CORPORATE LAW NOTES

CHARACTERISTICS OF A COMPANY
INTRODUCTION
The word 'Company' is an amalgamation of the Latin word 'Com' meaning "with or
together" and 'Pains' meaning "bread". Originally, it referred to a group of persons who took
their meals together. A company is nothing but a group of persons who have come together
or who have contributed money for some common person and who have incorporated
themselves into a distinct legal entity in the form of a company for that purpose. Under
Halsburys Laws of England, the term "company" has been defined as a collection of many
individuals united into one body under special domination, having perpetual succession
under an artificial form and vested by the policies of law with the capacity of acting in
several respect as an individual, particularly for taking and granting of property, for
contracting obligation and for suing and being sued, for enjoying privileges and immunities
in common and exercising a variety of political rights, more or less extensive, according to
the design of its institution or the powers upon it, either at the time of its creation or at any
subsequent period of its existence. However, the Supreme Court of India has held in the
case of State Trading Corporation of India v/s CTO that a company cannot have the status of
a citizen under the Constitution of India.
A company as an entity has several distinct features which together make it a unique
organization. The following are the defining characteristics of a company :-
1.INCORPORATED ASSOCIATION
The company must be incorporated or registered under the Companies Act. Minimum
number required for this purpose is seven in the case of public company and two in the
case of a private company (section 12). It may also be mentioned that an association of
more than 10 persons in the case of banking business and 20 persons on other commercial
activities, if not registered as a company or under any other law, becomes an illegal
association (section 11).
2. SEPARATE LEGAL ENTITY
Unlike a partnership firm which has no existence apart from its members, an incorporated
company has a distinct legal or juristic existence independent of its members. Under the
law, such a company is a distinct entity existing independent of its members. Section 34(2)
of the companies Act, 1956 provides that from the date of incorporated, the subscribers to
the memorandum and other members shall be a body corporate by the name contained in
the memorandum, capable of exercising all the functions of an incorporated company and
having perpetual succession and a common seal. This in other words, means that an
incorporated company exists as a complete being by virtue of its legal personality and is
often described as an artificial person in contrast with a human being who is natural person.
The company, as a legal entity is separate and distinct from its promoters, shareholders,
directors, officers or employees and as such it is capable of enjoying rights and being subject
to duties which are not the same as those enjoyed or borne by its members. The property of
the company belongs to it and not its members; it may sue or be sued in its own name; it
may enter into contracts with third parties independently and even the members
themselves can enter into contract with the company. Thus, with incorporation the entity of
the company becomes institutionalised. This principle of the independent corporate
existence of a registered company is well illustrated by the house of Lords decision in
Salomon v. Salomon & Co. the facts of the case are:-
Salmond was a boot and shoe manufacturer having a sound business with substantial
surplus of assets over liabilities. He incorporated a company named Salomon & Co. Ltd. for
carrying on his business. The seven shareholders who were subscribers to the memorandum
of this company were Salomon, his wife and daughter and four sons. Salomon, with his two
sons, constituted the board of directors of the company. Salomons wife and his five
children held one share each in the company and all the remaining shares were held by
Salomon himself. The business was transferred to the company for 40, 000. By way of
payment Salomon took 20,000 share of each and debentures worth. These debentures
created a charge on the assets of the company. The company went into liquidation, within a
year and its assets amounting to 6,000 were insufficient to pay the debentures in full, and
the ordinary creditors received nothing. The liquidator sought to have the debentures in full,
and the ordinary creditors received nothing. The liquidator sought to have the debentures
cancelled on the ground that the company was only an agent of salomon. The unsecured
creditors, on their part, contended that though incorporated under the act, the Salomon &
Co. Ltd gad no independent existence and it was in fact only Salmon who was the sole
person behind it, he was the managing director, the other directors being his sons, were
under his control. Thus in effect the company was a one-mans show and therefore its
existence was contrary to the spirit and meaning of the company law. The House of Lords,
however, ruled that Salmon & Co. Ltd, was a real company complying with all the legal
requirements of incorporation. As such, was a legal entity having its independent existence,
separate from its members. Their lordships of the House of Lords inter alia observed:
When the memorandum is duly signed and registered, though there be only seven share
taken, the subscribers are a body corporate capable forthwith of exercising all the functions
of an incorporated company. It is difficult to understand how a body corporate thus created
by statute can lose its individuality by issuing the bulk of its capital to one person. The
company is at law a different person altogether from the subscribers of the memorandum;
and though it may be that after incorporation the business is precisely the same as before,
the same persons are managers, and the same hands receive the profits, the company is not
in law their agent or trustee. The statute enacts nothing as to the extent or degree of
interest which may be held by each of the seven or as to the proportion of interest, or
influence possessed by one or majority of the shareholders over others.
Referring to one-man company like that of Salomon & Co. Ltd., Honble Justice Kania, J of
the Bombay High Court observed:
Under the law, an incorporated company is a distinct entity, and although all the shares
may be practically controlled by one person, in law a company is a distinct entity and it is not
permissible or relevant to enquire whether the directors belonged to the same family or
whether it is , as compendiously described a one-man company.
Thus In re Kondoli Tea Co. Ltd., the High Court of Calcutta observed that the company was
altogether a separate person, different from its shareholders and therefore the transfer was
as much a conveyance, a transfer of the property, as if the shareholders had been totally
different persons. In this case, the members transferred a Tea Estate to a company and
claimed exemption from ad valorem duty on the ground that they themselves being the
shareholders in the company, it was in fact a transfer to themselves in another name. The
court, however, rejected their contention and ruled that in the eyes of law the company was
a distinct independent person. Separate from its shareholders.
3. LIMITED LIABILITY
The principle of limited liability implies that the liability of a member in the event of the
companys winding up, in respect of the shares held by him is limited to the extent of the
unpaid value on such shares. Thus the liability does not fluctuate but remains limited to the
amount which, for the time being remains unpaid, whether from the original shareholder or
the transferee of such shares as the case may be. Thus, if a shareholder has 100 shares of
Rs. 10/- each at par, and has already paid Rs. 5/- on each share, he has paid Rs. 500/- and
therefore his liability extends to remaining Rs. 500/- i.e., unpaid value of the shares held by
him and nothing more than that. Even if he has transferred these partly shares, the
transferees liability shall be limited to the extent of unpaid value of shares only. The
company itself, being a legal persona, is always fully liable and therefore its liability is
unlimited. In other words, it is liable to pay the debts so long as assets are available. The
order of priority for payment of debt shall, however, depends on the class of creditors as
laid down in the companies act.
The English Joint Stock Companies Act, 1844 which for the first time allowed associations of
persons to obtain registration under the act, did not initially provide for the privilege of
limited liability. As such this privilege had to be obtained only by a specific Royal Charter or
Act of Parliament. It was after a considerable deliberation in the British Parliament that the
privilege of limited liability was extended to registered companies by the Limited Liability
Act, 1855.
In India, the companies( Amendment) Act, 1857 allowed companies to be registered with
limited liability but this privilege did not extend to companies which were formed for the
purpose of banking and insurance business. The restriction on banking and insurance
companies was later removed by the Amendment Act of 1860.
Section 34(2) of the Companies Act, 1956 provides that in the event of the company being
wound up, the members shall have liability to contribute to the assets of the company in
accordance with the act. In the case of limited companies, no member is bound to
contribute anything more than the nominal value of shares held by him. The privilege of
limiting the liability is one of the main advantages of carrying on business under a corporate
organisation.
Commenting on the advantages of limited liability Buckley, J. In Re London & Globe Finance
Corporation, observed:-
the statutes relating to limited liability have probably done more than any legislation of the
last fifty years to further the commercial prosperity of the country. They have, to the
advantage as well of the investor as of the public, allowed and encouraged aggregation of
small sums into large capitals which have been employed in understandings of great public
utility largely increasing the wealth of the country.
The contribution of the principle of limited liability to the commercial world is further
emphasised by an eminent American scholar who expressed a view, Limited Liability
Corporation is the greatest single discovery of modern times. Even steam and electricity are
less important than the limited liability company.
Despite the advantages of limited liability, some critics of this doctrine have refused to
accept it as a sound principle. Thus, to quote an example, Lawton, L.J. in Rolled Steel
Products (Holdings) Ltd. v. British Steel Corporation, inter alia observed:
the fact that limited liability has all too often enabled many to enrich themselves at the
expense of those who have given credit to the companies they control, is the price the
business world has to pay for the potentiality for growth and convenience which goes with
limited liability.
.4. PERPETUAL SUCCESSION
Company being an artificial person cannot be incapacitated by illness and it does not have
an allotted span of life. Being distinct from the members, the death, insolvency or
retirement of its members leaves the company unaffected. Members may come and go but
the company can go forever. It continues even if all its human members are dead. Even
where during the war all the members of a private company, while in general meeting were
killed by a bomb, the company survived. Not even a hydrogen bomb could have destroyed
it.[ K/9 Meat Suppliers (Guildford)Ltd., Re [ 1966] 1 W.L.R. 1112].
A company does not die or cease to exist unless it is specifically wound up or the task for
which it was formed has been completed. Membership of a company may keep on changing
from time to time but that does not affect life of the company. Death or insolvency of
member does not affect the existence of the company.
5. SEPARATE PROPERTY
Shareholders are not, in the eyes of the law, part owners of the understanding. In india, this
principle of separate property was best laid down by the supreme court in Bacha F. Guzdar
v. CIT. The Supreme Court held that a shareholder is not the part owner of the company or
its property, he is only given certain rights by law, for example, to vote or attend meetings,
or to receive dividends.
In Macaura v. Northern Assurance Company Ltd.[ 1925] AC 619, it was held that a member
does not even have an insurable interest in the property of the company. In this case,
Macaura held all except one share of a timber company. He had also advanced substantial
amount to the company. He insured the companys timber in his own name. On timber
being destroyed by fire, his claim was rejected for want of insurable interest. The court
observed: No shareholder has any right to any item of property owned by the company for
he has no legal or equitable interest therein. the property of the company is not the
property of the shareholders; it is the property of the company.
A company is a distinct legal entity. The companys property is its own. A member cannot
claim to be owner of the company's property during the existence of the company.
6. TRANSFERABILITY OF SHARES
Shares in a company are freely transferable, subject to certain conditions, such that no
share-holder is permanently or necessarily wedded to a company. When a member
transfers his shares to another person, the transferee steps into the shoes of the transferor
and acquires all the rights of the transferor in respect of those shares.
The Companies Act, 1956 in section 86 echoes this feature by declaring the shares,
debentures or other interest of any member in a company shall be movable property,
transferable in the manner provided by the articles of the company. However, in the case
of private companies certain restrictions are placed on right of a member to transfer his
share.
7. COMMON SEAL
A company is a artificial person and does not have a physical presence. Therefore, it acts
through its Board of Directors for carrying out its activities and entering into various
agreements. Such contracts must be under the seal of the company. The common seal is the
official signature of the company. The name of the company must be engraved on the
common seal. Any document not bearing the seal of the company may not be accepted as
authentic and may not have any legal force. However, in SICAL CWL Distriparks Ltd. v.
Besser Concrete Systems Ltd. [2003] 46 SCL 196( Mad.), it was held that it is not necessary
that agreement executed on behalf of company should bear seal of company but question
whether agreement is valid or not would depend upon facts of each case.
In term of section 34(2) of the Companies Act, 1956, the provision of a common seal is a
statutory requirement for a company.
CONTENT OF COMMON SEAL
The seal should have the companys name engrave in legible character. It may consist of the
words corporate seal, the place of the company and the date of its incorporation.
PURPOSE OF COMMON SEAL
The purpose of the seal is to furnish evidence regarding authenticity of a document.
Statutorily, the common seal is required to be affixed to the following documents:
1. Power of attorney empowering any person as the companys attorney to execute
deeds in or outside India.(section 48(1)).
2. Documents authorising any person in a territory outside India to affix the companys
official seal to a deed or other documents.( section 50(2)).
3. Share certificate.( section 84)
4. Share warrant.( section 114)
Thus, other documents need not be under the common seal [ section 54], except to the
extent provided in the articles of association. Further, it is not statutorily required that
debenture certificate should be issued under the common seal.
The companys seal may however, be affixed to various deeds and agreements like lease
deed, sale deed, debenture trust deeds, promissory notes, negotiable instruments ( except
cheque), hypothecation, loan agreements, guarantees, etc.
SAFE CUSTODY OF THE SEAL
The seal should be kept under the safe custody of a responsible official, duly authorised for
the purpose. The Board of directors, shall provide for the safe custody of the seal.
The person authorised to use the seal should ensure that it is kept under his personal
custody and is used very carefully because any deed, instrument or a document to which
seal is improperly or fraudulently affixed will involve the company in legal action and
litigation.
MANNER OF AFFIXING THE SEAL
Companies which have adopted Table A.
Regulation 84(2) of the Table A provides that the common seal is to be affixed on any
instrument in the presence of at least two dirtectors and of the secretary or such other
person as the Board may appoint for the purpose; and those two directors and the secretary
or other person shall sign every instrument to which the seal of the company is so affixed in
their presence.
Companies which have not adopted Table A but made provision in the articles
The article will provide the manner in which the seal is to be affixed. Where the articles
require the seal on a particular document, everyone dealing with the company is bound to
take notice of it.
Empowering a person to affix common seal
As per section 48, a company may, by writing under its common seal, empower any person,
either generally or in respect of any specified matters, as its attorney, to execute deeds on
its behalf in any place either in or outside India [ sec 48(1) ].
It further provides that a deed signed by such an attorney on behalf of the company and
under his seal where sealing is required, shall bind the company and have the same effect as
if it were under the common seal [ sec 48(2) ].
REQUIREMENTS FOR USE OF COMMON SEAL OUTSIDE INDIA
Section 50 provides that where a company has any business or does any transaction outside
India, a facsimile of the common seal may be kept there. Such official seal shall also contain
the name of the place where the seal would be used.
A person must be authorised under the common seal of the company to use the official seal.
The person so authorised shall sign his name, put the name of the place and date on any
document on which the seal is affixed.
A deed or document to which an official seal is duly affixed shall bind the company as if it
has sealed with the common seal of the company. The person so authorised shall continue
to bind the company during the period, if any, mentioned in the instrument conferring the
authority. In case no period is specified, he will bind the company until notice of revocation
of his authority has been given to the person dealing with him.
8. CAPACITY TO SUE AND BEING SUED
A company can sue or be sued in its own name as distinct from its members.
9. SEPARATE MANAGEMENT
A company is administered and managed by its managerial personnel i.e. the Board of
Directors. The shareholders are simply the holders of the shares in the company and need
not be necessarily the managers of the company.
10. ONE SHARE-ONE VOTE
The principle of voting in a company is one share-one vote. i.e. if a person has 10 shares, he
has 10 votes in the company. This is in direct contrast to the voting principle of a co-
operative society where the "One Member - One Vote" principle applies i.e. irrespective of
the number of shares held, one member has only one vote.
11. ARTIFICAL PERSON
The company, though a juristic person, does not possess the body of a natural being. It
exists only in contemplation of law. Being an artificial person, it has to depend upon natural
persons, namely, the director, officers, shareholders, etc., for getting its various works done.
However, these individuals only represent the company and accordingly whatever they do
within the scope of the authority conferred upon them and in the name and on behalf of
the company, they bind the company and not themselves.

THEORIES OF CORPORATE PERSONALITY
Although the common meaning of the term person is a living human being, yet in law, it
includes artificial persons like companies, registered societies and public corporations.
Under section 3(42) of the General Clauses Act, 1897 a person includes any company or
association or body of individuals whether incorporated or not. There are four generally
preferred theories on the nature of legal personality.
Fiction Theory
Under the first theory, corporations have their origin through fiction. The fiction theory had
its evolution since the Roman times when creation of artificial persons was very common.
Savigny elaborated this theory by saying that, in the eye of law, certain ideal persons are
regarded as existing and, as such, legal consequences can be attached to them. According to
him, persons other than real persons, can be exteriorised and individualised by law. Person
signifies what the law makes it to signify. The juridical personality is thus a creation of law of
the state which endows it with capacity. Into its nostrils, the state must breathe the breath
of a fictitious life, for otherwise, it would be no animated body but individualistic dust. The
theory of state creation of corporations dates back to fourteenth century when English kings
made efforts to make themselves powerful against the existing feudal system which
threatened the power of the state. By the sixteenth century, incorporation came to be
understood as always requiring the sovereign assent.
A corporation is a fictitious, artificial person, composed of natural persons, created by the
state, existing only in contemplation of law, invisible, soulless, immortal. Such a definition
is a congeries of self-contradictory terms. For example, a corporation cannot possibly be
both an artificial person and an imaginary or fictitious person. That which is artificial is real,
and not imaginary: an artificial lake is not an imaginary lake, nor is an artificial waterfall a
fictitious waterfall. So a corporation cannot be at the same time "created by the state" and
fictitious. If a corporation is "created," it is real, and therefore cannot be a purely fictitious
body having no existence except in the legal imagination. Moreover, a corporation cannot
possibly be imaginary or fictitious and also composed of natural persons. Neither in
mathematics nor in philosophy nor in law can the sum of several actual, rational quantities
produce an imaginary quantity.
State recognition may be either through a general law or a specific one. Under the former,
for example, come the Indian Companies Act and the Societies Registration Act, under
which various government undertakings and societies have been respectively established;
and under the latter, come, for example, the Air Corporations Act, the Life Insurance
Corporation Act, and the Food Corporations Act, under which the two air corporations, the
Life Insurance Corporation and the Food Corporation, respectively have been established.
The state recognition is, therefore, the summum bonum of this theory.
Object/ Aim as Personality
The second theory is associated with Brinz, Bekker, Demelius and Duguit who believe that
there is a mass of rights and duties which belong not to any particular individual but are
related to certain aims for which corporations, temples, churches, hospitals, etc. are
created. The state, according to this theory, is the master of all situations. Corporate
property is not owned by a fictitious being created by the state but by no person at all. It is
not the property of a person but of a purpose. The property of every corporation, not
merely charitable corporations but also business companies, is in a sense dedicated to an
object. But the common law recognises in such dedication, not the ownership of the
property by an object, but rather the elements of a somewhat peculiar trust. The purpose to
which such property is dedicated amounts to a mere restriction on the otherwise more
extensive right of disposition enjoyed by those who manage the property.
Subject of Rights
The third theory put forth by Ihering, looks at the members of the corporations and
beneficiaries as the true subjects for vesting rights; and, therefore, considers the
corporations to have the capacity of being treated as persons. The proponents of this theory
concur with the advocates of the fiction theory in maintaining that the personality of a
corporation, or even its existence as an entity, is a pure fiction or metaphor; but they
maintain that the fictitious personality is not created by the state, because it does not
exist. To them, a corporation is merely an abbreviated way of writing the names of the
several members. This theory has been criticised on the ground that neither all the
members of a corporation are the masters of the undertaking nor they are owners of it.
Organism Theory
The fourth theory, commonly called the organism theory, considers that the subjects of
rights need not be the human beings only. Gierke was the leading exponent of this theory.
Every being possessing a will and a life of its own is the subject of rights and, in this sense,
states and corporations are being just as alive and as capable of having a will as the human
beings. When a company is formed by the union of natural persons, a new real person, a
real corporate organism, is brought into being. They are, so the theory says, social
organism just as human beings are physical organism. This theory is of immense importance
in determining the tortious and criminal liability of corporate persons.
Reference
Krishna Bahadur, Personality of Corporation and Lifting of Corporate Veil, 14 JILI
207 (1972)
Arthur Machen Jr., Corporate Personality, 24 HLR 253 (1911)


LIFTING OF CORPORATE VEIL
A corporation under Company law or corporate law is specifically referred to as a "legal
person"- as a subject of rights and duties that is capable of owning real property, entering
into contracts, and having the ability to sue and be sued in its own name. In other words, a
corporation is a juristic person that in most instances is legally treated as a person, and
empowered with the attributes to own its own property, execute contracts, as well as ability
to sue and be sued.
One of the main motivations for forming a corporation or company is the limited
liability it offers its shareholders. By this doctrine (limited liability), a shareholder can only
lose only what he or she has contributed as shares to the corporate entity and nothing
more.
Nevertheless, there is a major exception to the general concept of limited liability.
There are certain circumstances in which courts will have to look through the corporation,
that is, lift the veil of incorporation, otherwise known as piercing the veil, and hold the
shareholders of the company directly and personally liable for the obligations of the
corporation.
The veil doctrine is invoked when shareholders blur the distinction between the
corporation and the shareholders. It is worthy of note that although a separate legal entity,
a company or corporation can only act through human agents that compose it. As a result,
there are two main ways through which a company becomes liable in company or corporate
law to wit: through direct liability (for direct infringement) and through secondary liability
(for acts of its human agents acting in the course of their employment).
There are two theories for lifting of corporate veil in Europe and they are "alter-ego"
and "instrumentality" theory.
The alter-ego theory considers if there is any distinctive nature of the boundaries between
the corporation and its shareholders. And instrumentality theory on the other hand
examines the use of a corporation by its owners in ways that benefit the owner rather than
the corporation. It is up to the court to decide on which theory to apply or make a melange
of the two doctrines.
Courts are generally reluctant to pierce the corporate veil, and this is only done when
liability is imposed to reach an equitable result.
Incorporation and Corporate Veil
According to Companies Act, 1956 as soon as a company is incorporated it becomes a
separate legal entity and is different from its members who have formed it. Its members are
only its agents who work for it. A company can sue and be sued and can own property and
there are many other legal implications which follow its incorporation. As a result of
incorporation, an incorporated company wears a corporate veil and thus acquires
the corporate personality, behind which there are shareholders who have formed the
company. Although in law the company has an independent personality, it is an artificial
person and hence, behind the corporate curtain, there are natural persons, i.e. shareholders
who have associated themselves into a company. So if this corporate personality is
uncovered or unveiled, the shareholders are found to be behind the veil. Thus, to lift, tear or
pierce the corporate veil means to ignore the corporate personality of an incorporated
company with a view to ascertaining the human personality hiding behind the facade of the
corporate garb, when, especially, this facade is used as a disguise by human beings who try
to conceal their identity after perpetrating some wrong or fraud in the guise of the
company. The Saloman v. Saloman
1
and a number of other cases have firmly established the
principle of a separate legal entity of an incorporated company distinct from its
shareholders. This is the doctrine of Limited Liability.


Facts and Decision of Saloman Case
Mr. Aron Salomon was a British leader merchant who for many years operated a sole
proprietor business, specialized in manufacturing leather boots. In 1892, his son, also
expressed interest in the businesses. Salomon then decided to incorporate his businesses
into a limited company, which is Salomon & Co. Ltd. However, there was a requirement at
the time that for a company to incorporate into a limited company, at least seven persons
must subscribe as shareholders or members. Salomon honored he clause by including his

1
[1897] A.C. 22 (H.L.)
wife, four sons and daughter into the businesses, making two of his sons directors, and he
himself managing director. Interestingly, Mr. Salomon owned 20,001 of the company's
20,007 shares - the remaining six were shared individually between the other six
shareholders. Mr. Salomon sold his business to the new corporation for almost 39,000, of
which 10,000 was a debt to him. He was thus simultaneously the company's principal
shareholder and its principal creditor.
At the time of liquidation of the company, the liquidators argued that the debentures used
by Mr. Salomon as security for the debt were invalid, and that they were based on fraud.
Vaughan Williams J. accepted this argument, ruling that since Mr. Salomon had created the
company solely to transfer his business to it, the company was in reality his agent and he as
principal was liable for debts to unsecured creditors.
The House of Lords later quashed that Court of Appeal (CA) ruling, upon critical
interpretation of the 1862 Companies Act. The court unanimously ruled that there was
nothing in the Act about whether the subscribers (i.e. the shareholders) should be
independent of the majority shareholder. The company was duly constituted in law, the
court ruled, and it was not the function of judges to read into the statute limitations they
themselves considered expedient. The 1862 Act created limited liability companies as legal
persons separate and distinct from the shareholders.
In other words, by the terms of the Salomon case, members of a company would not
automatically, in their personal capacity, be entitled to the benefits nor would they be liable
for the responsibilities or the obligations of the company. It thus had the effect that
members' rights and/or obligations were restricted to their share of the profits and capital
invested.

Doctrine of Lifting of Corporate Veil
The other name of this doctrine is Doctrine of Piercing of Corporate veil. Under this doctrine
may under certain circumstances pierce or lift the corporate veil and find the members or
shareholders of the company and hold them liable so as to do equitable justice with the
victim of the acts of the members or shareholders which were done from behind the
corporate veil of the company. And courts in many cases have not considered the Saloman
case and limited liability of the company and have gone behind the corporate veil and have
found the members of the company liable. But this is not the general rule which is to be
generally followed and is to be applied in the exceptional circumstances. The Courts in India
traditionally have been reluctant to interfere with the functioning of the incorporated
bodies. However, with the demarcating line between State and corporations becoming
unclear and with the expansion of the economy and role of the corporations over the years
the Courts have admitted that situation warranting, such exercise the corporate veil can be
lifted. It is now well settled that the corporate veil can in certain situations be pierced or
lifted. The principle behind the doctrine is a changing concept and it is expanding its horizon
as was held in State of U.P. v. Renusagar Power Co
2
. The ratio of the said decision clearly
suggests that whenever a corporate entity is abused for an unjust and inequitable purpose,
the court would not hesitate to lift the veil and look into the realities so as to identify the
persons who are guilty and liable therefore.

Lifting of Corporate Veil
There are two methods of lifting of corporate veil:
1. Statutory lifting
2. Judicial lifting
So these are the two methods through which the corporate veil could be pierced and the
individual members could be found for holding them liable personally for the wrongs they
have done from behind the corporate veil.

1. Statutory Lifting of Corporate Veil
Since the analysis of this doctrine is done in the Indian context so the Companies Act,
1956 is relevant for this analysis. The Companies Act through its provisions provides
certain circumstances under which the corporate veil of a company could be lifted.
The provisions of the Companies Act which provide for lifting of corporate veil are as
follows:
(1) A company carries on business for more than six months after the number of its
members has been reduced below seven in the case of a public company and two in
the case of a private company. Every person who was a member of the company
during the time when it carried on business after those six months and who was
aware of this fact, shall be severally liable for all debts contracted after six months
3
,
(2) The application money of those applicants to whom no shares has been allotted is
not repaid within 130 days of the date of issue of the prospectus, then the Directors
shall be jointly and severally liable to repay that money with the prescribed interest
4
,
(3) An officer of the company or any other person acts on its behalf and enters into a
contract or signs a negotiable instrument without fully writing the name of the
company, then such officer or person shall be personally liable
5
,
(4) The court refuses to treat the subsidiary company as a separate entity and instead
treat it as only a branch of the holding company
6
,
(5) In the course of winding up of the company, it appears that the business of the
company has been carried on with intent to defraud the creditors of the company or
any other person or for any fraudulent purpose, al those who were aware of such
fraud shall be personally liable without any limitation of liability
7
.

2
AIR 1988 SC 1737
3
Section 45
4
Section 69
5
Section 147
6
Section 212, 214
7
Section 542
And there are certain specific provisions in some statutes which also provide for the
lifting of corporate veil like section 85 of the Information Technology Act, 2000.
2. Judicial Lifting of Corporate Veil
There are certain exceptional circumstances other than those provided by the
relevant statute Companies Act, 1956. And so for these the court has to come in
action and interpret whether those exceptional circumstances are present in a case
so as to lift the corporate veil and for this all the facts and circumstances of the case
has to be considered. So some the basic circumstances in which court may lift the
corporate veil are:
1. Where the doctrine conflicts with the Public policy,
2. Where corporate veil has been used for fraud or improper conduct,
3. Where the corporate facade is only an agency instrumentality,
4. For determining the real character of the company,
5. Where the veil has been used for evasion of taxes,
6. In quasi-criminal cases,
7. For investigating the ownership of the company,
8. For investigating the affairs of the company
8
,
9. Where the company is used as a medium to avoid various welfare and labour
legislations,
10. In case of economic offences,
11. Where the company is used for some illegal and improper purpose, etc.

Judicial Interpretation of Doctrine of Lifting of Corporate Veil
Tata Engineering & Locomotive Co. Ltd. v. State of Bihar
9

". . . . However, in course of time, the doctrine that the corporation or a company has a legal
and separate entity of its own has been subjected to certain exceptions by the application of
the fiction that the veil of the corporation can be lifted and its face examined in substance.
The doctrine of the lifting of the veil thus marks a change in the attitude that law had
originally adopted towards the concept of the separate entity or personality of the
corporation. As a result of the impact of the complexity of
economic factors, judicial decisions have sometimes recognised exceptions to the rule about
the juristic personality of the corporation. It may be that in course of time, these exceptions
may grow in number and to meet the requirements of different economic problems, the
theory about the personality of the corporation may be confined more and more."

State of UP v. Renusagar Power Co. Ltd
10

The veil on corporate personality, even though not lifted some-times, is becoming more and
more transparent in modern company jurisprudence. The ghost of Salomans case still visits

8
Section 239
9
AIR 1965 SC 40
10
(1989) 1 CLA 1 (SC)
frequently the hounds of Company Law but the veil has been pierced in many cases. In the
expanding horizon of modern jurisprudence, lifting of corporate veil is permissible. Its
frontiers are unlimited. It must, however, depend primarily on the realities of the situation.
The aim of the legislation is to do justice to all the parties. The horizon of the doctrine of
lifting of corporate veil is expanding.

Subra Mukherjee v. Bharat Coking Coal Ltd
11

The Board of directors of a private company, N, by resolution dated September 21, 1970,
decided to sell certain immovable property of the company to the appellants for a
consideration of Rs.5,000. The appellants were the wives of two of the directors, who were
brothers. The appellants paid Rs.7,000 to one of the directors, husband of the first
appellant, and the sale deed was executed by the company on March 20, 1992. The
company was one of the companies mentioned in the Schedule to the Coal Mines
(Nationalisation) Act, 1973, and under the Act, its properties stood vested in the
respondent, a Government company. Upon initiation of proceedings by the respondent
under the Public Premises (Eviction of Unauthorised Occupants) Act, 1971, for eviction of
the appellants from the property in question, the appellants filed a suit for a declaration of
their rights in, title to and interest over the suit property.
The Supreme Court held that where a transaction of sale of its immovable property
by a company in favour of the wives of the directors was alleged to be sham and collusive,
as in the instant case, the Court would be justified in piercing the veil of incorporation to
ascertain the true nature of the transaction, as to who were the real parties to the sale and
whether it was genuine and bona fide or whether it was between the husbands and the
wives behind the facade of the separate entity of the company. This was what was done by
the High Court. The High Court was right in holding that the transaction was sham because :
(a) On the basis of the intrinsic evidence, the conclusion that the resolution was an ante-
dated document, appeared to be irresistible;
(b) Though the resolution mentioned the sale consideration as Rs.5,000, there was no
explanation as to why it was enhanced to Rs.7,000;
(c) The appellants did not exercise their rights as purchasers over the suit property till the
date of the suit;
(d) The transaction of sale was between the husbands and the wives and that they had no
independent source of their income, which fact could not be ignored altogether as
irrelevant.

Conclusion
As soon as the company is incorporated and given the certificate of incorporation
12
it
becomes a separate legal entity and is an artificial person who enjoys certain privileges
13


11
[2000] 101 Comp Cas 257 (SC)
12
Section 34 of Companies Act, 1956
13
Section 35
under the Companies Act. Its members and shareholders are separate from it and here
arises the concept of limited liability and its shareholders hold that much liability that they
hold shares in the company. But this corporate veil and limited liability concept has been
sometimes used by the persons behind the corporate veil to defraud the law and commit
fraud and wrongful conduct. In Salomans case court held that a company is a separate legal
entity and its veil cannot be lifted. But because of increase in the corporate crimes the law
makers felt the necessity to provide for the lifting of corporate veil and so the relevant
statutes have provided for the lifting of corporate veil and also courts through their judicial
pronouncements have developed the doctrine of lifting of corporate veil. Initially courts
were reluctant in lifting the corporate veil but they have now started lifting the corporate
veil as the doctrine is developing, but still the doctrine is not fully developed and needs to
be developed more. Still the doctrine is applied only in exceptional circumstances when
there only is a desperate requirement for the lifting of corporate veil so as to render justice
to the opposite party. In India once the veil is lifted by the courts the liability of the
management and the shareholders becomes unlimited they may have to make good all the
losses or else suffer from penal consequences. That is why this doctrine is to be developed
as a balance is to be struck between the lifting of corporate veil and limited liability as the
liability is made unlimited once the veil is lifted, which is rarely lifted.

PROCEDURE FOR INCORPORATING A COMPANY

Incorporation of Companies in India and setting up of branch offices of foreign corporations
in India are regulated by the Companies Act, 1956. The Companies Act of 1956 sets down
rules and regulations for the establishment of both public and private companies in India.

For the purpose of incorporation in India under the Companies Act, 1956, the first step for
the formation of a company is the approval of the name by the Registrar of Companies
(hereinafter referred as ROC) in the State/Union Territory in which the company will
maintain its registered office. This approval is subject to certain conditions. For instance,
there should not be an existing company by the same name. Further, the last words in the
name are required to be "Private Ltd." in the case of a private company and "Limited" in the
case of a Public Company.

Foreign companies engaged in manufacturing and trading activities are permitted by the
Reserve Bank of India to open its branch offices in India. Application for permission to open
a branch, a project office or liaison office is made via the Reserve Bank of India by
submitting form FNC-5 to the Foreign Investment and Technology Transfer Department of
the Reserve Bank of India. For opening a project or site office, application may be made on
Form FNC-10 to the regional offices of the Reserve Bank of India. A foreign investor need
not have a local partner, whether or not the foreigner wants to hold full equity of the
company. The portion of the equity thus not held by the foreign investor can be offered to
the public.

The ROC generally informs the applicant within seven days from the date of submission of
the application, whether or not any of the names applied for is available. Once a name is
approved, it is valid for a period of six months, within which time Memorandum of
Association and Articles of Association together with miscellaneous documents are required
to be filed. A company is formed by registering the Memorandum and Articles of
Association with the Registrar of Companies.

After the duly stamped Memorandum of Association and Articles of Association, documents
and forms are filed and the filing duly fees are paid, the ROC scrutinizes the documents and,
if necessary, instructs the authorized person to make necessary corrections. The ROC will
give the certificate of incorporation after the required documents are presented along with
the requisite registration fee, (Annexure A) which is scaled according to the share capital of
the company, which will be stated in its Memorandum of association. In case the
Memorandum and Articles is to be signed by any of the promoters out side India, then the
signatures are required to be made in the presence of Consul of India at the Indian
Consulate.

Minimum number of Directors and shareholders: -

a) For incorporating a Private Limited Company a minimum of two directors are required
and minimum two shareholders.
b) For incorporating a Public Limited Company a minimum of three directors are required
and minimum seven subscribers.

Thereafter, a Certificate of Incorporation is issued by the ROC, from which date the
company comes in to existence. It takes about one to two weeks from the date of filing
Memorandum of Association and Articles of Association to receive a Certificate of
Incorporation.

A private company can commence business on receipt of its certificate of incorporation. A
public company has the option of inviting the public for subscription to its share capital.
Accordingly, the company has to issue a prospectus, which provides information about the
company to potential investors. The Companies Act specifies the information to be
contained in the prospectus. The prospectus has to be filed with the ROC before it can be
issued to the public. In case the company decides not to approach the public for the
necessary capital and obtains it privately, it can file a statement in lieu of prospectus with
the ROC. On fulfillment of these requirements, the ROC issues a Certificate of
Commencement of business to the public company. The company can commence business
immediately after it receives this certificate.

To sum up, a company is formed by registering the Memorandum and Articles of
Association with the Registrar of Companies of the State in which the main office of the
proposed company would be located. After the duly stamped Memorandum of Association
and Articles of Association, documents and forms are filed and the filing fees are duly paid,
the ROC scrutinizes the documents and, if necessary, instructs the authorized person to
make necessary corrections. The ROC grants the certificate of incorporation after the
required documents are presented along with the requisite registration fee, which is scaled
according to the share capital of the company, as stated in its Memorandum. Thereafter, a
Certificate of Incorporation is issued by the ROC and the company officially comes in to
existence w.e.f the date shown on this certificate. It usually takes one to two weeks from
the date of filing Memorandum of Association and Articles of Association to receive a
Certificate of Incorporation. As a recent development in incorporation procedures, various
forms and applications under Companies Act, 1956 and the Rules and Regulations are being
facilitated through e-filing which is projected by Ministry of Company Affairs.

