securities, HDFC bonds, current account of bank, etc.
12. Brokerage – Cases were there in past where huge amount of money was siphoned
from company to family and friends as brokerage. Brokerage payment has now
been capped as follows: -
Deposit Period Brokerage
Up to 1 year Up to 1% of amount collected through the broker
1 Year to 2 years Up to 1 ½ % of the amount collected through the broker
More than 2 years Max up to 2 % of the amount collected through the broker
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13. Register of Deposits – Every company accepting a public deposit is to maintain a
register of deposits at its head office containing complete details of investor and
deposit including amount, interest rate, etc.
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Date: 13 Mar 2006
Company Meetings
A company being an artificial person, all decisions on its behalf are taken by its members
through meetings. The members have various meetings. Three pre-requisites of a proper
meeting are:
(a) It should be properly convened.
(b) It should be properly constituted
(c) It should be properly conducted.
If any of the above three vital elements is missing while holding any meeting, the meeting
is null and void and the decisions taken in that meeting do not have legal sanction for
implementation.
There are three kinds of meetings in a company:
(a) Annual General Meeting (AGM).
(b) Statutory Meeting
(c) Extra-ordinary General Meeting
Annual General Meeting (AGM)
1. Convening of Meeting -
(a) Authority - Any meeting should be called by a person who has proper
authority for calling the meeting. Generally, people authorised to call
meeting are listed in AOA. In case it is not listed in AOA, Board of
Directors (BoD) becomes automatically eligible to call meeting by virtue of
Residual Rights principle. Company Secretary does not have rights to call a
meeting. But Company Law Board can call a meeting in situations where
some investor complains or there is a deadlock in the board.
(b) Notice –
(i) Whom - Notice about date, time, place and agenda is required to be
sent to all members as well as Auditors and any other persons who
are entitled to attend meeting for any reason.
(ii) Length of Notice - Notice should be sent at least 21 clear days in
advance. (Clear days means – Day of dispatch of notice and day of meeting are
not counted. Also, two days for postal delivery are excluded).
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(iii) Contents of Notice – The notice should contain list of ordinary
business and special business. Following four are ordinary
businesses:
(aa) Election of new Directors
(ab) Adopt statement of accounts
(ac) Appointment of Auditors.
(ad) Declaration of Dividend
All other businesses other than above are considered to be special
business and should contain explanatory statement explaining the
entire background of particular business and include all relevant
facts to enable an informed member to take a decision on the issue.
(iv) Notice About Appointment of Proxy. Notice should contain
information about eligibility of members to appoint their Proxies for
attending the AGM on their behalf and vote. A single person can act
as proxy of two or more persons.
2. Properly Constituted Meeting –
(a) Chairman – Every meeting should be headed by a Chairman. AOA names
the Chairman of Board of Directors. If the named Chairman is not present or
Chairman is not named in AOA, then any of the directors can be elected as
President. In case no director is present or they can not decide on
appointment of President within 15 minutes of commencement of meeting,
members can elect one among themselves as Chairman and conduct
meeting.
Role of Chairman –
- Maintain order in the meeting.
- Rule on any point of order that may be raised in meeting.
- Decide on priority of speakers and amount of time.
- Casting Vote
- Ascertain sense of meeting (Judge the feeling of members in favour
or against the topic under discussion. Derive the conclusion of
discussion).
- Declare results
Contrary to popular belief, Chairman does not have much power in the
company except for the conduct of meeting.
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As per Companies Act, there is no casting vote for the Chairman. However,
most AOAs, bestow the Chairman with casting vote (an extra vote over and
above this own vote) to be exercised in case of “Tie” in the poll to be able to
break the deadlock.
Corporate Governance frowns upon the concept of Chairman cum Managing
Director. As per one school of thought, Managing Director works under the
Board of Directors. His performance is appraised by the Board of Directors.
In case he heads the Board of Directors as well, who will appraise his
performance?
