Forfeiture of Shares – Meaning, Process & its Effect Under the Companies Act, 2013 – Complete Guide

  • Setindiabiz Team
  • June 3, 2024
Complete Guide on Share Forfeiture under the Companies Act, 2013

This blog is a complete practical guide on the Forfeiture of Shares in company law, its meaning and step wise process under the Companies Act 2013, its causes, implications, and processes, and to provide a comprehensive guide to all stakeholders. In the ever-changing world of corporate finance, share forfeiture is a mechanism that enforces discipline in terms of financial obligations associated with share ownership. This process is governed in India under the Companies Act, 2013. The blog explains the procedure of forfeiture of shares, its nuances and implications of forfeiture of shares in Companies Act 2013 which is crucial for shareholders, companies, and prospective investors alike to make informed decisions.

BRIEF SUMMARY

Understanding Share Forfeiture

In the world of corporate finance, the concept of forfeiture of shares plays a crucial role. In fact, forfeiture of shares in company law refers to a process a company can use to make sure shareholders fulfill their financial duties tied to owning shares. Here’s how it works: let’s say a person buys shares in a company, but then they don’t pay for these shares as agreed. The company can then enforce what’s known as ‘share forfeiture’.
This means the company cancels or takes away the shares that the person owns. So, in simple terms, share forfeiture is like a tool that companies can use to ensure that shareholders follow through on their financial promises related to owning shares. It’s the company’s way of saying, “If you don’t hold up your end of the deal, we have the right to take back the shares.”
While it may seem similar to other share-related actions, it’s important to distinguish forfeiture from surrender or lien.
Share surrender, in contrast, is a voluntary act by the shareholder who returns their unpaid shares back to the company, essentially renouncing their ownership. The company is under no obligation to accept the surrender. Share line, on the other hand, is a right given to the company to retain shares of a shareholder as a security against any debt due to the company. It doesn’t necessarily result in the cancellation of shares but rather restricts their transfer.
Therefore, while share forfeiture, surrender, and lien are all mechanisms associated with share ownership, they differ fundamentally in terms of their initiation, process, and consequence, and it’s crucial to understand these differences.

Legal Framework

Understanding the legal aspect of forfeiture of share is important, and in India, this is guided by the Companies Act, 2013. Specifically, the procedure and validity of forfeiture of share are governed by the articles of association of the company, which is a document that outlines the rules for running the company. The Companies Act doesn’t explicitly cover forfeiture of shares, but it does allow companies to provide for it in their articles. Regulations 28 to 34 of Table F of Schedule I of the Companies Act, 2013 contain regulations regarding forfeiture of share.
Usually, most companies include a clause in their articles of association stating that if a shareholder fails to pay the amount due on their shares by a certain date, the company has the right to forfeit those shares. This right must be exercised in good faith, meaning the company has to act fairly and can’t just forfeit shares for no reason.
The company must also provide the shareholder with a proper notice period before forfeiting the shares, giving them a chance to pay their dues. If the shareholder still fails to pay within the notice period, the company’s board of directors can pass a resolution to forfeit the shares. In short, while the Companies Act doesn’t directly talk about share forfeiture, it gives companies the power to include this in their articles of association and carry it out in a fair and transparent way.

Causes for Share Forfeiture

Share forfeiture can occur under several circumstances. Understanding these scenarios is crucial for both companies and shareholders to ensure adherence to rules and avoid unforeseen situations. Here are some key situations that may trigger share forfeiture:
  1. Non-payment of Calls: The most common cause of share forfeiture is the non-payment of calls. A ‘call’ is a demand made by the company for the payment of the amount due on the shares. If a shareholder fails to pay this amount within the specified period, the company may choose to forfeit their shares.
  2. Violation of Company Rules: Share forfeiture can also occur when a shareholder breaches the rules laid down in the articles of association of the company. These rules might pertain to a wide range of situations, from financial responsibilities to conduct within the company. If these rules are violated, it gives the company grounds to enforce share forfeiture.
  3. Other Causes: There can be other scenarios where a company may exercise its right to forfeit shares. These might be unique to the company’s articles of association or the shareholder agreement. For example, the company may reserve the right to forfeit shares if a shareholder is involved in activities that harm the company’s reputation or interests.
Remember, every situation of forfeiture of share is dictated by the regulations set out in the Companies Act, 2013, and the specific clauses in the articles of association. As such, it’s essential for all parties to familiarize themselves with these guidelines to avoid any potential missteps.

