Bonus shares are possible under the new Act

by Suresh Perera, LLB, Attorney-at-Law, Director - Tax, KPMG, Ford Rhodes, Thornton & Co.

The introduction of the new Companies Act launched the local commercial community into a debate as to whether the issuance of bonus shares is possible under the new Act.

Legal opinion on this issue is divided resulting in the commercial community blaming the legal profession for confusing what used to be a simple issue. Perhaps this is the biggest controversy to face the history of Company Law in Sri Lanka.

This controversy has arisen largely due to erroneous assumptions of principles of Company Law.

This article points out that according to Authorities on Company Law bonus shares are issued for a consideration and concludes that Parliament has intended to issue bonus shares under the new Act.

The article also sheds light on the misconstruction of the interaction between Sec. 47 and Sec. 48 of the New Zealand Companies Act of 1993 which is the origin of the confusion.

Script issues

The term "bonus shares" is misleading. Authorities such as 'Charlesworth' point out that the proper term should be "capitalisation" or "script issues."

"When a company capitalises its distributable reserves, it reduces at a stroke its accumulated realised profits available for dividend and issues in their place to existing ordinary shareholders in proportion to their holdings shares or loan stock credited as full paid up.

From an accounting view point, the distributable reserves figure in the balance sheet is reduced and the share or loan capital accounts increased by an equivalent offsetting amount.

As a result, other things being equal, the net effect on the value of an individual's holding in the company remains unchanged.

The term used to describe such issues as "bonus" issues is therefore misleading, and more appropriate descriptions are "capitalisation", "scrip" or "script - issues" (Charlesworth's Company Law-13th edition, page 604).

All the judges who have decided cases involving bonus shares, such as C.I.T v Macan Markar (1 CTC 154), I.C.R v. Blott (8 T.C.. 101), Bouch v. Sproule ([1887] 12 A.C. 385), Swan Brewery Co. v King ([1914] A.C. 231), IRC v. Wright (11 T.C. 181), refer to the process of capitalisation of reserves as bonus shares.

Whatever the terminology is apt for this, this Article uses the term 'bonus' to denote the process of issuance of shares pursuant to transfer from reserves or profits to the Stated Capital (or share capital).

The basis of contention that issue of bonus shares is not possible under the New Act Section 51 read in conjunction with Section 52 of the Act empowers the Board of Directors to issue shares and prior to issuance of any shares, the Board of Directors is obliged to decide the consideration for such shares which should be fair and reasonable to the company and all the existing shareholders.

In the context of the aforesaid statutory provisions some argue that issue of bonus shares is not possible under the new Act based on the erroneous premise that bonus shares are free shares or a free gift from the company.

Therefore directors are unable to issue bonus shares due to the absence of consideration for such an issue. Furthermore it has been pointed out that Sec.48 of the Companies Act of 1993 of New Zealand provides an exception to the requirement for consideration stipulated in Sec. 47 for issuance of bonus shares and in the absence of such a Section in our Act bonus shares can not be issued in Sri Lanka. Therefore this article also addresses the misinterpretation of the New Zealand Act.

Bonus shares are issued for a consideration and not gratuitously

There is a common erroneous notion that bonus shares are not issued for a consideration. Authorities on Company Law reject this erroneous notion. The following extract from Pennington's Company Law - 8th edition, page 521 shows that bonus shares are issued for a consideration.

"New shares, debentures or debt securities issued in this way on a capitalisation of profits or reserves are known as bonus shares or debentures, but the name is misleading in that it implies that they are a gift from the company. If they were issued gratuitously, they would not be paid up at all, and in the case of bonus shares, the company could call on their holders to pay for them in cash.

In fact bonus shares or debentures are not issued gratuitously, because their nominal value is paid in full or in part by the capitalised profits or reserves of the company which could otherwise have been distributed to the shareholders as a cash dividend, or in the case of unrealised profits, retained as reserve.

On the other hand, since no cash dividend is declared, bonus shares are not paid for in cash by the share holders to whom they are allotted, because there is at no point of time any debt owing to such a shareholder by the company with which he can satisfy his liability to pay for the shares.

Consequently, an issue of bonus shares must be treated as an issue for a consideration other than cash, and an appropriate and written contract for the allotment must be delivered to the Registrar of Companies.

Thus the authorities on Company Law clearly point out that the process of capitalisation of reserves is the consideration of the issuance of bonus shares and bonus shares are not issued gratuitously.

Pennington points out that bonus shares are issued for 'consideration other than cash'. Section 58 (2) of our new Act refers to this concept. It is noteworthy that Pennington makes this statement upon due recognition of the fact that 'at no point of time is any debt owing to such shareholder' in the case of the issuance of bonus shares.

Hence Pennington clearly recognises the fact that all reserves form assets of the company until they are legally distributed by the company. Notwithstanding this Pennington states that bonus shares are issued for consideration other than cash.

Ranking & Spicer's Company Law 10th Edition (Wilson and South) page 153 quoting a decided case points out "The issue of bonus shares as a gift is illegal (Re Eddystone Marine Insurance Co. (1893), 3 Ch. 9), but a company may pay up the nominal value of bonus shares out of capitalised profits.

Hence this Authority on Company Law too points out that bonus shares are not a gift and is for a consideration as they are fully paid up 'out of capitalised profits'. Thus capitalisation of profits forms the consideration for the issuance of bonus shares.

Whilst Sec. 51 empowers the Board of Directors to issue shares Sec. 52 stipulates that the Board of Directors should decide the consideration and resolve that in its opinion that consideration is fair and reasonable to the company and all existing shareholders.

Section 52 (2) states "the consideration for which a share is issued may take any form including cash, promissory notes, future services, property of any kind or other securities of the company".

This is an inclusive definition and not an exhaustive one. For the purpose of the Company's Act, bonus shares are certainly issued for a consideration and not gratuitously as the Authorities on Company Law have clearly pointed out.

To be continued