Further Issue of Share Capital and Bonus Shares

• (i) the offer shall be made by notice specifying the number of shares offered and limiting a time not less than fifteen days, or such lesser number of days as may be prescribed, and not exceeding thirty days from the date of the offer, within which, if not accepted, the offer shall be deemed to have been declined;
• (ii) unless the articles otherwise provide, the offer shall be deemed to include a right to renounce the shares in favour of any other person, and the notice shall contain a statement of this right;
• (iii) after the expiry of the time specified, or on earlier intimation of declining, the Board may dispose of them in such manner which is not disadvantageous to the shareholders and the company.

Three numbers and one default to remember. Not less than fifteen days, not more than thirty days; silence is a refusal; and renunciation is the default unless the articles exclude it.

Section 62(2): how the notice goes out. The notice under clause (a)(i) shall be dispatched through registered post or speed post or through electronic mode or courier or any other mode having proof of delivery to all the existing shareholders at least three days before the opening of the issue.

(b) To employees under a stock option scheme

To employees under a scheme of employees' stock option, subject to a special resolution passed by the company and subject to such conditions as may be prescribed.

(c) To any persons, on a special resolution and a valuation

To any persons, if authorised by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer, subject to compliance with the applicable provisions of Chapter III and any other prescribed conditions.

Clause (c) is the preferential allotment route, and the two safeguards are the special resolution and the registered valuer's price. The valuer requirement exists precisely so that shares cannot be issued cheaply to friends of the Board.

Conversion of debentures and loans: section 62(3) to (6)

Section 62(3): a term already agreed. Nothing in the section applies to an increase of subscribed capital caused by the exercise of an option attached to debentures issued or a loan raised by the company to convert them into shares, provided that the terms of issue containing that option were approved before the issue or the raising of the loan by a special resolution in general meeting.

So a conversion right agreed in advance, with the members' consent, escapes the pre-emption rules. The members have already voted for the dilution.

Section 62(4): Government conversion. Notwithstanding sub-section (3), where debentures have been issued or a loan obtained from any Government, and that Government considers it necessary in the public interest, it may by order direct that the debentures or loan or part of it shall be converted into shares on such terms as appear reasonable, even if the terms of issue contain no conversion option.

The proviso gives an appeal: where the terms are not acceptable, the company may within sixty days of communication of the order appeal to the Tribunal, which shall, after hearing the company and the Government, pass such order as it deems fit.

Section 62(5): what the Government must weigh. In determining the terms of conversion the Government shall have due regard to the financial position of the company, the terms of issue of the debentures or loan, the rate of interest payable, and such other matters as it may consider necessary.

Section 62(6): the memorandum alters itself. Where such an order has been made and no appeal has been preferred, or the appeal has been dismissed, then where the order has the effect of increasing the authorised share capital, the memorandum shall stand altered and the authorised capital shall stand increased by the value of the shares into which the debentures or loan has been converted.

Note how unusual that is: the memorandum is altered by force of statute, without a resolution.

Bonus shares: section 63

Section 63(1): the three sources. A company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out of:

• (i) its free reserves;
• (ii) the securities premium account; or
• (iii) the capital redemption reserve account.

The proviso: no issue of bonus shares shall be made by capitalising reserves created by the revaluation of assets.

That proviso is the heart of the section. A revaluation reserve is an unrealised paper gain: the company has not received a rupee. Turning it into share capital would inflate the capital with money that does not exist.

Note the consistency across the Act. Section 52(2)(a) permits the securities premium account to be applied towards fully paid bonus shares, and section 55(2) proviso (c) creates the capital redemption reserve account and treats it as paid-up capital. Section 63(1) lists exactly those two, plus free reserves.

Section 63(2): six conditions. No company shall capitalise its profits or reserves for the purpose of issuing fully paid-up bonus shares unless:

• (a) it is authorised by its articles;
• (b) it has, on the recommendation of the Board, been authorised in the general meeting;
• (c) it has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;
• (d) it has not defaulted in respect of the payment of statutory dues of the employees, such as contribution to provident fund, gratuity and bonus;
• (e) the partly paid-up shares, if any, outstanding on the date of allotment, are made fully paid-up;
• (f) it complies with such conditions as may be prescribed.

Conditions (c) and (d) are the fairness conditions, and they are worth a sentence in an answer: a company that has not paid its depositors, its debenture holders or its employees' provident fund may not hand free shares to its members.

Condition (e) prevents a mixed capital structure: the partly paid shares must be brought up to fully paid first.

Section 63(3): the prohibition.

The bonus shares shall not be issued in lieu of dividend.

Short and absolute. A company that has promised a dividend and cannot pay it may not discharge the promise in paper.

A worked example

Solapur Pumps Limited has a subscribed capital of two crore rupees in twenty lakh equity shares of ten rupees each, held as to five lakh shares by Ms Kulkarni.

