New Companies Act

Some thoughts on its implementation

By K.T. Chitrasiri, Commercial High Court Judge

Some of the major changes in the New Companies Act are as
follows:

K.T. Chitrasiri

1) The manner of incorporating companies;
2) Selecting a name for a company to be incorporated;
3) Recognition of single shareholder companies;
4) Doing away with the par value of shares and
the introduction of stated capital;
5) Issue of shares within 20 days after the receipt of
consideration;
6) Matters concerning the bonus issues;
7) Serious loss of capital;
8) Introduction of solvency test;
9) Reduction of capital;
10) Purchase of shares by the company itself;
11) Redemption of shares;
12) Validity of the acts done outside the objects of the
company / abolition of ultra vires doctrine;
13) Director's duties;
14) Introduction of the matters concerning major transactions;
15) Recognition of filing derivative actions on behalf of the
company;
16) Dividends and its distributions;
17) Manner of holding Annual General meetings;
18) Introduction of company disputes board;
19) Continuity of the status of the existing companies;
20) Provisions relating to the jurisdiction of Courts.

1. The manner of incorporating companies
The Memorandum and Articles are not necessary to incorporate a company.
Under Sec.4 of the Act a person may make an application to the Registrar of Companies in the prescribed form along with a declaration regarding:

- the name of the company;
- the Articles of Association of the Company;
- consent of the Directors under Sec.203, to act as a Director; and
- consent of the Company Secretary under Sec.221 (2).

Thus the incorporation has been simplified. The majority of complaints we saw earlier were in respect of the preliminary stages of incorporations. At that point, the applicants were required to obtain the approval of the Registrar even for the objects clause referred to in the Memorandum. Now that these matters are done away with, the delay in incorporating companies will be minimized.

2. Selecting a name of a company to be incorporated
The old system was to obtain approval from the Registrar before a company is incorporated. This system has sometimes caused immense problems as the Registrar was reluctant to give the consent when there was a doubt as to the similarity of the name. Therefore the promoters had to interview the Registrar or to seek legal remedies in order to obtain the consent of the Registrar. Such delays would not occur in the future since the incorporation could be made on a declaration referred to in Section 4(a) as to the similarity of the name of an existing company.

However, Section 7(1) clashes with this procedure since it provides for the Registrar not to register a company with a name identical to the name of an existing company. Therefore, the concept introduced by Section 4(a) would become meaningless. Moreover, the form issued by the Registrar to incorporate a company has a cage to fill in the name approval number. This again would cause problems to the promoters and the main object of simplifying the procedure would become nugatory. However, I must mention that the procedure referred to in Section 4(a) could be abused to obtain undue benefit by some parties in the process. Furthermore this would open the gates for litigation, probably on the law of tort, by the existing companies which have names similar to the names of companies that are incorporated afresh.

3. Recognition of Single Shareholder Companies
Sec.4 (2) deals with this aspect. The plain reading of both Sinhala and English texts of this Section seems to be rather confusing. This Section starts by stating that a company shall not have less than 2 shareholders. However the balance part of this Section is the proviso to the main Section and it allows even an individual to form a single shareholder company. Therefore there is no rationale behind the first part of the sentence which contains the basic requirement. Thus it is appropriate to amend this Section without delay. If the object of the legislature is to allow the incorporation of a single shareholder company, then it is necessary to provide for the procedure when the said single shareholder is dead.

4. Par value of shares; stated capital
The concept of par value of shares has been abolished. The new concept of stated capital has been introduced by Sec.58 of the Act. Stated capital is defined as follows. The total of all amounts received by the company or due and payable to the company: a) in respect of the issue of shares; and b) in respect of calls on shares. The values of the shares are determined in accordance with the consideration given to the company by that particular shareholder.

Therefore the necessity to open a share premium account and a share discount account will not arise. This also has simplified the accounting part of a share issue and the studying of the subject of company law.
However this concept has created confusion over the issue of bonus shares. This confusion has now been resolved by obtaining money to the company from the existing share premium accounts and capital reserves such as capital redemption reserve fund and revaluation reserve.

5. Issue of shares
Under the old Act, no period of time was necessary to receive the consideration when the shares were issued. Now the Sections 51 and 52 of the Act, require the company to issue shares immediately after its incorporation. The Directors are authorized to issue shares to such persons as they consider appropriate. This will facilitate the company to collect funds from the shareholders whenever a lucrative investment opportunity arises. Also, the company doesn’t need to wait to obtain permission from the regulatory authorities for the issue of shares. However this may lead to problems since there is no proper scrutiny and supervision by an independent person or a regulator. However this system is more attributable to a country like New Zealand where the corruption rate is at the minimum.

