If a member, having been called upon to pay, defaults, the company may bring an action against him. But articles of association often provide that in such a case the company may proceed to forfeit his shares.
Shares cannot be forfeited unless there is a clear power to that effect in the articles.
Thus, in Madhwa Ramachandra Kamath v Canara Banking Corpn Ltd:1941 The articles of a company only authorised it to expel a member. That was held to be not sufficient to enable the company to deprive the expelled member of his shares.
Forfeited shares become the property of the company. To this extent forfeiture involves a reduction of the company’s capital. The shares can however, be re issued even at a discount, but that is not the same thing as an allotment.
Forfeiture is the remedy available to the company for
– Non-payment of calls or
– Instalments of call or other sums as premium: due in respect of shares.
Conditions or Procedure for Forfeiting of shares: The Companies Act, 2013 prescribes the rules and procedures of forfeiture of shares to be mentioned in the AOA.
Therefore, the forfeiture of shares is, governed by the “Articles rather than the Act itself.”
However, Table-F of the First schedule of the Act lays down the draft Articles of a company limited by shares which may be adopted either in full or with some modifications.
In accordance with the Act and Table-F, the conditions and applicable rules for forfeiture of shares are as under –
- In accordance with articles. -A forfeiture to be valid must proceed on the grounds specified in the company’s articles. It seems to be a principle of English law that shares can be forfeited only for non-payment of calls.
A call which does not fix the time for payment cannot support a valid forfeiture. A forfeiture on any other ground would be an illegal reduction of capital.5 But the Supreme Court has now held in Naresh Chandra Sanyal v Calcutta Stock Exchange Ass Ltd that “there is no provision in the Companies Act restricting the exercise of the right to non-payment of calls only”.
A stock broker, holding one fully paid share in the Exchange, carried on business on its premises. He had agreed to buy certain shares from a company, but failed to carry out his commitment. The shares were then resold by the company with the authority of the Exchange. The broker was required to pay the difference between the contract and resale prices. On his failure to do so his share was forfeited. The Supreme Court held the forfeiture to be valid.
The court said: [A] company may by its Articles lawfully provide for grounds of forfeiture other than non-payment of call, subject to the qualification that the Articles relating to forfeiture do not offend against the general law of the land and in particular the Companies Act, and public policy; and that the forfeiture contemplated does not entail or effect a reduction in capital or involve or amount to purchase by the company of its own shares, nor does it amount to trafficking in its own shares.
The learned judge then stated that the forfeiture of shares did not result in reduction of capital. The company was under an obligation to dispose of the forfeited share, and could not retain the same. Further, the reissue of a forfeited share was not an allotment, but only a sale, for otherwise the forfeiture, even for non-payment of call, would be invalid as involving an illegal reduction of capital.
But fully paid shares not allowed to be forfeited for the fact that the NRI holder had not obtained RBI approval as held in the case of Mohammad Farooq vs Portan Cirkit Electronics (P) Ltd 1997.
- Notice prior to forfeiture: Before shares can be forfeited, the company must serve a notice on the defaulting shareholder, specifying –
- The last day upto which the calls can be paid
- The amount of unpaid call including any interest which may have accrued. (Article 28. Table F).
- A clear warning about forfeiture of shares, in case of non-payment of calls within the period specified in the notice, not less than 14 days’ time from the date of service of notice for the payment of the amount due. Article 29 of Table F .
- In the event of non-payment: State that in the event of non-payment of the amount due within the period mentioned in the notice, the shares in respect of which the call was made will be liable to be forfeited, (Article 29. Table F).
The notice of forfeiture must also specify the exact amount due from the shareholder. If the notice is defective in any respect, the forfeiture will be invalid.
- It has been held by Bachawat J in a decision of the Supreme Court, in the case of public passenger Service Ltd vs MA Khadar that a notice which does not specify the amount claimed by the company as call money, interest and expenses, is defective.
“The defect in the notice, though slight, invalidates it and is fatal to the forfeiture.”
In a case of Promila Bansal vs Wearwell Cycle Co India Ltd before the Delhi High Court, shares were forfeited on the basis of a registered acknowledgment due notice which came back as unserved, it was held that the forfeiture was bad, for it was the duty of the company to know whether the address of the member had changed.
- Resolution of the Board:
- If a defaulting shareholder does not pay the amount within the time specified in the notice, the directors must pass a Board resolution forfeiting the shares (Article 30).
- If the resolution is not passed, the forfeiture is invalid.
- However, the notice warns the forfeiture i.e. inserted in notice the resolution of forfeiture as well. (E.g., when it states that in the event of default the shares shall be deemed to have been forfeited,) Then no further resolution is necessary.
- Thus where the final resolution of forfeiture was not passed the court held in the case Paryam Prasad vs Gaya Bank and trade association 1931 that, “a declared intention to forfeit not carried into effect is no forfeiture at all’, But the notice threatening forfeiture may incorporate the resolution of forfeiture as well. It may state that in the event of default the shares shall be deemed to have been forfeited. In such a case no further resolution is necessary.
Good faith: The power to forfeit shares must be exercised by the directors in good faith and for the benefit of the company.
Effect of the Forfeiture:
- Cessation of membership: A person whose shares have been forfeited ceases to be a member in respect of the shares so forfeited. He, however, remains liable to pay to the company all moneys which, at the date of forfeiture were payable by him to the company in respect of the shares.
- Cessation of liability: The liability of the person whose shares have been forfeited ceases if and when the company receives payment in full of all such money in respect of the shares.
- Reissue: Forfeited shares become the property of the company and may be reissued or otherwise disposed of on such terms and in such manner as the Board thinks fit.
- Liability of the purchaser: The liability of a member whose shares have been forfeited depends upon the provisions of the articles. The articles may provide that the member should be liable to pay all calls owing upon the shares at the time of the forfeiture. In such a case the members will remain liable as debtor of the company, but not as a contributory.
When the forfeited shares are resold member whose share is forfeited can collect from the company the surplus of the sale proceeds after deducting the amount due. Thus the Supreme Court in Naresh Chandra Sanyal vs Calcutta Stock exchange Assn Ltd 1971 declared that the articles of the Exchange which allowed it to a retain such proceeds were invalid for two reasons: –
- First it would amount to penalty against the spirit of section 74 Indian Contract Act
- Secondly it would also be equivalent to a purchase by the company of its own shares in contravention of section 67.
The case is different from others as forfeited shares here were fully paid and not that of non-payment shares as generally happen to be.
A person to whom forfeited shares have been reissued is governed by the terms of reissue. When the reissue is without any stipulation as to the outstanding calls, the new allottee cannot be held liable for the previous calls and interest on the overdue amount and his shares cannot be forfeited on that ground.”