Procedure for Forfeiture of Share

The procedure of forfeiture of shares is not just a matter of company policy, but also a legal procedure outlined in the Companies Act, 2013. It’s vital to adhere to the procedure for forfeiture of shares to ensure that the forfeiture is valid and enforceable and is executed with transparency and fairness. Here are the key steps involved:
Procedure of Share Forfeiture

Step-1: Issue Notice to defaulting shareholder

The first step towards forfeiture is issuing a notice to the shareholder. The company must provide a written notice to the shareholder stating the amount due, including any interest, and give them a specific date by which they must make the payment. This date must be at least 14 days from the date of the notice.

Step-2: Pass Board Resolution

If the shareholder fails to pay the due amount within the notice period, the next step involves the company’s board of directors. The board holds a meeting and passes a resolution to forfeit the shares of the defaulting shareholder. The resolution must clearly state the number and details of the shares being forfeited, and the name of the shareholder. It must be noted that once the resolution is passed, the forfeiture is complete, and the shareholder loses all rights related to the forfeited shares.

Step-3: Declaration and Updation of Registers

Any one director will issue a declaration that the share forfeiture has been effected as per the articles of association and send such a declaration to the old shareholder. The forfeiture must be recorded in the company’s register of members, and a notice of share forfeiture must be sent to the shareholder. It’s essential that the process is well-documented and communicated to maintain transparency.

Step -4: Sale of Forfeited Shares

After forfeiture, the shares can be sold to recover the unpaid amount. The Board of Directors are empowered to allot the forfeited shares to any willing person as it may deem fit. However, the original shareholder has no claim over the proceeds of this sale.

Implications of Share Forfeiture

While forfeiture of shares is a valid tool to enforce financial obligations, it’s essential for both shareholders and companies to understand the potential implications. Thus, it should be exercised with due caution and fairness. Here are the implications for the shareholder and the company.
  1. For the Shareholder: Share forfeiture can have several significant implications for the shareholder.
    1. Loss of Rights: The most immediate impact is the loss of shareholder rights. Once shares are forfeited, the shareholder loses all their rights and benefits related to those shares, including the right to receive dividends and attend shareholder meetings.
    2. Loss of Voting Power: With the forfeiture of shares in company law, the shareholder also loses their voting power in the company proportional to the forfeited shares. This can affect their influence over company decisions.
    3. Potential Financial Loss: The shareholder can also suffer a financial loss. Although they are relieved from any future liability towards the unpaid amount, they lose the money they have already paid for the shares. Plus, they lose out on potential future returns from those shares.
  2. For the Company: The implications of share forfeiture for the company can be both financial and reputational.
    1. Financial Implications: On the financial side, the company may recover the unpaid amount by reselling the forfeited shares. However, it could face potential losses if the shares are sold at a price lower than what was originally due.
    2. Reputational Implications: Repeated instances of forfeiture of shares companies Act 2013 might raise questions about the company’s financial stability and management quality. This could impact the company’s reputation among existing and potential investors and may affect future fundraising efforts.

Legal Redress and Remedies

Despite the well-defined legal procedures for share forfeiture, there may be instances where a shareholder feels their shares have been unfairly forfeited. In such cases, the Companies Act, 2013 provides several avenues for legal redress and remedies for shareholders.
  1. Internal Redressal: The first step for shareholders is usually to approach the company’s board of directors and contest the forfeiture. They can present their case, provide any evidence they might have, and ask the board to reconsider its decision. For instance, if a shareholder has proof that they had paid the call money within the due period, they can submit this evidence to the board. If the board is satisfied, they may reverse the forfeiture.
  2. Approaching the NCLT: If the internal redressal does not yield a satisfactory result, shareholders can approach the National Company Law Tribunal (NCLT), which was established under the Companies Act, 2013. For example, if a shareholder believes the notice for payment was not duly served or the board of directors did not pass the forfeiture resolution in good faith, they can file a petition with the NCLT, citing these reasons. The NCLT, after considering all the facts and circumstances, can either uphold the forfeiture or reverse it.
  3. Civil Courts: In some cases, shareholders may also approach civil courts if they believe their rights have been infringed. It’s essential to note that this is usually considered a last resort, as it often involves a lengthy process.
  4. Arbitration: If the shareholder agreement or the company’s articles of association contain an arbitration clause, the shareholder can choose to go for arbitration as well.
Remember, in any legal dispute, the specific circumstances and evidence at hand play a significant role. Therefore, shareholders should consult with a legal professional to understand the best course of action for their situation. It’s also essential to note that these remedies do not absolve shareholders of their financial obligations; they are avenues to contest procedural discrepancies or violations of shareholders’ rights.