Promoters

A promoter is people who bring about the incorporation and organization of a
corporation. He brings together the persons who become interested in the enterprise,
aids in procuring subscriptions and sets in motion the machinery which leads to the
formation itself. Explain and illustrate.
1. Introduction:
The term Promoter finds its place in the company law, it has not been defined anywhere
under the Companies Act, 1956 (Act)

. This is because the term does not have any legal
connotation but contains a business element. Promotion is a term of wide import denoting
the preliminary steps taken for the purpose of registration and floatation of the company.
The persons who assume the task of promotion are called promoters. A promoter may be
an individual, association, partner or company.
It is noteworthy that the concept of promoter is enunciated in the Securities Exchange
Board of India (Disclosure and Investor Protection), 2000 (DIP Guidelines) which is mostly
from the disclosure perspective. The term Promoter also finds place in the Securities
Exchange Board of India, Takeover Code 1997. It is stated that a promoter is neither an
agent nor a trustee of a company under incorporation but certain fiduciary duties have been
imposed upon him both under the English Companies Act and the Indian Companies Act.
They have the power of defining how and when in what shape and under whose supervision
the company shall come into existence.
Corporators are those who compose a corporation, whether as stockholders or as members.
Incorporators are those stockholders or members mentioned in the articles of
Incorporation as originally forming and composing the corporation and who are signatories
thereof. Every incorporator must be a stockholder
1.
most important piece of legislation that empowers the Central Government to regulate
the formation, financing, functioning and winding up of companies. The Act contains the
mechanism regarding organizational, financial, and managerial and all the relevant aspects
of a company. It empowers the Central Government to inspect the books of accounts of a
company, to direct special audit, to order investigation into the affairs of a company and to
launch prosecution for violation of the Act.
2.
Substantial acquisition of Shares and Takeover Regulations
3
Control shall include the right to appoint the majority of the directors or to control the
management or policy decisions exercisable by a person or persons acting individually or in
concert, directly or indirectly, including by virtue of their shareholding or management
rights or shareholding agreements or voting agreements or in any other manner
2. Defination Of A Promoter :
(i) The person or persons who are in over-all control of the company;
(ii) The person or persons who are instrumental in the formulation of a plan or programmed
pursuant to which the securities are offered to the public;
(iii) The persons or persons named in the prospectus as promoters(s). Provided that a
director/ officer of the issuer company or person, if they are acting as such merely in their
professional capacity shall not be included in the Explanation.
(iv) Promoter is inclusive in nature and is a term of wider significance, and does not confine
itself to de jury control
Summarizing the definition we can say that a promoter is a person who exercises substantial
control over the company or a person who undertakes all necessary steps in the floatation
of the company. The relationship between a promoter and a company which he has floated
must be deemed to be a fiduciary relationship from the day the work of floating the
company started .The status of the promoter is generally terminated when the Board of
directors has been formed and they start governing the company.
As a company promoter
(i) Any company in which promoter holds 10% or more of the equity capital or which holds
10% or more of the equity capital of the promoter
(ii) Any company in which a group of individuals or companies or combinations thereof who
holds 20% or more of the equity capital in that company also holds 20% or more of the
equity capital of the issuer company;
(iii) Any company in which 10% or more of the share capital is held by the promoter or an
immediate relative of the promoter or a firm or HUF in which the promoter or any one or
more of his immediate relative is a member;
(iv) Any company in which aggregate share of the promoter and his immediate relatives is
equal to or more than 10% of the total; and all persons whose shareholding is aggregated
for the purpose of disclosing in the prospectus under the heading shareholding of the
promoter group
The above definition not only encompasses within its ambit the promoter and his
immediate relatives but also takes into account the subsidiary or the holding company or
any other company in which the promoter holds 10% or more of the capital of the company.
In cases of promoter being a natural person, any firm in which the promoters and his
immediate relatives possess an aggregate shareholding which is either equal to or more
than 10% of the total capital of the company. The definition also tends to include persons
whose shareholding is aggregated to satisfy the disclosure requirements in the prospectus.
In the light of the issues raised above, it may be noted that the above definition of
promoter is segregated into two parts. The first part deals with the general concept of the
term promoter whereas the second part differentiates between promoters as natural
persons (including his immediate relatives, companies, partnership firms in which he
possesses the prescribed shareholdings) and as corporate promoters (including the
holding companies and its subsidiaries). It is pertinent to cite Clause 8.3 of the Malegam
Committee Report
4
.
4.
It needs to be clarified that the above definitions of Promoter and Promoter As a
company are designed specifically for the purposes of disclosure in the prospectus of
shareholding and share transactions and are not to be used for any other purposes.
4. Judicial Decisions About Promoter:
According to the judicial interpretation of the term promoter there are many certain
activities that are attributed to ;
(i). Controlling the management of such companies after its incorporation.
(ii). Activities undertaken and exertions made towards the forming of the company and
assumption of subsequent duties towards it.
(iii). Persons involved in the process of finding directors, qualifying them, preparing the
prospectus and incurring expenses in printing, advertising and other allied activities,
incidental to bringing the company into existence.
(iv). Persons acting in their professional capacity are not promoters, unless they become a
party to the issuance of shares, procurement of subscriptions or acting outside the scope of
their professional duties
5. A Promoters Lock-In Requirements
a promoter is required to contribute to the extent of:
20% of the post-issue capital in case of an unlisted company;
20% of the proposed issue or of the post-issue capital in case of a listed company;
20% of the post-issue capital after offer for sale.
All the abovementioned cases the promoters contribution shall be locked in for a period of
three years starting from the date of allotment in the proposed public issue. Further the
entire pre issue share capital of the issuer company shall be locked in
5
for a period of one
year.
5
A note relating to promoters contribution and lock-in period, stating date of allotment,
date when made fully paid up, nature of allotment (rights, bonus, etc.), number of
securities, face value of securities, issue price of securities, percentage of promoters
contribution to total issued capital and the date up to which the securities are locked-in
6. Disclosure Regarding Promoters Entities:
There are several disclosure that are regarding to promoters Entities
1. Date of incorporation.
2. Shareholding of the Company.
3. Nature of activities including the main objects.
4. Location of the registered office.
5. History of the Company and the promoters of the Company.
6. Financial information for the past three years, which includes:
i. Reserves (excluding revaluation reserves).
ii. Sales.
iii. Profit after tax.
iv. Earning per share.
v. Net asset value.
vi. Highest/lowest market price (if any)
7. Full particulars of the nature and extent of the interest, if any, of every promoter in the
promotion of the issuer company or in any property acquired by the issuer company within
two years of the date of the prospectus or proposed to be acquired by it need to be
disclosed.
8. Litigation details regarding promoters and promoter group entities and details of
contingent liability as on date of last audited financial statement
7. Disclose Personal Profits Of The Promoter:
The promoters who purchase property and then create a company to purchase that
property stand in a fiduciary position towards the company. They must make a faithful
disclosure to the company of all relevant facts which might affect the willingness of the
company to purchase the property, including any profits made.
The promoters have certain basic duties towards the company formed:-
1. He must not make any secret profit out of the promotion of the company. Secret profit is
made by entering into a transaction on his own behalf and then sells the concerned
property to the company at a profit without making disclosure of the profit to the company
or its members. The promoter can make profits in his dealings with the company provided
he discloses these profits to the company and its members.
2. He must make full disclosure to the company of all relevant facts material to any
transaction made by him with the company. He must use his position fairly and reasonably
and in the interest of the company and must abstain from exercising undue influence and
fraud.
In case of default on the part of the promoter in fulfilling the above duties, the company
should be:-
1. Rescind the contract and recover the purchase price where he sold his own property to
the company.
2. Recover the profit made, even though rescission is not claimed or is not possible.
3. Claim damages for breach of his fiduciary duty. The measure of damages will be the
difference between the market value of the property and the contract price can be
recovered from him
8. Liability of Promoter:
1. Promoter is liable to the original allotted of shares for the misstatements contained in the
prospectus- He may also be imprisoned for a term extending to two years or fine upto Tk.
50,000 for such untrue statements in the prospectus.
2. In the course of winding-up of the company, on an application made by Official
Liquidator, the court may make a promoter liable for misfeasance or breach of trust.
Where there is more than one promoter, they are jointly and severally liable and if one of
them is sued and he pays damages, he is entitled to claim contribution from others. The
death of a promoter does not relieve his estate from liability arising out of abuse of his
fiduciary position.
9. Conclusion
A corporation results from careful planning and preliminary arrangements by promoters,
the creative force behind the corporate enterprise. They from and set in motion the
corporation, frequently continuing in control after the corporation achieves legal existence.
Promoters are so to speak, the midwife of corporate business. The promoter must first
discover a promising business opportunity such as a patent, amine, anew ides of achieving a
business goal, anew business or the combining of two or more business associations into a
new corporation. After discovery he must have thought out the economic possibilities of the
new venture what market is there for the product. A promoter is one who brings together
the persons who become interested in the enterprise, aids in procuring subscription and
sets in motion the machinery which leads to the formation of the corporation itself. It is the
promoter works which brings the corporation into existence. While ordinary a promoter
ceases to be such when the corporation is fully formed and the business turned over to the
directors, such is not necessarily the ease. As long as the work of formation continues, those
carrying on such work retain the character of promoters. A pre-incorporation contract never
binds a company since a person (legal or juristic) can not contract before his or its existence
and a company before incorporation has no legal existence. Another reason is that
promoters are proverbially profuse in their promises and if the corporation were to be
bound by them, it would be subject to many unknown, unjust and heavy obligations. A
promoter may also be incorporator, subscriber, shareholder, director or other officer in a
private corporation and , in the usual case.
A promoter and a company , there relation is fiduciary relationship an based upon at most
good faith .

Kinds of company
Company defined:
Company is defined as the group of people working together to accomplish a
common goal or objective. The term 'company' means a group of people working together
for some common object or objects. The purpose for such group to associate are different
but the term 'company' is normally set aside for those linked with economic purpose means
to work for the profit motive. The term company as defined by Lord Justice Lindley as
follows:
"By a company is meant an association of many persons who contribute money or
money worth to a common stock and employ it in some trade or business, and who
share the profit and loss (as the case may be) arising there from, The common stock
so contributed is denoted in money and is the capital of the company.
There are various kinds of companies according to their nature and characteristics which are
categorized according to their incorporation, liability and control. The Companies Act, 1956
provides for a variety of companies that may be promoted and registered under the Act.
Basically company may be divided into two categories. Those are:
Private companies
Public companies.
1. Private companies:
A private company must have minimum paid up share capital of Rs. 1,00,000. The
articles of association of a private company must contain the following:
a. Restrictions on the transfer of shares.
b. Limitation on the maximum no. of members to 50.
c. Prohibition on inviting the public to subscribe for shares or debentures.
d. Prohibition on accepting deposits from the public other than its members, directors.
The minimum paid up share capital requirement of Rs. 1,00,000 is not applicable to
Section 25 of Companies Act. The term share capital means equity or preference.
In the case of a private company not having the share capital the Articles of association
will not contain any restriction on the transfer of shares.
The number of members of a private company cannot exceed 50 while calculating the
no. of members; the following points should be noted:
a. Employee share holder who has been allotted shares weather there are in present
employment or past employment should not be counted.
b. Joint shareholders that are two or more persons holding one or more shares jointly
should be taken as single member.
c. The number of debenture holders may exceed 50.
A private company may accept deposits from members, directors and their relatives of
its members or directors.
At least two persons are required to form a private company.
If a private company is registered with limited liability its name must end with Pvt. Ltd
2. Public companies:
A public company, as per the Companies (Amendment) Act, 2000 means a company
which is not a private company.
Public Company must have a minimum paid up share capital of Rs. 50000.
The Articles of association of the public company will not contain any restrictions or
limitations or prohibitions. Therefore:
a. Shares are freely transferable without any restrictions.
b. There is no maximum limit on the no. of members.
c. Shares and debentures can be allotted to the public and the deposits may be
created from the public.
The requirement of minimum paid up share capital is not applicable to Sec 25 of
Companies Act.
The share capital may be equity or preference.
Where a private company is a subsidiary of a public company shall also be deemed
to be a public company.
At least 7 persons are required to form a public company.
If a public company is incorporated with the limited liability its name must end with
the word Ltd.


Distinction between private and public company:
1. Minimum number of members [sec 12]: In case of a private company minimum
number of persons to form a company is two while it is seven in case of a public
company.
2. Maximum number of members [sec 3]: In case of private company it is 50 whereas
there is no such restriction in case of a public company.
3. Transferability of shares [sec 3 & 32]: In a private company the right to transfer
shares is restricted, whereas in case of a public company the shares are freely
transferable.
4. Prospectus [sec 3]: A private company cannot issue prospectus, while a public
company, may, through prospectus, invite the general public to subscribe its shares,
debentures or deposits.
5. Statement in lieu of prospectus [sec70]: A public company is required to file a
statement in lieu of prospectus with the registrar of companies at least 3 days before
allotment, where it does not issue a prospectus. A private company is exempted
from this requirement.
6. Minimum number of directors [sec 252]: A private company must have at least two
directors, whereas a public company must have at least three directors.
7. Commencement of business [sec 149]: A private company can commence its
business immediately after receiving the certificate of incorporation, while a public
company can commence business only when it receives the certificate to commence
business from the registrar of companies.
8. Statutory meetings and statutory report [sec 165]: A private company need not hold
a statutory meeting or file a statutory report but a public company must hold a
statutory meeting and file a statutory report with the registrar.
9. Quorum for general meetings [sec 174]: Two members personally present to form
the quorum in a private company but in a public company the number is five.
10. Filing of returns: A private company is exempted from filing of various returns except
few, which are required to be periodically filed by a public company with the
registrar of companies.
11. Retirement of directors [sec 256]: Directors of a private company are not required to
retire by rotation, but in case of a public company at least 2/3
rd
of the directors must
retire by a rotation at each annual general meeting.
12. Public deposits: A public company is free to accept deposits from the public but a
private company cannot accept deposits from the public other than the
shareholders, directors and their relatives.
13. Paid-up capital: A private company can be registered with a paid-up capital of one
lakh but a public company must have a minimum paid-up capital of 5 lakhs.

Other companies:
Companies may also be classified as Statutory companies, registered companies,
existing companies, associations not for profit, government companies, foreign companies,
holding & subsidiary companies and investment companies.
1.Holding and subsidiary Company (sec 4):
1) The terms holding and subsidiary companies are interrelated.
2) A holding company must satisfy one or more of the following three conditions in its
subsidiary.
a. The holding company must control the composition of B.O.D in the subsidiary or
b. The holding company must hold more than half of the equity share capital in its
subsidiary (preference share holdings must be ignored they do not carry voting rights) or
c. The holding company must hold the more than half of the voting rights
3) Any subsidiary of a subsidiary company will also be the subsidiary company of the holding
company
4) Shares may be held by a holding company in its subsidiary either by itself or together with
only of its subsidiary
5) A subsidiary cannot purchase even a single share of its holding company after 1-4-1956
after it became its subsidiary.
The position regarding holding-subsidiary relationship has been discussed in the
case of M. Velayudhan vs Registrar of Companies [1980] 50 Comp. cas. 33. It has been held
that section 4 envisages the existence of subsidiary companies in different situations. It may
be noted that by acquiring sufficient share capital of a company, sufficient control may be
obtained over that company to enable control in the composition of the board of directors.
Such a control may be by reason of an agreement such as where one company may agree to
advance funds to another company and in return may, under the terms of an agreement
gain control over the right to appoint board of directors.
2.Government Companies (sec 617):
1) A government company is which not less than 51% of the paid up share capital (equity or
preference share capital) is held by central government or one or more state government
partly by the central government and partly by one or more state companies.
2) Any subsidiary of a government company shall also treated as a government company.
3) A government is not agreement itself therefore employees of Government Company are
not government companies.
4) A government company can sue the government in that own name.
5) A government company may be incorporated either as a private company or as public
company. However the most of the government in India are incorporated as private
companies because it was very continent and enjoy privileges and advantages.
6) Government company need not use the name of Pvt as the part of the name of the
company.
7) The auditor of the government company will be appointed by C&AGI (Comptroller and
Audit General of India) .

3.Foreign Companies (sec 591):
1) This is a company which is incorporated outside India under the law of another company
but having a place of business in India. Example: British airways, Cathey pacific
2) Copys of memorandum, articles etc. must be filed by every foreign companies act at the
following two places:
a. R.O.C at New Delhi
b. R.O.C at the state where the company was principle place of business.
3) The name of the company and the country of its incorporation must be conspicuously
written in English and local news paper in vernacular language in the name board,
prospectus, letter etc.
4.Illegal Companies (sec 11):
1) An association or partnership which consists of more than 10 persons in the case of
Banking business and which is and which consists of more than 20 persons in another and
which is unregistered either under the companies act 1956 (or) any under act will be called
an illegal association.

2) Exemptions:
Sections will not apply to the following entities
a. Associations which are formed without any profit like NGOs and charitable institutions.
b. Stock Exchanges: These are formed without profit motive.
Case: Ruia vs. dalmia
c. One single Hindu Undivided family carrying on business.
3) When two or more Hindu undivided Family s come together to do business then sec 11
will apply in that case all adult members both male and female be counted, minor members
should be ignored.
5.Registered companies:
A company registered under the Companies Act is known as a registered
company. Registered companies can be incorporated as limited liability companies or as
unlimited liability companies. Further, they may be incorporated as public companies.
6.Associations not for profit:
It is an association which is formed not for making profits but for promoting
commerce, art, science, religion, charity or any other useful social purpose. Such an
association may or may not be registered as a company under the Companies Act. When
such an association is registered as a company with limited liability, it may be given a licence
by the Central Government. Section 25 of the Companies Act permits the registration under
a licence granted by the central government of all associations not for profit with limited
liability without being required to use the word limited or the words private limited at the
end of their names.
The central government may grant such a licence if the following two conditions
are fulfilled:
i) It is intended to form a company for promoting commerce, art, science. Religion,
charity, or any other useful object;
ii) The company prohibits payment of aany dividend to its members but intends to
apply its profits or other income in the promotion of its objects.
When the above two conditions are fulfilled, the central government may, by licence, direct
that the association may be registered as a company with limited liability without the
addition to its name of the word limited or the words private limited as per section 25(1).

MEMORANDUM OF ASSOCIATION
The first important step in the formation of a company is the preparation of the
Memorandum of Association. It is a document which sets out the constitution of the
company and as such, is really the foundation on which the structure of the company rests.
That is why Memorandum of Association has often been called the charter of the company
in its relation to this outside world. The promoters of the company prepare this document.
The Memorandum of association must contain the following clauses. Memorandum of
Association is a document that regulates a companys external activities. As the companys
charter it ((together with the companys articles of association) forms the companys
constitution. Also called memorandum, it gives the firms name, names of its members
(shareholders) and number of shares held by them, and location of its registered office. It
also states the firms objectives, the amount of authorized share capital, whether liability of
its members is limited by shares or by guarantee, and what type of contracts the firm is
allowed to enter into.
It is meant to be a company charter that encloses in itself the essential conditions based on
which the company could be conveniently commenced and incorporated. It highlights the
major elements that constitute the foundation of the company and adumbrates its scope
beyond which the company could not go. As for the purpose of the Memorandum, it is of
two dimensions. The first dimension comprises the shareholder where it tells the
shareholder the field and scope of the company and with the help of that the shareholder
decides the suitability of his investment in the company. The second dimension involves
any stakeholder of the company. The Memorandum tells these companies whether the
objectives that the respective stakeholder aims to accomplish with the help of the company
are within the realm of the companys objectives or not.
Clauses of memorandum of association
There are many clauses related to the memorandum of association. Some of them are as
follows:
Name Clause:
The first clause of the memorandum is required to state the name of the proposed
company. A company may adopt any name but it should not be identical to the name of an
existing company registered with the registrar of the company.
The name of every private company shall contain as its last words, the words Private
Limited and every public company shall contain in its last word Limited. The object is that
name of the company should indicate whether it is a private company or a public company
barring the cases covered by Section 25.
It is an offence under Sec. 631 to carry on any business or trade using the word Limited as
a part of the name where the person using the name is not entitled to do so. This kind of
illegality does not invalidate contracts made in the ordinary course of business and trade.
Registered Office Clause:
The second clause must specify the state in which the registered office of the company is
situated. A company must have a registered office at which all the communications and
notices are to be addressed. Within thirty days of incorporation or commencement of
business whichever is earlier , the exact place where the registered office is to be located
must be decided and notice of the situation given to the Registrar who is to record the
same.
Objects Clause:
This is the most important clause in the memorandum. It clearly defines the sphere of the
companys activities. It specifies the activities which a company can carry on and which
activities it cannot carry on. The company cannot carry on any activity which is not
authorised by its MA. This clause must specify:-
i. Main objects of the company to be pursued by the company on its incorporation
ii. Objects incidental or ancillary to the attainment of the main objects
iii. Other objects of the company not included in (i) and (ii) above.
In case of the companies other than trading corporations whose objects are not confined to
one state, the states to whose territories the objects of the company extend must be
specified.
Doctrine of the ultra-vires Any transaction which is outside the scope of the powers
specified in the objects clause of the MA and are not reasonable incidentally or necessary to
the attainment of objects is ultra-vires the company and therefore void. No rights and
liabilities on the part of the company arise out of such transactions and it is a nullity even if
every member agrees to it.
Consequences of an ultravires transaction:-
1. The company cannot sue any person for enforcement of any of its rights.
2. No person can sue the company for enforcement of its rights.
3. The directors of the company may be held personally liable to outsiders for an ultra
vires
However, the doctrine of ultra-vires does not apply in the following cases :-
1. If an act is ultra-vires of powers the directors but intra-vires of company, the
company is liable.
2. If an act is ultra-vires the articles of the company but it is intra-vires of the
memorandum, the articles can be altered to rectify the error.
3. If an act is within the powers of the company but is irregualarly done, consent of the
shareholders will validate it.
4. Where there is ultra-vires borrowing by the company or it obtains deliver of the
property under an ultra-vires contract, then the third party has no claim against the
company on the basis of the loan but he has right to follow his money or property if it exist
as it is and obtain an injunction from the Court restraining the company from parting with it
provided that he intervenes before is money spent on or the identity of the property is lost.
5. The lender of the money to a company under the ultra-vires contract has a right to
make director personally liable.
Liability Clause:
This clause of memorandum states the nature of liability that the members incur. If the
company is to be incorporated with limited liability then the clause must contain the
declaration that the liability of the shareholders is limited to the extent of the value of
shares held by them.
A declaration that the liability of the members is limited in case of the company limited by
the shares or guarantee must be given. The MA of a company limited by guarantee must
also state that each member undertakes to contribute to the assets of the company such
amount not exceeding specified amounts as may be required in the event of the liquidation
of the company. A declaration that the liability of the members is unlimited in case of the
unlimited companies must be given. The effect of this clause is that in a company limited by
shares, no member can be called upon to pay more than the uncalled amount on his shares.
If his shares are already fully paid up, he has no liability towards the company.
The following are exceptions to the rule of limited liability of members:-
1. If a member agrees in writing to be bound by the alteration of MA / AA requiring him
to take more shares or increasing his liability, he shall be liable upto the amount agreed to
by him.
2. If every member agrees in writing to re-register the company as an unlimited
company and the company is re-registered as such, such members will have unlimited
liability.
3. If to the knowledge of a member, the number of shareholders has fallen below the
legal minimum, (seven in the case of a public limited company and two in case of a private
limited company ) and the company has carried on business for more than 6 months, while
the number is so reduced, the members for the time being constituting the company would
be personally liable for the debts of the company contracted during that time.
Capital Clause:
This clause is required to specify the amount of share capital with which the company
proposes to be registered and secondly the divisions of that capital into shares of a fixed
amount. The amount of share capital with which the company is to be registered divided
into shares must be specified giving details of the number of shares and types of shares. A
company cannot issue share capital greater than the maximum amount of share capital
mentioned in this clause without altering the memorandum. A public company must have a
minimum paid up capital of five lakh rupees or such higher amount as may be prescribed
and a private company is required to have a minimum paid up capital of one lakh rupees or
such higher amount as may be prescribed.
Subscription Clauses:
This clause contains a statement by the subscribers that they are eager of forming
themselves into a company and agree to have a number of shares written against their
respective names. A declaration by the persons for subscribing to the Memorandum that
they desire to form into a company and agree to take the shares place against their
respective name must be given by the promoters.
ALTERATION OF MEMORANDUM OF ASSOCIATION
Alteration of memorandum of association involves compliance with prescribed procedure.
Alterations only to the extent necessary for simple and fair working of the company would
be permitted. Alterations should not be prejudicial to the members or creditors of the
company and should not have the effect of increasing the liability of the members and the
creditors.
Contents of the memorandum of association can be altered as under:
Change of name:
The company can effect the change in the name of the company by passing a special
resolution in a General Meeting of the members of the company and after obtaining Central
Government approval. An application is to be made to the Registrar of Companies for
availability of new name. After passing a special resolution Central Government approval is
to be obtained. Reasons for effecting a change in sufficient details are to be mentioned in
the applicants for change of name. No approval of Central Government is necessary where
the only change in the name of the company is addition or deletion of the word Private
because of conversion of a public company into a private company or vice versa. Where a
company changes its name, the Registrar shall issue a fresh certificate of incorporation with
necessary alterations embodied therein. The change of name shall be complete and
effective only o the issues of such a certificate. Powers in this respect have been delegated
to the Registrar of Companies.
Effects of change of name:
The change of name shall not effect any rights or obligations of the company or render
defective any legal proceedings by or against it. Any legal proceedings which might have
been continued or commenced by or against the company by its former name may be
continued by or against the company in its new name. The alteration effected is only in the
name and not in the identity of the company. The change of name does not affect the entity
of the company or its continuity as the same entity with the same rights privileges and
liabilities as before. A change of name does not bring into existence a new company.
Nothing authorizes the company to commence a legal proceeding in its former name at a
time when it had acquired its new name.
Change in the registered office of the company:
Change in the registered office of the company from one place to another, in the same city,
in a particular State and be effected by an ordinary Board resolution. Intimation of change is
to be filed with the Registrar within 30 days of the change.
Change in the registered office of the company from one city to another city in the same
State, requires a special resolution and confirmation by the Regional Director under section
17 A inserted by Companies (Amendment) Act 2000, with effect from 01.03.2001.
Confirmation of Regional Director is required only when registered office is changed by the
company from the jurisdiction of one Registrar of Companies to the jurisdiction of another
Registrar of Companies within the same state. Intimation of the change is to be filed the
Registrar within 30 days of the change.
Change in the registered office of the company from one State to another State in India
pursuant to Section 17 of the Act involves alteration of memorandum of association of the
company. A special resolution is therefore required to alter the provisions of its
memorandum, so as to change the place of its registered office from one State to another.
Petition is to be filed with Company Law Board for confirmation of the change. The
alteration of the provisions of memorandum relating to the change of the place of its
registered office from one state to another shall not take effect unless it is confirmed by the
Company Law Board on the Petition.
Companies (Amendment) Act, 2002 confers the power upon the Central Government
instead of Company law Board to confirm alteration of Memorandum of Association of a
company regarding change of registered office from one state to another.
Alteration of Objects
Section 17 allows alteration of objects within certain defined limits. The limits imposed upon
the power of alteration are of two kinds namely, substantive and procedural.
Alteration in objects may be done by way of special resolution passed in a general meeting
of the members of the company for the following purposes:
(a) to carry on its business more economically or more efficiently;
(b) to attain its main purpose by new or improved means;
(c) to enlarge or change the local area of its operations;
(d) to carry on some business which under existing circumstances may conveniently or
advantageously be combined with the business of the company;
(e) to restrict or abandon any of the objects specified in the Memorandum;
(f) to sell or dispose of the whole, or any part, of the undertaking, or any of the
undertakings of the company; or
(g) to amalgamate with any other company or body of persons.
Furthermore, Section 18 mandates that the copy of the special resolution by which the
alteration has been facilitated must be file with the Registrar of Companies within one
month from the date of the resolution.

ARTICLES OF ASSOCIATION AND ALTARATION OF ARTICLES
INTRODUCTION
To obtain the registration of a company an application has to be filed with the Registrar of
Companies. The application must be accompanied by the following documents,
1. Memorandum of Association
2. Articles of Association, if necessary and
3. The agreement, if any, which the company proposes to enter into with any individual
for his appointment as its managing or whole-time director or manager.
The articles of association of a company are its by-laws or rules and regulations which
govern the management of its internal affairs and the conduct of its business. They are
framed with the object of carrying out the aims and objects as set out in the Memorandum
of Association. According to Section 2(2) of the Companies Act, 1956 articles means the
articles of association of a company as originally framed or as altered from time to time in
pursuance of any previous companies laws or of the present Act, i.e the Act of 1956.
The Articles regulate the internal management of the company. They define the powers of
its officers. In Naresh Chandra Sanyalvs Calcutta Stock exchange association Ltd(AIR 1971 SC
422), the SC said that the articles of association also establish a contract between the
company and the members and between the members inter se. This contract governs the
ordinary rights and obligations incidental to membership in the company.
Articles are like the partnership deed in a partnership. They set out provisions for the
manner in which the company is to be administered. In particular, they provide for matters
like the making of calls, forfeiture of shares, directors qualifications, appointment, powers
and duties of auditors, procedure for transfer and transmission of shares and debentures.
CONTENTS OF ARTICLES OF ASSOCIATION
Articles usually contain provisions relating to the following matters-
1. Share capital including sub division thereof, rights of various shareholders, the
relationship of these rights, payment of commission, share certificates,
2. Lien of shares
3. Calls on shares
4. Transfer of shares
5. Transmission of shares
6. Forfeiture of shares
7. Surrender of shares
8. Conversion of shares into stock
9. Share warrant
10. Alteration of capital
11. General meetings and proceedings thereat
12. Voting rights of members, voting by poll, proxies
13. Directors, including first directors or directors for life, their appointment,
remuneration, qualifications, powers and proceedings of Board of directors
meetings
14. Dividends and reserves
15. Accounts and audits
16. Borrowing powers
17. Winding up
Utmost care must be taken to prepare the articles of association of the proposed company.
They are certain matters in respect of which powers can be exercised by the company only if
the articles so provide and in the manner provided therein. Therefore, the articles must
contain provisions in respect of all matters which are required to be contained therein so as
not to hamper the working of the company later. At the same time, the articles of
association should not provide for matters in respect of which it has no powers to exercise.
It cannot, for example, provide for expulsion of a member, as such a power is opposed to
the fundamental principal of company jurisprudence and, therefore, ultra vires the
company.
COMPANIES WHICH MUST HAVE ARTICLES (SECTION 26)
The following companies must have their own articles, namely
1. Unlimited companies
2. Companies limited by guarantee
3. Private companies limited by shares
The articles shall be signed by the subscribers of the Memorandum and registered along
with the Memorandum. A public company may have its own Articles of association. If it does
not have its own Articles, it may adopt Table A given in Schedule I to the Act.
Section 27 provides that the regulations with respect to the aforesaid companies should
provide for the following:-
1. In case of unlimited companies, the articles shall state the number of members with
which the company is to be registered and if the company has a share capital, the
amount of share capital with which the company is to be registered.
2. In case of companies limited by guarantee, the articles shall state the number of
members with which the company is to be registered.
3. In case of private company having a share capital, the articles shall contain
provisions which-
a) Restrict the right to transfer shares
b) Limit the number of its members to 50 (not including employee-members),
and
c) Prohibit any invitation to the public to subscribe for any shares in, or
debentures of, the company.
NO ARTICLE COMPANY
According to section 28(1), company limited by shares may either frame its own set of
articles or may adopt all of any of the regulations contained in Table A. but if it does not
register any Articles, Table A applies, if it does not have some regulations, for the rest, as far
as applicable, table A applies, insofar as its regulations are not excluded [(section 28(2)].
Thus, in case of a limited liability company having share capital, if the articles do not
expressly exclude any or all provisions of table A, and at the same time not providing
anything for them, applicable clauses of Table A shall automatically apply to it.
FORM AND SIGNATURE OF ARTICLES
According to section 30 of the Companies act, 1956 the articles shall
a) be printed;
b) be divided into paragraphs numbered consecutively; and
c) be signed by each subscriber of the memorandum of association (who shall
add his address, description and occupation, if any,) in the presence of at
least one witness who shall attest the signature and shall likewise add his
address, description and occupation, if any.
ALTERATION OF ARTICLES
Sec. 31 of the Companies Act, 1956, provides that a company may by passing a special
resolution, alter regulations contained in its Articles any time subject to
a) the provisions of the Companies Act and
b) Conditions contained in the Memorandum of Association [Section 31(1)].
A copy of every special resolution altering the Articles shall be filed in Form no 23, with the
Registrar within 30 days its passing and attached to every copy of the Articles issued
thereafter. The fundamental right of a company to alter its articles is subject to the
following limitations:
a) The alteration must not exceed the powers given by the Memorandum of
Association of the company or conflict with the provisions thereof.
b) It must not be inconsistent with any provisions of Companies Act or any other
statute.
c) It must not be illegal or against public policies
d) The alteration must be bona fide for the benefit of the company as a whole.
e) It should not be a fraud on minority, or inflict a hardship on minority without any
corresponding benefits to the company as a whole.
f) The alternation must not be inconsistent with an order of the court. Any subsequent
alteration thereof which of inconsistent with such an order can be made by the
company only with the leave of the court.
g) The alteration cannot have retrospective effect. It can operate only from the date of
amendment. [Pyarelal Sharma v. Managing Director, J & K Industries Ltd. [1989] 3
comp. L.J. (SL) 70].
h) If a public company is converted into a private company, then the approval of the
Central Government is necessary. Printed copies of altered articles should be filed
with the Registrar within one month of the date of Central Governments approval.
[Section 31 (2A)].
i) An alteration that has the effect of increasing the liability of a member to contribute
to the company is not binding on a present member unless he has agreed thereto in
writing.
j) A reserve liability once created cannot be undone but may be cancelled on a
reduction of capital.
k) An assumption by the Board of Directors of a company of any power to expel a
member by amending its Articles is illegal or void.
PROCEDURES FOR ALTERATION OF ARTICLES OF ASSOCIATION
For effecting alteration to the articles of association, the following procedures is required to
be followed-
1. Take the necessary decision by convening a Board Meeting to change all or any of the
existing Articles of Association and fix up the day, time, place and agenda for a general
meeting for passing special resolution to effect the change.
2. See that any such change in the Articles of the company conforms to the provisions of the
companies Act, 1956 and the conditions contained in the Memorandum of Association of
the company.
3. See that any such change does not increase the liability of any member who has become
so before the alteration to contribute to the share capital of or otherwise to pay money to,
the company.
4. See that any such change does not have the effect of converting a public company into a
private company. If such is the case, then make an application to the Central Government
for such alteration.
5. See that any such change does not provide for expulsion of a member by the company.
6. Issue notices for the General Meeting proposing the Special resolution and explaining
inter alia, in the explanatory Statement the implication and reasons of the changes being
proposed.
7. If the shares of the company are enlisted with any recognised Stock Exchange, then
forward copies of all notices sent to the shareholders with respect to change in the Articles
of Association to the Stock Exchange.
8. Hold the General Meeting and pass the special resolution.
9. File with the stock exchange with which your company is enlisted six copies of such
amendments as soon as the company adopts it in General Meeting. Out of the six copies,
one copy must be a certified true copy.
10. Forward promptly to the Stock Exchange with which your company is enlisted three
copies of the notice and a copy of the proceedings of the General Meeting.
11. File the Special resolution with the concerned Registrar of companies with explanatory
statement in Form No.23 within thirty days of its passing after payment of the requisite
filing fee in cash as per Schedule X. If the Articles of Association have been completely or
substantially changed, file a new printed copy of the Articles after paying the requisite fee in
cash prescribed under Schedule X to the Companies Act, 1956. paymentsupto Rs.50/-
12. Effect the changes in all copies of the articles of association.
13. Any alteration so made be as valid as if originally contained in the Articles of Association
and be subject to alteration by Special Resolution as above.
14. If the articles are altered pursuant to an order of the Company law Board made under
section 397 or 398 then see that such alterations is not inconsistent with the said and if it is
so then obtain first leave of the Company Law Board to make such alteration.

