Unit 6: Raising of Capital

1. Prospectus and Mis-statement in Prospectus

1.1 Meaning of Prospectus

A prospectus, as defined under Section 2(70) of the Companies Act, 2013, is any document described or issued as a prospectus and includes any notice, circular, advertisement, or other document inviting offers from the public for the subscription or purchase of any securities of a body corporate.

Key Characteristics:

• An Invitation: It is not an offer itself, but an "invitation to offer". The application for shares by the public is the offer, and the company's allotment of shares is the acceptance.
• In Writing: It must be in written form. An oral invitation is not a prospectus.
• By the Company: It must be issued by or on behalf of the company.
• Public Offer: It must be an invitation to the public. An offer to a select group of people (private placement) is not a public offer and does not require a full-fledged prospectus.
• Relates to Securities: The invitation must be to subscribe to or purchase securities (shares or debentures).

1.2 Mis-statement in Prospectus

A prospectus is said to contain a mis-statement if it includes:

1. An Untrue or Misleading Statement: A statement that is false, deceptive, or misleading in the form and context in which it is included.
2. Omission of Material Fact: The inclusion or omission of any matter that is likely to mislead.

A fact is considered "material" if it is likely to influence the decision of a reasonable investor in deciding whether or not to subscribe to the securities.

1.3 Liability for Mis-statement in Prospectus

If a prospectus contains mis-statements, the persons who authorized its issue can be held liable. The liability is two-fold: Civil and Criminal.

A. Civil Liability (Section 35, Companies Act, 2013)

Any person who has subscribed for securities based on the prospectus and has suffered any loss or damage as a consequence of the mis-statement can claim compensation.

Who is Liable?

• The company.
• Every director of the company at the time of the issue of the prospectus.
• Every person who is named in the prospectus as a director or has agreed to become one.
• Every promoter of the company.
• Every person who has authorized the issue of the prospectus.
• Every expert (e.g., auditors, valuers, bankers) who has given a statement that is included in the prospectus.

Defenses Available (How to avoid liability):
A person can escape liability if they can prove:

1. Withdrawal of Consent: They had withdrawn their consent before the issue of the prospectus, and it was issued without their authority or consent.
2. Issue without Knowledge: The prospectus was issued without their knowledge or consent, and on becoming aware of its issue, they gave reasonable public notice of that fact.
3. Reasonable Ground for Belief: They had reasonable grounds to believe, and did believe up to the time of allotment, that the statement was true.
4. Expert's Statement: The mis-statement was a correct and fair representation of an expert's report, and the expert had given their consent, which was not withdrawn.

B. Criminal Liability (Section 34, Companies Act, 2013)

This liability arises when a prospectus is issued with the intent to defraud the applicants. It deals with punishment for fraud.

• Offence: Where a prospectus includes any statement which is untrue or misleading or where any inclusion or omission is likely to mislead, any person who authorizes the issue of such prospectus shall be liable under Section 447.
• Punishment under Section 447 (Fraud):
  • Imprisonment: For a term not less than 6 months but which may extend to 10 years.
  • Fine: Which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud.
  • If the fraud involves public interest, the minimum imprisonment shall be 3 years.

2. Shares and Share Capital

2.1 Meaning and Type of Share

Meaning of a Share:
As per Section 2(84) of the Companies Act, 2013, a "share" means a share in the share capital of a company and includes stock. It represents a fractional part of the company's capital and confers on the holder (shareholder) a certain set of rights and liabilities. It is considered movable property, transferable in the manner provided by the company's Articles of Association.

Types of Shares (Section 43):
The share capital of a company is primarily divided into two kinds:

A. Equity Shares (Ordinary Shares)

• These are shares that are not preference shares.
• Voting Rights: Equity shareholders typically have voting rights in proportion to their shareholding.
• Dividend: They receive dividends after the preference shareholders have been paid. The rate of dividend is not fixed and depends on the profits available and the recommendation of the Board of Directors.
• Repayment of Capital: In the event of winding up, they are the last to be repaid, after all other liabilities, including preference share capital, have been settled. They are the ultimate owners and risk-bearers of the company.

