A share is the interest of a shareholder in the company measured by a sum of money it is a bundle of rights (dividend, voting, surplus on winding up) and obligations (paying calls). Shares are the units into which the company's capital is divided. Stock is the aggregate of fully paid shares merged into one fund divisible into any fraction (not limited to the fixed denomination of shares).
Legal Framework
| Provision | Subject |
|---|---|
| S.2(84) | "Share" defined (includes stock except where distinction is expressed) |
| S.43 | Kinds of share capital (equity + preference) |
| S.44 | Nature of shares (movable property, transferable) |
| S.46 | Share certificate |
| S.52 | Application of premiums received on shares |
| S.53 | Prohibition of shares at discount |
| S.54 | Issue of sweat equity shares |
| S.55 | Preference shares (rights, types, redemption) |
| S.39 | Allotment of securities (minimum subscription, refund) |
| S.40 | Public offer through prospectus (by public companies only) |
| S.42 | Private placement |
| S.62 | Further issue rights issue (existing shareholders) |
| S.63 | Issue of bonus shares |
Definition and Nature of Shares
| Aspect | Content |
|---|---|
| S.2(84) | "Share means a share in the share capital of a company and includes stock" |
| Nature | Movable property (S.44); transferable as provided in articles |
| Not a physical thing | A share is an INTEREST a bundle of rights and liabilities |
| Farwell J. (Borland's Trustee) | "A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second" |
| Rights included | (1) Right to dividend (if declared), (2) Right to vote, (3) Right to surplus on winding up, (4) Right to attend meetings, (5) Right to transfer |
| Numbered | Every share has a distinctive number (S.45) except dematerialised shares (no distinctive number) |
Kinds of Shares (S.43)
The share capital of a company limited by shares is of TWO kinds:
1. Equity Shares (S.43(a))
| Feature | Content |
|---|---|
| Definition | Shares that are NOT preference shares |
| Dividend | Variable depends on profits and board's decision. No guaranteed rate. |
| Voting | Full voting rights one share, one vote (S.47(1)) |
| Winding up | Entitled to surplus AFTER preference shareholders are paid |
| Risk | Highest last to receive dividend and surplus |
| Return potential | Unlimited if company prospers, equity value grows enormously |
| Types | (a) With voting rights, (b) With differential voting rights (DVR S.43(a)(ii)) |
2. Preference Shares (S.43(b) read with S.55)
| Feature | Content |
|---|---|
| Definition | Shares carrying preferential rights to: (a) dividend at fixed rate, (b) repayment of capital on winding up |
| Dividend | FIXED rate (e.g., 8% preference) paid BEFORE equity dividend |
| Voting | Normally NO voting rights (except on matters directly affecting preference shareholders; full voting if dividend unpaid for 2+ years) |
| Winding up | Capital returned BEFORE equity shareholders |
| Risk | Lower than equity (priority in dividend and return) |
| Return | Capped at fixed rate (doesn't benefit from extra profits) |
| Redemption | MUST be redeemed within 20 years from issue (S.55(2)) |
Types of Preference Shares
| Type | Feature |
|---|---|
| Cumulative | Unpaid dividend accumulates and must be paid in future years before equity gets anything |
| Non-cumulative | Unpaid dividend for a year lapses no accumulation |
| Participating | After receiving fixed preference dividend, ALSO shares in surplus profits with equity |
| Non-participating | Gets ONLY the fixed rate no share in surplus |
| Convertible | Can be converted into equity shares on specified terms/date |
| Non-convertible | Redeemed in cash; no conversion right |
| Redeemable | Company repays capital at specified date (mandatory: within 20 years S.55) |
Share vs Stock
| Aspect | Share | Stock |
|---|---|---|
| Nature | Unit of fixed denomination (e.g., Rs.10 per share) | Aggregate of fully paid shares merged into one fund |
| Denomination | Fixed (Rs.10, Rs.100, etc.) | No fixed denomination divisible into ANY fraction |
| Transfer | In complete units only (cannot transfer half a share) | Any fraction can be transferred (Rs.371.50 of stock) |
| Numbering | Each share has distinctive number | Stock has no distinctive numbers |
| Prerequisite | Original issue is ALWAYS in shares | Stock arises only by CONVERSION of fully paid shares |
| Partly paid | Can be partly paid (calls remaining) | Only FULLY PAID shares can be converted to stock |
Statutory Restrictions on Allotment (S.39)
| Restriction | Rule |
|---|---|
| Minimum subscription | Company cannot allot shares unless MINIMUM SUBSCRIPTION (stated in prospectus) is received (S.39(1)) |
| Refund if not raised | If minimum subscription not received within 30 days of prospectus issue → refund application money within 15 days (S.39(3)) |
| Application money | At least 5% of nominal value must be paid on application (S.39(2)) |
| Return of allotment | Company must file return of allotment with ROC within 30 days (S.39(4)) |
| Listing | If public offer: shares must be listed on stock exchange; if listing not granted → refund within prescribed time |
| Irregular allotment | Allotment without minimum subscription or before expiry of minimum period → VOIDABLE at option of applicant (S.40) |
Why: Minimum subscription protects the public ensures the company has ENOUGH capital to function. Without it, a company might allot shares to 5 people (raising Rs.5 lakhs) while the prospectus planned for Rs.5 crores. Those 5 investors' money would be wasted on an underfunded venture. The law says: either raise the minimum amount or return everyone's money.