EFFECT OF ARTICLES OF ASSOCIATION
Section 36 provides that the memorandum and articles, when registered, bind the company
and its members to the same extent as if they have been signed by the company and by
each member and contain covenants on its and his part to observe all the provisions of the
memorandum and of the articles. Thus the company is bound to its members, the members
are bound to the company and the members are bound to other members by whatever is
contained in these documents. But in relation to articles, neither a company nor its
members are bound to outsiders.
The articles of association merely govern the internal management, business or
administration of a company. They may be binding between the members affected by them
but do not have the force of statute- Irrigation Development Employees Association vs
Government of Andhra Pradesh [2005]55 SCL 459 (AP).
Binding effect of Articles of association
Merely because in articles of association, the board of directors is empowered to refer any
claim or demand to arbitration, provisions of section 36 cannot be interpreted to mean that
the company or its directors shall be bound to incorporate a provision for arbitration in
every agreement that a company executes- Skypark builders & distributors Vs Kerala Police
housing & construction Corpn Ltd. [2004] 50 SCL 254.
The discussion on legal effect of memorandum and articles may be made under the
following heads-
1. Members bound to the company
2. Company bound to its members
3. Members bound to members
4. Company and the outsiders
Members bound to the company
Each member must observe the provisions of articles and memorandum. For instance, a
company has a right of lien on members shares or to forfeit the shares on non-payment of
calls. Every member is bound by whatever is contained in the memorandum and articles. In
Borlands Trustee vs steel Bros. Co. Ltd *1901+ 1 Ch. 279, the articles of a company contained
a clause that on the bankruptcy of a member, his share should be sold to the other persons
and at a fixed price by the directors. B a shareholder was adjudicated bankrupt. His trustee
in bankruptcy claimed that he was not bound by these provisions and should be at liberty to
sell the shares at the true value. It was held that the trustee was bound by the articles as a
share was purchased by B in terms of the articles.
In Mallesonvs National Insurance & Guarantee Corpn, it was held that each member is
bound by the covenants of memorandum and articles as originally framed or as altered form
time to time in accordance with the provisions of the companies Act.
In V.B Rangarajvs V.B Gopalkrishnan [1992], 73 SC, it was held that the articles are the
regulations of the company binding on the company and on its shareholders. Shareholders,
therefore, cannot among themselves enter into an agreement which is contrary to or is
inconsistence with the articles of the company.
Company bound to members
A company is bound to its members by whatever is contained in its articles and
memorandum. The company is bound not only to the members as a body but also to the
individual members as to their individual rights. The members can restrain the company
from spending money on ultra vires transaction. An individual can make the company fulfil
its obligation to him such as to send the notice for the meetings, to allow him to cast his
vote in the meeting.
In wood vs Odessa waterworks [1889] 42Ch. D. 636, the directors proposed to pay dividend
in kind by issuing debentures. The articles provided for the payment of dividend. The courl
held that the payment means payment in cash and therefore the company could be
compelled to pay dividend in terms of the articles.
Members bound to members
The articles bind the members inter se, i.e one to another as far as rights and duties arising
out of the articles are concerned. It is well settled that the articles of association will have a
contractual force between the company and its members as also between members inter se
in relation to their rights as such members- Ramakrishna industries (P) Ltd vs P. R
Ramakrishnan, 1988.
After the articles are registered, they not only constitute a contract between the association
or company on the one hand and its members on the other, but also they constitute a
contract between the members inter se- Shiv OmkarMaheshwarivsBansidharJagannath,
1957.
Company and the outsiders
The articles do not constitute any binding contract as between a company and an outsider.
An outsider cannot take advantage of the articles to found a claim against the company.
This is based on the general rule of law that a stranger to a contract cannot acquire any
rights under the contract. Thus if a right is conferred by the articles on a person in any
capacity other than that of the member, it cannot be enforced against the company.
Eleyvs Positive Govt. Security Life Ass. Co. 1876,1 Ex. D. 88, the articles of a company
provided that E should be the solicitor of the company for life and could be removed from
office only for misconduct. E took office and became a shareholder. After sometime the
company dismissed him without alleging misconduct. E sued the company for damages for
breach of contract. It was held that the articles did not constitute any contract between the
company and the outsider and as such no action could lie.

ARTICLES OF ASSOCIATION UNDER ENGLISH LAW
The articles of association (often just called 'articles') of a UK company contain the rules for
its internal regulation and management. The articles deal with such things as meeting
procedure, powers of directors, members' rights, procedure for paying dividends, winding
up etc. The articles can often be quite lengthy (for example they could typically comprise
over 100 numbered paragraphs spanning, say 30 pages). However, the UK Companies Act
1985 contains a mechanism intended to simplify the task of preparing articles of association
- various standard articles of association documents have been enacted. These are
contained in regulations made under the Act - The Companies (Tables A to F) Regulations
1985. The most commonly used of these standard articles of association documents is
known as 'Table A' (which is intended for use in the case of companies limited by shares).
Table A may, if desired by the person(s) forming the company, be incorporated by reference
(in whole or in part) into the company's own articles, thereby reducing the length of the
document to be prepared. Every UK company limited by shares (which is a far more
common type of company than the company limited by guarantee or the unlimited
company) is deemed to have articles of association in the form of Table A except in so far as
articles are registered (i.e. lodged at Companies House) which exclude or modify Table A -
section 8 of the Companies Act 1985. It is common for UK companies to adopt the
provisions of Table A in a modified format as experience has shown that Table A is rarely
ideal in its unmodified form.
Effect of the Articles
When the memorandum and articles of association are registered, the company is bound to
its shareholders, as though those shareholders had individually signed and sealed it and also
contained covenants on the part of each member to observe all the provisions of the
memorandum and of the articles: Companies Act 1985, s.14(1). The articles of association
become a contract between the company and its shareholders; it is a statutory contract of a
special nature.Courts regarded these documents as a business documents and therefore
construed so as to give them business efficacy.As with a memorandum of association, how
far the articles constitute a binding contract between a company and its shareholders on the
one hand and between its shareholders inter se on the other hand, is not entirely unclear. It
has been held that the contractual force given to the articles is limited to provisions which
apply to the relationship of shareholders in their capacity as shareholders, not a private one.

Inconsistencies between the Articles and the Memorandum
The articles are subordinate to the memorandum; any clause in them which is inconsistent
with the memorandum is overruled: Guinness v Land Corpn of Ireland Ltd (1882) 22 ChD
349 at 376.
The memorandum is the charter of the company which defines its powers The articles of
association play a another role. They outline the duties, rights and powers of the governing
body as between themselves and the company at large, and the mode and form in which
the business of the company is to be carried on and in which changes in its internal
regulations may be made. The memorandum and articles may, however, in certain
circumstances be read together, at all events so far as may be necessary to explain any
ambiguity appearing in the terms of the memorandum or to supplement it upon any matter
as to which it is silent.
Alteration of articles
The Articles of Association may be changed by the shareholders passing a special resolution
in a general meeting or by written resolution. A copy of the resolution and the new articles
of association must be sent to Companies House within 15 days. The changes to the Articles
of Association cannot be made in breach of other company law rules and there are
protections against such changes where they increase the liability of individual
shareholders, vary the rights of any class of shareholders or otherwise prejudice minority
shareholders. Special resolutions require the votes of 75% of members present in person or
by proxy, who are entitled to vote and do vote at the meeting. The meeting at which the
resolution is proposed must have had at least 14 days notice, unless a shorter period was
agreed by a majority in number of members holding at least 90% of the shares (95% in the
case of public companies). Alternatively, the written resolution procedure can be used, and
the special resolution will be passed if approved by shareholders representing not less than
75% of the total voting rights of the shareholders entitled to vote on the written resolution
on the day it is circulated.This Special Resolution - Alteration to Articles of Association is in
open format. Either enter the requisite details in the highlighted fields or adjust the wording
to suit your purposes.
Any alteration must be made in good faith for the benefit of the company as a whole:
Sidebottom v Kershaw, Leese& Co [1920] 1 Ch 154, CA. This means the company as an
entity, or as the interest of an individual hypothetical member: Greenhalgh v Arderne
Cinemas Ltd [1951] Ch 286 at 291, [1950] 2 All ER 1120.
It is for the shareholders to determine whether or not the alteration is for the benefit of the
company. The alteration may affect the rights of a member as between himself and the
company by retrospective operation, since the shares are held subject to the statutory
power of altering the articles. If a contract whether with a member or an outsider is so
drawn as by its terms or implication to prohibit the company from altering its articles to the
prejudice of the other contracting party, then, although the company cannot be precluded
from altering its articles, thereby giving itself power to act upon the provisions of the altered
articles, so to act may nevertheless be a breach of the contract. The articles cannot be so
altered as to increase the liability of a member to contribute to share capital or otherwise to
pay money to the company without his consent; and a special resolution altering articles
may be impeached if its effect is to discriminate between the majority of shareholders and
the minority shareholders so as to give the former an advantage of which the latter are
deprived. In a case where an order by the court by way of protection of a member of the
company against unfair prejudice requires the company not to make any, or any specified,
alteration in its articles, the company has no power without leave of the court to make any
such alteration.

BINDING EFFECTS OF MOA AND AOA:
Section 36 provides that the memorandum and articles when registered bind the
company and its members to the same extent as if they have been signed by the company
and by each member and they even contain covenants on its and his parts to observe all the
provisions of the memorandum and of the articles. Thus the company is bound to the
members ;the members are bound to the company and the members are even bound to the
other members by whatever is contained in these documents . But in relation to articles
neither a company nor its members are bound to outsiders.
The AOA merely govern the internal management, business or administration of a company
. They may be binding between the persons affected by them but they do not have the force
of statute.
BINDING ON COMPANY AND DIRECTORS:
Merely because in AOA the board of directors are empowered to refer any claim or
demand to attribution, provisions of section 36 cannot be interpreted to mean that the
company or its directors shall be bound to incorporate a provision for arbitration in every
agreement that the company executes.
The discussion on the legal effect of the memorandum and the articles can be classified
as follows:
1) Members bound to the company
2) Company bound to the members
3) Members bound to members
4) Company and outsiders
MEMBERS BOUND TO COMPANY:
All the members must observe the provisions of the articles and memorandum. Like
for example a company has a right of lien on the members share or to forfeit the shares on
non payment of calls. Every member is bound by whatever is contained in the memorandum
and articles. In Borlands Trustee v Steel Bros Co. Ltd *1901+, the articles of a company
contained a clause that on the bankruptcy of a member, his shares should be sold to other
person and at a price fixed by the directors. B a shareholder was adjudicated bankrupt. His
trustee in the bankruptcy claimed that he was not bound by these provisions and should be
at liberty to sell the shares at the true value. Held that the trustee was bound by the articles
as a share was purchased by B in terms of the articles. However it may be noted that in the
current position this decision will have a restricted application to private companies or
closely held public companies. It appears that such a restrictive clause in the articles will not
be acceptable to the registrar of companies.
Again a companys memorandum provided that it shall have a first and paramount
lien upon each share for debts due to the company by the members of the company. One of
the members owed some amount to the company . He pledged his share with the bank to
secure an overdraft and the bank gave notice of pledge to the company. The company
claimed priority over the pledge of the bank and contended that the shares pledged with
the bank were bound by the companys lien as given in the articles of association. In
Bradford banking Co. V Briggs Son & Co the court upheld the contention of the bank in
respect of debts incurred by the member before the notice of pledge was given to the
company.
Each member is bound by the covenants of the memorandum and articles as
originally framed or as altered from time to time in accordance with the provisions of the
companies Act.
Likewise the articles of association are the regulations of the company binding on
the company and the shareholders. The shareholders therefore cannot among themselves
enter into an agreement which is contrary to or inconsistent with the article sod association
of the company. This was upheld by the court in the case of V.B Rangraj v V.B gopalkrishnan
[1992]73 comp.cas201 (SC)
COMPANY BOUND TO MEMBERS:
A company is bound to members by whatever is contained in its memorandum and
the articles of association. The company is bound not only to the members as a body but
also to the individual members as to their individual rights. The members can restrain a
company from spending money on ultra vires transaction. An individual member can make
the company fulfils its obligation to him. Such as to send the notice for meetings, to allow
him to cast his vote in the meeting.
Normally action for breach of articles against the company can be brought only by a
majority of the members. Individually or minority members cannot bring such a suit except
when it is intended for enforcement of personal rights of members or to prevent the
company from doing any ultra vires or illegal act , fraud, or acts of oppression and
mismanagement.
MEMBERS BOUND TO MEMBERS:
The articles bind the members inter se ie. One to another as far as rights and duties
arising out of the articles are concerned. It is well settled that the articles of association will
have a contractual force between the company and its members as also between members
inter se in relation to their rights as such members. [Smt. Claude Lila Parulekar v Sakal
papers (P) Ltd. [2005]59 SCL 414(SC)]
After the articles are registered , they not only constitute a contract between the
association or company on the one hand and its constituent members on the other, but
they also constitute a contract between the members.
The articles of a company also provides that whenever any member wished to
transfer any shares , he is under an obligation to inform the directors of his intention and
the directors were under an obligation to take the said share equally between them at a fair
value. The directors refused to take shares of a particular member on the ground that the
articles did not impose an enforceable liability upon them. Held that the directors were
under an obligation to purchase the shares , as members of the company in terms of the
provisions of the articles. There is also a personal liability of the members inter se [ Rayfield
v Hand (1960)]
However articles do not create an express contract among the members of the
company. A member of a company has no right to bring a suit to enforce the articles in his
own name against any other member or members. It is the company alone which can sue
the offender so as to protect the aggrieved member. It is in this way that the rights of
members inter se are regulated.
A shareholder may however sue in his own name to restrain other or others from
doing fraudulent or ultra vires act. A share holder can also maintain an action against the
directors to compel them to restore to the company the funds of the company that have
been employed (by them) in a transaction , where they have no authority to enter into ,
without making the company a party to the suit.
WHETHER COMPANY OR MEMBERS BOUND TO OUTSIDERS:
The memorandum or articles do not confer any contractual rights upon outsiders
against the company or its members , even though the name of the outsider is mentioned in
the articles. An outsider ie. an non member cannot rely on article of association for his
action against the company.
The articles of a company provides that the board of directors could from time to
time appoint anyone or more of them as managing directors. Under the articles a managing
director can be removed in the same way as other directors of the company , namely by a
special resolution. Thus where a person is in dual capacity , namely an outsider as well as a
member , articles shall constitute a contract between the company and the member but in
his capacity as member only.
No article can constitute a contract between a company and a third person and that
no right merely purporting to be given by an article to a person , whether a member or not,
in a capacity other than that of a member , as for instance solicitor, promoter, director can
be enforced against the company.
While the articles cannot create a contract between the company and any person
other than a member in his capacity as a member, they may indicate the basis upon which
contracts maybe made by the company. If such a contract is entered into whether with a
member of the company or any other person , the conditions stated in the articles will be
tacitly adopted by that contract unless expressly negatived or guaranteed by the contract
itself.
WHETHER DIRECTORS ARE BOUND BY WHATEVER IS CONTAINED IN THE
ARTICLES:
The directors of the company derive their power from the articles and are subject to
limitation, if any, applied on their powers by the articles. If they contravene any provision of
the articles , two parties may be affected ie. The company itself and the outsiders. In case of
contravention of the provisions of the articles, the directors render themselves liable to an
action at the instance of the members. However members may ratify the act of directors , if
they so desire. But if as a result of breach of duty any loss has resulted to the company, the
directors are liable to reimburse to the company any loss so suffered. Further where the
directors contravene the provisions of the articles, it may affect outsiders interest also.

DOCTRINE OF ULTRA VIRES
SYNOPSIS:
1) INTRODUCTION
2) ORIGIN OF THE DOCTRINE
3) ESTABLISHMENT OF THE DOCTRINE
4) INDEPENDENT OBJECT CLAUSE
5) EFFECTS OF ULTRA VIRES TRANSACTIONS
I. ULTRA VIRES CONTRACTS
II. ULTRA VIRES BORROWINGS
III. ULTRA VIRES TORTS OR CRIMES
6) LIABILITY OF DIRECTORS
7) EXCEPTION TO THE DOCTRINE
8) PRESENT POSITION IN UK AND INDIA
9) CONCLUSION
1) INTRODUCTION:
In the formation of a company the first step is to prepare a document called the
Memorandum of Association. So, it is a document of great importance in relation to the
proposed company as said by the Palmer. For an incorporation of a company following
fundamental clauses are needed:
1) Name clause
2) Registered clause
3) Object clause
4) Liability clause
5) Capital clause
The object clause of the Memorandum of the company contains the object for which
the company is formed. An act of the company must not be beyond the objects clause,
otherwise it will be ultra vires and, therefore, void and cannot be ratified even if all the
members wish to ratify it. This is called the doctrine of ultra vires, which has been firmly
established in the case of Ashbury Railway Carriage and Iron Company Ltd v. Riche.
The expression ultra vires consists of two words: ultra and vires. Ultra means
beyond and Vires means powers. Thus the expression ultra vires means an act beyond the
powers. Here the expression ultra vires is used to indicate an act of the company which is
beyond the powers conferred on the company by the objects clause of its memorandum. An
ultra vires act is void and cannot be ratified even if all the directors wish to ratify it.
Sometimes the expression ultra vires is used to describe the situation when the directors of
a company have exceeded the powers delegated to them. Where a company exceeds its
power as conferred on it by the objects clause of its memorandum, it is not bound by it
because it lacks legal capacity to incur responsibility for the action, but when the directors
of a company have exceeded the powers delegated to them. This use must be avoided for it
is apt to cause confusion between two entirely distinct legal principles.
14
Consequently, here
we restrict the meaning of ultra vires objects clause of the companys memorandum.
2) Origin of the Doctrine:

14
Cf. Grower, The Principle of modern Company Law, p. 78.
The doctrine of ultra vires was first introduced in relation to the statutory
companies.
15
However, the doctrine was not paid due attention up to 1855. The reason
appears to be this that doctrine was not felt necessary to protect the investors and
creditors. The companies prior to 1855 were usually in the nature of an enlarged
partnership and they were governed by the rules of partnership. Under the law of
partnership the fundamental changes in the business of partnership cannot be made
without the consent of all of the partners and also the act of one partner cannot be binding
on the other partners if the act is found outside his actual or apparent authority, but it can
always be ratified by all the partners. These rules of partnership were considered sufficient
to protect the investors.
In 1855 some important developments took place. One of them was the
introduction of the principle of limited liability. After the introduction of this principle, it was
possible to make the liability of the members limited. Set Off long as the liability of the
members was unlimited, the creditors of the company considered themselves protected,
but after the development of doctrine of limited liability, they found themselves in a
miserable state. This necessitated a device to protect the creditors; this moulded the minds
of the pioneers towards the doctrine of ultra vires. In addition to it, the companies were
required to have two important documents, the memorandum and articles. The
memorandum was to contain the objects of the company. The alteration of the
memorandum was made difficult. Thus the importance of memorandum was realized and
the management of the company was desired to observe the objects stated in the
memorandum. All these created an atmosphere favorable for the development of doctrine
of ultra vires.

3) Establishment of the Doctrine
The doctrine of ultra vires could not be established firmly until 1875 when the
following case was decided by the House of Lords. The decision in this case confirmed the
application of this doctrine to the companies by registration under Companies Act. In
Ashbury Railway Carriage and Iron Company Ltd v. Riche,
16
In this case, the objects of the
company as stated in the objects clause of its memorandum, were to make and sell, or lend
on hire railway carriages and wagons, and all kinds of railway plaint, fittings, machinery and
rolling stock to carry on the business of mechanical engineers and general contractors to
purchase and sell as merchants timber, coal, metal or other materials; and to buy and sell
any materials on commissions or as agents. The directors of the company entered into a
contract with Riches for financing a construction of a railway line in Belgium. The contract
was ratified by all the members of the company, but later on it was repudiated by the
company. Riche sued the company for breach of contract.
Issue: whether the contract was valid and if not, whether it could be ratified by the
members of the company?

15
Sealy, L.S., Cases and Materials on Company Law.
16
(1875) L.R. 7 H.L. 653
The House of Lords held unanimously that:
(a) The contract was beyond the objects as defined in the objects clause of its memorandum
and, therefore it was void, and
(b) The company had no capacity to ratify the contract.
Decision: The House of Lords has held that an ultra vires act or contract is void in its
inception and it is void because the company had not the capacity to make it and since the
company lacks the capacity to make such contract, how it can have capacity to ratify it. If
the shareholders are permitted to ratify an ultra vires act or contract, it will be nothing but
permitting them to do the very thing which, by the Act of Parliament, they are prohibited
from doing. The House of Lords has expressed the view that a company incorporated under
the Companies Act has power to do only those things which are authorized by its objects
clause of its memorandum and anything not so authorized (expressly or impliedly) is ultra
vires the company and cannot be ratified or made effective even by the unanimous
agreement of the members.
Later on, in the case of Attorney General v. Great Eastern Railway Co.
17
, this
doctrine was made clearer. In this case the House of Lords affirmed the principle laid down
in Ashbury Railway Carriage and Iron Company Ltd v. Riche but held that the doctrine of
ultra vires ought to be reasonable, and not unreasonable understood and applied and
whatever may fairly be regarded as incidental to, or consequential upon, those things which
the legislature has authorized, ought not to be held, by judicial construction, to be ultra
vires.
The doctrine of ultra vires was recognized in Indian the case of Jahangir R. Mod i v.
Shamji Ladha
18
and has been well established and explained by the Supreme Court in the
case of A. Lakshmanaswami Mudaliar v. Life Insurance Corporation Of India
19
. In this case,
a company formed to buy, sell and deal in coal may for the purpose of carrying out the
stated objects, employ labour, open shops, buy and hire lorries, draw and accept bills of
exchange, borrow and give security and employ agents. In addition to the powers
specifically conferred by the memorandum, a company has the power to do whatever may
fairly be regarded as incidental to its express objects. Even in India it has been held that the
company has power to carry out the objects as set out in the objects clause of its
memorandum, and also everything, which is reasonably necessary to carry out those
objects.
20


4) Independent Objects Clause:
The main object rule of construction has been avoided by inserting a statement in
the objects clause to that effect that all the objects are independent and in no way ancillary
or subordinate to one another. this is known as independent objects clause. Thus, where

17
(1880) 5 A.C. 473.
18
(1868) 4 Bom. HCR 185.
19
(1963) 1 SCJ 521
20
Gujarat Mining& Manufacturing Company v. Motilal H.S. Weaving Company, AIR 1930 Bom. 84.
a clause stating that all objects specified in the objects clause are independent and not
ancillary or subordinate to one another is inserted, the failure of anyone of them cannot be
a ground for ordering the winding up of the company.tht is to say that a company cannot be
wound up merely because one of the two main objects has failed. Although the tendency of
inserting an independent objects clause has been criticized by the House of Lords in the
following case but the device was held to be valid and sufficient to exclude the main objects
rule of construction.
In Cotman v. Brogham, (1918) A.C. 514, In this case a rubber company underwrote shares in
an oil company. The objects clause in the memorandum of the company contained many
objects and one of them was to subscribe for shares of other companies. There was a clause
in the objects clause that each of the objects was to be considered independent and on this
ground the court held that the underwriting was not ultra vires.
In Re, Introductions Ltd.,
21
the court took a positive step to prevent such tendency. In this
case the court held that an independent objects clause could not convert a power into an
object. There is a difference between a power and an object. Only the objects are required
to be stated in the objects clause of the memorandum and not powers but if the powers are
also stated in the objects clause, they must be exercised to effectuate the objects stated
therein.
In Bell Houses Ltd., v. City Wall Properties Ltd. (1966) 2 WLR 1323, A company was
authorized by the objects clause of its memorandum to carry on any other trade or
business, which could, in the opinion of the directors be advantageously carried on by the
company in connection with its general business. This clause was held valid. The court held
that if there is such a clause and the directors decide to carry on a business which can be
carried on advantageously in connection with or ancillary to the main business will be intra
vires and not ultra vires even if it has no relationship with the main business of the
company. The acceptance of such a clause may be taken to mean the death of ultra vires
doctrine because a clause of this kind does not state any objects but leave the objects to be
determined by the bona fide opinion of the board of directors.

5) Effect of Ultra Vires transactions:
I) Ultra Vires contracts:
A contract beyond the objects clause of the companys memorandum is an ultra
vires contract and cannot be enforced by or against the company.
In Re, Jon Beaufore (London) Ltd ., (1953) Ch. 131., A company was authorized by its
memorandum to carry on the business of Contumiers, gown makers, tailors and other
activities of allied nature. Later on the company decided to carry on the business of
manufacturing Veneered Panels which was admittedly ultra vires and for this purpose
erected a factory. A firm of builders, who constructed the factory, brought an action to
recover 2078 from the company. Another firm supplied Veneers to the company and

21
[1969] 1 ALL E.R. 887.
claimed 1011. A third firm claimed 107 for supplying the fuel to the factory. The
claimants did not acknowledge that the Veneered business was ultra vires.
Issue: Whether the transaction was ultra vires?
Decision: However, the court held that the company was not liable to the claims of the
aforesaid claimants because the money was taken from them for the business of veneered
panels which was admittedly ultra vires the objects of the company, the court held that the
memorandum is a constructive notice to the public and therefore if an act is ultra vires, it
will be void and therefore will not be binding on the company and the outsider dealing with
the company cannot take a plea that he had no knowledge of the contents of the
memorandum.
II) Ultra Vires Borrowings:
A borrowing beyond the power of the company (i.e. beyond the objects clause of the
memorandum of the company) is called ultra vires borrowing. However, the courts have
developed certain principles in the interest of justice to protect such lenders. Thus, even in a
case of ultra vires borrowing, the lender may be allowed by the courts the following reliefs:
Injunction --- if the money lent to the company has not been spent the lender can
get the injunction to prevent the company from parting with it.
Tracing--- the lender can recover his money so long as it is found in the hands of the
company in its original form. Where his money is applied in purchasing certain
property, he can claim the property so long as it remains in the actual possession of
the company.
Subrogation---if the borrowed money is applied in paying off lawful debts of the
company, the lender can claim a right of subrogation and consequently, he will
stand in the shoes of the creditor who has paid off with his money and can sue the
company to the extent the money advanced by him has been so applied but this
subrogation does not give the lender the same priority that the original creditor may
have or had over the other creditors of the company.
III) Ultra Vires Torts or Crimes:
As regards the extent to which the ultra vires rules applied to torts and crimes, the
law is not well settled. The following views may be mentioned:
A Company is allowed to do only those acts which are stated in the objects clause
of its memorandum and, therefore, an act beyond the objects clause is not
considered as an act of the company. Since the objects clause can never include
the commission of wrongs, a company can never be liable in torts or crimes. In
other words, a wrong committed by the servants or the agents of the company
ostensibly on its behalf cannot be binding on the company because their acts are
beyond the powers of the company. However, this is not the present law on this
point and in practice companies are made liable in torts and convinced for crimes.
The second view is that the doctrine of ultra vires applies only to contract and
property and never applies to tortuous or criminal liability.
The third view is that a company may be held liable in torts or crimes provided
that they are committed in the course of an activity, which is warranted by the
objects clause of its memorandum. In other words, an act of the companys
servants or agents beyond the objects clause is not an act of the company and
therefore, the company cannot be held liable for the wrongs committed by its
servants or agents in respect of an activity which is not covered by the objects
clause of its memorandum.
But the correct rule is that a company may be held liable for torts or crimes committed in
pursuance of its stated objects but should not be liable for acts entirely outside its objects.
For example, if the object of the company is to run tramway, the company will be liable for
anything which its officer/employee do with the actual or usual scope of their authority in
connection with or ancillary to running trams but it will not be liable for a tort or crime
committed by its officers in connection with some entirely different business. Thus a
company may be held liable for any tort or crime if:
The tort or crime has been committed by the officers or agents or directors or the
servants of the company within the course of their employment, and
The tort or crime has been committed in respect of or in pursuance of any activity,
which falls within the scope of the objects clause of its memorandum.
22

6) Liability of Directors:
1) Liability towards the company: It is the duty of the directors to see that the funds of
the company are used only for legitimate business of the company. Consequently if
the funds of the company are used for a purpose foreign to its memorandum, the
directors will be personally liable to restore to the company the funds used for such
purpose.
2) Liability towards the third party: The directors of a company are treated as agents
of the company and therefore it is their duty not to go beyond the memorandum or
powers of the company. Where the directors represents the third party that the
contract entered into by them on behalf of the company is within the powers of the
company while in reality the company has not such powers under its memorandum,
the directors will personally be liable to the third party for his loss on account of the
breach of warranty of authority. However, to make the directors personally liable for
the loss to the third party, the following conditions must exist:
There must be representation of authority by the directors. The
representation must be of fact, not of law.
By such representation the directors must have induced the third party to
make a contract with the company in respect of a matter beyond the
memorandum or powers of the company.
The third party must have acted on such inducement and suffered some loss.
7) EXCEPTIONS TO THE DOCTRINE OF ULTRA VIRES:

22
Weeks v. Propert, (1873) L.R. 427
A brief analysis of the doctrine of ultra vires with regard to its consequences would
reveal that only those activities of the company shall be valid i.e., intra vires, which are:
a) Essential for the fulfillment of the objects stated in the main objects clause of the
memorandum;
b) Incidental or consequential or reasonably within its permissible limits of business;
and
c) Which the company is authorized to do by the Companys Act, in course of its
business.
All other activities of the company excepting the above shall be ultra vires and therefore
invalid. There are, however, certain exceptions to this doctrine, which are as follows:
I) An act, which is intra vires the company but outside the authority of the directors
may be ratified by the shareholders in proper form.
II) An act which is intra vires the company but done in an irregular manner, may be
validated by the consent of the shareholders.
III) If the company has acquired any property through an investment, which is ultra
vires, the companys right over such a property shall still be secured.
IV) While applying doctrine of ultra vires, the effects which are incidental or
consequential to the act shall not be invalid unless they are expressly prohibited
by the Companys Act.
V) If an act of the company is ultra vires the articles of association, the company can
alter its articles in order to validate the act.
8) PRESENT POSITION
ENGLAND:
In England the doctrine of ultra vires has been restricted by the European
Communities Act, 1972. According to Section 9(1) of the Act in favour of a person dealing
with a company any transaction decided by its directors shall be deemed to be within the
capacity of the company to enter into validity and the other party is not required to inquire
about the capacity of the company and thus such transaction may be enforced by the other
party acting in good faith against the company and the company cannot plead that the
transaction was ultra vires, but it cannot be enforced by the company against the other
party for the other party can still plead that the act was ultra vires. It is to be noted that in
England, the Act merely restricts the application of the doctrine of ultra vires but does not
abolish it. The company can still plead that the act was ultra vires, against the third party if it
is proved that the third party has not acted in good faith. It can be pleaded by the company
against the third party if the transaction or act has not been approved by the directors.
Along with it, as has been already stated, the third party can still plead against the company
that it has acted ultra vires, i.e. the ultra vires transaction cannot be enforced by the
company against the third party.
Thus the doctrine of ultra vires in England applies with certain restrictions and
modifications and certain provisions have been inserted in the European Communities Act,
1972 in order to protect innocent third party from the hardship created by this doctrine for
him.



INDIA:
In India there is no legislation like the European Communities Act. Consequently, the
principles laid down in Ashbury Railway Carriage and Iron Company Ltd v. Riche and
Attorney General v. Great Eastern Railway Co. are still applied without restrictions and
modifications. Thus, in India the ultra vires act is still regarded, as void and it cannot be
validated by ratification even if all the shareholders consent to such ratification. Thus in
India the ultra vires act or transaction neither can be enforced by the company against the
third party nor by the third party against the company and thus, both the third party and
company can plead against each other that the transaction or act was ultra vires. However,
the provisions similar to those inserted in the European Communities Act, 1972 should also
be inserted in the Indian Companies Act, 1956 to protect the innocent third party.

9) Conclusion:
So, I concluded with the following findings that:
An ultra vires act is void and cannot be ratified even if all the directors wish to ratify
it.
The provisions similar to those inserted in the European Communities Act, 1972
should also be inserted in the Indian Companies Act, 1956 to protect the innocent
third party.
The tendency of inserting independent objects clause to exclude the main objects
rule of construction is dangerous also because it makes the distinction between the
object and power obscure.
This doctrine prevents the wrongful application of the companys assets likely to
result in the insolvency of the company and thereby protects creditors.
The doctrine of ultra vires also prevents directors from departing the object for
which the company has been formed and, thus, puts a check over the activities of
the directions. It enables the directors to know within what lines of business they are
authorized to act.


Doctrine of indoor management
Memorandum of Association and articles of association are two most important documents
needed for the incorporation of a company. The memorandum of a company is the
constitution of that company. It sets out the (a) object clause, (b) name clause, (c) registered
office clause, (d) liability clause and (e) capital clause
whereas the articles of association enumerate the internal rules of the company under
which it will be governed.
Undoubtedly, both memorandum of association and the articles of association are public
documents in the sense that any person under section 610 of Indian company act, 1956 may
inspect any document which will include the memorandum and articles of the company kept
by the registrar of companies in accordance with the rules made under the destruction of
records act, 1917 being documents filed and registered in pursuance of the Act. As a
consequence, the knowledge about the contents of the memorandum and articles of a
company is not necessarily restricted to the members of the company alone. Once these
documents are registered with the registrar of companies, these become public documents
and are accessible by any members of the public by paying the requisite fees. Therefore,
notice about the contents of memorandum and articles is said to be within the knowledge of
both members and non-members of the company. Such notice is a deemed notice in case of
a members and a constructive notice in case of non-members. Thus every person dealing
with the company is deemed to have a constructive notice of the contents of the
memorandum and articles of the company. An outsider dealing with the company is
presumed to have read the contents of the registered documents of the company. The
further presumption is that he has not only read and perused the documents but has also
understood them fully in the proper sense. This is known as the rule of constructive notice.
So, the doctrine or rule of constructive notice is a presumption operating in favour of the
company against the outsider. It prevents the outsider from alleging that he did not know
that the constitution of the company rendered a particular act or a particular delegation of
authority ultra vires.

The doctrine of constructive notice is more or less an unreal doctrine. It does not take
notice of the realities of business life. People know a company through its officers and not
through its documents. The courts in India do not seem to have taken it seriously though.
For example, in Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas, the Allahabad
high court allowed an overdraft incurred by the managing agent of a company when under
the articles the directors had no power to delegate their borrowing power.

The doctrine of indoor management is an exception to the rule of constructive notice. It
imposes an important limitation on the doctrine of constructive notice. According to this
doctrine persons dealing with the company are entitled to presume that internal
requirements prescribed in memorandum and articles have been properly observed. A
transaction has two aspects, namely, substantive and procedural. An outsider dealing with
the company can only find out the substantive aspect by reading the memorandum and
articles. Even though he may find out the procedural aspect, he cannot find out whether the
procedure has been followed or not. For example, a company may have borrowing powers
by passing a resolution according to its memorandum and articles. An outsider can only
found out the borrowing powers of the company. But he cannot find out whether the
resolution has in fact been passed or not. The outsiders dealing with the company are
presumed to have read and understood the memorandum and articles and to see that the
proposed dealing is not inconsistent therewith, but they are not bound to do more; they
need not inquire into the regularity of the internal proceedings as required by the
memorandum and articles. They can presume that all is being done regularly.

The doctrine of indoor management is also known as the TURQUAND rule after Royal British
Bank v. Turquand. In this case, the directors of a company had issued a bond to Turquand.
They had the power under the articles to issue such bond provided they were authorized by
a resolution passed by the shareholders at a general meeting of the company. But no such
resolution was passed by the company. It was held that Turquand could recover the amount
of the bond from the company on the ground that he was entitled to assume that the
resolution was passed.
In one of the case the rule was stated thus: If the directors have the power and authority to
bind the company but certain preliminaries are required to be gone through on the part of
the company before that power can be duly exercised, and then the person contracting with
the directors is not bound to see that all these preliminaries have been observed. He is
entitled to presume that the directors are acting lawfully in what they do.

In another case where the plaintiff sued the defendant company on a loan of Rs.1,50,000, it
was held that where the act done by a person, acting on behalf of the company, is within the
scope of his apparent or ostensible authority, it binds the company no matter whether the
plaintiff has read the document or not. In this case among other things the defendant
company raised the plea that the transaction was not binding as no resolution sanctioning
the loan was passed by the Board of directors. The court after referring to turquands case
and other Indian cases, held that the passing of such a resolution is a mere matter of indoor
or internal management and its absence under such circumstances, cannot be used to
defeat the just claim of a bona fide creditor.

The rule is based on public convenience and justice and the following obvious reasons:

1. The internal procedure is not a matter of public knowledge. An outsider is presumed to
know the constitution of a company, but not what may or may not have taken place within
the doors that are closed to him.

2. The lot of creditors of a limited company is not a particularly happy one; it would be
unhappier still if the company could escape liability by denying the authority of officials to
act on its behalf.

Exceptions to the doctrine of indoor management:

The exceptions to the doctrine of indoor management are as under:

1. Knowledge of irregularity: when a person dealing with a company has actual or
constructive notice of the irregularity as regards internal management, he cannot claim
benefit under the rule of indoor management. He may in some cases, be himself a part of
the internal procedure. The rule is based on common sense and any other rule would
encourage ignorance and condone dereliction of duty.
T.R Pratt (Bombay) Ltd. V. E.D. Sassoon & Co. Ltd., Company A lent money to Company B on a
mortgage of its assets. The procedure laid down in the articles for such transactions was not
complied with. The directors of the two companies were the same. Held, the lender had
notice of the irregularity and hence the mortgage was not binding.

In Howard v. Patent Ivory Co, the directors had the authority under the articles to borrow
only up to 1000 without the resolution of general meeting. For any amount beyond 1000,
they needed the consent of general meeting. But the directors borrowed 3500 from
themselves without the consent of general meeting or shareholders and accepted
debentures. It was held that they had knowledge of internal irregularity and debentures
were good only up to 1000.



2. Negligence: where a person dealing with a company could discover the irregularity if he
had made proper inquiries, he cannot claim the benefit of the rule of indoor management.
The protection of the rule is also not available where the circumstances surrounding the
contract are so suspicious as to invite inquiry, and the outsider dealing with the company
does not make proper inquiry. If, for example, an officer of a company purports to act
outside the scope of his apparent authority, suspicion should arise and the outsider should
make proper inquiry before entering into a contract with the company.

Anand Bihari Lal v. Dinshaw & Co, the plaintiff, in this case, accepted a transfer of a
companys property from its accountant. Held, the transfer was void as such a transaction
was apparently beyond the scope of the accountants authority. The plaintiff should have
seen the power of attorney executed in favour of the accountant by the company.

3. Forgery: the rule in turquands case does not apply where a person relies upon a
document that turns out to be forged since nothing can validate forgery. A company can
never be held bound for forgeries committed by its officers. The leading case on the point is :
Ruben v. Great Fingall Consolidated Co., the secretary of a company issued a share
certificate under the companys seal with his own signature and the signature of a director
forged by him. Held, the share certificate was not binding on the company. The person who
advanced money on the strength of this certificate was not entitled to be registered as
holder of the shares.