B. Preference Shares

• These shares carry preferential rights over equity shares with respect to:
  1. Payment of Dividend: A fixed amount or a fixed rate of dividend is paid to them before any dividend is paid to equity shareholders.
  2. Repayment of Capital: In case of winding up, their capital is returned before the capital of equity shareholders is returned.
• Types of Preference Shares:
  • Cumulative: If dividends are not paid in a particular year due to insufficient profits, the arrears of dividend accumulate and must be paid in subsequent years before any dividend is paid to equity shareholders.
  • Non-Cumulative: Arrears of dividend do not accumulate. If no dividend is declared in a year, the right to that dividend is lost forever.
  • Participating: Holders are entitled to a fixed preferential dividend and also have a right to participate in the surplus profits with equity shareholders after a certain level of dividend has been paid to them.
  • Non-Participating: Holders are only entitled to their fixed rate of dividend and do not share in surplus profits.
  • Redeemable: These shares are issued with the condition that the company will repay the capital amount to the shareholders after a specified period or at the option of the company.
  • Irredeemable: These shares cannot be redeemed during the lifetime of the company. The Companies Act, 2013, prohibits the issue of irredeemable preference shares.
  • Convertible: These shares can be converted into equity shares after a specified period.
  • Non-Convertible: These shares cannot be converted into equity shares.

2.2 Minimum Subscription

• Meaning: The minimum amount that, in the opinion of the directors, must be raised through the share issue to provide for certain specified matters (e.g., purchase price of property, preliminary expenses, working capital).
• Purpose: To ensure the company does not start its business without adequate funds, thereby protecting investors.
• Legal Requirement: As per SEBI regulations, minimum subscription is set at 90% of the entire issue.
• Consequence of Non-receipt: If the company fails to receive the minimum subscription within 30 days from the date of issue of the prospectus, it must refund the entire application money received within the next 15 days. Failure to refund within this period will make the directors jointly and severally liable to repay the money with interest.

2.3 Issue Terms

Shares can be issued under the following terms:

1. Issue at Par: When the issue price of a share is equal to its face value (or nominal value). (e.g., a share of ₹10 is issued for ₹10).
2. Issue at Premium: When the issue price of a share is higher than its face value. (e.g., a share of ₹10 is issued for ₹12). The excess amount (₹2) is called the share premium and is transferred to a "Securities Premium Account".
3. Issue at Discount: When the issue price of a share is lower than its face value. As per Section 53 of the Companies Act, 2013, a company is prohibited from issuing shares at a discount. The only exception is the issue of Sweat Equity Shares (shares issued to employees or directors for their hard work or intellectual property).

2.4 Certificate of Commencement of Business

• Under Companies Act, 1956: This was a mandatory certificate required by a public company having share capital before it could commence any business activities or exercise any borrowing powers.
• Under Companies Act, 2013: The concept of a "Certificate of Commencement of Business" has been replaced. Now, under Section 10A, a company having a share capital incorporated after the commencement of the Companies (Amendment) Act, 2019, shall not commence any business or exercise any borrowing powers unless:
  1. A declaration is filed by a director with the Registrar of Companies (ROC) within 180 days of incorporation, confirming that every subscriber to the memorandum has paid the value of the shares agreed to be taken by them.
  2. The company has filed with the ROC a verification of its registered office.
• Failure to comply can lead to penalties and the ROC may initiate action for the removal of the company's name from the register.

2.5 Share Capital

Share Capital refers to the total funds raised by a company through the issue of shares. It is classified into different categories:

Authorised Capital (Maximum capital the company is allowed to issue)
|
+--- Issued Capital (Part of Authorised Capital offered to the public)
     |
     +--- Subscribed Capital (Part of Issued Capital actually taken up by the public)
          |
          +--- Called-up Capital (Part of Subscribed Capital demanded by the company)
               |
               +--- Paid-up Capital (Part of Called-up Capital actually paid by shareholders)

• Authorised/Nominal/Registered Capital: The maximum amount of capital mentioned in the Memorandum of Association that the company is legally authorized to raise by issuing shares.
• Issued Capital: The portion of the authorised capital which the company has offered to the public for subscription.
• Subscribed Capital: The portion of the issued capital that has been subscribed to (or applied for) by investors.
• Called-up Capital: The portion of the subscribed capital that the company has asked the shareholders to pay.
• Paid-up Capital: The portion of the called-up capital that the shareholders have actually paid. This is the real capital of the company.