Restrictions on Issue
| Method | Provision | Who Can Issue |
|---|---|---|
| Public offer | S.40 (prospectus) | Only PUBLIC companies |
| Private placement | S.42 | Any company (to max 200 identified persons per offer) |
| Rights issue | S.62(1)(a) | Existing shareholders pro-rata offer first |
| Bonus issue | S.63 | Existing shareholders free fully paid shares from reserves |
| ESOP/Sweat equity | S.54, S.62(1)(b) | Employees/directors for contribution |
| At discount | S.53 | PROHIBITED (shares cannot be issued below face value) except sweat equity |
| At premium | S.52 | Permitted premium goes to Securities Premium Account (restricted use) |
Illustrations
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Equity vs Preference (the risk-return trade-off): Company ABC makes Rs.10 crore profit. Has: 10 lakh preference shares (8% on Rs.100) and 10 lakh equity shares (Rs.100). Preference shareholders get: 8% × Rs.100 × 10 lakh = Rs.8 crore (FIRST guaranteed rate). Remaining for equity: Rs.10 Cr - Rs.8 Cr = Rs.2 crore ÷ 10 lakh = Rs.20/share.
Next year: profit Rs.100 crore. Preference STILL gets: Rs.8 crore (fixed rate). Equity gets: Rs.92 crore ÷ 10 lakh = Rs.920/share! Equity bears higher risk (might get Rs.0 in bad year) but captures ALL the upside. Preference gets certainty (Rs.80/share every year) but misses the bonanza.
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Why shares cannot be issued at discount (S.53): Share face value = Rs.10. If company issues at Rs.7 (discount of Rs.3): the company receives Rs.7 but creditors believe the company has Rs.10/share in capital. In liquidation, creditors expect Rs.10/share capital as buffer. S.53 protects creditors by ensuring ACTUAL capital equals STATED capital. Exception: sweat equity (S.54) allows issue at discount to employees for IP contribution because the "consideration" is intellectual work, not money.
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Minimum subscription protection (S.39): ABC Ltd issues prospectus: "We need Rs.50 crores minimum to build the factory." After 30 days: only Rs.12 crores received. Under S.39: company CANNOT allot must REFUND Rs.12 crores to all applicants within 15 days. Why? Rs.12 crores isn't enough to build the factory. If allotted, the company would have insufficient capital, the factory wouldn't be built, and investors lose their money in a failed venture. The refund rule prevents underfunded companies from gambling with investors' money.
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Rights issue (existing shareholders' protection): ABC Ltd has 10 lakh shares. Wants to issue 5 lakh more. Under S.62: MUST offer to EXISTING shareholders FIRST (pro-rata: each holder offered 1 new share for every 2 held). This prevents DILUTION if new shares went to outsiders, existing shareholders' percentage ownership would drop. Rights issue gives them the FIRST right to maintain their proportionate stake. Only if shareholders DECLINE (within 15 days) can company offer to others.
Recall Check
- What are the two kinds of share capital under S.43?
- What is minimum subscription and what happens if it is not received?
- Distinguish equity shares from preference shares on dividend, voting, and winding up.
Key Cases
Borland's Trustee v. Steel Bros (1901) Borlands-Trustee-v-Steel-Bros-1901 Issue: What is the legal nature of a share. Rule: A share is not a physical thing but an INTEREST measured by money, imposing liability (to pay calls) and conferring interest (dividends, voting, surplus). Held: "A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second." Shares are personal property, not real property.
Distinctions
| Aspect | Equity Shares | Preference Shares |
|---|---|---|
| Dividend rate | Variable (depends on profit + board decision) | Fixed (stated rate e.g., 8%) |
| Dividend priority | AFTER preference dividend paid | FIRST (before equity) |
| Voting | Full voting rights (one share one vote) | Generally NO voting (except on certain resolutions or if dividend unpaid 2+ years) |
| Risk | Higher (last in line) | Lower (priority in dividend and capital) |
| Return potential | Unlimited (captures all upside) | Capped at fixed rate |
| Winding up | Surplus AFTER preference repaid | Capital returned BEFORE equity |
| Redeemable? | Generally not (except buyback under S.68) | Must be redeemed within 20 years (S.55) |
| Aspect | Share | Debenture |
|---|---|---|
| Holder is | MEMBER (owner) | CREDITOR (lender) |
| Return | Dividend (uncertain, depends on profit) | Interest (fixed, regardless of profit) |
| Voting | Yes | No (at general meetings) |
| Priority on winding up | Last | Before shareholders |
| Capital | Share capital (equity of company) | Borrowed capital (debt of company) |
| Redeemable | Generally not (permanent capital) | Must be redeemed (S.71: within 10 years) |
Flashcards
Q: How is "share" defined under S.2(84)? A: "Share means a share in the share capital of a company and includes stock."