4. Acts outside the scope of apparent authority: if an officer of a company enters into a
contract with a third party and if the act of the officer is beyond the scope of his authority,
the company is not bound. In such a case, the plaintiff cannot claim the protection of the
rule of indoor management simply because under the articles the power to do the act could
have been delegated to him. The plaintiff can sue the company only if the power to act has
in fact been delegated to the officer with whom he entered into the contract.

Kreditbank Cassel v. Schenkers Ltd,a branch manager of a company drew and endorsed bills
of exchange on behalf of the company in favour of a payee to whom he was personally
indebted. He had no authority from the company to do so. Held, the company was not
bound. But if an officer of a company acts fraudulently under his ostensible authority on
behalf of the company, the company is liable for his fraudulent act.

Conclusion: Thus the doctrine of indoor management seeks to protect the interest of the
shareholders who are in minority or who remains in dark about whether the working of the
internal affairs of the company are being carried out in accordance with the memorandum
and articles. It lays down that persons dealing with a company having satisfied themselves
that the proposed transaction is not in its nature inconsistent with the memorandum and
articles, are not bound to inquire the regularity of any internal proceeding.

PROSPECTUS


GENERAL
- A document shall be called a prospectus if it satisfies two things:
1. It invites subscription to shares or debentures or invites deposits
2. The aforesaid invitation is made to the public
- Prospectus is defined in S 2(36)
- Pramathnath Sanyal v. Kali KumarDutt:
- In this case, an advertisement was inserted in a newspaper stating: some shares are
still available for sale according to the terms of the prospectus of the company which
can be obtained on application. This was held to be a prospectus as it invited the
public to purchase shares. The directors were, therefore, penalized for not
complying with the requirements of filing a copy thereof with the ROC.
- Nash v. Lynd:
- Single private communication does not amount to issue to the public. In this case,
several copies of a document marked strictly confidential and containing
particulars of a proposed issue of shares were sent by the MD of a company to a co
director, who in turn sent a copy to a solicitor, who gave it to a client who passed it
on to a relative. Thus, a document was passed on privately through a small circle of
friends of the directors, and the House of Lords held that there had been no issue to
the public.
- South of England Natural Gas and Petroleum Co., Ltd., Re., - case notes

RULES RELATING TO PROSPECTUS/ STATUTORY REQUIREMENTS IN RELATION TO A PROSPECTUS
1. S.55 - Every prospectus to be dated
2. S.60. Every prospectus to be registered (and Sarma then summarises the
Section):
- The copy for registration must be accompanies with
a. if a report of the expert is to be published consent of the expert
b. a copy of every contract relating to the appointment and remuneration of
managerial personnel
c. the consent in writing of the person, if any, named in the prospectus as the
auditors, legal advisors, banker or broker of the company to act in that capacity
3. S.60(4): The prospectus to be issued within 90 days of registration
4. S.60(5). The company and every person who knowingly issues a prospectus
without registration is punishable with a fine which may extent to
Rs.50,000/-.
WHERE THE PROSPECTUS NEED NOT CONTAIN ALL THE INFORMATION:
1. When the offer is made to the under writers
2. When the offer is made to the existing share holders or debenture holders of
the company
3. When it is issued as a newspaper advertisement
4. When the offer is not made to the public
5. When the securities offered are in all respects uniform with securities already
issued and quoted on a recognized stock exchange


ISSUING HOUSES AND DEEMED PROSPECTUS
- The provisions of the Companies Act relating to prospectus are restricted to cases
where the invitation is made by or on behalf of a company for subscription of its
shares or debentures
- It was possible at one time for a company to avoid such statutory provisions by
allotting shares/debentures to the public through the medium of Issue Houses - the
shares or debentures would be allotted to these Issue Houses which will in turn
invite subscription from the public through their own offer documents
- Thus, the company could indirectly raise subscriptions from the members of the
public without issuing an offer document or prospectus
- Section 64 now covers documents issued by the Issue Houses
- Therefore, such an offer document is treated as a prospectus issued by the company,
and Section 64 has been designed to check the by passing of the provisions of S 56,
which requires certain information to be disclosed
- Thus, S 64 ensures that all documents containing offer of shares or debentures for
sale shall be deemed as prospectus, and all enactments and rules of law as to the
contents of prospectus shall apply in respect of such documents
- Imp S S 64, Sarma has mentioned S 64(1)

GOLDEN RULE
- The public is invited to take shares on the faith of the representations contained in
the prospectus, and the public is at the mercy of company promoters. Everything
must, therefore, be stated with strict and scrupulous accuracy.
- Nothing should be stated as fact which is not so, and no fact should be omitted the
existence of which might in any degree affect the nature and quality of the principles
and advantages which the prospectus holds out as inducement to take shares
- The Rule was laid down by Kindersely V.C in New Brunswick and Canada Rly., and
Land Co., v. Muggeridge and was described as a Golden Legacy by Pagewood V.C.
in Henderson v. Lacon
- In a word, the true nature of the companys venture should be disclosed
- S.57 & 58
- If the prospectus included a statement purporting to be made by an expert, consent
in writing of that expert must be obtained and this fact should be stated in the
prospectus
- The expert should not be one who is himself engaged or interested in the formation,
promotion or management of the company. He should be unconnected with the
formation or management of the company
- S.59(2). The expression expert includes an engineer, a valuer, an accountant and
any other person
- Whose profession gives authority to a statement made by him
- The following two more documents should be filed with the prospectus
a. a copy of every material contract, unless it is entered into in the ordinary
course of business or two years before the date of the prospectus
b. A written statement relating to the adjustment of accounts with respect to
the figures of any profits and losses and assets and liabilities. It should submit
the reasons of adjustment

SHELF PROSPECTUS S 60A
- Shelf prospectus is a prospectus issued by any financial institution or bank for one or
more issues of the securities or class of securities specified in that prospectus
- Negotiations with various parties have to be finalized for typing up firm allotment/
reservation. Recently, developmental financial institutions have successfully raised
money from the public through the issue of bonds
- Every time any such issue comes, a fresh prospectus is required to be filed, and
procedural aspects take a lot of time
- Shelf prospectus was introduced to minimize the burden on such institutions, and
this shelf prospectus shall be valid for a period of one year from the date of opening
of the first offering of the shelf prospectus
- For subsequent offerings, information memorandum updating the information
under the various heads will have to be filed and the entire set comprising the shelf
prospectus and the information memorandum shall constitute the prospectus, and
have to be circulated to the general public
- Thus, any Public Financial Institution or Public Sector Bank or Schedule Bank whose
main object is financing shall file Shelf Prospectus.
- Further, a company filing Shelf Prospectus with the ROC shall not be required to file
prospectus afresh at every stage of offer of securities by it within a period of validity
of such shelf prospectus

INFORMATION MEMORANDUM S 60B
DEFINITION
- A prospectus containing major information regarding the issuer company but
without the price structure, called an information memorandum, can be circulated
to the public along with notice, circular, advertisement or document to explore the
demand for securities, and the price offered for the same
- In other words, a public company making an issue of securities may circulate
information memorandum to the public prior to filing of a prospectus
- Statutory definition S 2(19B) - Information memorandum is a process undertaken
prior to the filing of a prospectus by which a demand for the securities proposed to
be issued by a company is elicited, and the price and the terms of issue for such
securities is assessed, by means of a notice, circular, advertisement or document
RED HERRING PROSPECTUS
- The company is required to file a prospectus prior to the opening of the subscription
list and the offer as a red herring prospectus at least 3 days before opening of the
offer
- Red herring Prospectus means a prospectus which does not have complete
information on the price of the securities offered and quantum of securities
offered.


REMEDIES FOR MISSTATEMENT OF PROSPECTUS

INTRODUCTION
- A person who has relied on misstatements or omissions in the prospectus has i)
remedies against the company, ii) remedies against directors, iii) remedies against
experts (but not even mentioned, so no need to elaborate)
REMEDIES AGAINST THE COMPANY
- Any person who, relying on a prospectus containing misstatements or omissions of
material facts takes shares from a company may:
a. Rescind the contract
b. Claim damages
Rescission
- The effect of the rescission of the contract would be that the shareholder would give
up the shares and get back his money with interest
Liability for Misstatements in a
Prospectus
Civil SS 62
& 56
Criminal
S 63
- In order to claim this relief, the allottee has to show that the misstatement or
omission was:
- One of fact and not of law, nor an expression of opinion
- Material, and
- Acted upon by him
Suit for damages
- In addition to the above, the allottee has to prove:
- That those acting on behalf of the company acted fraudulently
- That those purporting to act on behalf of the company were authorized to act on its
behalf
- That he suffered a loss or damages
REMEDIES AGAINST THE DIRECTORS
- A shareholder who had been induced to take shares may claim from the directors or
promoters or from anyone else responsible for untrue statement occurring in the
prospectus:
a. Damages for fraudulent misrepresentation
b. Compensation under S 62
c. Damages for non compliance with the requirements of S 56 regarding the
contents of the prospectus

CIVIL LIABILITY
1. If the person making the statement honestly believes to be true, he is not
guilty of fraud, even if the statement is not true
- Derry v. Peek:
- The directors of a tramway company issued a prospectus stating that they had the
right to run tram cars with steam power instead of with horses as before. In fact, the
Act incorporating the company provided that such power might be used with the
sanction of the Board of Trade. But the Board of Trade refused to give permission
and the company had to be wound up. P, a shareholder sued the directors for
damages for fraud. The House of Lords held that the directors were not liable for
fraud as they honestly believed what they said in the prospectus to be true
2. The purpose for which the money is going to be used is an important fact
- Edington v. Fitzmaurice- case notes
3. The plaintiff should have taken the shares directly from the company by
allotment
- Peek v. Gurney case notes
4. Liability of the company: Before taking action against the company, that the
contract of allotment must first be rescinded
5. The decision of House of Lords in Derry v. Peek exposed the inadequacy of
the tort action of deceit to protect the interest of the investors in public
companies
6. The Directors Liability Act,1890=Section 43 of the English Companies Act,
1948=s. 62 of the Indian Companies Act, 1956
7. The following persons are liable under this section given in S 62(1)
8. Their liability is joint and several
9. The chief advantage of proceeding under this section is that the plaintiff does
not have to prove fraud
10. Special defenses under S 62(4) Two defences mentioned in the provision
11. Limits of Rescission
a. By affirmation
- Sharpely v. South and East Coast Rly., Co case notes
b. Unreasonable delay
- Christinville Rubber Ltd., Re case notes
c. By commencement of winding up

CRIMINAL LIABILITY

- Section 63 relates to criminal liability of persons authorizing the issue of a
prospectus containing an untrue statement

Rules relating to prospectus

The definition of prospectus in the Indian Companies Act, 1956 is based on the definition
found in the English Companies Act [Section 455(1)]. It then underwent amendment in 1960
following the recommendation of the Companies Act Amendment Committee of 1957 and
also in 1974. The current definition as per Section 2(36) stands as follows:
prospectus means any document described or issued as a prospectus and includes any
notice, circular, advertisement or other document inviting deposits from the public or
inviting offers from the public for the subscription or purchase of any shares in, or
debentures of, a body corporate.
Prospectus is very important for public (inverter) because this is a resource by which
potential investors can know about financial status and growth prospective of the company.
Their decision to invest or not to in a particular company depends on this information.
Therefore to protect the interest of inverter many provisions are made by companies Act and
SEBI both. At this place I am going to deal with Provisions relating to prospectus in
Companies Act . Provisions made by SEBI for this purpose will be explained under next
heading ICDR.
Provisions relating to prospectus in Companies Act 1956
Part 3 of the companies Act 1956 Deals with Prospectus and Allotment, and other matters
relating to issue of shares or debentures.
Section 55 of the Act says the A prospectus issued by or on behalf of a company or in
relation to an intended company shall be dated, and that date shall, unless the contrary is
proved, be taken as the date of publication of the prospectus.
Section 56 of the Act makes provision for the Matters to be stated and reports to be set out
in prospectus. This section says (1) Every prospectus issued (a) by or on behalf of a company,
or (b) by or on behalf of any person who is or has been engaged or interested in the
formation of a company, shall state the matters specified in Part I of Schedule II and set out
the reports specified in Part II of that Schedule; and the said Parts I and II shall have effect
subject to the provisions contained in Part III of that Schedule.
(2) A condition requiring or binding an applicant for shares in or debentures of a company to
waive compliance with any of the requirements of this section, or purporting to affect him
with notice for any contract, document or matter not specifically referred to in the
prospectus, shall be void.



(3) No one shall issue any form of application for shares in or debentures of a company,
unless the form is accompanied by a memorandum containing such salient features of a
prospectus as may be prescribed] which complies with the requirements of this section:
Provided that a copy of the prospectus shall, on a request being made by any person before
the closing of the subscription list be furnished to him:
Provided further that] this sub-section shall not apply if it is shown that the form of
application was issued either
(a) in connection with a bona fide invitation to a person to enter into an underwriting
agreement with respect to the shares or debentures; or
(b) in relation to shares or debentures which were not offered to the public.
If any person acts in contravention of the provisions of this sub-section, he shall be
punishable with fine which may extend to fifty thousand rupees

(4) A director or other person responsible for the prospectus shall not incur any liability by
reason of any non-compliance with, or contravention of, any of the requirements of this
section, if

(a) as regards any matter not disclosed, he proves that he had no knowledge thereof; or

(b) he proves that the non-compliance or contravention arose from an honest mistake of fact
on his part; or

(c) the non-compliance or contravention was in respect of matters which, in the opinion of
the Court dealing with the case 4 [were immaterial] or was otherwise such as ought, in the
opinion of that Court, having regard to all the circumstances of the case, reasonably to be
excused:
Provided that no director or other person shall incur any liability in respect of the failure to
include in a prospectus a statement with respect to the matters specified in clause 18 of
Schedule II, unless it is proved that he had knowledge of the matters not disclosed.

(5) This section shall not apply

(a) to the issue to existing members or debenture-holders of a company of a prospectus or
form of application relating to shares in or debentures of the company whether an applicant
for shares or debentures will or will not have the right to renounce in favour of other
persons; or
(b) to the issue of a prospectus or form of application relating to shares or debentures which
are, or are to be, in all respects uniform with shares or debentures previously issued and for
the time being dealt in or quoted on a recognised stock exchange,
but, subject as aforesaid, this section shall apply to a prospectus or a form of application,
whether issued on or with reference to the formation of a company or subsequently.

(6) Nothing in this section shall limit or diminish any liability which any person may incur
under the general law or under this Act apart from this section.


Section 57 of the Act prohibits to include a statement purporting to be made by an expert
this section says A prospectus inviting persons to subscribe for shares in or debentures of a
company shall not include a statement purporting to be made by an expert, unless the
expert is a person who is not, and has not been, engaged or interested in the formation or
promotion, or in the management, of the company
section 58 of the Act makes rule to include including a statement purporting to be made by
an expert this section says that Experts consent to issue of prospectus containing
statement by him. A prospectus inviting persons to subscribe for shares in or debentures of a
company and including a statement purporting to be made by an expert shall not be issued
unless.
(a) he has given his written consent to the issue thereof with the statement included in the
form and context in which it is included, and has not withdrawn such consent before the
delivery of a copy of the prospectus for registration; and
(b) a statement that he has given and has not withdrawn his consent as aforesaid appears in
the prospectus.

Section 58A of the Act which is inserted in this Act by Act 41 of 1974, (w.e.f. 1-2-1975).This
section prohibits to invite deposits without advertisement. This section says
.(1) The Central Government may, in consultation with the Reserve Bank of India, prescribe
the limits up to which, the manner in which and the conditions subject to which deposits
may be invited or accepted by a company either from the public or from its members.

(2) No company shall invite, of allow any other person to invite or cause to be invited on its
behalf, any deposit unless
(a) such deposit is invited or is caused to be invited in accordance with the rules made under
sub-section (1)

(b) an advertisement, including therein a statement showing the financial position of the
company, has been issued by the company in such form and in such manner as may be
prescribed, and

(c) the company is not in default in the payment of any deposit or part thereof and any
interest thereupon in accordance with the terms and conditions of such deposit.

(3) (a) Every deposit accepted by a company at any time before the commencement of the
Companies (Amendment) Act, 1974, in accordance with the directions made by the Reserve
Bank of India under Chapter IIIB of the Reserve Bank of India Act, 1934 (2 of 1934), shall,
unless renewed in accordance with clause (b), be repaid in accordance with the 5[terms and
conditions of such deposit].

(b) No deposit referred to in clause (a) shall be renewed by the company after the expiry of
the term thereof unless the deposit is such that it could have been accepted if the rules
made under sub-section (1) were in force at the time when the deposit was initially accepted
by the company.

(c) Where, before the commencement of the Companies (Amendment) Act, 1974, any
deposit was received by a company in contravention of any direction made under Chapter
IIIB of the Reserve Bank of India Act, 1934 (2 of 1934), repayment of such deposit shall be
made in full on or before the Ist day of April, 1975, and such repayment shall be without
prejudice to any action that may be taken under the Reserve Bank of India Act, 1934 for the
acceptance of such deposit in contravention of such direction.


(3A) Every deposit accepted by a company after the commencement of the Companies
(Amendment) Act, 1998, shall, unless renewed in accordance with the rules made under
sub-section (1), be repaid in accordance with the terms and conditions of such deposit.



(4) Where any deposit is accepted by a company after the commencement of the Companies
(Amendment) Act, 1974, in contravention of the rules made under sub-section (1),
repayment of such deposit shall be made by the company within thirty days from the date of
acceptance of such deposit or within such further time, not exceeding thirty days, as the
Central Government may, on sufficient cause being shown by the company, allow.

(5) Where a company omits or fails to make repayment of a deposit in accordance with the
provisions of clause (c) of sub-section (3), or in the case of a deposit referred to in sub-
section (4), within the time specified in that sub-section,

(a) the company shall be punishable with fine which shall not be less than twice the amount
in relation to which the repayment of the deposit has not been made, and out of the fine, if
realised, an amount equal to the amount in relation to which the repayment of deposit has
not been made, shall be paid by the Court, trying the offence, to the person to whom
repayment of the deposit was to be made, and on such payment, the liability of the
company to make repayment of the deposit shall to the extent of the amount paid by the
Court, stand discharged;

(b) every officer of the company who is in default shall be punishable with imprisonment for
a term which may extend to five years and shall also be liable to fine.


(6) Where a company accepts or invites, or allows or causes any other person to accept or
invite on its behalf, any deposit in excess of the limits prescribed under sub-section (1) or in
contravention of the manner or condition prescribed under that sub-section or in
contravention of the provisions of sub-section (2), as the case may be,
(a) the company shall be punishable,

(i) where such contravention relates to the acceptance of any deposit, with fine which shall
not be less than an amount equal to the amount of the deposit so accepted;

(ii) where such contravention relates to the invitation of any deposit, with fine which may
extend to ten lakh rupees] but shall not be less than fifty thousand rupees;



(b) every officer of the company who is in default shall be punishable with imprisonment for
a term which may extend to five years and shall also be liable to fine.

(7) (a) Nothing contained in this section shall apply to,

(i) a banking company, or

(ii) such other company as the Central Government may, after consultation with the Reserve
Bank of India, specify in this behalf.

(b) Except the provisions relating to advertisement contained in clause (b) of sub-section (2),
nothing in this section shall apply to such classes of financial companies as the Central
Government may, after consultation with the Reserve Bank of India, specify in this behalf.

(8) The Central Government may, if it considers it necessary for avoiding any hardship or for
any other just and sufficient reason, by order, issued either prospectively or retrospectively
from a date not earlier than the commencement of the Companies (Amendment) Act, 1974,
grant extension of time to a company or class of companies to comply with, or exempt any
company or class of companies from, all or any of the provisions of this section either
generally or for any specified period subject to such conditions as may be specified in the
order:
Provided that no order under this sub-section shall be issued in relation to a class of
companies except after consultation with the Reserve Bank of India.]

(9) Where a company has failed to repay any deposit or part thereof in accordance with the
terms and conditions of such deposit the 11[Tribunal] may, if it is satisfied, either on its own
motion or on the application of the depositor, that it is necessary so to do to safeguard the
interests of the company, the depositors or in the public interest direct, by order, the
company to make repayment of such deposit or part thereof forthwith or within such time
and subject to such conditions as may be specified in the order:

Provided that the Tribunal may before making any order under this sub-section give a
reasonable opportunity of being heard to the company and the other persons interested in
the matter.
(10) Whoever fails to comply with any order made by the Tribunal under sub-section (9)
shall be punishable with imprisonment which may extend to three years and shall also be
liable to a fine of 1not less than rupees five hundred] for every day during which such non-
compliance continues.

(11) A depositor may, at any time, make a nomination and the provisions of sections 109A
and 109B shall, as far as may be, apply to the nomination made under this sub-section.]

Explanation.For the purposes of this section deposit means any deposit of money with,
and includes any amount borrowed by, a company but shall not include such categories of
amount as may be prescribed in consultation with the Reserve Bank of India.

Section 58B of the Act extends the scope of section 58A . The provisions of this Act relating
to a prospectus shall, so far as may be, apply to an advertisement referred to in section 58A.

Section 59 of the Act deals with Penalty and says that If any prospectus is issued in
contravention of section 57 or 58, the company, and every person, who is knowingly a party
to the issue, thereof, shall be punishable with fine which may extend to fifty thousand
rupees.previously fine in this section was only five thousand rupee.. By Act 53 of 2000 the
word five thousand rupee substituted by fifty thousand rupees .(w.e.f. 13-12-2000).

section 60 of the Act makes Registration of prospectus mandatry. This section says (1) No
prospectus shall be issued by or on behalf of a company or in relation to an intended
company unless, on or before the date of its publication, there has been delivered to the
Registrar for registration a copy thereof signed by every person who is named therein as a
director or proposed director of the company or by his agent authorised in writing and
having endorsed thereon or attached thereto

(a) any consent to the issue of the prospectus required by section 58 from any person as an
expert; and

(b) in the case of a prospectus issued generally also

(i) a copy of every contract required by clause 16 of Schedule II to be specified in the
prospectus, or, in the case of a contract not reduced into writing, a memorandum giving full
particulars thereof; and

(ii) where the persons making any report required by Part II of that Schedule have made
therein, or have, without giving the reasons, indicated therein, any such adjustments as are
mentioned in clause 32 of that Schedule, a written statement signed by those persons
setting out the adjustments and giving the reasons therefor.

(2) Every prospectus to which sub-section (1) applies shall, on the face of it,
(a) state that a copy has been delivered for registration as required by this section; and
(b) specify any documents required by this section to be endorsed on or attached to the
copy so delivered, or refer to statements included in the prospectus which specify those
documents.

(3) The Registrar shall not register a prospectus unless the requirements of sections 55, 56,
57 and 58 and sub-sections (1) and (2) of this section have been complied with and the
prospectus is accompanied by the consent in writing of the person, if any, named therein as
the auditor, legal adviser, attorney, solicitor, banker or broker of the company or intended
company, to act in that capacity..

(4) No prospectus shall be issued more than ninety days after the date on which a copy
thereof is delivered for registration; and if a prospectus is so issued, it shall be deemed to be
a prospectus a copy of which has not been delivered under this section to the Registrar.

(5) If a prospectus is issued without a copy thereof being delivered under this section to the
Registrar or without the copy so delivered having endorsed thereon or attached thereto the
required consent or documents, the company, and every person who is knowingly a party to
the issue of the prospectus, shall be punishable with fine which may extend to fifty
thousand rupees.

Section 60Amakes rule for Filing of Shelf prospectus. (1) Any public financial institution,
public sector bank or scheduled bank whose main object is financing shall file a shelf
prospectus.

(2) A company filing a shelf prospectus with the Registrar shall not be required to file
prospectus afresh at every stage of offer of securities by it within a period of validity of such
shelf prospectus.

(3) A company filing a shelf prospectus shall be required to file an information memorandum
on all material facts relating to new charges created, changes in the financial position as
have occurred between the first offer of securities, previous offer of securities and the
succeeding offer of securities within such time as may be prescribed by the Central
Government, prior to making of a second or subsequent offer of securities under the shelf
prospectus.

(4) An information memorandum shall be issued to the public along with shelf prospectus
filed at the stage of the first offer of securities and such prospectus shall be valid for a period
of one year from the date of opening of the first issue of securities under that prospectus:

Provided that where an update of information memorandum is filed every time an offer of
securities is made, such memorandum together with the shelf prospectus shall constitute
the prospectus.

Explanation.-For the purpose of this section, -
(a) "financing" means making loans to or subscribing in the capital of, a private industrial
enterprise engaged in infrastructural financing or, such other company as the Central
Government may notify in this behalf;
(b) "Shelf prospectus" means a prospectus issued by any financial institution or bank for one
or more issues of the securities or class of securities specified in that prospectus.

Section 60b suggests to company to circulate Information memorandum to public prior to
filing of a prospectus. (1) A public company making an issue of securities may circulate
information memorandum to the public prior to filing of a prospectus.

(2) A company inviting subscription by an information memorandum shall be bound to file a
prospectus prior to the opening of the subscription lists and the offer as a red-herring
prospectus, at least three days before the opening of the offer.

(3) The information memorandum and red-herring prospectus shall carry same obligations
as are applicable in the case of a prospectus.

(4) Any variation between the information memorandum and the red-herring prospectus
shall be highlighted as variations by the issuing company.

Explanation.- For the purposes of sub-sections (2), (3) and (4), "red-herring prospectus"
means a prospectus which does not have complete particulars on the price of the securities
offered and the quantum of securities offered.
(5) Every variation as made and highlighted in accordance with sub-section (4) above shall be
individually intimated to the persons invited to subscribe to the issue of securities.

(6) In the event of the issuing company or the underwriters to the issue have invited or
received advance subscription by way of cash or post-dated cheques or stock-invest, the
company or such underwriters or bankers to the issue shall not encash such subscription
moneys or post-dated cheques or stock-invest before the date of opening of the issue,
without having individually intimated the prospective subscribers of the variation and
without having offered an opportunity to such prospective subscribers to withdraw their
application and cancel their post-dated cheques or stock-invest or return of subscription
paid.

(7) The applicant or proposed subscriber shall exercise his right to withdraw from the
application on any intimation of variation within seven days from the date of such intimation
and shall indicate such withdrawal in writing to the company and the underwriters.

(8) Any application for subscription which is acted upon by the company or underwriters or
bankers to the issue without having given enough information of any variations, or the
particulars of withdrawing the offer or opportunity for cancelling the post-dated cheques or
stock invest or stop payments for such payments shall be void and the applicants shall be
entitled to receive a refund or return of its post-dated cheques or stock-invest or
subscription moneys or cancellation of its application, as if the said application had never
been made and the applicants are entitled to receive back their original application and
interest at the rate of fifteen per cent from the date of encashment till payment of
realisation.

(9) Upon the closing of the offer of securities, a final prospectus stating therein the total
capital raised, whether by way of debt or share capital and the closing price of the securities
and any other details as were not complete in the red-herring prospectus shall be filed in a
case of a listed public company with the Securities and Exchange Board and Registrar, and in
any other case with the Registrar only.]

Terms of contract mentioned in prospectus or statement in lieu of prospectus, not to be
varied. A company shall not, at any time, vary the terms of a contract referred to in the
prospectus or statement in lieu of prospectus, except subject to the approval of, or except
on authority given by, the company in general meeting.
Section . 62 of the act impose Civil liability for mis-statements in prospectus this section says
that
(1) Subject to the provisions of this section, where a prospectus invites persons to subscribe
for shares in or debentures of a company, the following persons shall be liable to pay
compensation to every person who subscribes for any shares or debentures on the faith of
the prospectus for any loss or damage he may have sustained by reason of any untrue
statement included therein, that is to say,

(a) every person who is a director of the company at the time of the issue of the prospectus;

(b) every person who has authorised himself to be named and is named in the prospectus
either as a director, or as having agreed to become a director, either immediately or after an
interval of time;

(c) every person who is a promoter of the company; and

(d) every person who has authorised the issue of the prospectus:

Provided that where, under section 58, the consent of a person is required to the issue of a
prospectus and he has given that consent, or where, under 1[***] sub-section (3) of section
60, the consent of a person named in a prospectus is required and he has given that consent,
he shall not, by reason of having given such consent, be liable under this sub-section as a
person who has authorised the issue of the prospectus except in respect of an untrue
statement, if any, purporting to be made by him as an expert.

(2) No person shall be liable under sub-section (1), if he proves

(a) that, having consented to become a director of the company, he withdrew his consent
before the issue of the prospectus, and that it was issued without his authority or consent;

(b) that the prospectus was issued without his knowledge or consent, and that on becoming
aware of its issue, he forthwith gave reasonable public notice that it was issued without his
knowledge or consent;

(c) that, after the issue of the prospectus and before allotment thereunder, he, on becoming
aware of any untrue statement therein, withdrew his consent to the prospectus and gave
reasonable public notice of the withdrawal and of the reason therefor; or
(d) that

(i) as regards every untrue statement not purporting to be made on the authority of an
expert or of a public official document or statement, he had reasonable ground to believe,
and did up to the time of the allotment of the shares or debentures, as the case may be,
believe, that the statement was true; and

(ii) as regards every untrue statement purporting to be a statement by an expert or
contained in what purports to be a copy of or an extract from a report or valuation of an
expert, it was a correct and fair representation of the statement, or a correct copy of, or a
correct and fair extract from, the report or valuation; and he had reasonable ground to
believe, and did up to the time of the issue of the prospectus believe, that the person
making the statement was competent to make it and that person had given the consent
required by section 58 to the issue of the prospectus and had not withdrawn that consent
before delivery of a copy of the prospectus for registration or, to the defendants knowledge,
before allotment thereunder; and

(iii) as regards every untrue statement purporting to be a statement made by an official
person or contained in what purports to be a copy of or extract from a public official
document it was a correct and fair representation of the statement, or a correct copy of, or a
correct and fair extract from, the document:

Provided that this sub-section shall not apply in the case of a person liable, by reason of his
having given a consent required of him by section 58, as a person who has authorised the
issue of the prospectus in respect of an untrue statement purporting to be made by him as
an expert.

(3) A person who, apart from this sub-section, would, under sub-section (1) be liable by
reason of his having given a consent required of him by section 58 as a person who has
authorised the issue of a prospectus in respect of an untrue statement purporting to be
made by him as an expert, shall not be so liable, if he proves

(a) that, having given his consent under section 58 to the issue of the prospectus, he
withdrew it in writing before delivery of a copy of the prospectus for registration;


(b) that, after delivery of a copy of the prospectus for registration and before allotment
thereunder, he, on becoming aware of the untrue statement, withdrew his consent in
writing and gave reasonable public notice of the withdrawal and of the reason therefor; or

(c) that he was competent to make the statement and that he had reasonable ground to
believe, and did up to the time of the allotment of the shares or debentures, believe, that
the statement was true.

(4) Where
(a) the prospectus specifies the name of a person as a director of the company, or as having
agreed to become a director thereof, and he has not consented to become a director, or has
withdrawn his consent before the issue of the prospectus, and has not authorised or
consented to the issue thereof; or

(b) the consent of a person is required under section 58 to the issue of the prospectus and
he either has not given that consent or has withdrawn it before the issue of the prospectus;

the directors of the company excluding those without whose knowledge or consent the
prospectus was issued, and every other person who authorised the issue thereof, shall be
liable to indemnify the person referred to in clause (a) or clause (b), as the case may be,
against all damages, costs and expenses to which he may be made liable by reason of his
name having been inserted in the prospectus or of the inclusion therein of a statement
purporting to be made by him as an expert, as the case may be, or in defending himself
against any suit or legal proceeding brought against him in respect thereof:
Provided that a person shall not be deemed for the purposes of this sub-section to have
authorised the issue of a prospectus by reason only of his having given the consent required
by section 58 to the inclusion therein of a statement purporting to be made by him an
expert.

(5) Every person who, becomes liable to make any payment by virtue of this section, may
recover contribution, as in cases of contract, from any other person who, if sued separately,
would have been liable to make the same payment, unless the former person was, and the
latter person was not, guilty of fraudulent misrepresentation.

(6) For the purposes of this section


(a) the expression promoter means a promoter who was a party to the preparation of the
prospectus or of the portion thereof containing the untrue statement, but does not include
any person by reason of his acting in a professional capacity for persons engaged in
procuring the formation of the company; and

(b) the expression expert has the same meaning as in section 58.

Section 63 imooses Criminal liability for mis-statements in prospectus.This section imposes
fine of Rs 50000 or imprisonment for a term which may extend to two years. The section
says (1) Where a prospectus issued after the commencement of this Act includes any
untrue statement, every person who authorised the issue of the prospectus shall be
punishable with imprisonment for a term which may extend to two years, or with fine which
may extend to [fifty thousand rupees], or with both, unless he proves either that the
statement was immaterial or that he had reasonable ground to believe, and did up to the
time of the issue of the prospectus believe, that the statement was true.
(2) A person shall not be deemed for the purposes of this section to have authorised the
issue of a prospectus by reason only of his having given
(a) the consent required by section 58 to the inclusion therein of a statement purporting to
be made by him as an expert, or
(b) the consent required by sub-section (3) of section 60.

section 64 says that (1) Where a company allots or agrees to allot any shares in or
debentures of the company with a view to all or any of those shares or debentures being
offered for sale to the public, any document by which the offer for sale to the public is made
shall, for all purposes, be deemed to be a prospectus issued by the company; and all
enactments and rules of law as to the contents of prospectus and as to liability in respect of
statements in and omissions from prospectuses, or otherwise relating to prospectuses, shall
apply with the modifications specified in sub-sections (3), (4) and (5), and have effect
accordingly, as if the shares or debentures had been offered to the public for subscription
and as if persons accepting the offer in respect of any shares or debentures were subscribers
for those shares or debentures, but without prejudice to the liability, if any, of the persons
by whom the offer is made in respect of mis-statements contained in the document or
otherwise in respect thereof.



(2) For the purposes of this Act, it shall, unless the contrary is proved, be evidence that an
allotment of, or an agreement to allot, shares or debentures was made with a view to the
shares or debentures being offered for sale to the public if it is shown
(a) that an offer of the shares or debentures or of any of them for sale to the public was
made within six months after the allotment or agreement to allot; or
(b) that at the date when the offer was made, the whole consideration to be received by the
company in respect of the shares or debentures had not been received by it.
(3) Section 56 as applied by this section shall have effect as if it required a prospectus to
state in addition to the matters required by that section to be stated in a prospectus
(a) the net amount of the consideration received or to be received by the company in
respect of the shares or debentures to which the offer relates; and
(b) the place and time at which the contract under which the said shares or debentures have
been or are to be allotted may be inspected.

(4) Section 60 as applied by this section shall have effect as if the persons making the offer
were persons named in a prospectus as directors of a company.

(5) Where a person making an offer to which this section relates is a company or a firm, it
shall be sufficient if the document referred to in sub-section (1) is signed on behalf of the
company or firm by two directors of the company or by not less than one-half of the
partners in the firm, as the case may be; and any such director or partner may sign by his
agent authorised in writing.


65. Interpretation of provisions relating to prospectuses.
(1) For the purposes of the foregoing provisions of this Part
(a) a statement included in a prospectus shall be deemed to be untrue, if the statement is
misleading in the form and context in which it is included; and

(b) where the omission from a prospectus of any matter is calculated to mislead the
prospectus shall be deemed, in respect of such omission, to be a prospectus in which an
untrue statement is included.