A rights issue. The company needs one crore rupees. Under section 62(1)(a) it must first offer the new shares to existing equity shareholders in proportion to the paid-up capital on their shares. Ms Kulkarni holds a quarter, so she is offered a quarter of the new shares. The letter of offer specifies the number and gives her not less than fifteen and not more than thirty days; if she does not accept in time the offer is deemed to have been declined. Unless the articles say otherwise, the notice must tell her she may renounce in favour of anybody else. The notice goes out by a mode carrying proof of delivery, at least three days before the issue opens: section 62(2).

She declines. The Board may then dispose of her shares in a manner not disadvantageous to the shareholders and the company: section 62(1)(a)(iii).

An employees' scheme. The company wants to give options to its engineers. That is section 62(1)(b) and needs a special resolution and compliance with the prescribed conditions.

A strategic investor. A private equity fund offers to take shares worth four crore rupees. That is section 62(1)(c): a special resolution, and the price determined by the valuation report of a registered valuer, with Chapter III complied with.

A convertible debenture. Two years ago the company issued debentures with a conversion option, and the terms were approved by a special resolution before the issue. When the holders convert, section 62(3) applies and the pre-emption rules do not, because the members have already consented.

A Government loan. A State Government loan is converted into shares by order in the public interest under section 62(4), even though the loan carried no conversion term. The company thinks the terms unfair and appeals to the Tribunal within sixty days. If the appeal is dismissed and the order increases the authorised capital, the memorandum stands altered by force of section 62(6).

A bonus issue. The company has free reserves of six crore rupees, a securities premium account of one crore, a capital redemption reserve of fifty lakh, and a revaluation reserve of three crore from revaluing its land.

It may capitalise the free reserves, the securities premium account and the capital redemption reserve account: section 63(1). It may not touch the revaluation reserve, by the proviso.

Before doing so it must check the six conditions of section 63(2): the articles authorise it; the general meeting has authorised it on the Board's recommendation; there is no default on fixed deposits or debt securities; there is no default on employees' provident fund, gratuity or bonus; and any partly paid shares are made fully paid on the date of allotment.

And a trap. The Board had announced a dividend it now cannot fund, and proposes to issue bonus shares instead. Section 63(3) forbids it outright: bonus shares shall not be issued in lieu of dividend.

Distinctions that carry marks

What this does NOT mean

It does not mean every further issue must go to members first. Clauses (b) and (c) of section 62(1) are alternatives, each with its own safeguard.

It does not mean the right of renunciation is absolute. It applies unless the articles otherwise provide.

It does not mean a bonus issue makes members richer. Their proportionate ownership is unchanged; the same value is spread over more shares.

It does not mean any reserve can be capitalised. Only the three in section 63(1), and never a revaluation reserve.

Quick revision

• 62(1)(a): offer to existing equity shareholders in proportion; notice specifying the number, not less than fifteen nor more than thirty days; silence is a decline; renunciation is included unless the articles provide otherwise; the Board may then dispose not disadvantageously.
• 62(2): notice by a mode with proof of delivery, at least three days before the issue opens.
• 62(1)(b): employees under an ESOP, special resolution, prescribed conditions.
• 62(1)(c): any persons, special resolution, price by a registered valuer's report, Chapter III complied with.
• 62(3): conversion options approved by special resolution before issue are outside the section.
• 62(4) to (6): a Government may order conversion in the public interest; sixty days to appeal to the Tribunal; the memorandum stands altered if the order increases authorised capital.
• 63(1): bonus shares, fully paid, out of free reserves, the securities premium account, or the capital redemption reserve account. Never out of a revaluation reserve.
• 63(2), six conditions: articles; general meeting on the Board's recommendation; no default on fixed deposits or debt securities; no default on employees' statutory dues; partly paid shares made fully paid; prescribed conditions.
• 63(3): not in lieu of dividend.

Test yourself

1. To whom must further shares be offered, and within what time must the offer be accepted? To existing equity shareholders in proportion to the paid-up capital on their shares, by a letter of offer specifying the number of shares and limiting a time not less than fifteen days, or such lesser number as may be prescribed, and not exceeding thirty days from the date of the offer, failing which the offer is deemed declined: section 62(1)(a)(i).

2. Is a rights offer renounceable? Yes, unless the articles otherwise provide. The offer is deemed to include a right to renounce in favour of any other person, and the notice must contain a statement of that right: section 62(1)(a)(ii).

3. How may a company allot shares to an outside investor? Under section 62(1)(c), if authorised by a special resolution, to any persons, for cash or for a consideration other than cash, if the price is determined by the valuation report of a registered valuer, subject to compliance with Chapter III and any prescribed conditions.

4. Out of what may bonus shares be issued? Free reserves, the securities premium account, or the capital redemption reserve account: section 63(1). No bonus issue may be made by capitalising reserves created by the revaluation of assets.

5. State the conditions in section 63(2). Authorisation by the articles; authorisation in general meeting on the Board's recommendation; no default in payment of interest or principal on fixed deposits or debt securities; no default in payment of employees' statutory dues such as provident fund, gratuity and bonus; partly paid shares outstanding on the date of allotment made fully paid; and compliance with prescribed conditions.

6. May bonus shares be issued instead of a dividend? No. Section 63(3) provides flatly that bonus shares shall not be issued in lieu of dividend.