In this article, Sai Manoj Reddy, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on the forfeiture of shares and its effects.

Introduction

What is forfeiture of shares?

Forfeiture of shares is a process where the company forfeits the shares of a member or shareholder who fails to pay the call on shares or instalments of the issue price of his shares within a certain period of time after they fall due. In other words, when the shareholder fails to pay the full amount of share which he agreed to pay in instalments the company can cancel his shares.

Legal Framework

When the shares are issued by the company, generally the shareholders are not asked to pay the whole amount of share at once. It happens in instalments. The company makes these calls on shares when it requires further capital.

The company may call up the unpaid money from the shareholders when it is needed from time to time. The board of directors are required to pass a resolution for making a call on shares. The articles of the company should contain the provisions regarding this call on shares and if nothing is mentioned in the articles then Regulations 13-18 of table F of Schedule I of Companies Act, 2013, will apply.

Those provisions provide that

1. the amount called must be not more than one-fourth of the face value of share;
2. the dates of two consecutive calls must differ by at least a month;
3. a minimum of fourteen days’ notice must be given to members;
4. the notice has to mention the time, place and amount of the call on shares.

Generally, the company will give 14 days’ notice to the shareholder and after 14 days if the shareholder is not willing to pay the money due to the company will forfeit the shares of that shareholder.  

The relationship between shareholder and company

Now if we look at the relationship between a shareholder and the company, it is a contractual relationship. The shareholder applies for an offer from the company and gets shares allotted. This process is nothing but the shareholder entering into a contract with the company as the offer and acceptance along with some consideration become a valid contract between him and the company. This contract makes it binding upon the shareholder to pay-up the amount due on the issue price of the share when company calls for it through the call on shares.

So the non-payment of call on shares amounts to a breach of contract by the shareholder, and therefore as per the terms and conditions of the issue of shares and after allowing the shareholder prescribed time and opportunity, if he still fails to pay the money due, the company can forfeit the shares of that shareholder. Shares which are forfeited will no longer remain the shares of that shareholder. The money paid by that shareholder is also not refundable by the company.

What happens after the shares are forfeited?

After the shares are forfeited, they may be either disposed of or they may be reissued to some other person. The only condition in reissuing the forfeited shares is that the price which will be fixed by the company for reissue of the forfeited share (i.e., the price of the reissued share + amount paid by the former owner of the share) should not be less than the face value of the share. This is done to ensure that the shares are not allotted at a discount.

If the previous shareholder (whose shares has been forfeited) requests the company to cancel the forfeiture, the board of directors can at any point before the reissue or disposal of such shares can cancel the forfeiture of shares in terms as the board thinks fit. For this, the board of directors has to pass a resolution to cancel the forfeiture.

Illustration

Pilot Ltd. has issued 1,00,000 equity shares of face value of Rs. 1000 each. The company set up its amount on the share as Rs. 100 at the time of application, Rs. 200 at the time of allotment, Rs. 300 per share on making the first call, and Rs. 40 on the final call.

Mr. Manoj has been allotted 400 shares by the company and while the final call of Rs. 400 is made by the company he was unable to pay the money for that final call. The company gave prescribed time period and notice to Manoj and even after that he failed to pay the money.

Now the company can forfeit the shares of Manoj and he ceases to be a member of the company and loses all rights on the shares he held.

Now Pilot Ltd. decided to reissue the forfeited shares to Mr. Rishvik and the minimum price at which the shares can be issued should not be less than Rs. 400. This is because the amount of money paid by Manoj (previous holder) is Rs. 600 and the face value of the share is Rs. 1000. Hence Rs.600 + Rs.400 will amount to 1000 and any amount which is less than Rs. 400 will amount to issuing the shares at a discount which is prohibited under section 53 of Companies Act,2013.

Now if Mr. Manoj comes and pleads with the company to cancel the forfeiture of shares after the reissue of the forfeited shares to Mr. Rishvik. This cannot happen because the board of directors has the power to cancel the forfeiture only before the disposal or reissue of shares as per regulation 31(2) of Table F, Schedule I of Companies Act, 2013.