(b) Quorum – Companies Act lays down minimum quorum for any meeting.
There should be minimum 5 members present in person (proxies excluded)
for a Public Ltd Company and 2 members for a private Ltd Company. This
minimum requirement can be increased through inclusion of relevant clause
in AOA. However, it can not be revised downwards.
The requirement of quorum is only for commencing the proceedings
of the meeting. Once the meeting has commenced, fall in attendance below
quorum has no consequences, unlike in case of meeting of Board of
Directors where minimum quorum should be present all the time.
Joint holders of stock are to be counted as one member only. Thus,
three stock holders holding a set of shares will be counted as one vote only.
Conversely, a single member will be counted as two or more in case he is
representative or proxy for two or more people. Take the case of Mr ABC
who is representative of a company holding shares in the Company “X”. He
is also a shareholder of the company in his personal capacity. Or, he may be
representative of 5 different govt companies holding shares of Company
“X”. In this case, he will be counted as 5 members. Remember, he is not a
proxy. Companies being artificial persons, are allowed to be represented by
nominated representatives as full members. Proxies are people who
represent Natural Persons.
In case quorum is not present at the appointed time, meeting will be
adjourned for 30 minutes. In case quorum is not present even after 30
minutes, meeting will be adjourned to same day, same time and same place
next week. (in case that day happens to be a holiday then on the next
working day after holiday). In case, quorum is not present even at that time,
then number of members present will constitute the quorum.
Law says that quorum is assumed to be present unless it is objected
by some one.
3. Proper Conduct of Meeting –
(a) Ascertaining the Sense of Meeting – Sense of meeting can be ascertained
by any of the following methods:
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(i) Voice Vote
(ii) Show of Hands
(iii) Division of Members – Members in favour and against the motion
are seated separately and then counted.
(iv) Poll – Ballot is used.
As per companies Act, most prevalent method is by show of hands for non
controversial issues. However, first three methods suffer from the weakness
that they follow “one person one vote” concept. But in case of companies, a
member’s voting power is proportionate to the number of shares held by
him.
Thus, the best method to ascertain the sense of meeting is poll. But
this method is to be adopted either at discretion of the Chairman or if a
member of group of members holding at least 10% of the voting power in
the meeting demand for it. (Here, 10% of voting power is translated as 10% of the
votes held by the members present (including proxies) in the meeting, and not total shares
of company).
(b) Resolution – As per Companies Act, there are two kinds of resolution
which can be passed by the meeting –
(i) Ordinary Resolution – Ordinary resolution is passed by simple
majority and used for ordinary business as well as special business of
the meeting.
(ii) Special Resolution – Special resolution requires support of
minimum 75% of members present and voting. Thus, no cognisance
is given to members who abstain from vote.
Any Special Business can be taken up for voting only if there was
explanatory statement included in the notice.
Statutory Meeting.
Statutory Meeting is applicable only in case of Public Ltd Company. (Pvt Ltd
Companies are exempt). Statutory meeting is held only once in lifetime of the company.
(a) When – Statutory Meeting is supposed to be held not earlier than one month
and not later then 6 month from commencement of formation of company.
(b) Purpose – Statutory meeting is not meant for much serious business
transaction. It is essentially meant to be a welcoming meeting and an
opportunity for members to meet the promoter who would be holding the
posts of Directors in the company and share the vision and business model
of the company.
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(c) Notice – Like any other meeting, in this case also, minimum 21 days’ clear
notice is required to persons eligible to attend meeting.
(d) Scope – Scope includes all issues connected with formation of company,
like floatation, membership, etc.
(e) List of Members – is required to be prepared and made available to every
one.
(f) Statutory Report – Statutory Report is supposed to accompany the notice
for meeting. Statutory Report contains following information:
(i) Allotment of Shares
(ii) Cash received from allotment of shares
(iii) Abstract of receipts and payments
(iv) Money due from directors on account of call.
(v) List and details of Contracts that Board wants to be approved by the
members.
