Unravelling the complications and ‘mystic’ of the Companies Act

Various legal advisors are providing different legal opinion on the ‘bonus issue’ debate that has surfaced with the new Companies Act, which came into effect on May 3 but the general opinion amongst companies, shareholders and the stock brokering community seem to be that bonus issues will not be practical in the future, while many are of the sentiment that the bonus shares would become less popular in the Colombo stock market.

“It is clear that the above companies should cancel the bonus issue declarations according to the new Companies’ Act, because it states that any free issue of shares (bonus issues) should be made on the market value of the shares. The new Act has directed listed firms to have retained earnings up to the market value of their shares if they are to launch bonus issues in the future.

The previous Companies’ Act said that the companies should have reserves equivalent to the par values of their shares, but now it is evident that they are expected to have reserves worth of the market values of the shares,” S. Umasudhan, Research Analyst, S.C. Securities told The Sunday Times FT.

The par value is the true value or the face value of a share which is usually one rupee. The market value is what a particular share is trading at. “For an example earlier, if a par value of a company is one rupee and the company decided to issue one free share for one existing share (One for one bonus), the company should have had one rupee worth of reserves to exercise the bonus issue. Now they should have the market value of the shares to have the bonus issue one for one,” Umasudhan explained, adding that the companies will have to capitalise the par value of the share to exercise the bonus issue.

“Presently everyone including the CSE (Colombo Stock Exchange), SEC (Securities & Exchange Commission), investors and stockbrokers are confused,” a stock market analyst said, adding that it is debatable whether a company can issue bonuses under the conventional method.
He said that the lack of understanding on the new Act has led to an ambiguity as to whether the recent bonus issue announcements made by the companies should be cancelled. According to the new Act, the bonus issues have almost been abolished, but the previous Companies Act allowed companies to declare bonus issue of shares to the existing shareholders by capitalising the par value of shares from the reserves in the balance sheet. Since the new Act entirely eliminates the concept of par value, capitalisation of reserves for bonus issues based on par values are prohibited,” he explained further.

“There are a lot of grey areas and many firms are seeking legal opinion,” he said, adding that there is ‘serious’ pressure from investors and stockbrokers to the regulators to clear the grey areas. A stock market analyst, who declined to be named, pointed out that there was no transitional period between drafting and implementation of the new Act, which is not very ‘professional’.

“Capitalising the market value or a similar reasonable value of the shares to the companies’ reserves is not a realistic concept,” Umasudhan said. Taking Carson Cumberbatch and Company Limited (CCCL) as an example, he explained that if the company wants to launch a bonus issue. It will have to debit the reserves with the market value of Carson shares. (A Carson share is around Rs.2, 500). “This is impossible. There fore they will not come out with a bonus issue,” he said.

Many listed firms such as CCCL and Asian Cotton Mills Limited (ASCOT) have withdrawn their bonus issues, until further clarification are sought.
“The bonus share issue’ is a total chaos. By this what I mean is that the total community who was influential in enacting the new Companies Act has created chaos,” one CCCL official said. Carson’s also stated to the CSE that their recommendation to issue bonus shares cannot be pursued subsequent to the announcement by the CSE.

“This Act has a lot of good tips and it is a progressive Act, but there are many anomalies and inadequacies in the transition clauses need to be addressed,” the CCCL official said. Niroshan Gunaratne, Director, ASCOT said that the company is abiding by the law. “Presently the lawyers are also ‘interpreting’ the law. There are different versions that are discussed, therefore we are unable to take a firm decision and until we are aware of the law, we will not take a solid decision on the bonus issue,” he said.

Umasudhan said that for the bonus issues to be valid, companies should have obtained the shareholder approval before 3rd of May 2007, on which date the new Companies Act came into effect. Mercantile Shipping Company, Chemanex, Kotagala Plantations, Kelani Cables and ACL Cables are also likely to withdraw their bonuses as they have been requested by the Colombo Stock Exchange (CSE) to submit an application for fresh approval to the CSE confirming compliance with the new Companies Act.

