Further Issues: Rights and Bonus

In one line

When a company issues more shares it must first offer them to its existing members in proportion to their holdings, because otherwise the board could reduce a member's stake without his consent; and the exceptions to that rule, employee options and issues to outsiders, each require the members' own approval.

In exam wording: under section 62(1) where a company having a share capital proposes to increase its subscribed capital by the issue of further shares, those shares shall be offered (a) to persons who at the date of the offer are holders of equity shares, in proportion, as nearly as circumstances admit, to the paid-up capital on those shares, by a letter of offer on the conditions stated; (b) to employees under a scheme of employees' stock option, subject to a special resolution; or (c) to any persons, if authorised by a special resolution, whether or not those persons include the holders in clause (a), at a price determined by the valuation report of a registered valuer.

Why the law has this at all

A member's stake in a company is a fraction, and a fraction can be destroyed without taking anything from him. If a company with a hundred shares issues a hundred more to a stranger, the holder of fifty has lost control although he still owns fifty shares. That is dilution, and it is the single most effective weapon a controller has against a minority.

Pre-emption is the answer. Section 62(1)(a) makes the further issue an offer to existing equity holders in proportion to their present holdings, so a member who takes up his entitlement keeps his fraction exactly. It also gives him a right to renounce unless the articles provide otherwise, so a member who cannot pay may sell the entitlement rather than lose it.

But pre-emption cannot be absolute. A company may need to bring in a strategic investor, to pay employees in shares, or to convert debt. So the Act permits departure from pre-emption only with the members' own special resolution, and, for issues to outsiders, at a price fixed by a registered valuer. The consent that matters is the consent of the very people being diluted.

Behind all of it sits an older principle the statute does not state: the power to allot shares is a fiduciary power, to be exercised for a proper purpose. Section 62 tells a board what procedure to follow; Nanalal Zaver and its successors tell it why a procedurally perfect issue can still be set aside.

Section 62(1)(a): the rights issue

Shares are offered to holders of equity shares at the date of the offer, in proportion, as nearly as circumstances admit, to the paid-up capital on those shares, by a letter of offer, subject to three conditions: