Bonus shares: Law Advisory Commission viewpoints

Two members of the Company Law Advisory Commission - its chairman K. Kanag-Isvaran and Nihal Sri Ameresekere – have raised some issues relating to our series on the Companies Act report in last week’s FT headlined “Unravelling the complications and mystic of the Companies Act.”

They said: “Though we understand your reporter was present (at a seminar on the Companies Act where both members made presentations), her article published in the aforesaid feature makes no mention of the clarifications and explanations given, more particularly on the question relating to bonus shares.”

Here are extracts of the letter providing clarifications and explanations on this issue:

Sections 57(7) and 58(2) of the repealed Companies Act No. 17 of 1982 stipulated that 'Bonus Shares' may be issued by applying the 'Capital Redemption Fund' and the 'Share Premium Account', respectively. However, there was no mention as to at what consideration such 'Bonus Shares' could have been issued. Nevertheless, 'Bonus Shares' were issued at the 'nominal value', which was unrelated to the actual value of a Share, and regardless of the 'net assets value', 'earnings value' or 'market value', since the existing Shareholders, themselves were receiving such additional shares in proportion to their respective shareholdings.
Since the repealed Companies Act No.17 of 1982 had specifically stipulated the issue of 'Bonus Shares', by utilizing on the 'Capital Redemption Reserve Fund' and the 'Share Premium Account', a reasonable query arises, as to how 'Bonus Shares' were issue by Companies, utilizing 'other Reserves', including unrealized Profits on revaluation? The question of the propriety of such a practice, curiously had not been adverted to by those, who have directly and/or indirectly, sought to question the legality of the issue of fully paid Shares (i.e. 'Bonus Shares') under the new Act!

Where a company wishes to retain its Profits/Reserves, without distributing in cash as Dividends/Distributions to Shareholders, it could 'capitalize' such Profits/Reserves, adding to the 'Stated Capital', and issuing additional shares to the Shareholders as fully paid shares (i.e. 'Bonus Shares'). In actual fact, there is no 'free gift', since the Shareholders' right and entitlement to the Profits/Reserves, are 're-invested' as 'Stated Capital' in the company, affording the Shareholders additional Share Certificates, which if a Shareholder so desires, could be transferred to another, realizing cash.

This concept is akin to the Profits/Reserves being 'deemed' to be distributed in cash as 'Dividends'/'Distributions' to the Shareholders, on the condition that they are required to re-invest such 'distributed Profits / Reserves', in the 'Stated Capital' of the company, for which the Shareholders are issued additional Shares. This is the 'effect' of the transfer of the quantum of Reserves to 'Stated Capital', called 'Capitalization.'

The above could also include fully paid ‘shares’ issued to Shareholders from 'unrealized profits' arising from a re-valuation of fixed assets, where such re-valuation 'Reserves', would likewise be added to the 'Stated Capital', issuing additional Share Certificates to the Shareholders, which if desired by a Shareholder, could be transferred to another, realizing cash.

Though this practice was prevalent, without express provision therefore in the Companies Act No. 17 of 1982, such practice would now come under the ambit of 'Distributions' in the Companies Act. No. 7 of 2007 which enables 'Distribution' to Shareholders, in cash or kind, surplus 'Reserves'. This new concept of 'Distribution' to Shareholders' provided for in Section 56, read with Sections 57 and 61, should not be mixed up with the distribution of 'Dividends' out of Profits, as per Section 60, where the manner of payment of Dividends could be by way of fully paid shares as well.

Where there is excess solvency in a company, in the form of either liquid funds or property, which accordingly would be represented by 'Reserves', it could also be distributed to Shareholders. Section 529 defined 'Distribution', to mean the direct or indirect 'transfer' of money or property, of a company, other than shares of a company, for the benefit of a Shareholder, 'including the payment of Dividends'.

Intrinsic in the term 'transfer' of shares, is that it refers to shares already issued and registered, and that therefore they cannot be transferred to Shareholders, as it would tantamount to a 'reduction of 'Stated Capita', for which there is a separate procedure provided for in Section 59. The issue of new fully paid shares (i.e. 'Bonus Shares') would not be a 'transfer' of shares of a company.

Section 70 stipulates restriction on giving financial assistance by a company for acquisition of its own shares; whilst Section 71 specifically stipulates that restrictions as per Section 70 shall not apply in respect of 'Distribution' to Shareholders and the issue of shares by the company.

Section 52 stipulates that the 'consideration' should be 'fair and reasonable' to the company and to all its existing Shareholders.
The quantum of Profits/Reserves to be capitalized divided by the number of fully paid shares (i.e. 'Bonus Shares') to be given equitably to all the existing Shareholders would be the 'consideration' for the purpose of Section 52, in the absence of the regime of a 'nominal value' of a share, which has been done away with. 'Bonus Shares' were hitherto given at 'nominal value', even though the repealed Companies Act No. 17 of 1982 had no specific requirement in that behalf.

However, prior to making a 'Distribution', which including the payment of Dividends, the Board has to satisfied that the company immediately after the proposed 'Distribution' will satisfy the 'Solvency Test', by obtaining a 'Certificate of Solvency' from the Auditors, and the Directors, who vote in favour of the 'Distribution', signing a Certificate that in their opinion, the company will satisfy the 'Solvency Test', immediately after such 'distribution' is made.

Corporate lawyer urges stakeholders to study new laws

A top corporate lawyer earlier this week urged stakeholders and the private sector to pay attention to and take heed of the new Companies Act, saying that whilst the new document gives a lot of freedom to the corporates, they are also empowered by the Act to become more responsible to the shareholders and the public at large. Aritha Wikramanayake "It is important for the corporate sector and future entrepreneurs to look at this Act and understand the Act together with its interpretations," Aritha Wikramanayake, Senior Partner, Nithya Partners told a gathering of young corporate leaders at The Sunday Times Business Club on Monday. He reprimanded those who raise questions about the new Act, which has been in circulation for the last 13 years. "Professionals, chambers and any other interested party should have looked at this Act way before, Wikramanayake said, pointing out that the recent debates and different opinions of the new Act shows how disorganised the execution of the Act has been. "Not putting this out for the last 13 years shows the indecisiveness of the politicians," he said. He said that Sri Lanka has been following the Companies' Act of 1982, which is based on the English Companies Act of 1948, for many years adding that, "This is an indictment of how inefficient the country has been compared to other countries." "This is a shameful thing and we should learn from this," Wikramanayake went on to say, explaining that for example in England, there is a continuous change in law, but in Sri Lanka as it does not happen, the country was unprepared for such a huge and fundamental change. "It is important to change our mindset to look at this law," he said. Wikramanayake explained that the new Act simplifies, rationalises and seeks to create greater balance with the shareholders. Explaining the rationalisation of the law, he said that earlier some of the procedures by the stakeholders relating to the companies such as incorporating a company were cumbersome and complex. "Now this procedure is very simple. Incorporating a company is just a matter of filling in one page which can be downloaded from the Internet. It is cheaper and affordable," he said, adding that such procedures mostly help the people in the outstations and also encourages the sole proprietors. He also said that procedures such as mergers and amalgamations were complex earlier, but now it can be passed by a simple resolution by the shareholders. On the modernisation aspect in the new Act, Wikramanayake said that the new law has 'weeded' out the more relevant principles that were hidden or seem insignificant earlier. Explaining certain clauses that are important for minority shareholders, Wikramanayake explained that the new Act, under 'buyouts and major transactions' stipulates that if a company decides upon a major transaction, then it needs to get special permission from the shareholders. "If a company changes its business or disposes its assets amounting to half or more than that of its size, it is considered as major transaction. This needs special resolution from its shareholders," he said, explaining that the thinking behind this principle is that such transactions are now considered as 'material change' in the nature of a company's business, which is a change in the direction of its business. He also said that if there are dissenting shareholders to such major transactions, they can make the firm buy back their shares of that particular company at a reasonable value. "Earlier the opposing shareholders who would be a minority if such transaction is approved, did not have an option, but now they do," he said. "It codifies the law. Under the previous law, the shareholders' rights and the responsibilities of the directors were under common law. The new law extracts these principles and lays it black and white on the Companies' Act itself," he said, adding that the objective of simplifying it in such a way to make it easier for the stakeholders to clearly interpret it.