Q: What are the two kinds of share capital under S.43? A: (1) Equity shares (with/without differential voting rights), (2) Preference shares (preferential dividend + preferential capital return).
Q: What is minimum subscription (S.39)? A: The minimum amount stated in the prospectus that MUST be raised before shares can be allotted. If not received within 30 days → refund all application money within 15 days.
Q: Can shares be issued at a discount? A: No S.53 prohibits issue of shares at discount (below face/nominal value). Exception: sweat equity shares (S.54) for employees.
Q: What is a rights issue (S.62)? A: Offer of new shares to EXISTING shareholders pro-rata (proportional to their current holding) BEFORE offering to outsiders. Protects against dilution.
Q: What is the difference between share and stock? A: Share: fixed denomination unit (e.g., Rs.10). Stock: aggregate of fully paid shares merged into one fund, divisible into any fraction. Only fully paid shares can be converted to stock.
Q: What rights does holding a share confer? A: (1) Right to dividend (if declared), (2) Right to vote, (3) Right to attend meetings, (4) Right to surplus on winding up, (5) Right to transfer.
Exam Scenario
Delta Ltd issues a prospectus stating minimum subscription as Rs.5 crores. After 30 days, only Rs.3.5 crores in applications are received. The board allots shares to all applicants. Three months later, the company runs out of funds and cannot complete its project. Applicant X wants refund. Advise.
Irregular allotment (S.39): The company allotted shares WITHOUT receiving minimum subscription (Rs.3.5 Cr < Rs.5 Cr required). This violates S.39(1): "no allotment shall be made unless the amount stated in prospectus as minimum subscription has been subscribed."
Consequence (S.39(5)): Allotment made in contravention is VOIDABLE at the option of the applicant (X). X can avoid the allotment within 2 years of allotment.
X's remedies: (1) Rescission: X can treat the allotment as void and demand REFUND of application money with interest. (2) Directors' liability: Directors who authorised the irregular allotment are liable to compensate X for loss suffered (S.39(5)(b)). (3) ROC action: Company's failure to refund within prescribed time attracts penalty on company and directors.
Company's obligations: (a) Should have REFUNDED all Rs.3.5 crores within 15 days of the 30-day expiry (S.39(3)). (b) Having allotted irregularly, the allotment is voidable. (c) Directors may be personally liable for any loss arising from the irregular allotment.
Principle: Minimum subscription is a MANDATORY precondition not discretionary. It ensures companies have viable capital before commencing operations. Non-compliance voids the allotment and exposes directors to personal liability.
Illustrations
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Equity vs Preference priority: ABC Ltd earns profit of Rs.1 crore. It has 10% preference shares (Rs.50 lakh face value) and equity shares (Rs.1 crore face value). Preference shareholders receive Rs.5 lakh first (10% of 50 lakh). Remaining Rs.95 lakh is available for equity dividend. If the Board declares 50% equity dividend (Rs.50 lakh distributed), the rest is retained.
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Cumulative preference: In 2023, ABC Ltd makes no profit and pays no preference dividend. In 2024, it earns Rs.20 lakh. Cumulative preference shareholders (10% on Rs.50 lakh = Rs.5 lakh/year) receive Rs.10 lakh (2023 arrears + 2024 dividend) before equity gets anything. Non-cumulative holders would have lost the 2023 dividend permanently.
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DVR shares: Tata Motors issued DVR shares (equity shares with differential voting rights): holders get 1/10th voting right but receive 5% extra dividend compared to ordinary equity. Investors who want income over governance prefer DVR shares. Total DVR shares cannot exceed 26% of total post-issue paid-up equity capital.
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Share as movable property: Asha wants to pledge her shares as collateral for a personal loan. Since shares are movable property (S.44), she can create a pledge under the Indian Contract Act. If she defaults, the pledgee (bank) can sell the shares. No immovable property transfer rules apply.
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Stock conversion: XYZ Ltd has 1 lakh fully paid equity shares of Rs.10 each (total Rs.10 lakh). By ordinary resolution under S.61, it converts these into stock. Now instead of distinct shares numbered 1-100000, there is a single fund of Rs.10 lakh. A member can transfer Rs.5,000 worth of stock (not "50 shares"). In practice, Indian companies almost never do this.
Recall Check
- What are the only two kinds of share capital permitted under S.43?
- What rights make a preference share "preferential"?
- Can a company issue irredeemable preference shares? What is the maximum redemption period?