Companies Act Section 63

Companies Act Section 63: Comprehensive Guidelines for Issuing Bonus Shares

Introduction to Bonus Share Issuance

Section 63 of the Companies Act outlines the rules that govern how a company can issue fully paid-up bonus shares to its existing shareholders. 

Bonus shares are additional shares distributed by the company to its shareholders without requiring them to make any further payment; they represent a capitalization of the company's profits, reserves, or surplus funds. 

This provision is especially relevant for companies wishing to reward shareholders, increase their equity participation, and enhance market capitalization without reducing cash reserves. 

The issuance of bonus shares also highlights a company's growth and financial strength, often signaling positive performance to the market and reinforcing shareholder confidence.

The detailed guidelines provided by Section 63 ensure that the issuance of bonus shares is done fairly, transparently, and responsibly, requiring companies to follow specific legal and procedural mandates.

1. Approved Sources for Issuing Bonus Shares

Under Section 63, a company is only permitted to issue fully paid-up bonus shares using particular sources of capital, thereby safeguarding the company’s assets and shareholder equity. These authorized sources include:

Free Reserves: 

These reserves consist of accumulated profits and retained earnings that are free of encumbrances and readily available for distribution. 

Free reserves do not include funds earmarked for specific purposes, meaning that the company can use only unrestricted profits to issue bonus shares, ensuring that such capitalizations are based on genuine, surplus earnings and not on unrealized or reserved profits.

Securities Premium Account: 

When a company issues shares at a price higher than their nominal or face value, the excess amount collected is stored in the securities premium account. 

These funds can only be used for specific purposes, including issuing bonus shares, in accordance with the guidelines provided in the Companies Act. 

Utilizing the securities premium account for issuing bonus shares also demonstrates that the company has generated enough surplus from its share issuance to return some value to its shareholders.

Capital Redemption Reserve Account: 

Created during the redemption of preference shares, this reserve acts as a safeguard for shareholders and creditors. 

The reserve can be capitalized by issuing bonus shares, giving shareholders additional value without impacting the company's financial stability. 

This allowance highlights the Act's flexibility in permitting companies to use specific accounts for capitalizing bonuses, as long as the reserves do not affect the company's ability to meet obligations.

Prohibition on Using Revaluation Reserves: 

The Act prohibits the use of reserves created from the revaluation of assets, such as real estate or machinery, for issuing bonus shares. 

Revaluation reserves represent unrealized gains, which are subjective and volatile. Thus, using them to issue bonus shares could lead to artificially inflated shareholder equity. 

This prohibition aims to ensure that only actual, realized funds are used in issuing bonus shares, maintaining transparency and protecting shareholders from potential financial risks due to fluctuating asset values.

2. Mandatory Preconditions for Issuing Bonus Shares

The Act mandates a set of prerequisites to be met before a company can issue bonus shares under subsection (1). 

These conditions are intended to ensure that the bonus issuance is justified, supported by a genuine surplus, and does not compromise the company’s financial stability or obligations. The required conditions include:

Authorization in Articles of Association: 

Before issuing bonus shares, a company must confirm that its articles of association permit such action. 

The articles serve as the company’s governing document, and any significant corporate actions must be authorized within it. 

If the articles do not currently allow for bonus issuance, the company must amend them, following proper procedures, to ensure compliance and transparency in its operations.

Approval from Board of Directors and Shareholders: 

The Board of Directors must first recommend the issuance of bonus shares based on the company’s financial position and potential benefits to shareholders. 

This recommendation must then be put to a vote in a general meeting, where shareholders can approve or reject the bonus issuance. 

This two-stage approval process ensures that both the company’s management and its shareholders are in agreement on significant financial decisions, thereby protecting shareholder interests and fostering accountability.

No Defaults on Financial Commitments: 

The company must not have any overdue payments on the principal or interest of any fixed deposits or debt securities it has issued. 

This condition ensures that the company’s commitment to fulfilling its financial obligations to creditors and deposit holders takes precedence over shareholder rewards. 

It also reflects the Act’s focus on responsible fiscal management and the need for companies to be financially stable before issuing bonus shares.

No Outstanding Statutory Dues for Employees: 

Before issuing bonus shares, the company must ensure it has cleared all statutory dues owed to employees, including provident fund contributions, gratuity, and bonuses. 

This requirement demonstrates the Act’s emphasis on employee rights and prevents companies from rewarding shareholders while neglecting obligations to their workforce.

Full Payment of Any Partly Paid-Up Shares: 

In cases where shareholders hold partly paid-up shares, these shares must be fully paid before issuing bonus shares. 

This requirement prevents potential inequities among shareholders and ensures that any new shares issued have been paid in full, protecting the integrity of the company’s share capital structure.

Compliance with Additional Prescribed Conditions: 

Any other conditions prescribed by regulatory authorities or the Companies Act itself must also be met. 

This provision gives flexibility for additional guidelines to be added over time to address specific regulatory needs and maintain compliance standards in bonus share issuances.

3. Restriction Against Issuing Bonus Shares as a Substitute for Dividends

 

One key provision in Section 63 states that bonus shares cannot be issued in lieu of dividends. While both dividends and bonus shares represent forms of shareholder returns, they differ fundamentally:

Dividends: 

Represent a cash return on shareholders’ investment, drawn from the company’s profits. They are typically distributed periodically and provide direct monetary value to shareholders. 

Bonus Shares: 

Increase the shareholder’s ownership stake by distributing additional shares without changing the total investment value in cash. Bonus shares are generally capitalized from the company's reserves or surplus, reflecting growth in company value rather than an immediate return on investment.

By prohibiting companies from using bonus shares as a dividend substitute, the Act maintains a clear distinction between these two types of shareholder rewards. 

This restriction ensures that shareholders receive dividends in cash or equivalent form and that bonus shares reflect long-term growth rather than a simple redistribution of profits.