“The law has changed. Listed companies can issue bonuses, but there is certain way to issue them,” Surekha Sellahewa, Director General CSE told The Sunday Times FT, adding that the companies who have not had EGMs will have to fall in line with Section 57 and 60 of the new Companies Act. The CSE has said that applications for bonuses by Touchwood Investments, Tokyo Cement and Ceylon & Foreign Trades will not be processed.

ACL Cables Limited, Carson Cumberbatch & Co. Limited, Ceylon & Foreign Trades Limited, Tokyo Cement Lanka Limited, Amana Takaful Limited and United Motors Lanka Limited have either declared the bonuses after 3rd May 2007 or before, but have not got the approval from the shareholders. CSE has also said that where the allotment of shares for the bonus issue has been approved by shareholders at an Extra Ordinary General Meeting (EGM) before May 3 the bonus issue can be taken up. Chemical Industries, Tangerine Beach Hotels, Asiri Surgical Hospital, Commercial Bank and DFCC fall under this category.

However, a broker pointed out that it is about time that the investors should be educated regarding the ‘intrinsic value’ of a company. “A bonus does not really create any value and the removal of a bonus does not ‘destroy’ the company’s value as is the rampant perception I the market today,” he explained, adding that lack of knowledge has affected investor sentiment, but not the real value of companies.

Analysts also said that alternatively these companies can consider the option of ‘Share Splits’ under the new Act, because they will increase the number of shares in the company with out capitalising the reserves. Umasudhan explained adding that this is merely a split of shares into smaller components and that executing ‘share splits’ will improve the liquidity of the share in the market.

“For such share splits, capitalisation of reserves is not required. It would be cheaper for companies to increase the number of shares in the market under the method specified above,” he said. He said that the new Act attempts to change the existing culture of the stock market, which reacts positively to bonus issues and bonus issue speculations. “This is the time that investors should realise that share splits or bonus issues should not be considered as a significant reason for the share price to jump,” he said.

Confusion is still rampant among the general public on the Companies Act No.7 of 2007 which is now in force. Complaints ranged from their inability to get a hold of the Act as well as the fact that the few seminars organized to enlighten the public on the new provisions were overpriced and catered to the privileged few.

According to some, trying to locate a copy of the Act proved to be an exercise in futility. Despite several public figures espousing the vast benefits of the act and its usefulness to directors, shareholders and the manner in which companies are run, some of these experts still seem to have some difficulty in answering questions according to accounts from participants at the first session of a recent seminar when taking questions from the audience.

The two day interactive seminar organized by the Institute of Chartered Accountants of Sri Lanka (ICASL) earlier this week saw representatives from the Colombo Stock Exchange (CSE), leading auditing firms and companies address a large gathering in the hope of clearing up any misunderstandings pertaining to the issues and implications of the Act. However, as witnessed by the audience, the answers by the panelists only served to highlight their own lack of familiarity with the provisions of the Act.

The new Act is said to be a vast improvement from the old which was commonly described as outdated and archaic and in dire need of a makeover. The second session of the seminar featured the Chairman of the Company Law Advisory Commission, K. Kanag-Isvaran PC, member of the Company Law Advisory Commission Nihal Sri Ameresekere and Registrar of Companies, DK Hettiarachchi, speaking on the salient features of the Act. Kanag-Isvaran and Ameresekere were both members of the committee formed to draft the new provisions. Kanag-Isvaran and Ameresekere both said the Act had been the public domain for quite awhile but the public has simply failed to pay attention.

The Act was originally put out as a bill on May 19, 2006 which went through Parliament. It was virtually ignored by all political parties with the exception of the Janatha Vimukthi Perumana (JVP). Ameresekere said the new provisions are particularly significant to ordinary segments of the population in villages and townships in allowing them to do business through corporate society, one of the reasons for the high interest from the JVP. The Act allows for any individual to start a company on their own overseas and decide how much capital to risk.

