Shareholding in any company means more than just having an ownership interest in the company for receiving future gains but also entails the responsibility of fulfilling certain financial commitments. If there is a breach of these commitments by any shareholder, then the company can resort to a drastic measure by forfeiting their shares. This is the concept of share forfeiture, which is essential in company law.
This understanding becomes imperative for both the investor and the businessman. In the case of an investor, it would mean that he has lost his money and property. In the case of a company, it means that this is one of the means by which they can discipline themselves when defaulting on payments. This blog aims to explain everything you should know regarding share forfeiture.
Key Takeaway
- Forfeiture of shares occurs when a member fails to pay “call money” on time.
- The company must follow a strict legal procedure, including serving a formal notice.
- Once forfeited, the shareholder loses all rights and the shares belong to the company.
- The company can choose to re-issue these forfeited shares to other investors.
What is Forfeiture of Shares?
To define forfeiture of shares simply, it is the act of a company cancelling the ownership of a shareholder because they failed to pay the money they owed on those shares. When you buy shares in a company, you might not pay the full amount upfront. The company may ask for the remaining balance in instalments, known as “calls.” If you miss these payments despite reminders, the company has the legal right to seize your shares.
The forfeiture of shares meaning goes beyond just losing a certificate. It involves the removal of the member’s name from the Register of Members. In the eyes of forfeiture of shares in company law, the contract between the shareholder and the company is terminated. This is a significant action because the shareholder also loses any money they had already paid to the company for those shares. Importantly, forfeiture does not automatically discharge the shareholder from their debt. The company may still pursue the former shareholder for any call money that remained unpaid at the time of forfeiture.
Traditionally, this power was exercised to ensure that companies were provided with the capital which had been committed by them during expansion. Even now, in contemporary business practices, this is an important power as far as discipline is concerned. While all the shares issued in the stock exchange markets (NSE and BSE) are fully paid, this power continues to be very relevant even now in private corporations.
How Does Forfeiture of Shares Work?
The procedure for the forfeiture of shares is not arbitrary. A company cannot simply take shares away without following the rules laid down in its Articles of Association (AoA). The AoA acts as the rulebook for the company’s internal management. If the AoA does not contain provisions for forfeiture, the company cannot execute it.
Notification to Shareholders
Before any shares are taken away, the company must provide a fair warning. This is a mandatory legal requirement in India. The company must send a clear notice to the defaulting shareholder. This notice must give the member at least 14 days from the date of service to make the payment.
It should show the amount owed, together with the interest that has been generated. The letter should also contain a clear indication that, in case the payment does not happen on or before the stated date, then the shares are liable to be forfeited. In most cases, such letters are delivered through registered mail.
Company’s Right to Forfeit
If the shareholder still fails to pay after the notice period ends, the Board of Directors must pass a formal resolution to forfeit the shares. Only after this resolution is passed does the forfeiture of shares actually take effect.
Once the shares are forfeited, they become the property of the company. The company can then decide whether to cancel them or re-issue them to someone else. If the company reissues them, the discount on reissue cannot exceed the amount forfeited on those shares (i.e., the sum already received from the defaulting shareholder). Any surplus remaining in the Share Forfeiture Account after reissue is transferred to Capital Reserve.
Why Do Companies Forfeit Shares?
The most common answer to what is forfeiture of shares driven by is the non-payment of calls. When a company needs funds for a project, it “calls” upon its shareholders to pay the unpaid portion of their shares. If many shareholders fail to pay, the company’s plans could stall. Forfeiture acts as a deterrent against such defaults.
Financial reasons are at the core of this action. A company must maintain a certain level of paid-up capital to meet regulatory requirements set by the Ministry of Corporate Affairs (MCA) or SEBI. By forfeiting shares from non-paying members, the company can bring in new investors who are willing to contribute the necessary capital.
In certain situations, forfeiture can even be employed for compliance purposes. For example, if an issue arises that makes a shareholder unfit to own the stock according to Indian law (such as foreign exchange law), then forfeiture may become necessary.
Effects of Share Forfeiture on Companies and Shareholders
The impact of this process is felt by both parties involved. For the shareholder, the effects are purely negative. They lose their ownership, their voting rights and any dividends they might have been entitled to. Most importantly, they do not get a refund of the money they have already paid.
For the company, the effects are more complex:
- Reduction in Share Capital: The paid-up capital decreases temporarily until the shares are reissued or formally cancelled. This should not be confused with a statutory ‘reduction of share capital’ under Section 66 of the Companies Act, which is a separate legal process.
- Accounting Changes: The money already received on the forfeited shares is transferred to a “Forfeited Shares Account.”
- Opportunity to Re-issue: The company gets a second chance to sell those shares, potentially to a more reliable investor.
Measures to Avoid Forfeiture of Shares
Shareholders can prevent this situation by practising active financial management. It is vital to keep your contact details updated with the company or your Depository Participant (DP) so that you never miss a “call notice.” If you are facing a temporary cash crunch, it is better to communicate with the company’s investor relations department rather than ignoring the payment requests.
Companies, on the other hand, should follow good practices to avoid the need for forfeiture. This includes:
- Clear Communication: Sending multiple reminders before the formal 14-day notice.
- Flexible Payment Options: Providing easy ways for shareholders from small towns and cities to make payments, such as online portals or specific bank branches.
- Reasonable Call Amounts: Ensuring that the money called for is not so high that it creates an undue burden on retail investors.
Conclusion
Understanding what forfeiture of shares is is essential for navigating the responsibilities of share ownership. While it is a harsh measure, it is a necessary part of the forfeiture of shares in company law to protect the collective interests of the business and its paying members. It ensures that the capital structure remains solid and that the company can meet its financial goals.
For shareholders, staying informed and fulfilling financial commitments is the only way to safeguard their investments. For companies, following the correct procedure for the forfeiture of shares is vital to avoid legal disputes.
FAQs on Forfeiture of Shares
Shareholders not able to meet payment obligation regarding “call money,” i.e., instalment payments, is a very common reason. Other grounds for this may involve breach of the Articles of Association by the shareholder or his/her actions that do not conform to the law.
Yes, in many cases, a company may allow a shareholder to recover their shares if they pay the outstanding amount along with interest and any expenses incurred by the company. However, this is only possible if the Board of Directors passes a resolution to cancel the forfeiture and if the shares have not already been reissued to someone else.
A “call” is a demand made by the company for shareholders to pay a portion of the unpaid value of their shares. forfeiture of shares is the punishment or consequence that happens if the shareholder fails to respond to that call and pay the requested money.
The shareholder’s loss on the amount already invested is treated as a capital loss for the shareholder. Yet, because the shares were forfeited instead of being sold, the claim for this loss under Indian Income Tax regulations may be tricky. It is strongly advised that you seek legal advice from a tax consultant before filing your ITR.
Companies must ensure that the power to forfeit is explicitly mentioned in their Articles of Association. They must also strictly follow the procedure for the forfeiture of shares, specifically the issuance of a proper 14-day notice. Any deviation from the legal steps can lead to the forfeiture being declared void by a court or the National Company Law Tribunal (NCLT).
Disclaimer: Investments in securities markets are subject to market risks. Read all related documents carefully before investing. The securities and examples mentioned above are only for illustration and are not recommendations.
