Bonus shares are possible under the New Act - part 2

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 definition of ‘bonus shares’ in Sec. 55 of the Securities & Exchange Commission of Sri Lanka Act No.36 of 1987 has also been quoted in aid of the proposition that bonus shares are issued gratuitously. However it is a well accepted Rule of Interpretation that the definition contained in one statute does not apply to another statute.

The definition given in due statute is for effectuating the provisions of that statute and not for effectuating the provisions of another statute. Definition for expression given in an Act cannot be used for purposes of another Act. (Cibatul Ltd v. Union of India (1980)21 Guj LR 284 (DB)

Where a definition is given in an Act, it should be confined as a general rule to interpret a word defined in that Act only and does not explain the meaning of a word in other statutes.

Maxwell on The Interpretation of Statutes, 12th edition, page 281, states “ Another reason why the same word or phrase sometimes receives two different constructions is that the sections in which it occurs are derived from two distinct enactments”.

N.S. Bindra’s Interpretation of Statutes comments on this approach as follows.

“It is no sound principle of construction to interpret the expressions used in one Act with reference to their use in another Act. The meaning of words and expressions used in an Act take their colour from the context in which they appear.

To take a word bearing a peculiar meaning in a particular Act and to clothe that word with the same meaning when found in a different context in a different Act is a fallacious process of interpretation.

If there are different enactments dealing with similar topics and containing same phrases, interpretation given to one of them cannot be relied on for interpreting the other”

Though the word bonus share in the Securities & Exchange Commission Act has been defined with reference to consideration, the meaning of the word ‘consideration’ for the purpose of the Securities Exchange Commission Act and the Companies Act is not identical.

Value of bonus shares

Whilst the word in the context of the Companies Act bears a broader definition, the same word connotes a narrow definition in the context of the Securities & Exchange Commission Act.

When issuing bonus shares the directors have the obligation of determining the cash value of the consideration for a share, i.e. the amount being capitalised divided by the number of shares to be issued3 and resolving that in it’s opinion it is fair & reasonable to the company and to all existing shareholders.

Is it fair and reasonable?

One may observe that when bonus shares are issued to shareholders by capitalising the profits, profits are retained by the company and the company could utilise these for further investments.

As such there is no unfairness or unreasonableness whatsoever caused to the company by issuance of bonus shares (at the value arrived at by dividing the amount capitalised by number of shares issued). In fact the company benefits as it retains the profits within the company.

Capitalisation at par value under the old Act was carried out simply because it was the lowest value at which it could have been done. Issuance of shares below the par value was prohibited under the old Act except with the sanction of a court.

Hence the reason for capitalisation at par value. L.C.B. Gower in his book ‘Modern Company Law’ third edition, page 110 states that “There is, it seems, no legal obligation to issue shares at the best price, thereby avoiding the dilution of the value of the existing shares, so long as there is no breach of the directors’ fiduciary duties or fraud on the minority”

Therefore the contention that bonus shares should be issued at market value is only a figment of the imagination. From the perspective of shareholders, as their shares become more readily marketable an advantage is derived by them due to the process.

As Gower points out “The only result, from the shareholder’s point of view is that his proportion of the capital of the business is now represented by a greater number of shares, each of which is therefore wothless and this may make them more readily marketable”.

A company should file form 6 with Registrar General of Companies to issue bonus shares. Has the legislature intended the issuance of bonus shares?

* Is capitalisation of reserves and issuance of shares possible under the new Act?

If there is an ambiguity it should be resolved by resorting to the universally accepted Rules of Interpretation of Statutes and not by comparison of our provisions against the company law of a foreign jurisdiction.

* Intention of the legislature

A fundamental rule of interpretation is that one must seek the intention of the legislature.

The dominant purpose in construing a statute is to ascertain the intent of the legislature, as expressed in the statute, considering it as a whole and in the context (Bindra on Interpretation of statutes - 8th Edition, page 417)

Has Parliament intended that bonus shares could be issued by capitalising reserves? Clear words of the intention of the legislature are embodied in Section 72(3) of the Act.