According to Ameresekere, the most crucial responsibility for the Board of Directors is to ensure their company is solvent. A company's assets must be greater than the stated capital and liabilities. "The Board of a Company is required to always be mindful and conscious of the solvency of the Company, consistently conforming to the Solvency Test." The company must be able to pay its debts as they become due in the normal course of business and that the value of the company's assets is greater than the total value of its liabilities and its stated capital. If a company does not pass the solvency test, explanations must be given to its shareholders for the failure in addition to outlining a plan for solving the problem.

Ameresekere said that minority shareholders cannot dictate terms to the management but they are entitled to their rights. Directors of companies are not necessarily the owners and stakeholders of companies but they do have a fiduciary duty, trust and responsibility to manage the resources of interest groups, without permitting corporate failure that are being witnessed today, due to corporate mismanagement and frauds deliberately and intentionally perpetrated. Kanag-Isvaran called it 'a beautiful piece of legislation, simple and uncomplicated.'
The success of the Act depends on proper implementation.

The issues and challenges of the company laws

By Sunil Karunanayake

After years of deliberations, reversals and setbacks Sri Lanka was able to deliver a modern piece of legislation replacing a highly outdated Companies Act to instill some kind of fresh air into the local commercial community. The Companies Act provides the backbone to the corporate entities and a regulated environment to ensure justice and fair play.

The new Act No 7 of 2007 came into legal existence on May 3 through a gazette notification. However it took some time for the printed acts to be made available thus creating an air of uncertainty in the minds of the concerned public. Gradually these issues seem to be getting resolved and now the interpretations and operational issues have become a hot topic in the corporate community.

The new Act brings into existence a number of new provisions that are now being deliberated by the experts. One of the controversial issues that arose was the belief that the issue of bonus shares (conversion of accumulated reserves in to share capital) is prohibited in the new Act, undoubtedly this caused quite a stir as even the small investor looks forward to the periodic bonus share to enhance his share ownership. Much to everybody’s relief D. K. Hettiarachchi, Registrar General of Companies addressing a packed audience at the Institute of Chartered Accountants confirmed that the Act does not prohibit the issue of bonus shares.

However the registrar added that this distribution too must comply with the provisions of the section 56 of the Act requiring resolution of the Board, shareholders approval and satisfaction of the solvency test. According to the Registrar General decisions regarding the issue of “Bonus shares” made prior to coming in to operation of the Act may be proceeded with so far as it could have been made under the provisions of the Act, as mandated by section 530 (1) of the Act.

According to Section 487 of the new Act within a period of 12 months from the coming into operation of the new Act, all existing companies shall apply to the Registrar to assign a new number as its company number, in a form as may be prescribed by the Registrar. The new number so assigned shall be entered in the Register and also on the fresh certificate of incorporation to be issued.

The solvency test (section 57) is yet another innovation in the Act which brings in a concept of cautiousness where directors are required to satisfy that the company is able to pay its debts as they become due in the course of business and to ensure that a company’s asset value exceeds the liabilities and the company’s stated capital. This provision provides a useful safeguard for the financial health of the company and will also minimize the concerns of the lenders thus contributing to the overall financial stability of the system.

With the abolition of the par value the company’s stated capital will be equivalent to the total of all amounts received by the company in respect of issue of shares and in respect of calls on shares. The dividends are expected to be paid on a rupees-per-share basis.
Abolition of par value will also take away the concepts of Share Premium account and of the Capital Redemption Reserve fund thus making the Balance sheets simpler.

Though a fair number of seminars have been held during the last few weeks yet the confusions and concerns seems significant and it would be appropriate for the Registrar General of Companies, Securities and Exchange Commission and Colombo Stock Exchange to come out jointly and clarify the major changes of the Act for the benefit of the general public.
Email - suvink@eureka.lk