(2) For the purposes of sections 61, 62 and 63 and clause (a) of sub-section (1) of this
section, the expression included when used with reference to a prospectus, means
included in the prospectus itself or contained in any report or memorandum appearing on
the face thereof or by reference incorporated therein or issued therewith.
Section 66 makes rule on Newspaper advertisements of prospectus.this says that Where any
prospectus is published as a newspaper advertisement, it shall not be necessary in the
advertisement to specify the contents of the memorandum or the signatories thereto, or the
number of shares subscribed for by them.
Commant :SEBI ICDR regulation makes detail provision an Newspaper advertisements of
prospectus

REMEDIES FOR MISSTATEMENT IN PROSPECTUS

When any prospectus is issued by the company, then it is basically to invite people to
purchase their share.
Now, it is the duty of the company to see that the statements mentioned in the prospectus
are of true nature. As, prospectus is a soul of the company, it is the duty of the co. to
prepare such prospectus with complete due care. Also, when any prospectus is made the co.
is bound to mention every detail regarding the co. in its prospectus. Omission of single fact
also may mislead the investors. Preparing a prospectus is of a great responsibility. Thus, the
company, director or a promoter is liable if any of the statement mentioned in the
prospectus is of untrue nature.
MIS-STATEMENTS IN THE PROSPECTUS (S. 62) [CIVIL LIABILITY]
every person authorizing the issue of prospectus has a primary responsibility to see that the
prospectus contains the true state of affairs of the company and does not give any
fraudulent picture to the public. Section 62 was first enacted in England in the Directors
Liability Act, 1890, which was subsequently replaced by section 43 of Companies Act, 1948.
The section 62 of the Companies Act, 1956 makes certain person liable to pay compensation
to every person who subscribes for any shares of debentures on the faith of the prospectus
for any loss or damage he may have suffered by reason of any untrue statement made in
the prospectus. These would include Directors of the company, Promoters, or even the
company. Thus, this section deals with the cases of misstatements of facts in a prospectus. It
is immaterial for the purpose of this section whether the Director sees the prospectus or
not; it is enough that he authorizes its issue.
The effect of Section 62 is not to alter the tortuous nature of the acts in respect of which
there is to be liability but, to render it easier to establish liability against the Directors in a
common law action of deceit by raising certain legal presumptions against them. Thus, this
provision is an effective remedy to the deceived shareholders. This section is meant to
tighten up the duties of directors and others who are in connection with the prospectus. So,
this section provides statutory civil liability for untrue statement
Misstatement means a falsehood or concealment or an ambiguity or an exaggeration all of
these have the potential to mislead a prospective investor in the company. The term untrue
statement or misstatement is used in the broader sense. So, an untrue statement means
a statement in fact untrue, not a statement in the belief of the Directors untrue. It includes
not only false statements but also statements which produce a wrong impression of actual
facts.
Conditions for invoking Section. 62:
1) The company had issued a prospectus inviting persons to subscribe for its shares or
debentures.
2) An untrue statement was included in the prospectus.
3) The person who is claiming for the compensation had subscribed for the shares or
debentures offered by the prospectus.
4) Such person has subscribed for the shares or debentures relying upon the untrue
statement contained in the prospectus.
5) Such person has sustained a loss or damage after having subscribed for the shares or
debentures.
Persons liable under Section.62:
1) Every director holding the office at the time of the issue of the prospectus.
2) Every person named in the prospectus as a director or a proposed director, if he has
consented to include his name in the prospectus as such.
3) Every promoter of the company as defined in sub-section (6) (a) of this section.
4) Every other person who has authorized the issue of prospectus.
Defenses to escape from liability:
1) Withdrawal of consent: The director will not be liable if he had withdrawn his consent
to become a director before the issue of the prospectus and it was issued without his
authority or consent. Reasonable public notice must be given of withdrawal of consent.
2) Issue without knowledge: The director can escape from his liability if he proves that
the prospectus was issued without his knowledge and when he became aware about it, and
then he gave a public notice for it. Some of the principal newspapers is not enough, it
should be all newspapers in which the prospectus was advertised and with same
frequency too. But, I dont agree with this statement as it is very difficult to advertise in all
the newspapers, and it may cause huge expenses too.
3) Withdrawal of the consent after the issue of the prospectus but before allotment:
When the director becomes aware about such misstatement in the prospectus, after the
issue of the prospectus but before the allotment, then he can withdraw his consent and can
give a public notice for it.
4) Reasonable ground for belief: The director shall be protected if he can show that he
had such reasonable ground to believe, which he did up to the time of allotment. Here,
showing honesty is not enough, as one has to go beyond the principle of honesty.
5) Statement of expert: If any statement is made by the expert, then director can always
contended the fact that he had a reasonable ground to believe that such statements made
were made under competent authority, and he did believe such statement to be true till the
time of allotment. Even for public official document, the same rule shall apply.
REMEDIES AGAINST THE DIRECTOR:
1) Damages for Fraudulent Misrepresentation:
In Contract Law, Misrepresentation means a false statement of fact made by one party to
another party and has the effect of inducing the party into the contract. The
misrepresentation should relate to a material fact. Where it is represented that something
will happen or be done in future, this does not amount to a representation of fact.
The person who has been allotted the share may bring an action for fraudulent
misrepresentation. Now, a director who was aware that a prospectus was being issued to
the public, and if that person did not read the prospectus and did not withdraw his consent,
is very much responsible for the contents of the prospectus. In certain cases, where the
representation which are true at the time of issue of prospectus become false before the
allotment is made. In such cases, the applicant should be informed about the changed
circumstances.
Lord Hewart C.J. in one of his judgments pointed out that, As a normal business seeking
development when money is really being asked to feed and supply an ambitious gamble, is
merely deceit. The argument is not that in this or that particular this prospectus was untrue;
the argument is that its whole purpose and effect were to deceive.
P.P.S. Gogna states that It may be noted that the liability of these persons (it includes
promoters, directors or other persons) is for a mere untrue statement in the prospectus,
and it is not necessary that such a statement should be made with an intention to deceive
the investors. Thus, the investor can claim compensation for any untrue statement in the
prospectus without proving any fraud or intention to deceive. However, in Taxmann its
stated, There must be an intention to defraud and that is to be proved by him.
When those who have made a misrepresentation wish to resist the claim, the onus is upon
them to show that notice of the misrepresentation was given to and received by the person
whose claim they are residing.
Cases:
Derry vs. Peek
The directors of a tramway company issued a prospectus stating that they had the
right to run tram cars with steam power instead of with horses as before. The Act
incorporating the company provided that such power might be used with the sanction of
the Board of Trade. But, the Board of Trade refused to give permission and the company
had to be wound up. One of the shareholders sued the directors for damages for fraud.
Now, the House of Lords held that the directors were not liable in fraud because they
honestly believed what they said in the prospectus to be true. Lord Herschel in this case
observed that Fraud is proved when it is shown that false representation has been made
(a) knowingly, (b) without belief in its truth, or, (c) recklessly, carelessly whether it be false
or true.
Hallows vs. Fernie
Here, the prospectus contained one statement which said that the company would
commence operations with six crew steamships of 20,000 tons and 300 H.P. each having
capacity of 2000 tons of cargo. Also, the steamers were guaranteed to steam 10 knots and
calculated to perform the voyage from F to R in 25 days. But, there were no steamships in
possession of the company when the prospectus was issued. And neither had it had any
contract to obtain those steamships. Thus, the contention which was made was that the
statements misrepresentation of fact. But, this contention was overruled. Court held that,
the prospectus did not announce clearly and in unequivocal language to the public that the
promoters of the company actually possess any steamships or has entered in the contract
with respect to that. The Court further observed that there is a difference when we talk
about words which can bear one meaning and another which is left to people to interpret.
Also, the future sense must be given to words in the past or present to which it contains.
Thus, in this way Court gave a very mild interpretation in this case.
I firmly disagree with this case as when any statement is issued in the prospectus then any
individual would infer the fact that it is true. Here, when the prospectus mentions the
details of the steamships then anyone would think that the ships are in possession. Thus,
Court has given a very liberal judgment to the case.

Re Reese River Silver Mining Company.
In this case, the prospectus contained the statement that the property which the
company had contracted consisted of 50 acres land. It also said, Containing several very
valuable claims, some of which are in full operation, and make large daily returns. The
statement made was completely false as no such claims were in full operation. Now, the
party contented that the statement was based on the report which was received by the
director, and believed the same honestly. The Court said that there was a misrepresentation
of facts. Court further observed that the company had committed the mistake by stating the
circumstances as facts instead of stating as information received. If the company speaks that
they have got the information from the report, then its their duty not to mention as facts.
The Court is completely right in judging the case as the Company shouldnt have
mentioned such claims when they dont exist.
Again, the Court has done a fair job by judging the case as the prospectus stated
entirely about wheels, that they have been ordered and now they are in use, but the fact
mentions that no such wheels have been ordered. So, its nothing but misrepresentation of
facts. When we see the definition of misrepresentation, then the statement is falsely made
in the prospectus and the persons should be liable for the same.
2) Damages for omission:
Lord Macnaghten has rightly stated that, the prospectus must be taken as a whole for
everybody knows that half a truth is no better than a downright falsehood. A prospectus
may be fraudulent where its statements are true but on omitting something, it may create a
false impression. To render a prospectus fraudulent, it is not necessary that there should be
a false representation in it. The suppression of material fact is also fraudulent. If an omission
of a material fact is such that even if the omitted statement were included in the prospectus
it would not render untrue the statement made in the prospectus, such omission will not
entitle the purchaser to avoid the contract; nor will it make the persons responsible for the
issue of the prospectus liable in damages. Thus a prospectus must be looked from a point of
view of Constitution of a Company. So, in this regard, a company should never omit
material facts which are directly relevant for investing in the company. Omission of such
material facts should be handled strictly.
S. 56 do not provide in clear terms that such persons are liable for omission of the
particulars in the prospectus. It is immaterial whether or not the omission made in the
prospectus is false or misleading. It is important to note that S. 56 does not entitle the
shareholder to rescind the contract to take shares by reason merely of the omission of any
of the facts required to be disclosed. But, in Shiromani Sugar Mills Case, it was held that if
the omission amounts to fraud of misrepresentation, the contract may also be rescinded.
A person responsible for the issue of prospectus shall not be liable if: (a) if there is no
knowledge of the particular statement that such statement has not been disclosed, (b)
there was a honest mistake of fact on his part, (c) when Court considers that omission
should be excused or is immaterial.
Cases:
Rex v. Kylsant Here, Kylsant issued a prospectus where it was stated that the company
had paid dividend varying from 5 to 8% every year between 1911 to 1927, except in or 2
years where a lower rate of dividend or no dividend was paid. The prospectus thus rejected
that the company was financially strong and stable. But, the facts were that the last 7 years,
the company had incurred heavy losses and dividends were paid only out of the
accumulated profits which had been stored up during the war period. The Court held that
the prospectus was misleading not because of what is stated but because of what it
concealed or omitted.
The Court is completely right in judging the case as the fact that the company has
incurred heavy losses from past 7 years, and that the dividends is paid form a fund is a
material fact. And so, its the duty of a company to disclose such fact.
Peek v. Gurney
Here, in this case, a deceitful prospectus was issued by the defendants on behalf of a
company. The plaintiff received a copy of it but did not take any shares originally in the
company. The allotment was completed and after several months, the plaintiff bought 2000
shares on the stock exchange. His action against the directors was rejected. A purchaser of
shares in the open market has no remedy against the company or the promoters though he
might have bought on the faith of the representations contained in the prospectus. The
Court further observed that Those only who are drawn on by the misrepresentation in the
prospectus to become allottees can have remedy against the directors. The Court also held
that As regards omission and concealment of material facts the Directors and other
persons responsible for issue o the prospectus are liable, and the purchasers of shares are
entitled to avoid their contracts for the purchase of shares in the company, if the facts
concealed or omitted are not only material facts but are also of such character that if stated
in the prospectus they would render false that which is included in the prospectus or would
render false statement, or any part thereof, contained in the prospectus. The conditions
drawn in this case are:
The misstatement in the prospectus must be fraudulent i.e. must be made knowingly
and with the intention to deceive. In other words, there must exist the elements of
fraud.
The fraudulent misstatement must relate to some existing facts which are material
to the contract of purchasing shares or debentures and the investor must be
induced to purchase the shares of debentures in the co.
The investor must have taken the shares directly from the co. A person who
purchases the shares in the open market has no remedy against the co. or directors
etc. even if he bought the shares on the faith of representation contained in the
prospectus.

Manavedan Tirumalpad (T), Rajah of Nilumbur vs. Amirchand Dass
Here, in this case, a prospectus contained a statement that the Government of
Cochin have agreed to encourage the company by giving a steady and continuous supply of
timbers extracted from the state forests required for the purpose of the company at
economical prices in order to encourage the establishment of industries for which there are
natural advantages in the State. Now, in reality, there was only a conditional promise held
out by the Government to give such steady supply of timber at reasonable rates that the
first years transaction should be found to be mutually satisfactory. It was held that the
statement made in the prospectus was false and misleading and the same did not amount
to any fair representation of what was stated by the Government. The Court also held that
If the directors have taken the responsibility of asserting that there was an unconditional
promise given by the Cochin Government to supply timber steadily for the purposes of the
company, they must bear the consequences.
This case clearly shows that the company suppressed the material fact for its own
benefit. The condition mentioned by the Government was not at all disclosed and with this
any prudent man would believe that the agreement with the Government is unconditional.
So, the Court has completely justified the case by stating that the statement made in the
prospectus is misleading and not true.
3) Compensation under Section. 62:
An allottee of shares or debentures is entitled to claim compensation from directors,
promoters and any other persons who authorized the issue of a prospectus, for damages
sustained by reason of any who authorized the issue of prospectus, for any damages
sustained by reason of any untrue statement in it.
The persons liable to pay compensation are: Every person who is the director of the
company at the time of issue of prospectus, or any person who has authorized himself to be
named in the prospectus or has agreed to become a director, every person who is the
promoter of the company, or every person who has authorized the issue of the prospectus.
If a person who makes a false statement entertains a bonafide belief that the statement is
true, an action of deceit cannot be maintained against him on the ground that he formed his
belief carelessly or on insufficient reason. The compensation which is given must be with
reference to the loss sustained by a person and not to be seen as penalty imposed.
Only such subscribers who apply for allotment of the securities on the faith of the
prospectus purporting to contain an untrue statement are entitled to be compensated for
any loss or damage sustained by reason of the untrue statement. The shareholder is entitled
to recover the difference between what he paid for the shares and what they were worth
(i.e. true value) when they were allotted to him.
Cases:
Kisan Mehta vs. Universal Luggage Mfg. Co. Ltd.
Here, in this case, Mehta filed a suit for injunction to restrain the company from
issuing a prospectus. Mehta alleged that it contained misleading statements. The suit was
later dismissed. Court held that Only a person who has suffered loss or damage on the faith
of the prospectus is entitled to a remedy under the section. Thus, public interest litigation
shall not be allowed with this. The Court further said that If a subscriber, who purchases
shares on the faith of a prospectus which allegedly contains misstatements, wants to take
an action in addition to what is contemplated under section 62 or section 63, it is open to
him to take an action; but that does not mean that any other person who is not interested
in the company at all can come forward and say that the statements contained in the
prospectus are false, and that a future investor might be duped, that he might suffer, and
therefore, the company should be restrained from acting in any particular manner.

Thus, the Court is right in judging the fact that any person is not entitled to file a case
stating that the prospectus is misleading. The right is absolute and is given only to those
people who have subscribed such shares.
Clark vs. Urquhart
Lord Summer held in this case that, Compensation had no technical significance. The
word was selected because it represented the difference between the actual value of the
shares or debentures taken and the sums paid for them on the fact of the prospectus and at
the same time avoided the invidious association of damages.
4) Damages under the General Rule:
The persons responsible for the issue of false prospectus may also be held liable for the
payment of damages under the general law. Thus, a person who has been induced to invest
money in a company by fraudulent statement in a prospectus can recover damages for
fraud under the Indian Contract Act or the Law of Trots.
Period of Limitation: There is no such Article in the Limitation Act, 1963 which specifically
provides for actins against a director or a promoter of a co. in respect of a false statement
made in the prospectus. The Madras High Court in one of its judgment stated that the suit
alleging compensation must be filed within two years from the date of cause of action. Also,
any people who claim to retire from a company on the ground that he was induced to
become a member by misrepresentation in the prospectus is bound to come at the earliest
possible moment after he becomes aware of the misrepresentation.
REMEDIES AGAINST THE COMPANY
1) Recession of the Contract
It is a general principle of law that if one of the parties to a contract does not disclose what
he is bound to disclose to the other party, then he has full rights to rescind the contract.
Where a prospectus contains certain misstatement then the shareholder has full right to
rescind the contract. Thus, by avoiding such a contract, a person is able to get rid of his
shares and can claim the money he paid for it. Section 75 of the Contract Act speaks that a
person who lawfully rescinds a contract is entitled to compensation for any damages which
he has sustained in the non-fulfillment of the contract.
A suit for compensation or damages under this section is thus not based on a cause of
action arising out of a contract, because at the stage of issue of prospectus there is no
contract between a shareholder and anybody else. So, when the shares are allotted, then
the contract is between the shareholder and the co. and with the director of the company.
Recession will not be a remedy if the investor has been induced to buy shares on a material
misrepresentation of law.
There are certain conditions for Recession of the contract. They are:
It must be established that the prospectus issued by the co. or by someone on behalf
of the co.
There must be an untrue statement in the prospectus.
The misrepresentation contained in the prospectus must be material to the contract
of taking shares. A fact will be material if it is likely to influence the judgment of a
prospective investor in deciding whether he should purchase shares in the co. or
refrain from doing so. Misrepresentation must be one of fact and not merely an
expression of opinion or expectation.
The aggrieved party must have relied upon the prospectus while applying for shares.
He must have taken the shares directly from the co.
The aggrieved party must exercise the right to rescind the contract within
reasonable time of becoming aware of a misstatement in the prospectus.
The contract is valid till its rescinded. A shareholder has only a limited time to rescind the
contract. So, he must rescind it promptly on becoming aware of the fraud which is done to
him. The right of recession is not available where the allottee has subscribed for the shares
before looking at the prospectus, where the prospectus itself makes it clear that such
statements are mere hearsay statements and are not true otherwise, where the allottee has
not relied on such statements but made a personal investigation for it, he is such a person
who cant get misled merely by the statements of prospectus.
The reason that a shareholder should be prompt in rescinding the contract is that the
register of the shareholders is to be the creditors guarantee, showing them to whom and to
what they have to trust. A shareholder knowing hat he has been induced by fraud to enter
into the contract of purchase of shares, cannot lie by, let his name remain in the register
and let the third party enter into the contracts with the co. on the faith of the register.
Loss of right to recession: To avoid the contract must be done within a reasonable period of
time. Though there is no specific time which has been allotted, but when a person gets to
know about such fraud, then he must rescind the contract duly. Also, where a party who has
a right to rescind the contract and even after having the knowledge of it acts which affirms
the contract, then later that same person cant avoid the contract. In certain cases the right
to recession is lost. They are:
If the proceedings for recession are not begun within a reasonable time.
If he affirms the contract, directly or indirectly after becoming aware of the
misleading nature of the prospectus.
If he initiates legal action only after the commencement of the winding up
proceedings of the co. the reason for this is that the creditors would have relied
upon his membership also while making the deals with the co.
If it is proved that he had not been induced by the prospectus to make the contract.
The right of recession is lost on the commencement of winding up of the co.
Thus, this right to recession is a better remedy against the company and on becoming aware
of any such fraudulent conduct of the co. one should definitely use this rt. and should
rescind the contract immediately.
2) Damages for fraud:
The allottee can claim for damages of fraud from the co. Now, such damages can be claimed
only after the allottee has rescinded the contract and ceased to remain the shareholder.
Thus, if he still continues to be a shareholder of that same co. even after knowing the fact
that the co. is acting fraudulently, then that person has no right to ask for any further
damages.
Fraud occurs when any statement is made without belief in the truth or carelessly. It shall
be necessary to establish that there is fraudulent misrepresentation in the prospectus. If the
aggrieved person can prove it, he can claim for the all the loss which has been sustained by
him as a result of such fraudulent acts or statement. The fraudulent statement must be
related to facts which were material to the contract of purchasing shares and the aggrieved
party must have actually relied on such facts and must have taken the shares on the basis of
such statement only. Thus, the right to claim damages is exercised against the co. as wll as
against the directors or promoters of the co.
Case:
Edington vs. Fitzmaurice
A company issued a prospectus inviting subscriptions for debentures. The prospectus
contained a statement that the objects of the issue of debentures are (a) to complete
alterations in the buildings of the co., (b) to purchase horses and vans and, (c) to develop
the trade of the co. However, the real object raised by debenture was to payoff the
liabilities. Relying upon the statement in the prospectus, a person advanced money to the
co. and purchased its debentures. The co. became insolvent, and that person filed a suit
against the directors for fraud. It was held that the directors were liable for fraud. Here, the
statement made was of existing fact as the director has misrepresented their state of mind
and the statement made in the prospectus was material to the contract of purchasing
debentures.
Here, the Court is right in judging the case as the object of the debentures mentioned
in the prospectus is totally contradictory to the actual purpose. The company is rightly liable
for fraud.
EXPERTS LIABILITY
The provision of experts was introduced in the English Act, 1947. Section 58 of the
Indian Companies Act, 1956, speaks that before an opinion of an expert is relied upon by a
co. the co. must have the opinion in writing, and the manner of publication of such opinions
should be different. An expert who has given the consent under Section 59 of the
Companies Act, 1956, shall not by reason of having given such consent be liable as a person
who has authorized the issue of the prospectus except any untrue statement made by him
being an expert unless he establishes bonafide pleas which are available to him.
It has been held in some English cases that if a co. issues a prospectus on the
bonafide report of an expert and the report proves to be inaccurate, any material
inaccuracy in the prospectus though based on the report, will be a ground for recession of
the contract to take shares unless the prospectus contains a clear and unambiguous warning
to the public that the co. does not guarantee the accuracy of the statements contained in
the report.
An expert is also liable to pay compensation under Section 62. However, he may not
be entitled to pay the same is he proves that:
That having given the consent in the prospectus, he withdrew the same in writing before
the delivery of a copy of the prospectus to the registration; or
After the delivery of prospectus for registration but before allotment he withdrew his
consent in writing when he became aware about such untrue statement made, and he also
gave a public notice for the same.
That he was competent to make such statement, and believed on reasonable grounds that it
was true.
The allottee of the shares, who has been induced to take shares on the faith of the untrue
statement made by an expert, is entitled to claim damages and compensation under Section
62 from the expert. The expert shall be entitled to give compensation in the same manner
as director or promoter gives. The expert shall not be criminally liable for any misstatements
in the prospectus.
PROMOTERS LIABILITY
Promoter has lots of meanings. It was an old name for a common informer and the
technical term for the prosecutor of a suit in the ecclesiastical Courts. But, in general terms,
the promoters of a co. are those who are leading in the formation or floatation of the
company. The Act does not define promoter. Lord Justice Bowen in one of his case speaks
that: the term promoter is not a term of law but of business usefully summarizing-up in a
single word a number of business operations familiar to commercial world by which a co. is
generally is brought into existence.
A promoter stands in the fiduciary relationship to the company and his duties
includes, drafting the prospectus, negotiating with people, getting the directors of the
company, entering into agreements, hiring the professionals like company accountants etc.
So, one can say that a promoter is the one who promotes the business or rather funds the
business, gives a new identity as co., prepares the souls of the company i.e. memorandum
and articles of association. Its the promoter who appoints the directors for the company.
Thus, a promoter is the one who is the machinery of the company where the business is in
his hands.
A promoter may be personally liable for any breach of contract done by him before a
new company is formed. But, the persons who are merely a servant or agents of the
promoters or other persons working for the company cant be classified under the term
promoter. Also, those people who have subscribed their share initially cant be treated as a
promoter of the co.
A company promoter stands in a fiduciary relationship with the company Fiduciary is
a person, such as trustee, who holds a position of trust or confidence with respect to
someone else and who is, therefore, obliged to act solely for that persons benefit. Thus, the
position of a promoter is of trust and confidence. Thus, promoters stand in the fiduciary
relationship to the future allottees of the shares. If promoters attempt to acquire any secret
profits out of their dealings with the company, they are responsible to make good to the
company with those profits. Also, the promoter cannot make any co-promoter liable for any
of his own independent acts done by him.
The duties of a promoter are:
The promoter shouldnt make any secret or extra profits form the expense of the co.
if any such profits accrued by any promoter are disclosed by the promoter, then
that profit shall no longer be secret. Thus, a promoter cant retain any profit made
out of a transaction to which co. is a party, without full disclosure.
A promoter is an independent Board of Directors
A promoter is an existing and intended shareholder
To act honestly for the co. by taking the due care of the co.
There are certain rights of a promoter. They are:
The promoter has full right in getting the profits even when he sells off the co. even
if he discloses such a fact; the promoter has full right to do so.
The directors may pay a promoter certain expenses which are incurred by him at the
time of formation of the co.
The promoter has no right of indemnity against the co. in respect of any obligation
undertaken on his behalf before its incorporation, stipulating that he shall be paid
a certain sum as the preliminary expenses.

There are certain remedies available if a promoter fails to make full disclosure of a profit
made by him out of the promotion. They are:
Where the promoter has e.g. has sold his own property to the company, the co. may
rescind the contract and recover the purchase-money paid
The co. may compel the promoter to account for any profit he has made.
The co. may sue the promoter for damages for breach for his fiduciary duty.
Thus, even a promoter is liable for any such breach. He is treated the same as to the
directors of the co. Thus, the promoter is not the king of the co. who can do whatever he
likes if he has formed the company even he is abided by the rules of law and cant deny
them. So, we can say that the promoter, director or the company cant move away from
their duties and responsibilities. Even though they are at a particular position, they have to
go in accordance with the law, and for any breach they shall be punished.
CONCLUSION
One thing which is clear is that everyone is liable to the shareholders if any wrong is
committed by the co. or by any other person who is working on behalf of the company.
Thus, law leaves no one when it comes to giving justice to people. Court is very strict in
every minute thing also that it sees that if there is any aggrieved person is there then shelter
must be provided by the law.
So, the shelter given by the Court gives more rights to the shareholders and scares
the co. not to do any illegal act which may affect the shareholder. In many judgments Court
has tried to come up with justice by making company liable. Thus, the civil liability covers
every aspect of wrong which is normally done by the company the Court has laid down
exclusive principles also in many of the cases. Thus, the remedies available against the
company and the directors or the promoters are quite enough for any shareholder to take
help and gain compensation for any loss.
One can easily infer the fact from various cases that the Court has understood the
importance of money and has passed the judgments which are in favor of the shareholder.
Thus, it is very difficult for the company to escape from such civil liability

ALLOTMENT OF SHARES
Allotment of shares is discussed under section 73(3A) of the companies Act, 1956.
This provides that the application money standing to the credit of the separate bank
account shall not be utilized for any purpose other than the following purposes, namely:
Adjustment against allotment of shares, where the shares have been permitted to be
dealt in on stock exchanges specified in the prospectus
Repayment of moneys received from applicants in pursuance of the prospectus,
where shares have not been permitted to be dealt in on the stock exchange or each stock
exchange specified in the prospectus, as the case may be, or, where the company is for any
other reason unable to make the allotment of shares.
Section 75(1) makes it obligatory on the part of every company allotting share to file
with the concerned registrar of companies, return of allotment of the shares within thirty
days of the allotment along with the prescribed filing fee. The return should not show any
shares as having been allotted for cash if cash has not actually been received in respect of
such allotment. The return of allotment of shares is required to be sent in e-form 2 as
prescribed in the companies (central governments) general rules and forms (amended)
rules, 2006
SHARES ALLOTTED FOR CONSIDERATION OTHERWISE THAN IN CASH
Section 75(2) lays down that in the case of shares allotted as fully or partly paid up
otherwise than in cash, the company is required to produce before the ROC for inspection
and examination. A contract in writing constituting the title of the allottee to the allotment
together with any contract of sale or contract of services or other considerations in respect
of which that allotment was made. The company is required to file along with the return of
allotment, copies of such contracts verified by an affidavit of a responsible officer of the
company stating that they are true copies, as prescribed in Rule 5 of the companies (central
governments) general rules and forms, 1956. If the contracts are not reduced In writing,
prescribed particulars of contract in e-form 3 duly stamped along with copy of board
resolution approving allotment of shares otherwise than in cash are to be filled in and
signed e-form 3 on stamp paper, physical form are required to be sent to the concerned
ROC office simultaneously.
RETURN OF ALLOTMENT OF BONUS SHARES
In the case of allotment of bonus shares, the company is required to attach to the
return of allotment, a certified copy of the ordinary resolution of the general meeting
authorizing the issue of such shares [Section 75(a) (c) (i)].
RETURN OF ALLOTMENT OF SHARES ISSUED AT DISCOUNT
The company is required to attach to the return of allotment, a certified copy of the
resolution passed by the company for the issue of shares at discount together a copy of
order of the company law board sanctioning the issue and where the minimum rate of
discount exceeds ten per cent, a copy of order of the central government permitting the
issue at a higher percentage.
DISPOSAL OF FORFEITED SHARES- NO ALLOTMENT RETURNS TO BE FILED
According to section 75(1) of the companies Act, a company is required to file a
return of allotment of shares and not for re-issue of forfeited shares. Allotment as we have
seen above is appropriation of the previously unappropriated capital of a company of a
certain number of shares to a certain person. Till such allotment the shares do not exist as
such. However, in the case of forfeited shares, they had already been allotted and they had
come into existence at the time of their allotment and their forfeiture is a proof of their
existence. Therefore no return of allotment is required to be filled with ROC by a company
at the time of re-issue or disposal of forfeited shares.[srigopaljalan and co v. Calcutta stock
exchange association(1963) 33 com.cases 862:AIR 1964 SC 250].
RETURN OF ALLOTMENT IS TO FILED IN RESPECT OF EVERY ALLOTMENT
The duty of a company to file a return of allotment is not confined to the first
allotment. The company has to file the return of allotment whenever it makes any allotment
of shares.

ALLOTMENT OF FRACTIONAL SHARES
The issue of coupons for fractional shares cannot be said to be allotment of any
shares till the holders are issued letter of allotment in respect of any shares from the
company in their names In exchange of the coupons. Any dividend declared meantime in
respect of the capital represented by such coupons should not be treated as dividend
declared in favour of any particular holder of share as such, but dividend is kept embarked
for whoever may be allotted full shares in exchange of the coupons.
SHARE APPLICATION FORM
The process of allotment of shares or debentures in a company commences with an
application. Which is an offer made by a prospective investor to the company to accept the
shares of the company. The company may or may not accept the offer which means the
company has the discretion to accept the offer full or in part or can reject the application
totally. The share application form shall be accompanied by memorandum of the company
containing the salient features of the company. Section 56(3) provides that the company
shall issue the share application form with the memorandum of the company containing
such features as may be prescribed by the companies Act. This section is not applicable
when the company issues the shares in connection with a bona fide invitation to a person to
enter into an underwriting agreement with respect to the shares or debentures. And this
section is not applicable in respect of the offer which is not made to the public.
The central government instructed that the share application shall form part of the
abridged prospectus. If any company contravenes these provisions then the company or the
person who is in default will be punishable with a fine which may extent to Rs. 50,000.
TIME LIMIT FOR ALLOTMENT
An allotment should be made within a reasonable time and an applicant is not bound
to accept an allotment after the lapse of a reasonable time. A delay of one year is
unreasonable. Indian co-operative navigation & trading co. Ltd v. padamseypremji (1934) 4
comp cases 110 (Bom).
IRREGULAR ALLOTMENT
Sections 69, 70, 72 of the companies Act, 1956 prescribes conditions of valid
allotment. Violation of any one of those conditions would result into defective or irregular
allotment. An irregular allotment may be void or it may be voidable. A void allotment is no
allotment whereas avoidable allotment may be one which may be avoided by the allottee.
Where the allotment is defective for the reason that it was made before the expiry of the
fifth day ager the publication of prospectus issued by the company generally or such other
later day specified in the prospectus, the allotment is valid, but the company and the every
officer of the company who is in default shall be punishable with fine which may extend to
fifty thousand rupees as per the sub-section (3) of section 72 of the Act.
VOID ALLOTMENT AND ITS EFFECTS
According to section 73(1A) of the Act, where a prospectus states that an application
has been made for permission for shares or debentures offered thereby to be dealt in one
or more stock exchanges, such prospectus shall state the names of the stock exchanges
where the shares of the company are proposed to be traded. If the permission is not
received by the stock exchanges then the allotment will become void. However where the
appeal is preferred by the company against the decision of the stock exchanges then the
allotment shall not become void until the appeal is dismissed by the appellate tribunal.
Section 73(2) provides that where the permission is not granted by the stock
exchanges then the company shall repay the amount received from the public without
interest all the amount. If such amount is not repaid within eight days after becomes liable
to repay it. The company and every director of the company who is an officer in default
shall, after the expiry of said period liable to repay that amount with interest at such rate
not less than four per cent and not more than fifteen per cent, as may be prescribed by the
central government( at present 15%).

TRANSFER OF SHARES AND TRANSMISSI ON OF SHARES

Under Section 82 of the companies Act, 1956, the shares of any member in a company are
movable property, transferable in the manner provided by the articles of association of the
company. Shares of a public company are freely transferable. However, in terms of section
3(1) (iii), a private company is required to restrict the right to transfer its shares by its
articles.

REGISTRATION OF SHARE TRANSFER:
Section 108 of the Companies Act, 1956 regulates the registration of transfer of the
shares in a company. Sub-section (1) lays down that a company shall not register transfer of
its shares unless a proper instrument of transfer duly stamped and transfer of its shares
unless a proper instrument of transfer duly stamped and executed by or on behalf of the
transferor and by or on behalf of the transferee and specifying the name, address and
occupation, if any, of the transferee, has been delivered to the company along with the
certificate relating to the shares, or if no such certificate is in existence, along with the letter
of allotment of the shares.
The stamp duty under article 62(a), schedule I to the Indian Stamp Act, on the
transfer of shares in a company, for every one hundred rupees or part thereof of the market
value of shares has been paise fifty.

CANCELLATION OF SHARE TRANSFER STAMPS IS MUST FOR REGISTRATION OF
TRANSFER:
The share transfer stamps so affixed on a share transfer form are required to be cancelled
either at the time of affixing them or at the time of execution of the deed by the transferee.
The transferee must make sure that before lodgment of the transfer with the company, he
must cancel the stamps by crossing them on their face. No such cancellation of stamps is
required in case shares are in dematerialized form.


AFFIXING SHARE TRANSFER STAMPS ON A SEPARATE SHEET OF PAPER
ATTACHED TO THE SHARE TRANSFER FORM:
When the number of share transfer stamps to be affixed on a share transfer form is
large it is practically impossible to affix all the stamps on the share transfer form. In such a
situation, the share transfer form, with which a separate sheet of paper with share transfer
stamps of appropriate value having been affixed is permanently attached, should be treated
as duly stamped under the stamp Act.
LOSS OF DULY EXECUTED SHARE TRANSFER FORM:
According to the first proviso to section 108, where an application in writing has
been made to the company by the transferee and bearing the share transfer stamps of
appropriate value required for an instrument of transfer and it is proved to the satisfaction
of the Board of directors that the instrument of transfer signed by or on behalf of the
transferee has been lost, the Board of directors of the company may register the transfer on
such terms as to indemnity as it may think fit.
VALIDITY PERIOD OF THE TRANSFER INSTRUMENT:
Every instrument of transfer shall be in Form No. 7B, as prescribed in the Companies
(Central Government) General Rules and Forms,1956, and in case of a company whose
shares are listed on OTC(over the counter) exchange of India, the instrument of transfer
shall be in Form 7BB.
However, as per the provisions of section 108(1A):
a) Every share transfer form shall, before it is signed by or on behalf of the transferor
and before any entry is made therein, be presented to the prescribed authority
(ROC), who shall stamp or otherwise endorse thereon the date on which it is so
presented, and
b) Every instrument of transfer in the prescribed form with the date of such
presentation stamped or otherwise endorsed thereon shall, after it is executed by or
on behalf of the transferor and the transferee and completed in all other respects,
be delivered to the company-
i) In the case of shares dealt in or quoted on a recognized stock exchange, at any time
before the date on which the register of members is closed, in accordance with
section 154 of the Act, for the first time after the date of presentation of the
form to the prescribed authority or within twelve months from the date of such
presentation, whichever is later;
ii) In any other case, within two months from the date of such presentation.

Sub-section (1C) of section 108 provides that the provisions of section 108(1A)
and 108(1B) do not apply, inter alia, to-

i) Any share which is held by a company in any other company in the name of a
director or nominee under section 49(2) and (3) of the Act as qualification
shares; or
ii) Any share held by a Government corporation in any other company in the
name of a director or nominee; or
iii) Any share in respect of which a declaration has been made to the public
trustee under section 153B of the Act.
iv) Any share deposited by any person with any bank by way of security for
repayment of any loan or advance to or for the performance of nay
obligation undertaken by such person.
The instrument of transfer n such form duly completed in all respects and duly stamped to
the effect, as the case may, is delivered within two months from the date so stamped or
endorsed.
Sub-section (3) of section 108 provides that the provisions of this section also do not apply
to transfer of a security effected b the transferor and the transferee both of whom are
entered as beneficial owners in the records of a depository.
STATUTORY REMEDY AGAINST REFUSAL BY COMPANY TO REGISTER THE
TRANSFER:
One of the fundamental features of joint stock companies is that their shares are
capable of being transferred. The right of the shareholder to transfer his shares in a
company is absolute as it is inherent in the ownership of the shares subject only to
provisions of the Act and regulations, if any, lay down in the articles.
According to Section 111(2) of the Companies Act, 1956 the transferor or the
transferee, or the person who gave intimation of the transmission by operation of law, as
the case may be appeal to the Company Law Board against any refusal l of the company to
register the transfer or transmission, or against any failure on its part, within the period
referred to in sub-section (1) either to register the transfer or transmission or to send notice
of its refusal to register the same.
An appeal under sub-section (2) shall be made within two months of the receipt of
the notice of such refusal or, where no notice has been sent by the company within four
months from the date on which the instrument of transfer, or the intimation of
transmission, as the case may be, was delivered to the company (Section 111(3)).
TRANSMISSION OF SHARES:
Transmission by operation of law is not a transfer. It refers to those cases where a
person acquires an interest in property by operation of any provision of law, such as by right
of inheritance or succession or by reason of the insolvency or lunacy of the shareholder or
by purchase in a court-sale.
This is known as transmission or transfer by operation of law, or involuntary
assignment. Thus, transmission of shares takes place when the registered shareholder dies
or is adjudicated as an insolvent, or if the shareholder is a company, it goes in to liquidation.
Because a deceased person cannot own anything the ownership of all his property passes,
after his death to those who legally represent him. Similarly, when a person is declared
insolvent, all his property vest in the official assignee or official receiver. Upon the death of
a sole registered shareholder, so far as the company is concerned, the legal representatives
of the deceased shareholder are the only persons having title to the shares unless
shareholder had appointed a nominee, in which case he would be entitled to the exclusion
of all others.
In Re. Greene, (1949) ch. 333, the articles of the company provided that upon the
death of any director, if such director leaves a wife surviving him the shares of such director
shall be deemed to have passed on the death of such director to such deceased directors
wife and such wife shall be the only person recognized by the company as having any title to
the shares and shall forthwith be registered as the holder. On the death of a director, the
question arose as to whether his widow was entitled to the shares or his legal
representatives. The court held that the legal representatives of the deceased were entitled
to the shares. And the articles were contrary to the requirements of the Companies Act
concerning instrument of transfer and were illegal and void.
DISTINCTION BETWEEN TRANSFER AND TRANSMISSION:
The distinction between transfer and transmission is as under:
1. Transfer takes place by a voluntary act of the transferor while transmission is the
result of the operation of law.
2. An instrument of transfer is required in case of transfer but no instrument of transfer
is required in case of transmission.
3. Transfer is a normal course of transferring property, whereas transmission takes
place on death or insolvency of a shareholder.