In this section Parliament has pronounced the consequence of bonus shares issued by capitalisation of profits in a crossholdings situation. Now could somebody hasten to conclude that bonus shares are not possible under the Act in the context that the legislature has enacted rules regarding consequences of a bonus issue in a crossholding situation ?

If bonus shares are not intended under the new Act, Parliament would not have made any provision for the consequences issuance of bonus shares under crossholding situation.

Sec. 72(3)(b) of Act No. 7 of 2007

“Where a body corporate is permitted to continue as a member of the holding company .................. , an allotment of fully paid shares in a company may be validly made by way of capitalisation of reserves of the company, which share also will have no right to vote”

Would Parliament enact the consequences of a bonus issue if its intention ever was that issuance of bonus shares was not possible under the Act? Hence the intention of the legislature is too clear for any dispute to arise in this regard, if proper Rules of Interpretation had been invoked in the first instance.

* Bonus shares - the interpretation consistent with smooth working of the system to be selected

At present due to the alternate view expressed that bonus shares are not possible under the Act, there is much confusion regarding the issue of bonus shares.

“The Interpretation of statutes” by Maxwell, a well-known authority among lawyers and judges, clearly indicates that if there is a choice between two interpretations, the one that fails to accord with the manifest purpose of legislation must be disregarded. (Sec. 72 (3)(b) of the Act manifests the intention of the legislature regarding capitalisation of reserves and issuance of bonus shares.)

If this issue is subject matter for adjudication on a future date, a court of law should reject the interpretation which introduces uncertainty and confusion in o the system, in keeping with the Rules of Interpretation.

During the last few months many companies that sought to issue bonus shares have faced much inconvenience due to the confusion created by the alternate view based on erroneous presumptions.

The Interpretation of Statues by Maxwell - 12th edition, page 45, lays down the rule regarding this.

“If the choice is between two interpretations, the narrower of which would fail to achieve the manifest purpose of legislation, we should avoid a construction which would reduce the legislation to futility and should rather accept the bolder construction based on the view that Parliament could legislate only for the purpose of bringing about an effective result.

Where alternative constructions are equally open that alternative is to chosen which will be consistent with the smooth working of the system which the statute purports to be regulating; and that alternative is to be rejected which will introduce uncertainty, friction, or confusion into the working into the system.” (Construction ut res magis valeat quam pereat)

Power to issue shares pursuant to a capitalisation

Normally the power to issue bonus shares on capitalisation of profits / reserves need not stem from the Act itself. Since this is an internal matter that could be provided for in the Articles.

For instance neither the U.K. Companies Act of 1948 nor the Companies Act of 1982 of Sri Lanka contained a specific section in the Act to issue bonus shares on capitalization of reserves. Sections 57(5) and 58(1) provided merely for the issuance of bonus shares out of the capital redemption reserve fund and the share premium account respectively.

A company derived power to issue bonus shares by capitalization of profits from the Articles (Article 129 of table A). This fact of deriving power from the Articles to issue bonus shares by capitalisation of reserves is referred to in Ranking & Spicer with reference to U.K Companies Act 1948 as follows

“The issue of shares as a gift is illegal........ but a company may pay up the nominal value of bonus shares out of capitalized profits, or out of the Share Premium Account ... or the Capital Redemption Reserve Fund.

In the last two instances, the power is statutory, but it can only be employed to pay up unissued shares for distribution as fully - paid bonus shares. In the first instance, power to capitalize profits must be contained in the Articles. Table A contains such a power .... and also authorizes the distribution of shares in other companies by way of bonus5”.

It must be pointed out here that the comparison of the New Zealand Companies Act with the new Sri Lankan Act could lead to erroneous conclusions due to the differences in the governing regulatory frameworks.

Companies in both countries are devoid of Memorandums whilst companies in Sri Lanka are governed by the provisions in Companies Act and provisions in Articles of Association, inter alia. However in New Zealand companies could be incorporated with Articles as well as without Articles.

The latter category of companies would be governed only by the provision of the statute6. Therefore a direct comparison of the New Zealand Act with our Act could lead to incorrect conclusions.