3. Company Management

3.1 Position of Directors

The legal position of directors is complex and is often described from three perspectives:

1. As Agents: Directors act as agents for the company. When they act within the scope of their authority, their actions bind the company. However, they are not agents of the individual shareholders.
2. As Trustees: Directors are considered trustees of the company's money and property. They must exercise their powers for the benefit of the company and not for their own personal gain. They hold a fiduciary position.
3. As Managing Partners: Directors are professionals elected by the shareholders to manage the company's affairs. They have vast powers to control and oversee the business, similar to managing partners in a firm.

Conclusion: Directors are best described as holding a quasi-fiduciary position, combining elements of an agent, trustee, and managing partner.

3.2 Appointment and Removal of Directors

A. Appointment of Directors

• First Directors: Usually named in the Articles of Association. If not, the subscribers to the Memorandum of Association are deemed to be the first directors.
• Subsequent Directors: Appointed by shareholders in the Annual General Meeting (AGM). Typically, one-third of the rotational directors retire every year, and their vacancies are filled at the AGM.
• Appointment by the Board: The Board can appoint directors in three situations:
  1. Additional Director: To add a new director between two AGMs. They hold office only up to the date of the next AGM.
  2. Alternate Director: To act in place of a director who is absent from India for more than three months.
  3. To Fill a Casual Vacancy: To fill a vacancy arising due to the death, resignation, or disqualification of a director.
• Appointment by Tribunal: The National Company Law Tribunal (NCLT) can appoint directors to prevent mismanagement or oppression.

B. Removal of Directors

• By Shareholders: A director can be removed before the expiry of their term by an ordinary resolution passed by the shareholders at a general meeting. A special notice of the intention to move such a resolution must be given to the company. The concerned director must be given a reasonable opportunity to be heard.
• By the Tribunal (NCLT): The NCLT can order the removal of a director on grounds of fraud, oppression, or mismanagement.

3.3 Types of Directors

• Executive Director: A director who is in the full-time employment of the company, such as a Managing Director or Whole-time Director. They are involved in the day-to-day management.
• Non-Executive Director: A director who is not in the full-time employment of the company. They attend board meetings and provide independent advice and oversight.
• Managing Director (MD): A director who is entrusted with substantial powers of management of the company's affairs.
• Whole-Time Director (WTD): Includes a director in the whole-time employment of the company.
• Independent Director: A non-executive director who has no material or pecuniary relationship with the company, its promoters, or its management. They bring objectivity and impartiality to the board's deliberations, especially in matters of strategy, performance, and risk management.
• Nominee Director: Appointed by a financial institution, bank, or other creditor to represent their interests on the board of a company to which they have lent money or have a stake in.
• Alternate Director: Appointed by the Board to act in the place of an original director during their absence from India for a period of not less than three months.
• Small Shareholders' Director: In a listed company, shareholders holding shares of nominal value of ₹20,000 or less may elect one director to represent their interests.

3.4 Powers and Duties of Directors

A. Powers of Directors (Section 179)

Directors derive their powers from the Companies Act and the company's Memorandum and Articles of Association. The Board of Directors exercises its powers collectively at board meetings. Key powers include:

• To make calls on shareholders for unpaid money on their shares.
• To authorize buy-back of securities.
• To issue securities, including debentures.
• To borrow monies.
• To invest the funds of the company.
• To grant loans or give guarantees.
• To approve financial statements and the Board's report.
• To diversify the business of the company.
• To approve amalgamation, merger, or reconstruction.

B. Duties of Directors (Section 166)

Section 166 codifies the duties of directors, which are primarily fiduciary in nature.