FORFEITURE OF SHARES
WHAT IS FORFEITURE OF SHARES?
To forfeit means to lose the right to, be deprived of; to lose or become liable to lose, as in
consequence of fault or breach of promise or contract. It is a penalty for a breach of
contract or neglect; a fine that is imposed for not complying with the stipulated condition,
obligation or duty.
For example In the case of a company if a shareholder fails to pay the allotment money
and or calls made on him his shares are liable to be forfeited. Forfeiture of shares may be
set to be the compulsory termination of membership by way of penalty for nonpayment of
allotment.
DOES THE COMPANIES ACT, 1956 CONTAINS A PROVISION ON FORFEITURE?
The companies Act, 1956 do not contain any specific provision regarding forfeiture of
shares. However, the articles of association of almost all the companies contain detailed
provisions regulating forfeiture of shares. These provisions are based on the regulations 29
to 35 in Table A of Schedule I to the companies Act, 1956 or recast based on the regulations.
NOTICE TO THE DEFAULTING SHAREHOLDER:
The directors cannot forfeit the shares of the shareholder unless the defaulting shareholder
has given notice to pay the amount due with interest before a specified date. Then the
directors shall pass a resolution for forfeiting the shares of a duly constituted meeting of
board of Directors.
EFFECT OF FORFEITURE:
A person whose shares have been forfeited shall cease to be member in respect of the
forfeited shares, but shall, remain liable to pay to the company all money which, at the date
of forfeiture, was presently payable by him to the company in respect of the shares. The
liability of such person shall cease if and when the company shall have received payment in
full and all such moneys in respect of the shares.
The only effect of the forfeiture of shares is that the shares pass out of the hands of the
holder; the liability incurred prior to forfeiture of shares to pay the allotment and call money
still remains, if the shareholder fails to pay the allotment money and call money he loses all
his rights in the shares and ceases to be a member.
PROCEDURE FOR FORFEITURE OF SHARES:
1. A forfeiture of any share must be done on the authority of the Board of Directors or,
of a committee of the Board if authorised by articles of association for the purpose,
by its resolution. The resolution should provide for a notice to be given to the
shareholder concerned before the forfeiture is actually effected in pursuance of the
resolution, requiring payment of so much of the call as is unpaid, together with any
interest which may have accrued.
2. The notice threatening forfeiture in pursuance of the Board resolution must be given
in accordance with the provisions of the articles. The notice aforesaid shall
- Name a further day (not being earlier than the expiry of fourteen days from the date
of service of the notice) on or before which the payment required by the notice is to
be made; and
- State that in the event of non-payment on or before the day so named, the shares in
respect of which the call was made will be liable to be forfeited.
3. The notice must
- Specify clearly the amount payable on account of unpaid call money as well as
interest accrued, if any, and other expenses.
- Mention the day on or before which the amount specified ought to be paid, not be
earlier than 14days from the date of service of the notice.
- Contain an unambiguous statement to the effect that in the event of failure to pay
the specified amount latest on the appointed day, the shares in respect of which the
amount remains unpaid would be liable to be forfeited.

4. The notice threatening forfeiture as contemplated in regulation 29 of table A must
be served in accordance with the provisions of section 53 of the Companies Act.
5. If the call money is not paid in response to such notice threatening forfeiture, the
company may at any time thereafter, before the payment required by the notice has
been made, forfeit the shares by a resolution of the Board to that effect.
6. It is common practice to publish a notice of forfeiture in newspapers so that the
members of the public are made aware of the forfeiture and cautioned not to deal in
the forfeited shares.
7. A further notice after the shares are forfeited is not necessary. However, it is
advisable and a common practice to give a notice of the shares having been forfeited
to the concerned shareholders by registered post.
8. Regulation 34 of Table A provides for a verified declaration in writing to be issued
under the signature of a director, manager or secretary of the company that a share
in the company has been duly forfeited on a date stated in the declaration. The
declaration so made shall be conclusive evidence of the facts stated therein as
against all persons claiming to be entitled to the shares forfeited. The accidental
non-receipt of notice of forfeiture by the defaulter is not a ground for relief against
forfeiture regularly effected.
9. The fact of the forfeiture will be entered in the Register of Members and the name
of the concerned shareholder as a member of the company will be deleted from the
register.
10. Notify the Stock Exchange at which the securities of the company are listed about
such forfeiture of shares.


RULES RELATING TO CALLS ON SHARES
A call on shares may be defined as a demand made by the company on its share holders to
pay the whole or part of the balance remaining unpaid on each share at any time during the
life time of a company". Every shareholder is under an obligation to pay the full amount of
the shares held by him. The liability of a shareholder to pay the full value of the shares held
by him is enforced by making calls for payment. For example the price of a share is Rs.100/-.
At the time of applying for shares, the investor has to pay Rs.5/- of the nominal value of
share i.e. Rs.5, so Rs.95/- is balance on each share. As and when the company needs money
it asks its share holders to pay, suppose the company asks its shareholders to pay per share,
that is known as calls on shares.
The liability arises only when a valid call has been made. For example, in Pabna Dhana
Bhandar Co Ltd v. Foyezud Din Mia,
23
it was held that a mere demand by a company
acquiring the rights of another company in respect of its uncalled capital cannot take the
place of a formal call. However, according to Section 92 a company can accept voluntary
payment of the uncalled amount if it is authorized by its articles.

PROCEDURE REGARDING CALLS ON SHARES

23
AIR 1932 Cal 716
An enforceable call shall have to conform to the provisions of the Act and the articles of
association of a company. The following are some of the important rules relating to a valid
call:
(1) Board Meeting for passing a call resolution: A meeting of the Board of Directors will be
called. It must be ensured that the directors are duly appointed and duly qualified and that
the meeting of the directors has been properly convened, that the required quorum is
present and that the resolution making the call is duly qualified. In this meeting a resolution
will be passed regarding making a call. The resolution must specify the amount of call
money, the date and place of its payment; otherwise the call will be invalid. In E & W
Insurance Co.Ltd. v. Kamala Mehta
24
, the directors of a company had, by two resolutions,
resolved to make a call. But neither resolution specified the date and the amount of
payment. The blanks were subsequently filled by the secretary, who sent a notice of call to
the defendant. The call notice was held to be valid.
(2) Closing of the Register of member and the Share Transfer Book: In the same Board
meeting a resolution is passed, whereby the secretary is given permission to close the
transfer book and the register of members for a period of about 15 days.
(3) Preparing the call lists: After closing the transfer book, the work of preparing the call
lists from the register of member, is under taken by the secretary. A call lists shows details
like name and address of the share holders, numbers of shares held by them, the amount
due on the call etc. This helps the secretary in sending call letters to the members.
(4) Drafting call letters: The secretary prepares a draft of the all letter in consultation with
the chairman of the company. He gets the call letters printed in the required quantity. A call
letter is divided into three parts. They are: (i) A call letter proper, (ii) A call receipt, (iii) A call
slip.
(5) Issuing call letters / Dispatch of call notice: After the preparation of call lists, the
secretary issues a call letter to the share holders on their registered address. He also
publishes a call notice in a leading newspaper for the information of shareholders.
(6) Arrangement with bankers for call money: The secretary has to make necessary
arrangement with the bankers of the company to receive call money from the members.
Accordingly instructions are given to the bankers. The amount receive on calls is credited to
a separate account called a "Call Account". After receiving the call money, bankers arrange
to send the amount to the company. The call letter and call receipt are returned to the
shareholder with necessary entries, signature and stamp.
(7) Entries in the call list and the register of members: After receiving the call money,
bankers return call letter and call receipt to the members and send all call slips to the

24
AIR 1956 Bom 537
company's office. The secretary then makes entries against the respective names in the call
lists and the register of members.
(8) Preparing list of Defaulters: The secretary prepares a list of those members who have
not paid the call money on the stipulated date. Such a list is called a list of defaulters. It is
placed before the Board for necessary action. Unpaid call money by members is called as
"Calls in Arrears".
(9) Bonafide in Interest of Company: The amount called up must be used scrupulously for
the objects of the company and the amount uncalled must be only called when it is
necessary for the promotion of those objects. Hence, the power of making a call is in the
nature of a trust and is to be exercised in the interest of the company.
(10) Uniform Basis: Section 71 provides that calls shall be made on a uniform basis on all
shares falling under the same class. Hence, a call cannot be made on some of the members
only, unless they constitute a separate class of shareholders. But shares of the same
nominal value on which different sums have been paid shall not be deemed , for this
purpose, to fall under the same class.


ISSUE OF SHARES AT PREMIUM AND DISCOUNT
1. Procedure of issue of shares
When company has been registered, the following procedure is adopted by the company to
collect money from the public by issuing of shares
Step-1
Issue of prospectus: When a Public company intends to raise capital by issuing its shares to
the public, it invites the public to make an offer to buy its shares through a document called
Prospectus. According to Section 60 (1), a copy of prospectus is required to be delivered to
the Registrar for registration on or before the date of publication thereof. It contains the
brief information about the company, its past record and of the project for which company
is issuing share. It also includes the opening date and the closing date of the issue, amount
payable with application, at the time of allotment and on calls, name of the bank in which
the application money will be deposited, minimum number of shares for which application
will be accepted, etc.
Step-2
To receive application: After reading the prospectus if the public is satisfied then they can
apply to the company for purchase of its shares on a printed prescribed form. Each
application form along with application money must be deposited by the public in a
schedule bank and get a receipt for the same. The company cannot withdraw this money
from the bank till the procedure of allotment has been completed (in case of first allotment,
this amount cannot be withdrawn until the certificate to commence business is obtained
and the amount of minimum subscription has been received). The amount payable on
application for share shall not be less than 5% of the nominal amount of share.
Step-3
Allotments of shares: Allotments of shares means acceptance by the company of the offer
made by the applicants to take up the shares applied for. The information of allotment is
given to the shareholders by a letter known as Allotment Letter, informing the amount to
be called at the time of allotment and the date fixed for payment of such money. It is on
allotment that share come into existence. Thus, the application money on the share after
allotment becomes a part of share capital. Decision to allot the share is taken by the Board
of Directors in consultation with the stock exchange. After the closure of the subscription
list, the bank sends all applications to the company. On receipt of applications, each
application is carefully scrutinized to ascertain that the application form is properly filled up
and signed and the money is deposited with the bank.
Step-4
To make calls on shares: The remaining amount left after application and allotment money
due from shareholders may be demanded in one or more parts which are termed as First
Call and Second Call and so on. A word Final word is added to the last call. The amount of
call must not exceed 25% of the nominal value of the shares and at least 1 month have
elapsed since the date which was fixed for the payment of the last preceding call, for which
at least 14 days notice specifying the time and place must be given.
2. Modes of issue of shares:

A company can issue shares in two ways:
1. For cash.
2. For consideration other than cash.

Issue of shares for cash: When the shares are issued by the company in consideration for
cash such issue of shares is known as issue of share for cash. In such a case shares can be
issued at par or at a premium or at a discount. Such issue price may be payable either in
lump sum along with application or in instalments at different stages (e.g. partly on
application, partly on allotment, partly on call).
Issue of shares at par: Shares are said to be issued at par when they are issued at a price
equal to the face value. For example, if a share of Rs. 10 is issued at Rs. 10, it is said that the
share has been issued at par.
Issue of shares at premium: When shares are issued at an amount more than the face value
of share, they are said to be issued at premium. For example, if a share of Rs. 10 is issued at
Rs. 15; such a condition of issue is known as issue of shares at premium. The difference
between the issue price and the face value [i.e. Rs. 5 (Rs.15 Rs.10)] of the shares is called
premium. It is a capital profit for the company and will show credit balance; hence it will be
shown in the liability side of the Balance Sheet under the heading Reserves and Surplus in a
separate account called Security Premium Account. Shares of those companies can be
issued at premium which offer attractive rate of dividend on their existing shares, having a
good profit track for last few years and whose shares are in demand. The amount of
premium depends upon the profitability and demand of shares of such company.

Note: The Company may collect the amount of security premium in lump sum or in
installments. Premium on shares may be collected by the company either with application
money or with the allotment money or even with one of the calls. In absence of any
information, the amount of the premium is to be recorded with allotment.

Utilization of Security Premium Amount:
According to Section 78(2) of the Companies Act 1956, the amount of security premium may
be applied only for the following purposes:
1. To issue fully paid up bonus shares to the existing shareholders.
2. To write off preliminary expenses of the company.
3. To write off the expenses, or commission paid, discount allowed on issue of the
shares or debentures of the company.
4. To pay premium on the redemption of preference shares or debentures of the
company.
5. To buy-back its own shares as per section 77A.
6. If the company wishes to use the premium amount for any other purpose, it will
have to first obtain the sanction of the court for the same or it will be treated as
reduction of capital.
Unless articles of association of companies permit utilization of share premium account for
purpose other than those mentioned in section 78(2), company court cannot approve
resolution to that effect. Held in Hyderabad industries Ltd, In re (2004) 53 SCL 376, (A.P)
SEBI vide its Guidelines, 2000 has allowed every company which is entitled to make a public
issue, to offer its shares either at par or premium subject only to stating justification for
premium.
Issue of shares at discount: Shares are said to be issued at a discount when they are issued
at a price lower than the face value. For example if a share of Rs. 10 is issued at Rs. 9, it is
said that the share has been issued at discount. The excess of the face value over the issue
price [i.e. Re.1 (Rs. 10 Rs. 9)] is called as the amount of discount. Share discount account
showing a debit balance denotes a loss to the company which is in the nature of capital loss.
Therefore, it is desirable, but not compulsory, to write it off against any Capital Profit
available or Profit and Loss Account as soon as possible, and the unwritten off part of it is
shown in the asset side of the Balance Sheet under the heading of Miscellaneous
Expenditure in a separate account called Discount on issue of Shares Account

Conditions for issue of shares at discount: For issue of shares a discount the company has
to satisfy the following conditions given in section 79 of the Companies Act 1956
1. At least one year must have elapsed since the company became entitled to
commence business. It means that a new company cannot issue shares at a discount
at the very beginning.
2. The company has already issued such types of shares.
3. An ordinary resolution to issue the shares at a discount has been passed by the
company in the General Meeting of shareholders and sanction of the Company Law
Tribunal has been obtained.
4. The resolution must specify the maximum rate of discount at which the shares are to
be issued but the rate of discount must not exceed 10% of the face value of the
shares. For more than this limit, sanction of the Company Law Tribunal is necessary
5. The issue must be made within two months from the date of receiving the sanction
of the Company Law Tribunal or within such extended time as the Company Law
Tribunal may allow.
6. Offer Prospectus at the date of its issue must mention particulars of the discount
allowed on the issue of shares or the exact amount of the discount as has not been
written off. On default, the company and every officers of the company who is in
default shall be punishable with fine which may extend to Rs 500.

3. Issue of Sweat Equity Shares
What is Sweat Equity Share?
The expression sweat equity shares refers to equity shares issued by the company to
employees or directors at a discount or for consideration other than cash for providing
know-how or making available rights in the nature of intellectual property rights or similar
value additions to the company.


Issue
Issue of sweat equity shares is governed by the provisions of S. 79A of the Companies Act.
As per Explanation II to the said Section sweat equity shares means equity shares issued by
the company to employees or directors at a discount or for consideration other than cash
for providing the know-how or making available rights in the nature of intellectual property
rights or value additions, by whatever name called.
For the issuance of the Sweat Equity Shares, this section prescribes some conditions to be
fulfilled which are as follows:
Such issue is authorized by a special resolution of the company in the general
meeting;
Such resolution specifies the number of shares, current market price, consideration,
if any, and the class or classes of the directors or employees to whom such shares are to be
issued;
Such issue is after expiry of one year from the date on which the company was
entitled to commence business; and
In the case of an unlisted company, such shares are issued in accordance with the
prescribed guidelines.
The Companies (Amendment) Act, 2000 laid down that the provisions of this section are to
be administered by SEBI in respect of companies already listed or companies, which intend
to get listed. In respect of other companies, the administration shall be by the Central
Government.
The guidelines referred to in S. 79A are the Rules issued by the Central Government, which
need to be followed by unlisted companies. The Rules inter alia provide the procedure to be
followed by a company issuing sweat equity shares for consideration other than cash. These
Rules shall be applicable to issue of sweat equity shares by all unlisted companies. The
following are the highlights of the rules:
1. For the purpose of passing a special resolution under clause (a) of sub-section (1) of
section 79A of the Companies Act, 1956 (1 of 1956), the explanatory statement to be
annexed to the notice for the general meeting pursuant to section 173 of the said
Act shall contain particulars as specified below.
(i) the date of the meeting at which the proposal for issue of sweat equity shares was
approved by the Board of Directors of the company;
(ii) the reasons/justification for the issue;
(iii) the number of shares, consideration for such shares and the class or classes of
persons to whom such equity shares are to be issued;
(iv) the value of the sweat equity shares alongwith valuation report/ basis of valuation
and the price at the which the sweat equity shares will be issued;
(v) the names of persons to whom the equity will be issued and the person's
relationship with the company;
(vi) ceiling on managerial remuneration, if any, which will be affected by issuance of
such equity;
(vii) a statement to the effect that the company shall conform to the accounting
policies specified by the Central Government; and
(viii) diluted earnings per share pursuant to the issue of securities to be calculated in
accordance with the Accounting Standards specified by the Institute of Chartered
Accountants of India.
2. Approval of shareholders by way of separate resolution in the general meeting shall
be obtained by the company in case of grant of shares to identified employees and
promoters, during any one year, equal to or exceeding 1% of the issued capital
(excluding outstanding warrants and conversion) of the company at the time of grant
of the sweat equity shares.
3. The company shall maintain a Register of Sweat Equity Shares issued under section
79A in the Form specified in Schedule annexed to these rules.
4. The company shall not issue sweat equity shares for more than 15% of total paid up
equity share capital in a year or shares of the value of 5 crores of rupees, whichever
is higher except with the prior approval of the Central Government.
5. The Board of Directors, shall, inter alia, disclose either in the Directors' Report or in
the annexure to the Director's Report, the following details of issue of sweat equity
shares:-
a) Number of shares to be issued to the employees or the directors;
b) conditions for issue of sweat equity shares;
c) the pricing formula;
d) the total number of shares arising as a result of issue of sweat equity
shares;
e) money realised or benefit accrued to the company from the issue of
sweat equity shares;
f) diluted Earnings Per Share (EPS) pursuant to issuance of sweat equity
shares.
6. The price of sweat equity shares to be issued to employees and directors shall be at
a fair price calculated by an independent valuer.
7. Where a company proposes to issue sweat equity shares for consideration other
than cash, it shall comply with following:
a) The valuation of the intellectual property or of the know-how provided
or other value addition to consideration at which sweat equity capital is
issued, shall be carried out by a valuer;
b) the valuer shall consult such experts, as he may deem fit, having regard
to the nature of the industry and the nature of the property or the value
addition;
c) the valuer shall submit a valuation report to the company giving
justification for the valuation;
d) a copy of the valuation report of the valuer shall be sent to the
shareholders with the notice of the general meeting;
e) the company shall give justification for issue of sweat equity shares for
consideration other than cash, which shall form part of the notice sent
for the general meeting; and
f) the amount of Sweat Equity shares issued shall be treated as part of
managerial remuneration for the purposes of sections 198, 309, 310, 311
and 387 of the Companies Act, 1956 if the following conditions are
fulfilled:
(i) the Sweat Equity shares are issued to any director or manager; and,
(ii) they are issued for non-cash consideration, which does not take the form
of an asset which can be carried to the balance sheet of the company in
accordance with the relevant accounting standards.
8. Sweat equity shares issued to employees or directors shall be locked in for a period
of three years from the date of allotment.
9. In the case of every company that has allotted shares under these Rules, the Board
of Directors shall at each annual general meeting place before the shareholders a
certificate from the auditors of the company/ practising company secretary that
sweat equity shares have been allotted in accordance with the resolution of the
company in the general meeting and these Rules.
10. Where the sweat equity shares are issued for a non-cash consideration, such non-
cash consideration shall be treated in the following manner in the books of account
of the company:
a) where the non-cash consideration takes the form of a depreciable or
amortizable asset, it shall be carried to the balance sheet of the
company in accordance with the relevant accounting standards;or
b) where clause (a) is not applicable, it shall be expensed as provided in the
relevant accounting standards.
11. In respect of sweat equity shares issued during accounting period, the accounting
value of sweat equity shares shall be treated as another form of compensation to
the employee or the director in the financial statement of the company.

UK COMPANIES ACT 2006
Issue of share at discount: Section 580 of UKs companies act provides that Shares cannot
be allotted at a discount. It reads as follows:
i) A company's shares must not be allotted at a discount.
ii) If shares are allotted in contravention of this section, the allottee is liable to pay the
company an amount equal to the amount of the discount, with interest at the
appropriate rate.
Issue of share at premium: Section 610 of UKs companies act provides for the application
of share premiums. It reads as follows:
Application of share premiums
1) If a company issues shares at a premium, whether for cash or otherwise, a sum equal
to the aggregate amount or value of the premiums on those shares must be
transferred to an account called the share premium account.
2) Where, on issuing shares, a company has transferred a sum to the share premium
account, it may use that sum to write off
a) the expenses of the issue of those shares;
b) any commission paid on the issue of those shares.
3) The company may use the share premium account to pay up new shares to be
allotted to members as fully paid bonus shares.
4) Subject to subsections (2) and (3), the provisions of the Companies Acts relating to
the reduction of a companys share capital apply as if the share premium account
were part of its paid up share capital.
5) This section has effect subject to section 611 (group reconstruction relief); section
612 (merger relief); section 614 (power to make further provisions by regulations
6) In this Chapter the issuing company means the company issuing shares as
mentioned in subsection (1) above.

SHARES AND KINDS OF SHARES
SHARES
Meaning of Share:
The capital of a company is divided into a number of indivisible units of a fixed
amount. These units are known as shares.
According to Sec 2(46) of the Companies Act, 1956, a share is a share in the share
capital of the company, and includes stock except where a distinction between stock and
share is expressed or implied.
A share not only represents an interest of a shareholder in a company but it carries
with it certain rights and liabilities the company is going concern or while the company is
being wound up. Hence, it represents a bundle of rights and obligations.
Nature of a share:
A share is not a sum of money but 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, but also consisting of a series of mutual covenants entered by all the
shareholders inter se *Borlands Trustees v. Steel Bros. & Co. Ltd. *1901+ 1 Ch. 279 (Ch.D.) +
Shares are regarded as movable property according to Sec. 82 of the Companies Act;
however it suggests that they shall be transferred only in the manner provided by the
articles of the company. A share is not a negotiable instrument. A share is an expression of
proprietary relationship between a shareholder and the company [CIT v. Associated
Industrial Development Co. [1969] 2 Comp. U 19].
Share Certificate:
Section 82 of the Companies Act, 1956 in this regard describes a share as a movable
property transferable in the manner provided by the articles of the company. Section 84, on
the other hand, describes a 'certificate of shares', to mean a certificate, under the common
seal of the company, specifying any shares held by any member. Section 84 further suggests
that a share certificate shall be prima facie evidence of title of the member to such shares.
Thus, whereas 'share' represents property (movable), 'share certificate' is an evidence
(prima facie) of the title of the member to such property.
Thus, the share certificate being prima facie evidence of title, it gives the shareholder
the facility of dealing more easily with his shares in the market. It enables him to sell his
shares by showing at once marketable title.
Also, a share certificate serves as an estoppel as to payment against a bona fide
purchaser of the shares from alleging that the amount stated as being paid on the shares
has not been paid. However, a person who knows that the statements in a certificate are
not true cannot claim an estoppel against the company [Crickmer case [1875] LJ.Ch. 870].
Share v. Stock:
The term 'stock' on the other hand may be defined as the aggregate of fully paid-up
shares of a member merged into one fund of equal value. It is a set of shares put together in
a bundle. The 'stock' is expressed in terms of money and not as so many shares. Stock can
be divided into fractions of any amount and such fractions may be transferred like shares.
A company cannot make an original issue of the stock. A company limited by shares
may, if authorized by its Articles, by a resolution passed in the general meeting, convert all
or any of its fully paid-up shares into stock [Section 94(l)(c)]. On conversion into stock, the
register of members must show the amount of stock held by each member instead of the
number of shares. The conversion does not affect the rights of the members in any way.






Differences:
Share Stock
1. A share has a nominal value.
2. A share has a distinctive number which
distinguishes it from other shares.
3. Originally shares can only be issued.
4. A share may either be fully paid-up or partly
paid-up.
5. A share cannot be transferred in fractions. It is
transferred as a whole.
6. All the shares of a class are of equal
denominations.
1. A stock has no nominal value.
2. A stock bears no such number.
3. A company cannot make an original issue of
stock. Stock can be issued by an existing
company by converting its fully paid-up shares.
4. A stock can never be partly paid- up, it is
always fully paid-up.
5. A stock may be transferred in any fractions.
6. Stock may be of different denominations.

KINDS OF SHARES
Under the Companies Act, 1956, only two kinds of shares can be issued by a public
company. Section 86 of the Companies Act, as amended by the (Amendment) Act, 2000,
provides that the new issues of share capital of a company limited by snares shall be of two
kinds only, namely:
(a) Equity share capital
(i) With voting rights; or
(ii) with differential rights as to dividend, voting or otherwise in accordance with such rules
and subject to such conditions as may be prescribed;

(b) Preference share capital.

Equity share capital
Equity shares [Sec. 85(2)];the equity shares are those shares which are not
preference shares. In other words, shares which do not enjoy any preferential right in the
matter of payment of dividend or repayment of capital are known as equity shares. After
satisfying the rights of preference shares, the equity shares shall be entitled to share in the
remaining amount of distributable profits of the company. The dividend on equity shares is
not fixed and may vary from year to year depending upon the amount of profits available.
The rate of dividend is recommended by the Board of directors of the company and
declared by shareholders in the annual general meeting.
In a public company and a deemed public company equity shareholders have a right
to vote on every resolution placed in the meeting and the voting rights shall be in
proportion to the paid-up equity capital. As compared to this, the holders of preference
shares can vote only on such resolutions which directly affect the rights attached to the
preference shares. However, if the preference dividend is not paid fully for more than two
years, the preference shareholders shall also get voting right on every resolution placed
before the company
Prior to the amendment to the Companies Act in 2000, public companies were not
allowed to issue equity shares with differential rights. With respect to issue of equity shares
with differential voting rights, the Department of Company Affairs has notified Companies
(Issue of Share Capital with Differential Voting Rights) Rules, 2001. These rules, inter alia,
provide:
(i) Shares with differential voting rights, including non-voting shares, shall
beallowed to the extent of 25 per cent of the total issued share capital,
(ii) The company must have distributable profits, as per section 205, in the
threefinancial years preceding such issue.
(iii) Equity capital with regular voting rights will not be allowed to be
convertedinto shares with differential voting rights and vice versa.
(iv) Issue of such shares shall have to be approved by the shareholders resolution
in a general meeting. A listed company may obtain the shareholders'
approval through postal ballot.
(v) The notice of the general meeting must give the prescribed details by way
ofexplanatory statement".
(vi) A company which has defaulted in riling annual returns during immediately
preceding three financial years or has failed to repay its deposits or
interest thereon on due date or redeem debentures on due date or pay
dividend shall not be eligible to issue shares with differential rights.
(vii) Again, a company should not have defaulted in addressing investors'
grievances;
(viii) The issue of such shares should be permissible under the Articles of
association of the company.
(ix) The company should not have been convicted of any offence under:
(a) Securities and Exchange Board of India Act, 1992;
(b) Securities Contracts (Regulation) Act; 1956; and
(c) Foreign Exchange Management Act, 1999,
(x) Members holding equity shares with differential rights shall be entitled
tobonus and rights issue of the same class.
Issue of shares with differential voting rights, to be equitable, has to ensure that
shares having less or no voting rights are compensated by higher rate of dividend compared
to shares having bigger voting rights. Generally, majority (controlling) shareholders try to
secure bigger voting rights to remain in control and to throw out hostile takeover bid.

Preference shares or preference share capital
[Sec. 85] - Preference share capital means that part of the share capital of the
company which fulfils both the following requirements:
(1) During the life of the company it must be assured of a preferential
dividend. The preferential dividend may consist of a fixed amount (say one lakh
rupees)payable to preference shareholders before anything else is paid to the
equityshareholders. Alternatively, the amount payable as preferential dividend
may be calculated at a fixed rate, e.g., 12% of the nominal value of each share.
(2) On the winding-up of the company it must carry a preferential right to
be paid, i.e., amount paid up on preference shares must be paid back before
anything is paid to the equity shareholders. This preference, unless there is an
agreement to the contrary, exists only up to the amount paid up or deemed to
havebeen paid on these shares as in the case of subscribers to the
memorandumof association.
Voting rights of preference shareholders [Sec, 87(2)]
The holders of preference shares have a right to vote on any resolution of the
company directly affecting their rights. According to Explanation to section 87(2), any
resolution for winding-up of the company or for the repayment or reduction of its share
capital shall be deemed directly to affect the rights attached to preference shares.
Where dividends are in arrear
(a) holders of cumulative preference shares have a right to vote on all
resolutionsof the company at any meeting if their dividends are in arrear for an
aggregateperiod of not less than two years on the date of the meeting;
(b) holders of non-cumulative preference shares have a right to vote on all
resolutions of the company at any meeting, if their dividends are in arrear for the
twofinancial years immediately preceding the meeting or for any three years
during a period of six years ending with the financial year preceding the meeting;
(c) The voting rights of each holder of a preference share of either class [i.e.,
cumulative or non-cumulative] will be in the proportion which the capital paid up
on his shares bears to the total equity share capital of the company
In case of foreign company
Where foreign company purchased preference shares in Indian Company with
permission of Reserve Bank of India subject to condition that there should be a cap of 49
per cent of foreign equity and management control of company should remain with Indian
shareholders and shares so purchased by foreign company fell outside permissible foreign
equity cap, it was held that no voting rights could be given to foreign company in respect of
such preference shares, even though no dividend was paid qua said shares - COS Financial
Services (Mauritius) Limited v. BPL Communications Limited[2QQ4] 121 Comp. Cas. 374
(Bom.)

Types of Preference shares:
(I) Participating or non-participating:
Participating preference shares are those shares which are entitled to a fixed
preferential dividend and, in addition,carry a right to participate in the surplus profits along
with equity shareholders after dividend at a certain rate has been paid to equity
shareholders. Forexample, after 20% dividend has been paid to equity shareholders, the
preference shareholders may share the surplus profits equally with equity shareholders.
Again, in the event of winding-up, if after paying back both thepreference and equity
shareholders, there is still some surplus left, then theparticipating preference shareholders
get additional share in the surplusassets of the company. Unless expressly provided,
preference shareholders get only the fixed preferential dividend and return of capital in the
event ofwinding-up out of realised values of assets after meeting all external liabilitiesand
nothing more. The right to participate may be given either in thememorandum or articles or
by virtue of their terms of issue.
(II) Cumulative and non-cumulative shares:
With regard to the payment ofdividends, preference shares may be cumulative or non-
cumulative. A cumulative preference share confers a right on its holder to claim dividend
fixed at a sum or a percentage for the past and the current years out of future profits. The
fixed dividend keeps on accumulating until it is fully paid. The non-cumulative preference
share gives right to its holder to a fixed amount or a fixed percentage of dividends out of the
profits of each year. If no profits are available in any year or no dividend is declared, the
preference shareholders get nothing, nor can they claim unpaid dividend in any subsequent
year.
Preference shares are cumulative unless expressly stated to be non-cumulative.*
Dividends on preference shares, like equity shares, can be paid only out of profits and on
declaration of dividend for preference shares.
(III) Redeemable and Irredeemable Preference shares:
Subject to an authority inthe articles of association, a public limited company may issue
redeemablepreference shares to be redeemed either at a fixed date or after a certain period
of time during the life time of the company provided the companycomplies with the
following conditions laid down in section 80 of the Act:
(i) The articles must provide for the issue of such shares;
(ii) they may be redeemed only out of profits available for dividends or out of
the proceeds of a fresh issue of shares made for the purpose of redemption;
(iii) if premium is payable on redemption, it must have been provided for out of
the profits of the company or out of the company's securities premium
account', before the shares are redeemed;
(iv) no such shares can be redeemed unless they are fully paid;
(v) Where the shares are redeemed otherwise than out of the proceeds of the
fresh issue, a sum equal to the nominal amount of the shares redeemed shall
be transferred out of profits which would otherwise have been available for
dividend, to the "Capital Redemption Reserve Account". This fund may also
be used to issue fully paid bonus shares.
It may be noted that redemption of preference shares in pursuance of this section is
not to be taken as reducing the amount of the authorised capital of the company and
therefore, provisions of the Act with regard to reduction of capital are not required to be
complied with. Also, where a company has redeemed preference shares or is about to
redeem them, it has the power to issue new shares up to the nominal amount of the shares
redeemed or to be redeemed with the result that the share capital of the company shall not
be deemed to have been increased with the issue of new shares [Sec. 80(4)].
Preference shares can be redeemed not only in accordance with section 80 but also
in accordance with the provisions of section 100. If the shares are to be redeemed not out
of the fresh issue of shares made for that purpose nor out of the profits which would
otherwise be available for dividend as required under section 80, provisions of section 100
would have to be complied with. Two independent procedures are available to a company
for redemption of preference shares. It may redeem the shares by following the procedure
laid down under section 80 which is a special provision meant for redemption of preference
shares or it may take recourse to the general provision under section 100 which is applicable
for reduction of any capital, including preference capital, in any manner - Birla Global
Finance Ltd., In re [2004] 50SCL(Bom.).
It may be further noted that notice of redemption of preference shares must be sent
to the Registrar under section 95 of the Act.
Company's liability on undeclared preference capital dividend when such capital is
redeemed
Even though the preference capital carries a rate of dividend or amount of dividend
per share, that rate or amount becomes the company's liability only when declared. This is,
notwithstanding the fact that the shares are cumulative. The process of commutation starts
only when dividend is declared. If no declaration of dividendhas been made, no liability for
undeclared dividend attaches the company while redeeming such shares.
The Companies (Amendment) Act, 1988, as further amended in 1996 has prohibited
the issue of any preference share which is irredeemable or is redeemable after the expiry of
a period of twenty years from the date of its issue [Sec. 80(5A)].
Section 80A, also inserted by the Amendment Act, 1988, provides that all existing
irredeemable preference shares will be compulsorily redeemed within 5 years after the
commencement of the Amendment Act, 1988 (i.e., 15th June, 1988) and preference shares
redeemable after 10 years from the date of issue will either be redeemed as per terms of
issue or within 10 years from the commencement of the Amendment Act, 1988, whichever
is earlier.
However, where a company is not in a position to redeem any such share within the
period aforesaid and to pay the dividend, if any, due thereon, it may with the consent of the
Company Law Board, issue further redeemable preference shares equal to the amounts due
(including the dividend thereon) in respect of the unredeemed preference shares. On issue
of such further redeemable preference shares, the unredeemed shares shall be deemed to
have been redeemed [Section 80A (1)].
While consent of CLB may have to be obtained by a company for issuance of
redeemable preference shares by virtue of stipulations contained in section 80A, it cannot
be said that such a consent should have been mandatorily obtained in advance and in
absence of any such consent, any company can be wholly prevented from applying for such
consent after issuance of redeemable preference shares. Consent to be obtained under
proviso to section 80A from CLB can be obtained even after issuance of redeemable
preference shares in lieu of irredeemable preference shares already issued, so long as such
issuance is bona fide and is in order to fulfil object and purpose of amendment with which
section 80A came to be introduced in Sahu Cylinders &Udyog (P.) Ltd, v. Registrar of
Companies [2007] 80 SCL 37 (Mad.).
Non-compliance with the provisions of section 80A will render the company liable to
a fine up to Rs.1000 per day for the duration of the default [Sec. 80A (3)]. It will also render
every officer of the company liable to punishment by way of imprisonment up to three years
and also to fine.
Comparative study between preference shares and equity shares:
Preference shares are entitled to a fixed rate/amount of dividend. The rate of
dividend on equity shares depends upon the amount of net profit available after
payment of dividend to preference shareholders and the fund requirements of the
company for future expansion etc.
Dividend on the preference shares is paid in preference to the equity shares. In other
words, the dividend on equity shares is paid only after the preference dividendhas
been paid.
The preference shares have preference in relation to equity shares with regard to
the repayment of capital on winding-up.
If the preference shares are cumulative, the dividend not paid in any year is
accumulated and until such arrears of dividend are paid, equity shareholders are
notpaid any dividend.
Redeemable preference shares are redeemed by the company on expiry of
thestipulated period, but equity shares cannot be redeemed.
The voting rights of preference shareholders are restricted. An equity
shareholdercan vote on all matters affecting the company but a preference
shareholder can voteonly when his special rights as a preference shareholder are
being varied or theirdividend is in arrears for at least two years.
A company may issue rights shares or bonus shares to the company's existingequity
shareholders whereas it is not so allowed in case of preference shares (Section81).