6. Matters concerning the bonus issue
Sec.52 of the Act requires a company to decide the consideration for which the shares are issued. This consideration may be in the form of cash, promissory notes, etc. Therefore on principle, no issue of bonus shares can take place under the Act. However if the company can receive consideration out of the existing share premium account or from rest of the capital reserves the shares could be issued to such an amount as bonus shares. This will avoid the reduction of the wealth of the existing shareholders.

7. Serious loss of capital
In terms of Sec.220 of the Act, the Board of Directors shall call for an EGM of shareholders when it appears to a Director that the net assets of a company are less than half of its stated capital. Such a meeting shall be held not later than 30 working ays from the date of calling such meeting. A meeting under this Section is summoned to discuss the report prepared by the Directors under Sub Section 2 of Section 220 and also the financial position of the company.

This will enable the shareholders to question, discuss and/or comment on any matter in relation to the said reports and also the general management of the company. This again will cast a duty on the Directors by law. Therefore this may lead to more litigation whenever the directors do not adhere to this requirements referred to in this Section 220(2). However, this step would protect the creditors to a greater extent.

8. Solvency test
In the present day context a company could obtain loans even if the company does not have sufficient assets. This is possible with furnishing personal guarantees. Therefore the creditors were faced with many problems when recovering the loans given to the companies. This scenario has caused many difficulties to the state banks in the country. In the recent past, state owned Banks were unable to recover very large amounts of loans that were outstanding.

The solvency test introduced in the new Act would assure the solvency of a company. Sec. 56(2) requires the Board of a company to satisfy the solvency test and to obtain a certificate of solvency from the auditors before any distribution is made. A company shall be deemed to have satisfied the solvency test, if:-it is able to pay it's debts as they become due in the normal course of business; and the value of the company's assets is greater than the value of its liabilities and the company's stated capital.This system would ensure the stability of a company.

The creditors are also protected to a greater extent. However, this system may create unhealthy atmosphere for service oriented businesses such as financial institutions since they have relatively low assets although they are solvent. Moreover, the hotel industry in this country may be liable to undergo winding up proceedings as most of the hotels are now running with more liabilities than the assets.

9. Reduction of capital
In terms of the provisions in Act No. 17 of 1982 the sanction of court was necessitated when a reduction of capital is made. This system had been there specially to protect the shareholders and the creditors. Therefore such Sections gave the opportunity of making representations to court when a reduction of capital is to be made. Sec.59 of the new Act provides for the reduction of stated capital by special resolution. However several pre conditions have been imposed by Sec.59 before a reduction of stated capital is made. If those pre conditions are not followed or adhered to, it is regarded as an offence. Therefore this novel procedure of reducing the capital may not harm the creditors and the shareholders although the sanction of court in this regard has been taken away.

10. Purchase of shares by the company itself
Normally the purchase of shares by
the company is prohibited. This is because the price of a bundle of shares is transmitted to its owners without considering the rights of the other shareholders and the creditors.
However, this system may lead to a disturbance of the majority is prohibited. This is because the price of a bundle of shares is transmitted to its owners without considering the rights of the other shareholders and the creditors. However, this system may lead to a disturbance of the majority.

11. Redemption of shares
Redemption of shares is referred to in the Sections 66 to 69 of the Act. Option to redeem shares could either be done at the option of the company or of the holder of shares provided the Articles of the company permit for the same. There is no necessity to meet the solvency test if the redemption of shares is at the option of the holder or if redemption is required on a fixed date by the Articles. However this could be done only after obtaining a certificate by the auditors. If the redemption is at the option of the company the resolution to redeem the shares must be signed by the Directors ensuring that the company will be able to meet the solvency test after the redemption. This process will have to be exercised carefully since the capital and the number of shares is to be reduced by this process.

12. Abolition of Ultra Vires doctrine
Even though many other countries have done away with the defence of ultra vires, this feature is introduced into our statute only by the new Act. Even in the recent past the legal fraternity took up the objection that the contracts entered into outside the objects of the company are invalid in law. Therefore third parties who entered into the contracts with the company without the proper knowledge of the objects of that company faced many problems up to now. However this doubt has been now cleared with the introduction of Sec.13 of the Act.

13. Director’s duties
Until the new Act came into operation common law principles were applied when defining the duties of the Directors. They were commonly known as fiduciary duties and duties of skill and care. These principles are now brought into the statute book. Sec.187 stipulates that a Director shall act in good faith and to the best interest of the company. Standard of care of the Directors is described in the Sec.189 of the Act. Accordingly Directors shall not act in a manner which is reckless or grossly negligent and shall exercise the degree of skill and care that may reasonably be expected of a person of his knowledge and experience.
Identifying these duties of the Directors may compel the Directors to act accordingly. Therefore this may become a ground for the shareholders to file action on behalf of the company to ensure its proper management of the company.