(vi) The report is to be certified by minimum 2 directors, one of which
should be Managing Director, if appointed. It should also be certified
by the auditors.
Annual General Meeting
As the name suggests, Annual General Meeting is held annually. But every meeting held at
the interval of one year or more is not AGM. A meeting will be called AGM only when it
is so designated by the Board of Directors.
(a) First AGM should be conducted within 18 months from the date of
incorporation or within 9 months from the date of closure of Financial Year
which ever is earlier.
(b) Subsequent AGMs –
(i) Should be conducted at least once in every calendar year
(ii) Gap between two AGMs should not exceed 15 months
(iii) Within 6 months of close of Financial Year.
All the three conditions will give different dates. Thus, in order to
comply with all the conditions, the earliest of the three dates is to
be used.
(c) Registrar of Companies can grant extension up to three months.
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(d) Earlier, Directors’ tenure was from AGM to AGM. However, courts have
ruled that a director’s tenure will terminate and director will be deemed to
have vacated his office on the last day of the month AGM was due, even if
AGM is not held. (This directive is meant to discourage those who try to prolong their
directorial tenure by delaying AGM). However, there is no such curb placed on
Auditors’ term and their term continues to be from AGM to AGM
irrespective of delay in AGM. (The logic for this differential treatment is that
auditors have no say in scheduling of AGM and therefore can not manipulate it).
Extra-Ordinary General Meeting
Any meeting of the shareholders other than AGM is called EGM. EGM is held to seek
shareholders’ approval for some urgent matter before AGM.
Who can call EGM?
EGM can be called by either of the following:
(a) Board of Directors on its own.
(b) Board of Directors on requisition by members who hold minimum 10%
voting rights in the company.
(c) Members having 10% or more voting rights can call the meeting themselves
in case their requisition to the company is not met within stipulated period
of 45 days.
(d) Company Law Board.
An EGM can transact only matters which were listed in the notice for EGM and no other
business. When a requisition is deposited at the registered office of the company, the
directors should, within 21 days, move to call the meeting and hold the meeting not later
than 45 days from the date of the requisition. In the event that directors fail to call the
meeting, the requisitionists may themselves proceed to call the meeting and claim the
necessary expenses from the company. The directors cannot refuse to call the meeting on
the grounds that the matter proposed to be considered would be illegal/contrary to Act, etc.
That is a matter which can be considered by the court subsequently.
Class Meetings
Class meetings are the ones where only a particular class of investors meet. Like a meeting
of equity shareholders or preferential shareholders or debenture holders only. If a company
wants to vary the rights of a particular investor class, it can do so only with the consent of
the existing investors. Such changes can be incorporated only by special resolution passed
by 75% majority. Once a resolution is passed, it is applicable to all investors of the class.
Dissenting investors can make an application to the company Law Board/Tribunal and it
can give some relief to them.
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Is one man meeting possible?
By the definition of the word meeting, it is discussion between two or more people.
However, Companies Act permits one man meeting under special circumstances. In case of
single representative representing many companies (but not the proxy since proxies are not
counted towards quorum), single member meetings are permitted. Similarly, in case a
single investor holds all the instruments of a particular class, single member meetings are
permitted.
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Date: 20 Mar 2006
Accounts and Audits
Accounts
Section 209 of the Companies Act requires every company to maintain certain books of
accounts. The Act does not list the books of accounts but only lists the information to be
maintained.
1. Books to be maintained - Following information is required to be maintained:
(a) Details of Receipts and Payments and reasons thereof.
(b) All sales and purchases of goods by the company.
(c) The assets and liabilities of the company
(d) In case of certain class of companies, separately notified by Central
Government, cost records are also to be maintained.
The books are to be compulsorily maintained on accrual basis and according to
Double Entry system of accounting.
2. Persons Responsible for Keeping Proper Books of Accounts: Following persons
shall be held responsible to keep proper books of accounts:
(a) First and foremost responsibility for maintenance of books of accounts rests
on MD or Manager, as the case may be, if company has one.