Prior to the Companies Act, 1956, shares were classified into three kinds:
Ordinary shares or Equity Shares;
Preference shares; and
Deferred shares
Deferred/Founders' shares:
A private company may issue what are known as deferred or founders' shares. Such
shares are normally held by promoters and directors of the company. That is why they are
usually called founders' shares. These shares are usually of a smaller denomination, say one
rupee each. However, they are generally given equal voting rights with equity shares which
may be of higher denomination, say Rs. 10 each.
Thus, by in vesting relatively lower amounts, the promoters may gain control over
the management of the company. As regards payment of dividend to holders of such shares,
the articles usually provide that these shares will carry a dividend fixed in relation to the
profits available after dividends have been declared on the preference and equity shares. It
is because of this deferment of the dividend payment that these shares are called deferred
shares. The promoters, founders and directors tend to have a direct interest in the success
of the company because they will receive dividends on these shares only if the profits are
high enough to leave a balance after paying dividends to preference and equity
shareholders. Besides, greater the profits of the company, the higher will be the dividends
paid on these shares.

Apart from the above types of shares there are few more like:
Cumulative Convertible Preference Shares (CCPS) - The Government vide its guidelines
dated 19th August, 1985 permitted issue of another class of shares by public limited
companies, called cumulative convertible preference shares. Under SEBI Act, 1992, issue of
any security convertible into equity shall be subject to SEBI (Issue of capital and Disclosure
Requirements) Regulations, 2009. Accordingly, such shares can now be issued in accordance
with the said SEBI Regulations only.
Par Value of Shares - The companies have the freedom to issue shares in any denomination
to be determined by them in accordance with section 13(4) of the Companies Act, 1956 and
SEBI Regulations, 2009.Thus, different companies may now issue shares of different par
value. For instance, XYZ Ltd. can issue shares to the public at say, Rs. 3, while ABC Ltd. can
issue at Rs. 5. However, the facility of fixing par value other than Rs. 10 or Rs. 100 has been
made available only to those companies whose shares have either been dematerialized or
who have applied for the same.
Non-voting shares - 'Non-voting shares' as the term suggests are shares whichcarry no
voting rights. These are contemplated as altogether a different class of shareswhich may
carry additional dividends in lieu of the voting rights. Section 86, asamended by the
Companies (Amendment) Act, 2000 has allowed issue of equityshares without voting rights.


SHARE CAPITAL AND TYPES OF SHARE CAPITAL
A company, being an artificial person, cannot generate its own capital which has necessarily
to be collected from several persons. These persons are known as shareholders and the
amount contributed by them is called share capital. Since the number of shareholders is
very large, a separate capital account cannot be opened for each one of them. Hence,
innumerable streams of capital contribution merge their identities in a common capital
account called as Share Capital Account.
Share capital

1. What is share capital?

When people form a company, they decide whether to limit the members' liability by
shares. The memorandum of association (a document required in the companys formation)
must state: the amount of share capital the company will have; and the division of the share
capital into shares of a fixed amount.
From accounting point of view the share capital of the company can be classified as follows:



2. What is authorised capital?
A limited companys authorised share capital is the amount of capital with which it
starts its life (but which it can alter subsequently) and which the memorandum of
association states. A companys authorised share capital is not the same as its issued
capital.
Authorized Capital: Authorised capital is the amount of share capital which a
company is authorised to issue by its Memorandum of Association. The company
cannot raise more than the amount of capital as specified in the Memorandum of
Association. It is also called Nominal or Registered capital. The authorised capital can
be increased or decreased as per the procedure laid down in the Companies Act. It
should be noted that the company need not issue the entire authorised capital for
public subscription at a time. Depending upon its requirement, it may issue share
capital but in any case, it should not be more than the amount of authorised capital.
Issued Capital: It is that part of the authorised capital which is actually issued to the
public for subscription including the shares allotted to vendors and the signatories to
the companys memorandum. The authorised capital which is not offered for public
subscription is known as unissued capital. Unissued capital may be offered for
public subscription at a later date.
Subscribed Capital: It is that part of the issued capital which has been actually
subscribed by the public. When the shares offered for public subscription are
subscribed fully by the public the issued capital and subscribed capital would be the
same. It may be noted that ultimately, the subscribed capital and issued capital are
the same because if the number of share, subscribed is less than what is offered, the
company allot only the number of shares for which subscription has been received.
In case it is higher than what is offered, the allotment will be equal to the offer. In
other words, the fact of over subscription is not reflected in the books.
Called-up Capital: It is that part of the subscribed capital which has been called up
on the shares. The company may decide to call the entire amount or part of the face
value of the shares. For example, if the face value (also called nominal value) of a
share allotted is Rs. 10 and the company has called up only Rs. 7 per share, in that
scenario, the called up capital is Rs. 7 per share. The remaining Rs. 3 may be
collected from its shareholders as and when needed.
Paid-up Capital: It is that portion of the called up capital which has been actually
received from the shareholders. When the share holders have paid all the call
amount, the called-up capital is the same to the paid-up capital. If any of the
shareholders has not paid amount on calls, such an amount may be called as calls in
arrears. Therefore, paid-up capital is equal to the called-up capital minus call-in-
arrears.
Uncalled Capital: That portion of the subscribed capital which has not yet been
called-up. As stated earlier, the company may collect this amount any time when it
needs further funds.
Reserve Capital: A company may reserve a portion of its uncalled capital to be called
only in the event of winding up of the company. Such uncalled amount is called
Reserve Capital of the company. It is available only for the creditors on winding up
of the company.
What is issued capital?
Issued capital is the value of the shares issued to shareholders. This means the nominal
value of the shares rather than their actual worth.
A company may increase its issued capital by allotting more shares, but only up to the
maximum allowed by its authorised capital (i.e. a companys issued share capital cannot
exceed its authorised share capital); it must make allotments under proper authority .
A public company may offer shares to the general public in a prospectus or by listing
particulars.
A private company may normally only issue shares to its members, to staff and their
families, and to debenture holders. However the company may issue shares to anyone it
chooses by private arrangement.
Alternation of capital
A company limited by shares can alter the capital clause of its Memorandum in any of the
following ways provided that such alteration is authorised by the articles of association of
the company :-
1. Increase in share capital by such amount as it thinks expedient by issuing new
shares.
2. Consolidate and divide all or any of its share capital into shares of larger amount
than its existing shares. eg, if the company has 100 shares of Rs.10 each (
aggregating to Rs. 1000/-) it may consolidate those shares into 10 shares of Rs100
each.
3. Convert all or any of its fully paid shares into stock and re-convert stock into fully
paid shares of any denomination.
4. Subdivide shares or any of shares into smaller amounts fixed by the Memorandum
so that in subdivision the proportion between the amount paid and the amount if
any unpaid on each reduced shares shall be same as it was in case of from which the
reduced share is derived.
5. Cancel shares which have been not been taken or agreed to be taken by any person
and diminish the amount of share capital by the amount of the shares so cancelled.
The alteration of the capital of the company in any of the manner specified above can be
done by passing a resolution at the general meeting of the company and does not require
any confirmation by the court.

Can a company reduce its issued capital?
Provisions of The Companies Act, 1956
81. Further issue of capital.
(1)
1
[Where at any time after the expiry of two years from the formation of a
company or at any time after the expiry of one year from the allotment of shares in
that company made for the first time after its formation, whichever is earlier, it is
proposed to increase the subscribed capital of the company by allotment of further
shares, then,]
(a) such
2
[further] shares shall be offered to the persons who, at the date of the
offer, are holders of the equity shares of the company, in proportion, as nearly as
circumstances admit, to the capital paid up on those shares at that date;(b) the offer
aforesaid shall be made by notice specifying the number of shares offered and
limiting a time not being less than fifteen days from the date of the offer within
which the offer, if not accepted, will be deemed to have been declined;(c) unless the
articles of the company otherwise provide, the offer aforesaid shall be deemed to
include a right exercisable by the person concerned to renounce the shares offered
to him or any of them in favour of any other person; and the notice referred to in
clause (b) shall contain a statement of this right;

(d) after the expiry of the time specified in the notice aforesaid, or on receipt of
earlier intimation from the person to whom such notice is given that he declines to
accept the shares offered, the Board of directors may dispose of them in such
manner as they think most beneficial to the company.

Explanation.In this sub-section equity share capital and equity shares have the
same meaning as in section 85.

3
[(1A) Notwithstanding anything contained in sub-section (1), the further shares
aforesaid may be offered to any persons [whether or not those persons include the
person referred to in clause (c) of sub-section (1)] in any manner whatsoever(a) if
a special resolution to that effect is passed by the company in general meeting, or(b)
where no such special resolution is passed, if the votes cast (whether on a show of
hands, or on a poll, as the case may be) in favour of the proposal contained in the
resolution moved in that general meeting (including the casting vote, if any of the
Chairman) by members who, being entitled so to do, vote in person, or where
proxies are allowed, by proxy, exceed the votes, if any, cast against the proposal by
members so entitled and voting and the Central Government is satisfied, on an
application made by the Board of directors in this behalf, that the proposal is most
beneficial to the company.]
(2) Nothing in clause (c) of sub-section (1) shall be deemed(a) to extend the time
within which the offer should be accepted; or(b) to authorise any person to exercise
the right of renunciation for a second time on the ground that the person in whose
favour the renunciation was first made has declined to take the shares comprised in
the renunciation.
[(3) Nothing in this section shall apply (a) to a private company; or (b) to the
increase of the subscribed capital of a public company caused by the exercise of an
option attached to debentures issued or loans raised by the company (i) to convert
such debentures or loans into shares in the company, or(ii) to subscribe for shares in
the company:
5
[Provided that the terms of issue of such debentures or the terms of such loans
include a term providing for such option and such term
(a) either has been approved by the Central Government before the issue of
debentures or the raising of the loans, or is in conformity with the rules, if any made
by that Government in this behalf; and
(b) In the case of debentures or loans other than debentures issued to, or loans
obtained from, the Government or any institution specified by the Central
Government in this behalf, has also been approved by a special resolution passed by
the company in general meeting before the issue of the debentures or the raising of
the loans.]]
6
[(4) Notwithstanding anything contained in the foregoing provisions of this section,
where any debentures have been issued to, or loans have been obtained from the
Government by a company, whether such debentures have been issued or loans
have been obtained before or after the commencement of the Companies
(Amendment) Act, 1963, the Central Government may, if in its opinion it is necessary
in the public interest so to do, by order, direct that such debentures or loans or any
part thereof shall be converted into shares in the company on such terms and
conditions as appear to that Government to be reasonable in the circumstances of
the case, even if the terms of issue of such debentures or the terms of such loans do
not include a term providing for an option for such conversion.

(5) In determining the terms and conditions of such conversion, the Central
Government shall have due regard to the following circumstances, that is to say, the
financial position of the company, the terms of issue of the debentures or the terms
of the loans, as the case may be, the rate of interest payable on the debentures or
the loans, the capital of the company, its loan liabilities, its reserves, its profits during
the preceding five years and the current market price of the shares in the company.

(6) A copy of every order proposed to be issued by the Central Government under
sub-section (4) shall be laid in draft before each House of Parliament while it is in
session for a total period of thirty days which may be comprised in one session or in
two or more successive sessions.
(7) If the terms and conditions of such conversion are not acceptable to the
company, the company may, within thirty days from the date of communication to it
of such order or within such further time as may be granted by the Court prefer an
appeal to the Court in regard to such terms and conditions and the decision of the
Court on such appeal and, subject only to such decision, the order of the Central
Government under sub-section (4) shall be final and conclusive.]
85. Two kinds of share capital.
(1) Preference share capital means, with reference to any company limited by
shares, whether formed before or after the commencement of this Act, that part of
the share capital of the company which fulfils both the following requirements,
namely:
(a) that as respects dividends, it carries or will carry a preferential right to be paid a
fixed amount or an amount calculated at a fixed rate, which may be either free of or
subject to income-tax; and
(b) that as respects capital, it carries or will carry, on a winding up or repayment of
capital, a preferential right to be repaid the amount of the capital paid up or deemed
to have been paid up, whether or not there is a preferential right to the payment of
either or both of the following amounts, namely:
(i) any money remaining unpaid, in respect of the amounts specified in clause (a), up
to the date of the winding up or repayment of capital; and
(ii) any fixed premium or premium on any fixed scale, specified in the memorandum
or articles of the company.

Explanation.Capital shall be deemed to be preference capital, notwithstanding
that it is entitled to either of both of the following rights, namely:
(i) that, as respects dividends, in addition to the preferential right to the amount
specified in clause (a), it has a right to participate, whether fully or to a limited
extent, with capital not entitled to the preferential right aforesaid;
(ii) that, as respects capital, in addition to the preferential right to the repayment, on
a winding up, of the amounts specified in clause (b); it has a right to participate,
whether fully or to a limited extent, with capital not entitled to that preferential
right in any surplus which may remain after the entire capital has been repaid.
(2) Equity share capital means, with reference to any such company, all share
capital which is not preference share capital.
(3) The expressions preference share and equity share shall be construed
accordingly.
1
[86. New issues of share capital to be only of two kinds.The share capital of a
company limited by shares shall be of two kinds only, namely:
(a) equity share capital
(i) with voting rights; or
(ii) with differential rights as to dividend, voting or otherwise in accordance with
such rules and subject to such conditions as may be prescribed;
(b) preference share capital.]

Provision which deal with reduction of share capital.
Sections 100 - 105 of the Companies Act, 1956, provide for the reduction of capital.
Similarly a scheme of arrangement having the ingredients of demerger and " reduction of
share capital" was permissible under the provision of section 391-394 and could not said to
be beyond the purview of the Companies Act 1956.
Section 100 of Companies Act:
would like to mention section 100 of the companies Act, which states that:-
(1) Subject to confirmation by the (Tribunal) a company limited by shares or a
company limited by guarantee and having a share capital, may, if so authorized by its
articles, by special resolution, reduce its share capital in any way; and in particular and
without prejudice to the generality of the foregoing power, may-
(a) Extinguish or reduce the liability on any of its shares, in respect of share capital not paid
up;
(b) Either with or without extinguishing or reducing liability on any of its shares, cancel any
paid up share capital which is lost, or is unrepresented by available assets; or
(c) Either with or without extinguishing or reducing liability on any of its shares, pay of any
paid up share capital which is in excess of the wants of the company; And may, if and so for
as is necessary, alter its memorandum by reducing the amount of its share capital and of its
shares accordingly.
(2) A special resolution under this section is in this Act referred to as "a resolution for
reducing share capital".
To sum up section 100, a company may if so authorized by its articles of association,
by special resolution may reduce its share capital, which needs to be confirmed by an order
of (tribunal).
The three primary ways of making such a reduction are:-
(1) The extinction of liability on shares not fully paid up:-
(2) The cancelation of paid up share capital which is lost or not represented by assets;
(3) Pay of any paid up share capital which is in excess of the wants of the company.
Essential Requirements for Reduction:-
Taking into consideration section 100 of companies Act, it could be easily said that a
clause in the articles of association with regards to reduction, secondly special resolution to
that effect and lastly confirmation by the (Tribunal) , these three form the basic elements of
reduction of share capital.
Manner of Reduction:
There is no particular manner which is provided by the act for the reduction of capital
and the manner to eliminate the shareholder from the company. Section 100 does not
prescribe the manner in which the reduction of capital is to be effected. Nor is there any
limitation on the power of the (Tribunal), to confirm the reduction of capital, except that it
must be first satisfied that all the creditors entitled to object to the reduction have been
consented or have been paid or secured.
Process of Reduction:
Although, there is no particular process of reduction of capital as contemplated by the
Act, Yet the Supreme court in Punjab Distilleries India Ltd., V. CIT, (1965) 35 Comp Cases
541, 544 summed up the process of reduction thus: "First, there will be a resolution by the
general body of a company for reduction of capital by distribution of the accumulated
profits amongst the shareholders. Secondly, the company will file an application in the court
for an order confirming the reduction of capital. Thirdly, after it is confirmed, it will be
registered by the Registrar of Companies. Fourthly, after the registration the company will
issue notices to the shareholders inviting application for refund of the share capital and
fifthly on receiving the applications the company will distribute the said profits.
Internal Issue:
The majority of share holders involve themselves in reducing the share capital
without any hassle as it is considered to be an internal issue or an issue of domestic
concern. This principal has been taken into consideration is a number of cases. Let us look at
a few of them and how they enunciate the above said statement. The issue of reduction of
capital is a matter of domestic concern, one for the decision of the majority, of the
shareholders of the company. In other case it was held that reduction of the share capital of
a company is a domestic concern of the company and the decision of the majority would
prevail. If the majority by special resolution decides to reduce the share capital of the
company, it has the right to decide, how this reduction should be effected. While reducing
the share capital the company can decide to extinguish some of its shares without dealing in
the same manner with all other shares of the same class. A selective reduction is permissible
within the frame work of law for any company limited by shares. The same was upheld
even in the case of Re Panruti Industrial Co. (Private) Ltd., AIR 1960 Madras 537 (V47 (179).
Alterable Article of Association:
One of the basic ingredients for bringing into effect reduction of capital is a clause in
the articles of association to that effect. If suppose there is no clause in the articles of
association with regards to this and the person subscribes for being a shareholder, with the
conception that his stay in the company is secured, then also on the will of the majority, if
they want to eliminate him, it could be done easily by the majority. That is just by
introducing a clause in the articles of association with regards to reduction of capital. The
majority could simply bring on alteration in the articles of association through section 31 of
the Companies Act; this is definitely a kind of deception practiced by the majority
shareholders.
General Rule of Reduction:
The general rule of reduction of capital, is that the prescribed majority of
shareholders are entitled to decide whether there should be a reduction of capital and if so,
in what manner and what extent it should be carried into effect.
Objective not taken into consideration:

There are a number of reasons why the majority share holders want to reduce their
share capital. Some of the reasons may be doubtful value, to mislead the government, to
remove the minority etc. When send to the court to get its nod for reduction, the court
doesn't look at the motive behind the reduction. When exercising its discretion the court is
concerned to see that the reduction is fair and equitable .
Majority Affairs:
Even though the court has said that reduction of capital is a domestic affair in number
of cases. Virtually specking it is majority affairs and not domestic affairs, since it is only the
majority which decides what needs to be done. Reduction of capital is a sort of power which
has been entrusted in the hands of the majority promoter shareholder. An issue could be
said to be domestic or inside issue when it involves the active participation of all the persons
existing inside the family or company, but here it is not the case.
Reduction of capital without the sanction of the court
Reduction of capital can take place without the sanction of the court in the following cases
1. Buy back of shares in accordance to the provisions of Section 77A and 77B
2. Forfeiture of shares - A company may if authorised by its articles forfeit shares for
non-payment of calls by the shareholders. Such proceedings amount to reduction of
capital but the act does not require court sanction for this purpose.
3. Valid surrender of the shares - A company may accept the surrender of shares
4. Cancellation of capital - A company may cancel the shares which has not been taken
up or agreed to be taken by the person and diminish the amount of its share capital.
5. Purchase of shares of member by the company under Section 402B. The Company
Law Board may, on application made under Section 397 or Section 398, order the
purchase of shares or interest of any member of the company by the company.
These provisions come in force when a prescribed number of members make a
complaint to the CLB for mis-management or oppression of the minority
shareholders in the company.
6. Redemption of redeemable preference shares. Where redeemable preference
shares are redeemed, it actually amounts to reduction of the capital. However, this
does not require the sanction of the court.
Buy-back of shares : Buy back of its own shares by a company is nothing but reduction of
share capital. After the recent amendments in the Companies Act, 1956 buy back of its own
shares by a company is allowed without sanction of the Court. It is nothing but a process
which enables a company to go back to the holders of its shares and offer to purchase from
them the shares that they hold.
There are three main reasons why a company would opt for buy back :-
1. To improve shareholder value, since with fewer shares earning per share of the
remaining shares will increase.
2. As a defense mechanism against hostile take-overs since there are fewer shares
available for the hostile acquirer to acquire.
3. Public Signaling of the Managements Policy.
Cases:
Om metals & materials Ltd.,In re [2003],when in spite of publication of notice in
newspapers and gazette none of shareholders or creditors appeared to oppose
petition under section 101, reduction of share capital as resolved and effected by
resolution by the company was to be confirmed.
Hyderabad Industries Ltd., In re[2004]
When a resolution of general body of shareholders resolving to reduce share capital
of company does not prejudicially affect rights of shareholders and creditors, there is
no legal impediment for company court to grant its approval / confirmation to such a
resolution.

CONCLUSION

Thus I would like to conclude by saying that , in most of the cases, a company on the
pretext of reducing capital utilizes its accumulated profits to pay to the minority
shareholders whole or part of the paid up amount on the shares. A minority shareholders
though in form gets back the whole or a part of the capital contributed by him, in effect he
gets a share of the accumulated profit, which if a straight forward course was followed, he
should have received dividend. This is elimination of minority under the guise of reduction
of capital.
In case of unlisted company, how do you decide a fair price for the share, what is fair
and equitable, must depend on circumstances of each case.Thus, fair price is denied to the
minority shareholders in most of the cases.

RIGHTS ISSUE
Introduction:
A rights issue is a way in which a company can sell new shares in order to raise capital.
Shares are offered to existing shareholders in proportion to their current shareholding,
respecting their pre-emption rights. The price at which the shares are offered is usually at a
discount to the current share price, which gives investors an incentive to buy the new shares
if they do not, the value of their holding is diluted.
SEBI regulations regarding rights issues under Issue of Capital and Disclosure Regs, 2009
Applicability:
1) These guidelines apply to the rights issues made by existing listed companies (i.e.
Companies whose equity capital is listed). Therefore, a company whose debentures/
bonds are listed but not the equity (i.e. shares) will not be governed by these
guidelines.
These guidelines are not applicable where the size of the issue is uptoRs. 50 Lakhs
(including premium)
Record Date:
1) A listed issuer making a rights issue shall announce a record date for the purpose of
determining the shareholders eligible to apply for specified securities in the
proposed rights issue.
2) The issuer shall not withdraw rights issue after announcement of the record date.
3) If the issuer withdraws the rights issue after announcement of the record date , it
shall not make an application for listing of any of its specified securities on any
recognised stock exchange for a period of twelve months from the record date
announced under sub-regulation (1)
Provided that the issuer may seek listing of its equity shares allotted pursuant to conversion
or exchange of convertible securities issued prior to the announcement of the record date,
on the recognised stock exchange where its securities are listed.
RESTRICTIONS ON RIGHTS ISSUE
1) No issuer shall make a rights issue of equity shares if it has outstanding fully or partly
convertible securities instrument at the time of making rights issue, unless it has
made reservation of equity shares of the same class in favour of the holders of such
outstanding convertible debt instrument in proportion to the convertible part
thereof.
2) The equity shares reserved for the holders of fully or partially convertible debt
instrument shall be issued at the time of conversion of such convertible debt
instruments on the same terms on which the equity shares offered in the rights issue
were issued.
LETTER OF OFFER, ABRIDGED LETTER OF OFFER, PRICING AND PERIOD
OFSUBSCRIPTION
1) The abridged letter of offer, along with application form, shall be dispatched through
registered post or speed post to all the existing shareholders at least three days
before the date of opening of the issue:
Provided that the letter of offer shall be given by the issuer or lead merchant banker to
any existing shareholder who has made a request in this regard.
2) The shareholders who have not received the application form may apply in writing
on a plain paper, along with the requisite application money.
3) The shareholders making application otherwise than on the application form shall
not renounce their rights and shall not utilise the application form for any purpose
including renunciation even if it is received subsequently.
4) Where any shareholder makes an application on application form as well as on plain
paper, the application is liable to be rejected.
5) The issue price shall be decided before determining the record date which which
shall be determined in consultation with the designated stock exchange.
6) A rights issue shall be open for subscription for a minimum period of fifteen days and
for a maximum period of thirty days.
PRE-ISSUE ADVERTISEMENT FOR RIGHTS ISSUE:
1)The issuer shall issue an advertisement for rights issue disclosing the following:
a) The date of completion of despatch of abridged letter of offer and the application
form
b) The centres other than registered office of the issuer where the shareholders or the
persons entitled to receive the rights entitlements may obtain duplicate copies of the
application forms in case they do not receive the application form within a reasonable
time after opening of the rights issue.
c) a statement that if the shareholders entitled to receive the rights entitlements have
neither received the original application forma nor they are in a position to obtain the
duplicate forms, they may make application in writing on a plain paper to subscribe to
the rights issue.
d) a format to enable the shareholders entitled to apply against their rights
entitlements, to make the application on a plain paper specifying therein necessary
particulars such as name, address, ratio of rights issue, issue price, number of equity
shares held, ledger folio numbers, depository participant ID, client ID, number of equity
shares entitled and applied for, additional shares if any, amount to be paid along with
application,and particulars of cheque, etc. to be drawn in favour of the issuers account.
e) a statement that the applications can be directly sent by the shareholders entitled to
apply against rights entitlements through registered post together with the application
moneys to the issuers designated official at the address given in the advertisement;
f) a statement to the effect that if the shareholder makes an application on plain paper
and also on application from both his applications shall be liable to be rejected at the
option of the issuer.
2) The advertisement shall be made in at least one English national daily newspaper with
wide circulation, one Hindi national daily newspaper with wide circulation and one
regional language daily newspaper with wide circulation at the place where registered
office of the issuer is situated, at least three days before the date of opening of the
issue.
UTILISATION OF FUNDS RAISED IN RIGHTS ISSUE
The issuer shall utilise funds collected in rights issues after the finalisation of the basis of
allotment.
Duty of transfer to transferee in respect of rights shares- There may be pending transfers
at the time when a rights issue takes place. This raises the question whether the
transferor of an unregistered transfer is under any obligation towards his transferee to
apply for the rights shares for the benefit of the transferee. The Bombay High Court in
Dinge Venkstarama reddy v Padampat Singhania AIR 1950 Bom.76 held that It was the
duty of the transferor to apply for the new shares and to hold them in trust for the
transferee. But, the Supreme Court in R. Mathalone v. Bombay Life Assurance co. Ltd
AIR 1953 SC 385 has upheld a contrary view. The Supreme Court, in this case, observed
that after the transfer form has been executed, the transferor cannot be held to
undertake any additional financial burden in respect of the shares at the instance of the
transferee where, after the transfer of shares, but before the company had registered
the transfer, the company offered rights shares to its members. The transferor could not
be compelled by the transferee to take up on his behalf the rights shares offered to the
transferor and all that he could require the transferor to do was to renounce the rights
issue in the transferees favour.
Allotment to renounce-As per section 81(10)(c), unless the Article of the company
otherwise provide, the letter of offer of rights shall be deemed to include a right to
renounce the shares offered to a member in favour of any other person: and the notice
sent to him must contain a statement to this effect. When a shareholder renounces any
of the right shares offered to him, in favour of a third person, it is not in the nature of
transfer of such shares. The Board of director, therefore, cannot refuse to allot the
shares to the renounce unless the Article so provide.Re Simo Securities Trust Ltd. [1972]
42 Comp. Cas. 457
In the case of shares registered in joint names, any of the joint holders may lodge a
letter of renunciation.
Procedure for issue of Rights Shares- For issue of rights shares, a company is required to
follow the procedure as laid down in section 81 of the Companies act and also the
regulations issued by SEBI in this regard.( the SEBI Regulations apply only to rights issue
made by existing listed companies. They do not apply to issue of rights shares of any
amount by existing private company/ closely held or other unlisted company)
The various steps involved for issue of rights shares may be noted as follows:
1) See that the rights issue in within the authorised share capital of the company.If not,
steps should be taken to increase the same.
2) If the rights shares are to be issued out of unclassified shares, take steps to amend
the capital clause to classify unclassified shares as equity/ preference shares
proposed to be issued.
3) Notify the stock exchange concerned the date of the Board meeting at which the
rights issue is proposed to be considered.
4) Where the issue size exceeds Rs. 50 lakhs, take steps for the appointment of eligible
merchant banker since, as per SEBI regulations, the appointment of a eligible
merchant banker in case of rights issue of listed companies exceeding Rs. 50 Lakhs in
mandatory.
5) In case the issue proposed to be made at premium, fix the premium in consultation
with lead manager to the issue. Differential premium may, however, be charged,
e.g., a higher premium may be charged from foreign investor as compared to the
other existing shareholders.
6) Appoint registers and the underwriters. Appointment of underwriters, as per SEBI
regulations, is, however, optional.
7) Note that there can be no preferential allotment in respect rights issue to the
employees or any other identified person like group companies or financial
institutions, etc.
8) In consultation with the stock exchange(s), fix the record date for the proposed
issue.
9) If it is proposed to offer shares to person other than the existing members, a general
meeting be convened and a special resolution or an ordinary resolution in lieu of
special resolution passed for the purpose in terms of section 81(1A). It may be noted
that the Central Governments approval is necessary in case of ordinary resolution.
10) If issue is to be offered to NRIs, file the requisite form and declarations with RBI. No
prior approval of the RBI required for offer of shares to NRIs on non- repatriation
basis
11) Forward sis sets of letter of offer to the concerned stock exchange.
12) Note that in case the rights issue is withdrawn after the announcement of the record
date, the regional stock exchange will not permit the making of application for listing
of shares for a minimum period 12 months from the record date.
13) Make arrangements with bankers for acceptance of shares application forms.
14) Make arrangements for despatch of letters of offer to shareholders containing
details as per section 81 of the Companies Act, 1956 as well as SEBI regulations.
15) Ensure that the issue is kept open for a minimum period of 15 days but not beyond
30 days.
16) Open a specific bank account for keeping subscription received rights issue. Note
that the money deposited in this account cannot be utilised until and unless the
company has received from the concerned regional stock exchange(s) approval for
utilisation of this money.
17) In case the company does not receive 90% of the issue amount including accepted
development from underwriters within 60 days from the date of the closure of the
issue, the amount of subscription received shall be required to be refunded.
In respect of underwriter devolvement, lead merchant banker must ensure that the
underwriters honour their commitments within 70 days of the closure of the issue.
18) Prepare a scheme of allotment in consultation with stock exchange(s)
19) Convene Board meeting and make allotment of shares.
20) File return of allotment in Form No. 2 with Registrar of Companies within 30 days of
allotment.
21) Complete other formalities such as refund of excess application money, issue of
allotment letters, making of entries in various registers, etc.
22) Forward a report in the prescribed form to the SEBI within 15 days of the date of
finalisation of allotment or within 15days of refund or money in case of failure of
issue.
23) Note that if the instrument of transfer of shares has been delivered to the company
but the same has not been registered till the date of closure of register of members,
keep in abeyance the offer of rights shares relating to the shares involved in the
transfer [section 206A] of the Companies Act, 1956.



REDUCTION OF SHARE CAPITAL
INTRODUCTION:
A reduction of capital is a capital re-organization that has the effect of allowing the
return to shareholders of capital would otherwise not be distributable. A reduction of
capital is used to increase distributable reserves to make dividend payments possible, or to
make a large return of capital more efficient. There are a number of possible mechanisms,
including:
a share buyback,
the conversion of share capital and non distributable reserves into debt capital
the conversion of non distributable reserves into distributable reserves.
Section 100-105 of Indian Company Act, 1956 provide for the reduction of share capital.
A company limited by share, if so authorized by its articles, may by special resolution, which
is to be confirmed by the court, reduce its share capital. Here I deal with the basis of
reduction of capital and how unfairly the minority shareholders are eliminated from the
company in certain occasions with the help of reduction of capital.
The term Minority means persons who hold relatively less number of shares compared
to other shareholders in the company. The word "Capital" involved in "reduction of capital"
includes nominal share capital, whether issued or unissued and if issued whether fully paid
or not and "share" includes "stock" so that a company must reduce its stock. Every
reduction of capital must reduce the nominal capital, and a reduction of unissued capital
may be combined with a reduction of issued capital, while issued capital may be reduced,
whether fully paid or not.
A Company limited by shares or a guarantee company having a share capital may
reduce its capital in anyway, those are:-
a) by reducing or extinguishing the liability of members for uncalled capital.
b) By paying off or returning capital which is in excess of the wants of the company.
c) Pay off paid-up capital on the understanding that it may be called up again.
d) Cancel any paid up share capital which is lost or is unpresented by any available
assets.
25

PROCEDURE FOR REDUCTION OF SHARE CAPITAL:
After passing the special resolution for the reduction of capital, the company has to
apply to the court by way of petition to confirm the resolution under section-101. The
creditors are entitled to object where the proposed reduction of share capital involves
either:-
The diminution of liability in respect of unpaid capital or
The payment to any shareholder of any paid up share capital or in any other case, if
the court so directs.
Then the court settles a list of such people. If any creditor objects, either his consent to
the proposed reduction should be obtained or he should be paid off or his payment is
secured. Where all secured creditors have signified their consent to the proposed reduction,
court may dispense with the drawing up of list of creditors and notice such secured creditor.
Section-102 mandates that if the court is satisfied that either the creditors entitled to
object have consented to the reduction, or that their debts have been paid or secured, it
may confirm the reduction. Again the company must publish the reasons for the reduction
of the capital.
Again the reduction of share capital takes effect only on registration of the courts.
The Registrar will issue a certificate of registration which will be a conclusive
evidence for the requirements of reduction of capital.
Section-104 states the liability of members after reduction. A member shall be liable be
to pay the amount deemed to have been unpaid on his shares. So, his liability is to pay the
difference between the amount deemed to have been paid on his shares and the nominal
value of the reduced shares.
Section-105 provides for the punishment with imprisonment extending to one year or
fine both, if any officer of the company knowingly conceals the name of any creditor
entitled to object to the reduction or misrepresents the nature or amount of claim or debt.
Reduction of share capital without the sanction of the court:

25
See Vantech Industry Ltd. Re(1999)2 comp LJ47, a company allowed to cancel capital in respect of shares
which were allotted to public but which remained unpaid.
There are some cases in which there is reduction of share and no confirmation by the court
is necessary. These are:
a) Forfeiture of shares: A company may in pursuance of its articles, forfeit shares for
non-payment of calls.
b) Surrender of shares
c) Diminution of capital: section-94 states that diminution of capital does not amount
to reduction of capital.
d) Redemption of redeemable preference share
e) Purchase of shares of a member by the company: the CLB may order the purchase
of shares of any member of the company by the company under certain
circumstances.
f) Purchase of its own shares: Where a company purchases its own shares as per the
provisions of Section- 77A, 77AA and 77B.
Essential Requirements for Reduction:- Taking into consideration section 100 of companies
Act, it could be easily said that a clause in the articles of association with regards to
reduction, secondly special resolution to that effect and lastly confirmation by the
(Tribunal), these three form the basic elements of reduction of share capital.
Manner of Reduction: There is no particular manner which is provided by the act for the
reduction of capital and the manner to eliminate the shareholder from the company.
Section 100 does not prescribe the manner in which the reduction of capital is to be
effected. Nor is there any limitation on the power of the (Tribunal), to confirm the reduction
of capital, except that it must be first satisfied that all the creditors entitled to object to the
reduction have been consented or have been paid or secured.
Process of Reduction: Although, there is no particular process of reduction of capital as
contemplated by the Act, Yet the Supreme court in Punjab Distilleries India Ltd., V. CIT,
(1965) 35 Comp Cases 541, 544 summed up the process of reduction thus:
First, there will be a resolution by the general body of a company for reduction of
capital by distribution of the accumulated profits amongst the shareholders.
Secondly, the company will file an application in the court for an order confirming
the reduction of capital.
Thirdly, after it is confirmed, it will be registered by the Registrar of Companies.
Fourthly, after the registration the company will issue notices to the shareholders
inviting application for refund of the share capital and fifthly on receiving the
applications the company will distribute the said profits.