14. Recognition of filing derivative action on behalf of the company
As I have explained in the preceding paragraph the shareholders could file action to ensure the proper management of the company. Normally the majority shareholders are capable of managing the company according to their wish. This may lead to improper management of the company and no person would be in a position to overcome the majority rule even if the decisions are not for the betterment of the company. In such a situation a minority shareholder could file a derivative action by resorting to Section 234 of the new Act. This principle has always been accepted by the decision pronounced by the Supreme Court in the Hilton hotel case although there are no other actions have been filed in this manner.

15. Dividends and its distributions
Dividends are the distributions out of the profits of a company other than on an acquisition of its own shares or redemption of shares. (Sec.60) A distribution includes a payment of a dividend, purchase or redemption of shares. All the distributions must be authorized by the Board and should be approved by the shareholders at an ordinary meeting.
Decision for distribution could be made provided the company meets with the solvency test immediately following the distribution. Therefore, heavy responsibility is cast upon the Directors when making the decision for distribution.

16. Matters concerning major transactions
Major transactions are defined in Sec.185 (2) of the Act. Major transactions described in this Section could be entered into only if such transaction is;
(a) approved by a special resolution contingent on approval by special resolution consented to in writing by all the shareholders of the company or a transaction which the company is expressly authorized to enter into by a provision in its Articles, which was included in it at the time the company was incorporated.This process will prevent the abuse of powers by the Directors and the managers. At the same time this may cause delay or hamper the smooth running of a business.

17. Annual General Meetings
The way Annual General Meetings are held is described in Sec.133 of the Act whilst the Extra Ordinary General Meetings are described in the subsequent sections.

18. Introduction of company disputes board
This is a new feature introduced by Sec.507 of the Act. In fact a similar feature was found even in the old Act where it provided for the appointment of inquirers. This provision that was found in the old Act was not exercised at all except for the appointment of Mr. Leslie Abeysekara, a retired judge of the high court as an inquirer to investigate a dispute that arose amongst the Directors of a company when I was the Registrar of Companies. I believe that the success of constituting a Dispute ResolutionBoard would depend on the manner in which its members exercise their duties.

19. Continuity of the existing companies
Sec.531 of the Act ensures the continuity of the companies registered under the Companies Act 1972, Joint Stock Companies Act 1861 and the Joint Stock Banking Ordinance 1897. However S.485 - 487 require the existing companies to apply to the Registrar of Companies to assign a new company registration number. If those registered companies fail to do so, the Registrar after making a publication in the press has the power to strike off the name of the company from the registers. Striking off the names of the companies is made only when the companies are not doing the business. It is the duty of the Registrar to find out the companies that are not doing business. Even under the old Act the Registrar had the power to strike off the companies which do not file the necessary returns. These provisions were made use of only in few instances and may have been due to issues like lack of staff in the Registrar of Companies’ office.

This is evident by the statistics which show that there are around 60,000 registered companies whereas only around 15,000 companies are actively doing business. Therefore it would be meaningless to have such provisions, if the Registrar does not take proper steps to strike off defunct companies.

20. Jurisdiction of Court
Section: 529 of the Act defines the words "the court" as a High Court established under Article 154P of the Constitution for a province, empowered with civil jurisdiction by order published in the gazette under section 2 of the High Court of the Provinces (Special Provisions) Act, No.10 of 1996, within the Province for which such High Court is established, or where no such High Court vested with such civil jurisdiction is established for any Province, the High Court established for the Western Province. Section 529 read with Section 520 of the Act confers the island wide jurisdiction over the matters arising out of the Companies Act on the Commercial High Court in Colombo since no Civil High Courts are established in the other Provinces.

Section 530(3) of the Act further makes provision for the cases pending in all the District Courts in the country, other than the cases in which the adducing of evidence has commenced, to be transferred to the Commercial High Court in Colombo. These proposals will undoubtedly cause many hardships to the people who reside in distant places. Invariably the cost of litigation too will go up.

This problem may get aggravated as the fees of professionals in Colombo are generally higher than the fees charged by professionals in the out stations. If a creditor who lives in Hambantota needs to make an application to wind up a company situated in that area, he will have to come to Colombo for this purpose. This may be in contravention with the policy of decentralising the administration. Therefore it is better to consider this issue once again.There are many commendable features that have been introduced into the Act.
However there can be a few shortfalls since no perfect legislation could be expected especially when so many new features are introduced like in this instance.