Recent Case Laws

The law on share forfeiture is complex and has been evolving over time. In recent years, there have been a number of cases that have provided valuable insights into how the law is being applied in real scenarios.
  1. Bhagwandas Goverdhandas Kedia vs. Girdharilal Parshottamdas & Co (1966) 1 SCR 656: In this case, the Supreme Court of India ruled that the forfeiture of shares is not a matter to be taken lightly, and the process must adhere strictly to the requirements and conditions laid down in the company’s articles of association. The decision underlined the critical principle that the power of forfeiture is a drastic one and must be exercised in good faith and for the benefit of the company.
  2. M/s. Siel Foods & Fertilizer Industries vs. B.S. Atwal (1991). In this case, the Delhi High Court held that a notice of forfeiture served to a wrong address, as a result of the shareholder’s failure to notify the company of a change in address, is considered duly served. This case reinforced the importance of shareholders’ responsibility in maintaining up-to-date contact information with the company.
  3. In more recent years, there have been a number of cases that have further clarified the law on share forfeiture. For example, in the case of Hindustan Construction Co. Ltd. vs. S.J. Jain (2011) 144 Comp Cas 178 (NCLT), the National Company Law Tribunal (NCLT) held that the power of forfeiture can be exercised only after the shareholder has been given a reasonable opportunity to pay the amount due. The NCLT also held that the company must not be motivated by mala fide or ulterior considerations in exercising its power of forfeiture.
  4. These are just a few examples of recent cases that have helped to shape the law on share forfeiture. As the law continues to evolve, it will be important to stay up-to-date on the latest developments. Here are some other leading judgments on share forfeiture:
    1. Indian Bank vs. A.C. George (1989) 62 Comp Cas 353 (Mad)
    2. Union Bank of India vs. D.V. Patil (1994) 78 Comp Cas 116 (Bom)
    3. ITC Ltd. vs. A.K. Aggarwal (2003) 123 Comp Cas 328 (Del)
These cases provide valuable insights into the legal principles that govern share forfeiture. They also highlight the importance of following the correct procedures when forfeiting shares. Please note, as the legal landscape is continuously evolving, these cases should be considered in the context of their specific circumstances and timing. For the most current and relevant legal information, it’s always advisable to consult with a legal professional or authoritative legal resources.

Closing thoughts

Share forfeiture is a powerful tool that can be used by companies to protect their interests. However, it is important to use this tool carefully and in accordance with the law. By understanding the law on share forfeiture and following the correct procedures, companies can avoid legal challenges and ensure that they are using this tool in a fair and equitable manner. I hope this blog has been informative. If you have any questions, please feel free to contact me.

In conclusion, forfeiture of shares companies Act 2013 is a complex legal issue with a long history. The law on share forfeiture has been evolving over time, and recent cases have provided valuable insights into how the law is being applied in real scenarios. It is important for companies to understand the law on share forfeiture and to follow the correct procedures when forfeiting shares. Failure to do so could result in legal challenges.

In today’s corporate landscape, forfeiture of shares in company law is becoming increasingly relevant. As companies face financial challenges, they may be more likely to forfeit shares. This is why it is important for companies to have a clear and better understanding of the law on share forfeiture and to be prepared to take action if necessary.

Conclusion

FAQs

Q1: What is the forfeiture of shares?

If a shareholder can’t pay this full subscription amount, his shares are forfeited by the company. He won’t be an owner of the company anymore as his shares will be taken away by the company, and he will no longer owe any money to the company.

Q2: Do I appeal against the forfeiture of shares?

In certain cases, as a shareholder, you may have the right to appeal the forfeiture of shares. However, the procedures and requisites for appeal may depend on the laws and regulations of the jurisdiction and also the provisions mentioned in the company’s shareholder agreement or other governing documents.

Q3: What are the factors responsible for the forfeiture of shares?

The forfeiture of shares can take place due to a number of reasons such as non-payment of calls on shares, failing to provide required documents, breaching shareholder agreement, or terms mentioned in the Articles of Association (AoA) of the company.

Q4: What happens after the forfeiture of shares in company law?

On forfeiture of shares, the shareholder loses all his ownership rights as well as benefits associated with those shares. Moreover, the benefits a shareholder may miss out on forfeiture of his previously held shares include any future dividends, voting rights or/and rights to attend shareholder meetings. Generally, the forfeited shares are cancelled and reissued to new shareholders or sold on the open market.

Q5: Can shareholders safeguard themselves from forfeiture of shares?

The shareholders can protect themselves from the activity of forfeiture of shares by adhering to all the obligations as well as terms and conditions mentioned in the company’s documents mainly Articles of Association (AOA). Staying informed about the company’s requirements, such as payment deadlines, document submissions, and adhering to relevant regulations is necessary.

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