1. Duty to Act in Accordance with Articles: A director must act as per the company's Articles of Association.
2. Duty to Act in Good Faith: A director must act in good faith in what they believe to be the best interests of the company, its employees, shareholders, and the community.
3. Duty of Due Care: A director must exercise their duties with reasonable care, skill, and diligence.
4. Duty to Avoid Conflict of Interest: A director must not involve themselves in a situation where their personal interests conflict with the interests of the company.
5. Duty not to make Undue Gain or Advantage: A director must not achieve any undue gain or advantage, either for themselves or their relatives. If they do, they are liable to pay it back to the company.
6. Duty not to Assign Office: A director cannot assign their office to another person, as it is an office of personal trust.

4. Company Meetings

4.1 Meaning and Essentials of a Valid Meeting

Meaning: A company meeting is a gathering of the members of the company (or its directors) to discuss and decide on matters related to the company's affairs. Decisions are made through passing resolutions.

Essentials of a Valid Meeting:

1. Proper Authority: The meeting must be convened (called) by the proper authority, which is usually the Board of Directors.
2. Proper Notice:
   • A written notice must be sent to every person entitled to attend (members, directors, auditors).
   • The notice for a general meeting must be given at least 21 clear days before the meeting.
   • It must specify the date, day, time, and full address of the place of the meeting.
   • It must contain a statement of the business to be transacted (the agenda).
3. Proper Quorum: Quorum is the minimum number of members required to be present to validly transact business at a meeting. If the quorum is not present, the meeting is invalid. The quorum requirements are specified in the Companies Act (Section 103).
4. Proper Chairperson: Every meeting must be presided over by a Chairperson, who is responsible for conducting the meeting in an orderly manner.
5. Proper Conduct: The business must be transacted according to the agenda, and decisions must be made through voting and the passing of resolutions. Minutes of the proceedings must be properly recorded and maintained.

4.2 Types of Meetings

Company meetings can be broadly categorized as:

1. Board Meetings
2. Shareholders' Meetings (General Meetings)

1. Board Meetings

• Meaning: A meeting of the Board of Directors of the company.
• Frequency:
  • First Board Meeting: Must be held within 30 days of the company's incorporation.
  • Subsequent Meetings: A minimum of four board meetings must be held every year. The gap between two consecutive meetings should not be more than 120 days.
• Quorum: One-third of the total strength of the Board or two directors, whichever is higher.

2. Shareholders' Meetings

These are meetings of the members (shareholders) of the company.

A. Statutory Meeting

• Status: This meeting was mandatory for public limited companies under the Companies Act, 1956.
• Current Law: The concept of a Statutory Meeting has been omitted under the Companies Act, 2013. Companies are no longer required to hold this meeting.
• Historical Purpose: Its purpose was to provide shareholders with an opportunity, at an early stage of the company's existence, to get information about its formation, share allotment, and financial position.

B. Annual General Meeting (AGM)

• Meaning: An AGM is a mandatory yearly meeting of shareholders. It is the primary forum for communication between the management and the shareholders.
• Frequency:
  • One AGM must be held in each calendar year.
  • The gap between two AGMs must not be more than 15 months.
• Business Transacted:
  • Ordinary Business:
    1. Consideration and adoption of financial statements and the reports of the Board and auditors.
    2. Declaration of any dividend.
    3. Appointment of directors in place of those retiring.
    4. Appointment and fixing the remuneration of the auditors.
  • Special Business: Any other business transacted at an AGM is considered special business.

C. Extraordinary General Meeting (EGM)

• Meaning: Any general meeting of shareholders other than an AGM is called an EGM.
• Purpose: To transact any urgent or special business that cannot be postponed until the next AGM. Examples include altering the Memorandum or Articles, or removing a director.
• Who can call an EGM?
  1. The Board of Directors: The Board can call an EGM whenever it deems fit.
  2. By Requisitionists: The Board must call an EGM upon the request (requisition) of members holding at least one-tenth (10%) of the paid-up share capital of the company carrying voting rights. If the Board fails to call the meeting, the requisitionists themselves can convene it.