(b) Every Director of the company if the company does not have a MD or
Manager.
(c) In addition to the above, all officers and employees of the company.
If any of the persons above prove that a competent and reliable person was
delegated the duties of maintenance of accounts, they will be discharged of their
responsibility.
3. Inspection of Books – Following persons are authorised/entitled to inspect any
books of account at any time during business hours even without any prior notice:
(a) The Board of Directors and any director in individual capacity.
(b) The Registrar of Companies.
(c) Officers appointed by Central Government.
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(d) Officer appointed by SEBI.
4. Form of Final Accounts – Section 211 together with schedule VI of the Act deals
with form of final accounts. It clearly lays down the form of the Balance Sheet.
5. Provisions regarding Final Accounts –
(a) Approval of Final Accounts – Final accounts are approved by Board of
Directors in the meeting.
(b) Authentication – Once the accounts are approved by the meeting of the
Board, accounts are authenticated by signature of the directors. Minimum
two directors, one of which should be MD, should sign the account.
Thereafter, the account should be signed either by Company Secretary or the
Manager.
(c) Circulation – Authenticated Balance Sheet should then be circulated among
all the members minimum 21 days before the AGM.
6. Display of Accounts – This clause is applicable in case of listed companies with
large investor base. A company like Reliance would end up spending tens of crores
sending the Balance Sheet to its 40 lakh Shareholders. Such companies are allowed
to send only an abridged version of Balance Sheet and place the full Balance Sheet
in the Office of the Registrar as well as the Head Office for any one to scrutinise.
7. Adoption of Accounts - Final account is adopted by the shareholders in the AGM.
8. Filing - Once the account is adopted by the shareholders, same is required to be
filed with Registrar of Companies within 30 days of AGM.
Audits
Even though Shareholders are not allowed to inspect the books of accounts, they
collectively appoint the auditor who is authorised to inspect the books of accounts.
1. Qualification – Only a practicing Chartered Accountant can be appointed as
auditor.
2. Disqualification – Following entities or persons have been disqualified from being
appointed as an auditor of a company:
(a) A body Corporate - A Pvt Ltd or Public Ltd Company can not be appointed
as auditor. Only individuals and partnership firms of Chartered Accountants
can be appointed.
(b) Officer or Employee of the Company
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(c) Employee/Partner of an officer/employee of the company.
(d) Person indebted to company for Rs 1000 or more.
(e) A person holding any security carrying voting rights.
(f) A person disqualified due to any of the above reasons is automatically
disqualified to be auditor of any holding/subsidiary company too.
3. Appointment –
(a) First Auditor – First auditors on formation of a company are appointed by
Board of Directors within first month of registration.
(b) Subsequent Auditors – All subsequent appointment of auditors are made
by passing either a general or special resolution by the members in AGM. In
case 25% or more of the shares in a company are held by State Govt,
Central Govt, Financial Institutions, Banking Company or a combination of
theirs, then special resolution is required, else simple general resolution is
sufficient.
4. Term of Auditors –
(a) First – Up to the first AGM.
(b) Subsequent – From AGM to AGM. (It is to be noted that, if an AGM is not held for
5 years, he will continue for 5 years as auditor without being reappointed. He does not
vacate the office automatically in case of delay in conduct of AGM as is the case with
Directors).
5. Reappointment – Normally the retiring auditor is reappointed. But, reappointment
is not automatic. Reappointment is done by passing an ordinary resolution in AGM.
However, in case reappointment is not proposed, either due to disqualification of
the auditor, or his own unwillingness, or company/Board’s desire to appoint some
other auditor, then a special notice is to be included in the notice to shareholders
specifying the reasons for denying reappointment and name of new auditors.