Procedure for forfeiture of shares

Forfeiture of shares is a serious step since it involves in depriving a person of his property as a penalty of some act or omission. Accordingly, shares of members cannot be forfeited unless the articles of the company confer such power on the directors. The forfeiture of a share should happen only for the non-payment of the call on shares by the members and in accordance with articles of the company. But forfeiture can also be made for any other reasons which are specified in the articles of the company. Companies normally have their own rules and regulations regarding the forfeiture of shares and in case if those provisions are not present then the Regulations 28-34 of Table F of Schedule 1 of Companies Act, 2013 will apply.

The following is the procedure:

• In accordance with articles

Forfeiture of shares must be in accordance with the provisions contained in the articles of the company to be treated as valid forfeiture. The power of forfeiture of shares must be exercised bona fide and in the interest of the company. Thus, where the articles of the company authorize the directors to forfeit the shares of a shareholder, who commences an action against the company or the directors, by making a payment of the full amount of his shares, was held that such a clause was invalid as it was against the rights of a shareholder [Hope v. International Finance Society (1876) 4 Ch. D. 598]

• Proper notice

A proper notice under the authority of board must be served on the defaulting shareholder. The notice should mention that the shareholder has to pay the amount on a day specified which would not be earlier than fourteen days from the date of notice served. This is provided under Regulation 29 of Table F. the notice should also mention that in the event of non-payment, the shares will be liable to be forfeited.

The objective of sending the notice is to give the defaulting shareholder an opportunity to pay the call money, interest and any other expenses and hence notice should disclose enough information with particulars to the shareholder.

“A proper notice is a condition precedent to the forfeiture of shares and even the slightest defect in the notice will invalidate the forfeiture”. [Public Passenger Services Ltd. v. M.A. Khader [1996]]

A notice sent for forfeiture by registered post was returned unserved, the forfeiture will be held invalid” [Promiela Bansali v. Wearwell Cycle Co. Ltd. [1978] 48 Comp. Cas. 202 (Delhi).]

A notice sent to the holder of a partly paid share after his death is not a proper notice. Notice in this kind of situations is to be sent to the legal heir [George Mathai Noorani v. Federal Bank Ltd. [2007] 76 SCL 528 (CLB).]

• Resolution for forfeiture

If the defaulting shareholder does not pay the amount within the specified period mentioned in the notice properly served to him, the directors of the company may pass a resolution forfeiting the shares under regulation 30 of Table F. in the absence of such resolution the forfeiture shall be invalid unless the notice of forfeiture incorporates the resolution of forfeiture as well. For example, the notice may state that in the event of default the shares shall be deemed to have been forfeited.    

Effects of forfeiture

Cessation of membership

A person whose shares have been forfeited ceases to be a member in respect of forfeited shares. This is provided under regulation 32(1) of Table F of schedule 1 of Companies Act, 2013.

Cessation of liability

The liability of a person whose shares have been forfeited comes to an end when the company receives the payment in full of all such money in respect of shares forfeited. This is provided in Regulation 32(2) of Table F.

However, notwithstanding the forfeiture of shares, shareholder remains liable to pay to the company all money which, at the date of forfeiture, were payable by him to the company in respect of forfeited shares. Thus, the liability of unpaid calls remains even after the forfeiture of shares.

Liability as past member

The liability of a former shareholder remains as a liability of a past member to pay calls if liquidation of the company takes place within one year of the forfeiture.

Forfeited shares become company’s property

The forfeited shares become the property of the company on forfeiture. Accordingly, these may be re-issued or otherwise disposed of on such terms an in such manner which the board of directors thinks fit. This provided under Regulation 31(1) of Table F.

In the same Regulation clause (2) provides that at any point of time before a sale or disposal of forfeited shares the board may cancel the forfeiture of shares in terms as they think fit.