Thus one could see that the New Zealand Act contains more specific provisions that regulate activities of a company such as rules in relation to issuance of ‘share options’ and ‘convertible securities’ (Sec. 49), shares in lieu of dividends (Sec. 54 ) etc.

New Zealand contains these specific sections in recognition of the fact that it should facilitate the operation of companies functioning without Articles.

Thus even in the absence of Sec. 72(3)(b), bonus shares by capitalisation of reserves would still be possible under the New Act, provided such power is contained in the Articles.

As the Model Articles of the New Act is not meant to be exhaustive and does not contain such power, a company that adopts Model Articles should ensure to include an Article similar to A. 129 of the First Schedule Table A of the Old Act.

This identical issue arose in Singapore, pursuant to change of its company law regime from par value shares to no par value, by an amendment to its Companies Act with effect from January 30, 2006. (Companies (Amendment) Act 2005) i.e. Whether in the absence of express power in the Statute bonus shares could be issued ?

The clarification provided by the Authorities in Singapore is in the website www.sbf.org.sg/download/docs/home and an extract is reproduced below.

“The argument is premised on the assumption that express legislative provision is required before a company may issue bonus shares. We have doubts whether this is correct. It should be noted that nowhere in the Companies Act is the issue of bonus shares prohibited.

If so, we do not see why this should not be an internal matter for each company to determine in accordance with Articles of Association.”

Bonus shares in New Zealand

The origin of the confusion pertaining to issuance of bonus shares under the new Act could be traced to two erroneous presumptions.

(a) Issue of bonus shares are without consideration

(b) Misinterpretation of the interaction between Sections 47 and 48 of the New Zealand Act of 1993.

The interaction between sections 47 and 48 of the New Zealand Act has been misunderstood thereby leading to the confusion pertaining to bonus shares. It is a misconception to contend that section 48 provides an exception to the ‘requirement of consideration’ for the issuance of shares stipulated in Sec. 47 of the New Zealand Act in case of:

- capitalisation of reserves and issuance of fully paid shares (bonus shares) and

- consolidation and division of shares, and

- sub division of shares (share splits).

A study of the New Zealand Act in fact manifests that bonus shares are issued for consideration, which is a statutory confirmation of the concept elucidated by authorities such as Pennington and Ranking & Spicer. i.e. bonus shares are issued for consideration even in New Zealand.

Even in New Zealand bonus shares are issued for consideration

The consideration for issue of shares is defined in Section 46 of the New Zealand Act and includes “other securities of the company” inter alia. The Act incorporates by reference the definition of the term securities as defined in Sec. 2D of The Securities Act of 1978 of New Zealand.

This covers the interest of a person to participate in the earnings or property of the company. Thus the process of capitalization of earnings provides consideration for issuance of bonus shares even in New Zealand.

As Section 46 of the New Zealand Act read in conjunction with Section 2D of the Securities Act 1978 states that bonus shares are issued for consideration, the assumption that Section 48 of the Act provides an exception to the requirement of ‘consideration’ embodied in Section 47 has no basis in law whatsoever.

What then is the function of Section 48 vis a vis Section 47 in New Zealand?

Though the contents of Section 52(1) of our New Act has been extracted from Section 47 of the New Zealand Act, a study of the particular section in the New Zealand Act reveals that it contains many other aspects that have not been brought to our Act.

For instance it makes it mandatory for the directors to sign a certificate, when issuing shares and deliver a copy thereof to the Registrar of Company for registration and specifies the failure to do so to be an offence attracting a penalty.

However due to the exception provided in Section 48, the Board of Directors does not have the obligation of complying with this procedure when issuing bonus shares in New Zealand.

Thus due to the exception provided in Sec.48, the Directors do not have to have follow the procedural requirements when issuing bonus shares.

6. CONCLUSION

1. Authorities on Company Law such as Pennington, Ranking & Spicer establish the fact that bonus shares are issued for consideration.

2. Capitalisation of the reserves amounts to consideration as bonus shares are always considered “fully paid”.

3. The intention of the Parliament with regard to issuance of bonus shares could be gathered from 72(3)(b) of the Act.

4. The power for capitalisation of reserves and issuance of bonus shares should stem from the Articles of the company and need not be contained in the Statute itself.