Retiring auditor has the right of representation to the AGM. If such a
representation is received in advance, it should be included in the special notice to
members. Else, he should be allowed to make the representation at the time of
AGM. But if a company feels that this right to representation could be misused to
make scandalous remarks or defame company, it can approach the Central Govt for
denying the same.
6. Appointment by Central Govt - If no auditor has been appointed by the company,
Central Govt can appoint an auditor. When no auditor is appointed by the company
through the AGM for any reason, it has to inform the fact and circumstances of
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failure to Central Govt within 7 days of the AGM, and then the govt will appoint
the auditor.
7. Casual Vacancy – In case of a casual vacancy due to death, insanity,
disqualification or insolvency, the Board of Directors is empowered to fill the same.
However, in case of resignation by an auditor, the vacancy can not be filled by the
Board. It can then be filled only by calling a General Meeting.
8. Remuneration – There is no ceiling placed on remuneration to the auditors. It is to
be fixed by the authority which is appointing, BoD in case of first appointment and
casual vacancy and members in case of other appointments.
9. Ceiling on Number of Audit an Auditor Can Do – In order to avoid
concentration of audits in a few hands, as well as overwork for some, Companies
Act prescribes that no person can take up more than 20 audits in a year, out of
which 10 companies should not have paid up capital of Rs 25 lakhs or more.
In case of a partnership firm of auditors, above ceilings are to be multiplied
by the number of Chartered Accounts in the firm.
10. Removal of an Auditor – In order to make the removal of an honest and
conscientious auditor difficult, certain safeguards have been provided. It requires
that approval of the central govt be obtained by specifying the grounds for his
unsuitability to continue as auditor. Thereafter, an ordinary resolution be passed by
the members. Any auditor being so removed has the usual right of representation
and the company has right to seek denial, as detailed above.
Compromises and Arrangements
As an artificial person, a company is a nexus of contracts. It has contracts with every one
around it. It has contract with its members, its Board of directors, with employees, with
financers and outsiders. Any of these contracts may require modifications at a later date as
a result of any dispute or simply due to mutual convenience. Compromises and
arrangements is a mechanism provided to effect those modifications.
Formally it can be defined as – Revision of contracts and relaxing of rights and
obligations is called compromises and arrangements.
In case both the parties agree to the modifications without any dissent from any
member of any party, these arrangements have no utility. However, in case, while majority
may agree, there could be some dissenting members on either side. In such a case these
mechanism are required to be followed.
Mgmt study material created/ compiled by - Commander RK Singh [email protected]
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Jamnalal Bajaj Institute of Mgmt Studies
Meaning of Compromise – Compromise means an amicable settlement of differences by
mutual concessions by the parties of dispute. Here the key word is dispute. Compromise is
only in case of a dispute. In short – Variation or alteration of disputed rights.
Meaning of Arrangement – When a contract is reworked without there being any dispute,
it is called arrangement. It is an agreement about modifying the rights which have no
dispute. Examples are:
(a) Reorganisation of share capital of company by consolidation.
(b) Creditors agreeing to receive cash in part payment of their owing and balance
in shares or debentures.
(c) Preference shareholders agreeing to give up their claim on past dividends.
Procedure – Procedure in both cases is exactly same.
(a) Application to the court by
(i) Company, or
(ii) Members, or any class of members
(iii) Creditors, or any class of creditors.
Definition of members is not very strict here. (in effect it means any party to the
contract can apply to the court).
(b) Disclosures – The members of Board of Directors are required to make a
disclosure to Registrar of Companies, all the members and all the affected
parties regarding their interest in compromise and/or arrangement.
(c) Meeting with People with whom Compromise or Arrangement is
contemplated – Adequate notice is required to be given to all members of
such class of people whose rights are getting affected.
(d) Resolution – The resolution should be passed with 75% majority.
(e) Sanction by the Court – After the resolution is passed by the affected class
of people, sanction of the court is to be obtained before it can be enforced.
Court is not bound by the resolution and can refuse to approve it.
(f) Effect – Once the resolution is passed and approved by the court, it is