Variation in Shareholders Rights
Section 106 of the Companies Act 1956, provides that where the share capital of a company
is divided into different classes of shares, the rights attached to the shares of any class may
be varied with the consent in writing of the holders of not less than three-forth of the issued
share of that class or with the sanction of special resolution passed at their meeting.
However, this variation is possible only if provision for such variation is contained in the
Memorandum or Articles of the company, and in the absence of such a provision, if the
variation is not prohibited by the terms of issue of the shares of that class.
Section 107 of the Act provides that if the holders of 10% of the issued shares of that class
who had not assented to the variation apply to the court
26
within 21 days of the date of the
consent or the passing of the special resolution, the court may, after hearing the interested
parties, either confirms or cancel the variation. The company must within 30 days of the
service of the courts order, forward a copy of the order to the Registrar. In the event of a
default, the company and every officer in default is liable to fine up to Rs. 500.
In Girish kumar Kharia v. Industrial Forge & Engg. Co. Ltd. [1997] 21 SCL 234
The Patna High Court held that a variation which affects the enjoyment of right without
modifying the right itself is not a variation within the meaning of section 106. Increase in the
number of shares of any kind/ category for raising the capital or otherwise, though affects
the voting power of existing members by diminishing it in number, in no ways amounts to
variation of their rights as envisaged by section 106. The rights attached to ordinary equity
shares include the right to vote, right to receive dividend, right to maintain its face value
and right to transfer freely the shares to another. Unless such rights are altered or varied by
the company by the resolution of the shareholders in accordance with the provisions of
section 106, no action shall lie under section 107.
In Re, Chowgule & co.(P.) ltd. 1972 Tax LR 2163
The judicial commissioner of Goa, relying on the judgment in the case of St. James Court
Estates Ltd.[1944] Ch. 6, held that where the equity shares are sought to be converted into
redeemable preference shares, it was necessary to adopt the process of reduction of capital
under sections 100-104 of the Companies Act, 1956.
Can Redeemable preference shares be converted into convertible preference shares?
The proposition relates to variation of rights attached to existing redeemable preference
shares. Such shares would continue to be preference shares with further right to be
converted into equity shares as may be stipulated in the terms of alteration. Here, the case

26
Companies (Second Amendment) Act, 2002, the power now vests in the Tribunal [yet to take effect].

is centering round the companys basic right to issue convertible preference shares. Since
the companies generally poses that right( unless prohibited by the memorandum or the
articles), it seems that the alteration and the consequent creation of Convertible Preference
Shares is possible, subject to compliance with the provisions of the Memorandum of
association or the Articles of association. However when conversion to equity would take
place, the incidence of SEBIs Substantial Acquisition of Shares and Take Over Regulations
have to be taken into consideration. If instead of going by the provisions of section 106, the
concerned company can successfully get an arrangement approved by the court in terms of
section 391 and 394 of the Act, then the aforesaid compliance requirement with SEBIs
Regulations will not arise.


BUY BACK - INTRODUCTION

Share capital is a very essential part of a company, listed or unlisted. Share capital can be of
two types i.e. equity share capital or preferential share capital. The share capital of a
company has to be subscribed by one or more persons. After the share of a company has
been allotted to the subscribing members, the subscribers have no right over the money
gone as proceeds of the shares subscribed. All that the shareholder has is the right to vote
at the general meetings of the company or the right to receive dividends or right to such
other benefits which may have been prescribed. The only option left with the shareholder in
order to realise the price of the share is to transfer the share to some other person.

But there are certain provisions in the companies act which allow the shareholders to sell
their shares directly to the company and such provisions are termed as buy back of shares.
Buy back of shares can be understood as the process by which a company buys its share
back from its shareholder or a resort a shareholder can take in order to sell the share back
to the company.


HISTORY

Prior to the amendment of the 1999 of the companies act there was no way a company
could buy its shares back from the shareholders without a prior sanction of the court
(except for the preferential shares). The laws as to the buying of its share by the companies
were very stringent. Some of the ways by which a company could buy its shares back were
as follows:-

(i) Reduction of share capital as given in sections 100 to 104.
(ii) Redemption of redeemable preferential shares under section 80.
(iii) Purchase of shares under an order of the court for scheme of arrangement
under section 391 in compliance with the provisions of sections 100 to 104.
(iv) Purchase of shares of minority shareholders under the order of the company
law board under section 402(b).

Though there were ways by which a company could buy its shares back from the
shareholders but it could not be done without the sanction of the court. This was done to
protect the rights of the creditors as well as the shareholders. But the need of less complex
ways of buying its shares back by the company was always felt. The much needed change in
the companies act was brought about by the companies amendment act 1999.Sections 77A,
77AA and 77B were inserted in the companies act by this amendment.


REASONS FOR BUY BACK

In the words of the working group which recommended the introduction of buy back in the
companies act:
It is an erroneous belief that the sole reason for buy back is to block hostile take-overs. In
this connection it is pertinent to list five reasons why the bank of England favoured the
making of law to allow companies to repurchase their shares of which blocking take-over
was only one:
(i) To return surplus cash to shareholders
(ii) To increase the underlying share value
(iii) To support the share prices during temporary weakness.
(iv) To achieve or maintain a target capital structure.
(v) To prevent or inhibit unwelcome take-over bids.

Briefly a company resorting to the buy back may have surplus cash, and it may not have
found the right avenue to invest such surplus cash, during such period of dilemma the
company may decide to return the surplus cash by buying back its shares, with a hope that
at a later time when the company brings on an expansion the investors do not loose their
faith in the company. Secondly the company might as well think of buying its shares with a
view to increase the value of the shares which after the process of buy back still remain in
the market. For after the shares are bought back the number of marketable shares become
less and thus the prices increase. Thirdly, at times there is a slump in the share market due
to no fault of the company. Though the slouch may be temporary but may have continued
far too long .The management then may decide to give value to the shareholders and buy
back there shares at a price higher than the market price. This is generally done to instill
faith in the minds of the shareholders. Saving a company from hostile take-over has always
been seen as a major force behind bringing about this amendment, the company may use
the surplus cash available in buying back its shares and bringing the number of floating
shares down, resulting in the suitor not finding it a worthy investment or a profitable
acquisition. These could be certain reasons why a company may resort to buy back of its
shares.


RESOURCES OF BUY BACK:

The companies amendment act 1999 under section 77A prescribes for the sources of buying
back of shares or other specified securities by a company, which are as follows-:

i) Free reserves- a company may buy back out of its free reserves but a sum
equal to the nominal value of the shares so purchased must be deposited in the
capital redemption reserves account.
ii) Securities premium account.
iii) The proceeds of any shares or specified securities.

No buy back of any shares or securities shall be made out of the proceeds of an earlier issue
of the same kind of shares of same kind of securities


CONDITIONS FOR A BUY BACK :

Sub clause (2) of section 77A enshrines the conditions for a buy back, which are as follows :

a) It should be authorised by the articles of association of the company.
b) A special resolution has been passed at the general meeting of the company
authorising the buy back.
If the buy back is or less than 10 percent of the total paid up equity share capital,
a resolution at the general meeting is not needed to be passed rather a simple
board resolution is enough.
Provided that no offer of buy back shall be made within three sixty five days
reckoned from the date of proceeding offer of buy back.
c) The buy back is or less than 25 percent of the total paid up equity share\
capital and free reserves
d) The ratio of debt owned by the company is not more than twice the capital
and its free reserves after such buy back.
e) All the shares or other specified securities for buy back are fully paid up.
f) The buy back of shares or other specified securities listed on any recognised
stock exchange is in accordance with the regulations made by the securities and
exchange board of India in this behalf:
g) The buy back in respect of shares and other specified securities other than
those specified in the aforesaid clause is in accordance with the guidelines
specified.


DISCLOSURE IN THE EXPLANATORY STATEMENT :

Notice of the meeting at which a resolution for buy back is proposed to be passed has to be
accompanied by an explanatory statement stating
a) a full and complete disclosure of all material facts
b) the necessity for buy back
c) class of securities intended to be bought back under the buy back
d) the amount to be invested under buy back.


MODES OF BUY BACK :

Buy back of shares or other specified securities can be done through various sources which
have been illustrated under sub section 5 of section 77A, they are as follows:-

a) From the existing security holders on a proportionate basis or
b) From the open market, through ;
i) stock market
ii) book building process
c) From odd lots, that is to say where the lot of securities of a public company, whose
shares are listed on a recognised stock exchange, is smaller than such marketable
lot, as may be specified by the stock exchange; or
c) by purchasing the securities issued to employees of the company under a scheme
of stock option or sweat equity.


DECLARATION OF SOLVENCY:

Where a company has passed a special resolution under clause b of sub-section (2) or a
board resolution has been passed under some circumstances to buy back its own shares or
other specified securities, under the section, it shall before making such buy back ,file with
the registrar and the securities and exchange board of India a declaration of solvency in the
form as may be prescribed and verified by an affidavit to the effect that the board has made
a full enquiry into the affairs of the company as a result of which they have formed an
opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a
period one year of the date of declaration adopted by the board, and signed by at least two
directors of the company, one of whom shall be the managing director, if any.


REGISTER OF SECURITIES BOUGHT BACK :

Section 77A(9) prescribes for the manner in which a register shall be maintained a register
of shares so bought back and enter therein the following particulars:-
i) the consideration paid for the securities bought back.
ii) the date of cancellation of securities
iii) the date of extinguishing and physically destroying of securities.
iv) other particulars as may be prescribed.
The shares or the securities so bought back shall be physically destroyed within seven days
from the last date f completion of such buy back.


PROHIBITION ON FURTHER ISSUE OF SHARES AFTER BUY BACK :

Every buy back shall be completed within twelve months from the date of passing the
special resolution or the board resolution as the case may be. After the buy back is
completed the company is not allowed to issue the bought back shares for the period of six
months by any means including further issue of shares under section 81(1)(a) of the
companies act 1956. It may however issue bonus shares or discharge its subsisting
obligation of converting preference shares or other specified securities into equity shares.


PROCEDURE FOR BUY BACK

a. Where a company proposes to buy back its shares, it shall, after passing of the
special/Board resolution make a public announcement at least one English National
Daily, one Hindi National daily and Regional Language Daily at the place where the
registered office of the company is situated.
b. The public announcement shall specify a date, which shall be "specified date" for the
purpose of determining the names of shareholders to whom the letter of offer has to
be sent.
c. A public notice shall be given containing disclosures as specified in Schedule I of the
SEBI regulations.
d. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter
of offer shall then be dispatched to the members of the company.
e. A copy of the Board resolution authorising the buy back shall be filed with the SEBI
and stock exchanges.
f. The date of opening of the offer shall not be earlier than seven days or later than 30
days after the specified date.
g. The buy back offer shall remain open for a period of not less than 15 days and not
more than 30 days.
h. A company opting for buy back through the public offer or tender offer shall open an
escrow Account.


PROHIBITION OF BUY BACK IN CERTAIN CIRCUMSTANCES :

Section 77B holds the restrictions on the companies to buy back its shares. No company
shall buy its own shares or other specified securities
a) through any subsidiary company including its own subsidiary company.
b) Through any investment companies or group of investment companies.


PENALTY :

If a company makes default in complying with the provisions the company or any officer of
the company who is in default shall be punishable with imprisonment for a term which may
extend to two years, or with fine which may extend to fifty thousand rupees, or with both.
The offences are, of course compoundable under Section 621A of the Companies Act, 1956.


MEMBERS OF A COMPANY
Definition of member section 41
All the subscribers of the Memorandum of Association shall be deemed to have agreedto
become members of the company and on registration of a company shall be enteredas
members in the Register of members. Section 41 deals with definition of member which
provide as under:
i ) The subscribers of the Memorandum of a company shall be deemed to have agreed to
become members of the company, and on its registration, shall be entered as members in
its register of members.
ii) Every other person who agrees in writing to become a member of a company and whose
name is entered in its register of members, shall be a member of the company.(
iii) Every person holding equity share capital of a company and whose name is entered as
beneficial owner in the records of the depository shall be deemed to be a member of the
concerned company.

Shareholder Vs Member
In the case of a company limited by shares, the persons whose
names are put on the Register of members are the members of the members of the
company. They may also be called shareholders of the company as they have been
allotted shares and are holding them in their own right. In such a situation, the terms
`member` and `shareholder` are interchangeably used to mean the same person.
However, sometimes a distinction is maintained between a
member and a shareholder in the case of a company having a share capital.
1. Now, in the following three situation he will cease to be a shareholder, though he
continues to be the member of the company: -
a) On sale - X sells the shares to Y. He fills in a share transfer from and hands it
over to Y. He also gives the share certificate representing the shares to Y. In
return for sale of shares, he receives consideration from Y. X is no longer a
shareholder as he has sold the shares and property in the shares has passes to Y.
But the name of X continues to be on the Register of member till the transfer of
shares is registered by the company in favour of Y.
b) On death - X dies and his property including shares is inherited by Y, his legal
representative. X I no longer the shareholder. He is not in existence to hold the
shares. Y is holding the shares in his own right and, therefore, can right be
called the shareholder. But X continues to be the member as his name still
appears on the Register of members. However, as soon as Y gets his own name
registered in the Register of members, then X will cease to be a member.
c) On becoming insolvent - X becomes insolvent and his property, including shares,
vests in the Official Receiver of Official Assignee. The official Receiver or
Assignee is holding the shares in his own right. Therefore, X is no longer the
shareholder, though he continues to be the member of the company.
2. Ordinarily, a person who is holding a share warrant is shareholder but he is not a
member of the company as his name is struck off the Register of members [Section
2(27) and section 115].
3. In the case of a company limited by guarantee having no share capital or an
unlimited company having no share capital, there will be only `members` but no
`shareholder.

How to become a member
A person may become a member of a company in any of the following manner:
1. Membership by subscription to the Memorandum
A person subscribing to the Memorandum shall become a member of the company on its
incorporation and remains so till the company accepts his surrender of shares or he
transfers shares. In that case, an entry in the Register of members is not necessary and mere
allotment on the basis of subscription to Memorandum will suffice to constitute him as a
member.
Therefore, a subscriber is deemed to be a first member of the company and his membership
is beyond revocation after the issue of certificate of registration. A subscriber to
memorandum of association is deemed to have agreed to become a shareholder, even if he
submits no application and no allotment of shares is made to him. [Collector of
Moradabad v Equity Insurance Co. Ltd. (1948) 18 Comp Cas 309(Oudh)]. Subscribers can be
either literate or illiterate, man or woman, either resident or non-resident, either Indian
national or foreign national, etc. A company being an artificial legal person can also be a
subscriber. Even though the signature of a subscriber to memorandum of association of a
company is not properly attested, once the memorandum has been registered, such
subscriber cannot divest himself of his liability.
A subscriber to memorandum cannot, after issue of certificate of registration, repudiate his
subscription on ground that he was induced to sign by misrepresentation of an agent of
company. [Metal Constituents Ltd., In re (1902) 1 Ch. 707]. If subscribers to memorandum
have any objection to memorandum and articles of association, the time to object is before
putting their signatures to it.
2. Membership by agreement in writing
No person can become a member unless he has agreed in writing. Agreement in writing is
must to become a member of a company. To become a shareholder there must be an
agreement in writing under section 41(2) of the Companies Act between the shareholder
and the company. The words 'in writing' indicate by necessary implication that an
application for allotment of shares should be made in writing. However, as long as a
person's name is not entered in the Register of members, he will not be considered as a
member despite he has already purchased the shares of the company.
3. Deemed member
If a person whose name has been entered in the Register of members and who has, infact,
accepted the position and acted as a member, it will be presumed to be an agreement in
writing unless the presumption is rebutted by proof to the contrary.
4. Membership by conversion of debentures into shares
The company is under an obligation to issue equity shares for the convertible portion of
debentures, whether fully or partly as per the terms of the debentures issued by the
company.
5. Membership by operation of law or transmission of shares
A legal heir or other legal representative cannot be registered as member by mere
operation of law in case of transmission of shares, until intimation in writing has been given
by the legal heirs of the deceased member. The intimation in such case will constitute an
agreement in writing to become a member.

WHO CAN BECOME A MEMBER
In addition to an individual person, the following may also become a member of a
company:
1. A company
A company can become a member of another company. The company must have powers
under its Memorandum & Articles to make investment in other bodies corporate.
2. A registered co-operative society
A registered co-operative society may become a member of a company, provided it is
recognised as a separate legal entity and a society can be treated as a 'person' having
separate legal entity apart from the members constituting it and thereby capable of
becoming a member of a company under section 41(2) of the Act.
3. A Non-Resident Indian [NRI]
With the general or special permission of the Reserve Bank of India, a person, who is not
resident in India (even if he be an Indian citizen), can become a member of a company
registered in India, as no shares can be issued or transferred to him without general or
special approval of the RBI.
4. A Minor
Since the minor is incapable of entering into a contract because contract by a minor is void
ab initio and thereby not eligible to agree in writing to be a member, he cannot be entered
in the register of members. It has been clarified by the Department of Company Affairs that
when a guardian of a minor applies to be a member of a company, the company can allot
shares in the name of guardian.
5. HUF
Hindu undivided family is represented by its Karta. The Companies Act does not prohibit
membership of Hindu Undivided Family. In case of HUF, the shares can be registered in the
name of 'A' as Karta of HUF.
6. Registered Trade Union
It was held in the case of All India Bank Officers Confederation v. Dhanlakshmi Bank
Ltd (1997) 90 Comp Cas 225 that a trade union registered under the Trade Union Act, can be
registered as a member and can hold shares in a company in its own corporate name.
7. Shareholding in joint names
If more than one person jointly apply for and are allotted shares in a company, each one
will be regarded as a member. In the case of joint-applicants, they can insist on having their
names registered in such order as they may require. The following points should be
considered in the case of joint shareholders:
i) Joint shareholders shall be counted as one member in case of counting for quorum for a
voting and for requisitioning meeting under section 169.
ii) All the documents, notices and dividend warrant, etc., will be served on the first named
joint holder and it will be deemed as sufficient compliance unless the instructions in writing
to other effect have been given to the company.
iii) In case of transfer of shares by joint holders, the transfer will be effective and valid only if
it is made by all the joint shareholders.
iv) All the joint shareholders shall be jointly and severally liable to pay unpaid calls to the
company.

WHO CANNOT BECOME A MEMBER?
1. Partnership firm
Section 41(2) provides that only a person can be a member of a company who has agreed in
writing to become a member and whose name is entered in the Register of members. As per
Department's Circular No. 4/72, dated 9-2-1972, it has been clarified that "a firm" not being
a person, cannot be registered as a member of a company.
2. Membership by a subsidiary company in its holding company
A company cannot be a member of its holding company and any allotment or transfer of
shares in a company to its subsidiary shall be void.
3. Pawnee
The Pawnee of shares cannot exercise rights of a member.
4. Receiver
A receiver appointed under section 182A of the Land Revenue Act, cannot exercise
privileges of a member.
5. Legal representative
Legal representative of a deceased member cannot be compelled to have his name entered
on register.

RIGHTS OF MEMBERS
Only a person whose name is on register can exercise privileges of a member. Some ofthe
rights of a shareholder are:
i) to elect directors and thus to participate in the management through them;
ii) to vote on resolution at meetings of the company;
iii) to enjoy the profits of the company in the shape of dividends;
iv) to apply to the Court/Tribunal for relief in the case of oppression;
v) to apply to the Court/Tribunal for relief in the case of mismanagement;
vi) to apply to the Court/Tribunal for winding up of the company;
vii) to share in the surplus on winding up;
viii) the right to vote at all meetings;
ix) the right to requisition an extraordinary general meeting of the company or to be a joint
requisitionist;
x) the right to receive notice of a general meeting [section 172];(
xi) the right to appoint proxy and inspect proxy registers [section 176];(
xii) in the case of a body corporate which is a member, the right to appoint a representative
to attend a general meeting on its behalf [section 187];

CESSATION OF MEMBERSHIP
A person may cease to be a member of a company on the following grounds:
1. On a valid surrender of shares: If a member surrender his shares in accordance with
the provisions contained in company's Articles, he ceases to be a member.
2. On transfer of shares: If a member transfers all his shares held in the company he
ceases to be a member as soon as the transfer is registered in the name of the
transferee.
3. By rescission of contract of membership on ground of misrepresentation or mistake,
If a person who has applied for allotment of shares on the basis of the prospectus
issued by the company having misrepresentation or mistake, he may opt for
cancellation of contract and may claim compensation.
4. On Bankruptcy of a member: A bankrupt is held to be a member of the company so
long as his name is on the register of members. If the receiver is appointed by the
court then receivers name shall be entered in the Register of members.
5. On forfeiture of shares: A company has powers in its articles to forfeit the
shares in the case of any call remains unpaid. In that case on the date of valid
forfeiture of all the shares, a person may cease to be a member on his shares being
forfeited.
6. On death of the member: A person may cease to be the member on his death, but in
such a case the deceased member's state remains liable until the registration of
some person entitled under a transfer from his executors or administrators.
7. On buy-back of shares: If a shareholder/member offers all his shares for buyback by
a company and the same are bought back as per the relevant provisions, then he
ceases to be a member.

REGISTER OF MEMBERS
Every company shall keep, in one or more books, a register of its members. The Register of
members shall be kept at the registered office of the company or some other place within
the local area limit of the Registered Office as may be decided by the company.
Contents of the Register of members
The Register of members shall provide the following details as required under section 150(1)
of the Companies Act, 1956:
(a) The name, address and the occupation, if any, of each member;
(b ) In the case of a company having a share capital, the shares held by each member
distinguishing each share by its number except, where such shares are held with a
depository and the amount paid or agreed to be considered as paid on those shares;
(c) The date at which each person was entered in the register as a member; and
(d) The date at which any person ceased to be a member. Where the company has
converted any of its shares into stock and given notice of the conversion to the Registrar,
the register shall show the amount of stock held by each of the members concerned instead
of the shares so converted which were previously held by him.
Penalty for non-maintenance of Register of members
If default is made in maintaining the Register of members and in including there in requisite
particulars then the company and every officer of the company who is in default, shall
be punishable with fine which may extend to five hundred rupees for every day during
which the default continues. [Section 150(2)]
Place of keeping Register of members
The Register of members commencing from the date of registration of the company shall be
kept at the registered office of the company [section 163]. However, proviso to section
163(1) permits keeping of Register of members at places other than the registered office of
the company. Accordingly, the Register of members may be kept at any other place within
the city, town or village where the registered office is located, if:- (i ) such other place
has been approved for this purpose by a special resolution passed by the company in
General Meeting,
(ii) The Registrar has been given, in advance, a copy of the proposed special resolution at
the same time when notice for the meeting is sent to members, and
(iii) After the meeting, copy of the special resolution and explanatory statement shall be
filed with the Registrar in e-Form 23 with the prescribed filing fee as per Schedule X of the
Companies Act, 1956.
Inspection of Register of members and obtaining copy from the company
Section 163(2) of the Act provides that the Register of members shall, except, when the
same is closed under the provisions of section 154 of the Companies Act, 1956, be open
during business hours subject to such reasonable restrictions, as the company may impose,
so that not less than two hours on each day are allowed for inspection:
(i) of any member or debenture holder of the company without payment of any fee, and
(ii) of any other person, on payment of a fee of rupees ten. The right of inspection is a
statutory right. The company cannot ask the members, etc., seeking inspection, to state the
purposes for which he wishes to inspect and inspection cannot be denied on the ground of
mala fide intention on the part of the person seeking inspection.
Requirement to keep Index of members
Where the company has more than fifty members, the register of members shall have
an index for the purpose of locating entries in the register. If default is made in complying
with the requirements of section 151, the company and every officer of the company who is
in default, shall be punishable with fine, which may extend to Rs. 500.
Register and Index of debenture holders
Section 152 states that every company which has issued debentures shall keep in one or
more books a register of the holders of its debentures and enter therein the following
particulars:-
a) the name, address and occupation, if any, of each debenture holder;
b) the debentures held by each holder distinguishing each debenture by its number other
than the debentures held in a depository and the amount paid or agreed to be paid;
c) the date on which each person was entered as a debenture holder; and
d) the date on which any person ceased to be a debenture holder. All the provisions for
keeping Index of debenture holders are same as in the case of the Index of the register of
members.
Shares And Other Securities Held By A Depository
Section 152A of the Act provides that the register and index of beneficial owners
maintained by a depository under section 11 of the Depositories Act, 1996 shall be deemed
to be a register and an index of members and register and index of debenture holders as
the case may be for the purpose of the Companies Act, 1956.

CLOSURE OF REGISTER OF MEMBERS AND DEBENTUREHOLDERS
Section 154 provides power to the companies to close their register of members or
debenture holders. It applies to all companies registered under the Act without any
exception.
Purpose of closure of Register of members or debenture holders
Section 154 deals with book closures but the section does not elaborate the object and
purpose of book closure. Clause 16 of the listing agreement however indicates the
purpose of book closure. It is for declaration of dividend, issue of bonus/right shares, etc.
The purpose of book closure is to keep a cut off date, for deciding the members who would
be entitled for the benefits of dividend/right and bonus shares and not for determining the
voting rights. The purposes behind closure of Register of members may be declaration of a
dividend, issue of bonus shares, issue of right shares, holding of Annual General Meeting,
etc. The purposes behind closure of Register of debenture holders may be payment of
interest, conversion of debentures into shares, redemption of debentures, etc. It is not
compulsory for a company to close its register of members and even if it does, it may keep it
open for the inspection during such period and register the transfers of shares though it
may also refuse to register transfers or transmissions during the period.
Period for closure of Register of members or debenture holders
Section 154 of the Act provides that the Register of members can be closed for an
aggregate period of 45 days in a year but not exceeding 30 days at a time.

NOMINATION FOR SHARES AND SECURITIES
Sections 109A and 109B contain provisions regarding nomination facility to shareholders
and debenture holders. Section 109A(1) of the Act, provides that every holder of shares in,
or holder of debentures of, a company may at any time, nominate in the prescribed manner,
a person to whom his shares in, or debentures of the company shall vest in the event of his
death.
Who may use nomination facilities?
Only individuals can use nomination facility. Non-individual members or debenture holders
like body corporate, trust, society, HUF-Karta, power of attorney holder, etc.,
cannot nominate.
Nomination by holder of partly paid up shares or debentures
Nomination can be made by individuals holding shares in or debentures of a company even
in relation to partly paid-up shares/debentures.
Nomination for part of the holdings
Nomination should be made for full holdings of a shareholders or debenture holders under
a ledger folio and not for a part thereof.
Who can be nominated?
Nomination can be made in favour of a person in whose favour the shares or debentures
held by a holder should vest in on the death of the holder as per the desire of the holder.
Nomination can be made even in favour of a minor. Following provisions in this regard are
very important:-
i) Where the nominee is a minor, it shall be lawful for the holder of shares or holder of
debentures to make the nomination to appoint in the prescribed manner any person to
become entitled to shares in, or debentures of the company, in the event of his death,
during the minority. In case of a minor nominee, a person shall be named in Form 2B as
guardian in whose favour the shares or debentures shall vest in on the death of the
shareholder/debenture holder during minority of the nominee.
ii) Non-resident Indian can also be appointed as a nominee on repatriable basis with or
without Reserve Bank of India's approval depending upon whether the holder of shares is a
resident Indian or a non-resident Indian.
iii) There should be only one nominee per folio. In case, shareholders / debenture holders
hold shares/debentures in more than one folio but definitely under different order of names
or hold shares/debentures in joint names in more than on folio but the combination of joint
names differs from one folio to another, they can appoint different nominees for their
holdings under different folios.
Procedure for making nomination
For making nomination of a person, Form 2B is required to be filled in and sent to the
concerned company for the purpose of making nomination in respect of
shares/debentures held by him in the company. Form 2B is to be signed jointly in case of
joint holders. In case if the nominee is a minor, the name of a person shall be given who
shall be entitled to hold the shares/debentures on the death of the holder but up to the
minority of the nominee. The company shall verify the particulars stated in Form 2B and if
everything is found in order the company will register the nomination. It will also intimate to
the concerned holder about registration of his/her nomination. The company shall
allot nomination registration number to the shareholder.
Change in nomination
A shareholder/debenture holder/deposit-holder can change the nomination made earlier.
No procedure has been prescribed in the rules for effecting change in nomination already
made. It is advisable to write a letter to the company revoking nomination earlier made by a
shareholder/debenture holder/deposit holder and to submit fresh Form 2B for making new
nomination.
Options to nominee upon death of share or debenture holder
Section 109B(1) provides that any person who becomes a nominee by virtue of the
provisions of section 109A, upon the production of such evidence as may be required by the
Board and subject as hereinafter provided, he may elect, either:-
a) to be registered himself as holder of the share or debenture, as the case may be; or
b) to make such transfer of the share or debenture, as the case may be, as the deceased
shareholder or debenture holder, as the case may be, could have made. All the limitations,
restrictions and provisions of this Act relating to the right to transfer and the registration of
transfer of shares or, debentures shall be applicable to any such notice or transfer as
aforesaid as if the death of the member had not occurred and the notice or transfer were a
transfer signed by that shareholder or debenture holder, as the case may be.
Procedure for transmission of shares in favour of nominee
Where a nominee elect for transmission of shares in his favour, he is supposed to furnish
following documents for establishing his identity as a nominee upon the death of a holder or
death of all joint holders up to two:-
i) Certified/Attested copy of death certificate.
ii) The original share certificates.
iii) Proof of date of birth, if nominee is a minor.
iv) Affidavit/Declaration by nominee claiming his rights. The company will verify the
documents aforesaid and other documents, if required, and will advise the nominee to elect
either to register himself as a holder of shares, etc., or to transfer the same. Section 109B(2)
provides that if a person being a nominee, so becoming entitled elects to be registered as
holder of the share or debenture, himself, as the case may be, he shall deliver or send to the
company a notice in writing signed by him stating that he so elects and such notice shall be
accompanied with the death certificate of the deceased shareholder or debenture holder,
as the case may be. If the nominee elects to register himself as a holder, there will be
transmission of shares/debentures and the same will not attract stamp duty payment.
However, if the nominee elects to transfer shares/debentures in somebody else favour then
it will certainly attract stamp duty payment.
Rights of nominee
A person being a nominee, becoming entitled to a share or debenture, by reason of the
death of the holder shall be entitled to the same dividends and other advantages to which
he would be entitled if he was the registered holder of the share or debenture except that
he shall not, before being registered as a member in respect of his share or debenture, be
entitled in respect of it to exercise any right conferred by membership in relation to
meetings of the company.

POSITION IN U.K.
In the case of a company limited by shares, a member is a person holding shares in the
company, there can be no membership i.e. proprietary relationship to a company,
otherwise than through the medium of shareholding. Consequently the terms member and
shareholder are synonymous, apart from the now exceptional case of the bearer of a share
warrant who is a shareholder but is not a member because he is not registered in the
register of members.
It is in his capacity of member that the shareholder exercises the rights, enjoys the benefits
and is subject to the obligations which the holding of shares carries. The general position is
that law requires a company to have two or more members. However since 1992 one
person may by subscribing a MOA and otherwise complying the Act, incorporate a private
company limited by shares or guarantee.


SHAREHOLDERS
A share is a unit of account of measuring a members interest in his company. A members
interest in the company is composed of rights and obligations which are defined by the law
and by the memorandum and articles of association of the company. Shareholders
contribute towards the capital of a company, but their role in managing it is deliberately a
small one. When companies first began raising capital by issuing shares to the public, one of
the major concerns was that turning over control of a company to inexperienced and
scattered owners might disrupt its operations. So a system was designed to let shareholders
control the company only indirectly, through the directors they elect. For the most part,
this arrangement works smoothly. But shareholders do get into struggles over control of the
company when they disagree with the company's actions or its leadership. Shareholders can
express their opinion in one of two ways: by selling off their shares or by exercising their
voting rights.

WHO IS A SHAREHOLDER?
A shareholder is a person who holds a share or shares in a company. A member of a
company that is limited by shares must be a shareholder in the company. In practical terms,
a shareholder will invariably be a member of a company. However, it should be noted that a
person who purchases shares in a company, while being a shareholder from the date of
purchase, does not become a member of the company until her name is entered into the
register of members.

MEMBER V. SHAREHOLDER
Generally the terms member and shareholder are used interchangeably. In Srikanta Datta v.
Venkateshwara Real Estate Enterprises (P.) Ltd (1990), it was held that the word member
means a shareholder. But, there can be situations where a member and a shareholder may
be two different persons. The following are some such circumstances:
In case of a company limited by guarantee having no share capital or an unlimited
company having no share capital, there will be only members but no shareholders.
A bearer of a share warrant of the company is a shareholder but is not recognized as a
member.
When a member who is also a shareholder transfers his shares in favour of someone
else, she ceases to be a shareholder but continues to be a member until the company
removes her name from the Register of Members.
When a member who is also a shareholder dies, obviously ceases to be a shareholder
but continues to remain a member till the shares are transmitted to her legal heirs.
When a member who is also a shareholder is declared as insolvent, the shares get vested
in the Official Receiver and hence cease to be shareholder. However, she continues to
remain as a member till the company strikes off her name from the Register of Members.
A person who subscribes to the memorandum of association immediately becomes the
member, even though no shares are allotted to her.

WHO CAN BECOME A MEMBER?
Any person competent to enter into a contract under the Contract Act, 1872 is competent
to become a member of a company. However, the memorandum of association and the
articles of association may restrain certain persons from becoming a member. The capacity
of different persons to become members is discussed below:
Minor
A person who has not attained the age of 18 years is a minor. In case of a person to whose
property a guardian has been appointed, the age of majority is 21 years. A minor is
incompetent to enter into a contract and thus any agreement with a minor is void . Hence, a
minor cannot be a member of a 1company. If shares are allotted to a minor in response to
his application, and her name entered in the register of members, in ignorance of the fact of
her minority, the company can repudiate the allotment and remove her name from the
register of members on coming to know of the mistake. However, the company must repay
all moneys received from the minor in respect of the allotted shares.
Company
A company, having a separate legal entity may become a member of another company, if it
is so authorized by its memorandum of association and articles of association. However, a
subsidiary company cannot be a member of its holding company.
Partnership Firm
A partnership firm does not have an identity distinct from the partners and hence, cannot
be registered as a member in the register of members of a company. However, partners
may hold shares in a company in their personal capacity, either individually or jointly, as a
part of the partnership property. A partnership firm cannot sign since it is not a "person"
(like a company). Therefore, if partners of a firm subscribe, they become joint holders of the
subscribed shares. Partners must individually become members. If a change occurs in the
partnership and the shares are to continue as assets of the firm, their transfer will have to
be effected by a regular transfer in the names of the new partners
Alien
There is no restriction in the law on a foreigner becoming a member of a member of a
company. This is subject to the provisions of Foreign Exchange Management Act, 1999.
When the country, of which the foreigner is resident, is at war with India, the foreigner
becomes an alien enemy and, therefore, her voting rights and right to receive notices are
suspended during the period of war.
Public Office
Shares in a government company can be held in the name of the President of India or the
Governor of the State, depending on whether the Central Government or the State
Government holds the shares.
Society
A society registered under the Societies Registration Act, 1860 is not a body corporate as
per section 2(7) of the Act. However, such a society is treated as a person having separate
legal entity apart from members constituting it and thereby is capable of becoming a
member of a company.
Joint Members
Joint membership means that names of two or more persons are put on a company's share
certificate and recorded in the company's register of members. This gives rise to dual
relationship: (i) that between the company and the joint members; and (ii) that between the
joint members amongst themselves. Each relationship is independent of the other: the
company is not concerned with the mutual arrangement between the joint members. The
articles of association usually contain provisions about how many persons can be recognized
as joint members. In case of listed companies, not more than three persons can hold a single
share.

DUTIES AND LIABILITIES OF SHAREHOLDERS
The main duty of a member who is a shareholder in a limited liability company with share
capital is to pay the company any outstanding amount of the purchase price agreed for the
shares allotted to her. This sum becomes payable either where the company makes a call
for funds or, in circumstances where the terms of issue of the shares provide for the
payment of installments, on the payment date. Shareholders in a company with unlimited
liability are liable without limit for the debts of the company where it is insolvent, that is,
unable to pay its debts. In a company, members are protected by 'limited liability'. This
means that members can benefit from the profits while not being personally responsible for
its debts and obligations. The members though are still liable for the following:
Pay For Shares
If shares are not allotted for consideration other than cash, then a member must pay the
whole nominal value of his shares in cash.
Pay For Unpaid Amount On Shares
In a company limited by shares, members are only liable for the amount unpaid on the
shares that they hold. This liability arises to pay either where the company makes a call for
funds or, where the company is wound up.
Pay Guarantee Money
In a company limited by guarantee, members are liable for the amount of their guarantee,
the amount they have agreed to contribute to the company's assets if the company is
wound up.
Liability After Transfer Of Shares
When a shareholder transfers her share to another, she ceases to be a shareholder, but if:
the shares were partly paid up and the company goes into liquidation within one year of
such transfer, and the new shareholder does not pay the unpaid amount on shares, the
original shareholder may be included in the B list of contributories, as a past member, and
required to pay.
This rule is made to prevent shareholders from shirking their liability on partly paid shares if
it is evident that the company is heading towards an insolvent liquidation.
Fall In Members From Statutory Minimum
If the number of members falls below seven in the case of a public company or below two in
the case of a private company, and the business is carried on beyond six months, every
member who is aware of the reduced membership is liable for all the liabilities and debts
contracted after the expiry of six months from the date membership fell below the
minimum. Where in the course of winding up it appears that any business of the company
has been carried on with the intent to defraud any person or for a fraudulent purpose, the
Court may declare the persons who were knowingly parties to the transaction personally
liable without limitation of liability.

RIGHTS AND POWERS OF SHAREHOLDERS
The articles of association of a company set out the powers of members and those powers
that are delegated by the members to the directors of the company. The articles generally
provide that the business of the company is managed by the directors, subject to the
provisions of the articles of association and to such directions given by the members in a
general meeting. Number of fundamental matters must be ratified by the members, such as
an alteration of the companys articles of association. By amending the articles of
association, members can alter their relationship with the directors. The rights of a member
will depend on the articles of association of the company. Certain rights accrue only to
members who are shareholders in a company. A member of a company limited by shares
must be a shareholder in the company. Where a company has a share capital, it is presumed
that all shares have equal rights but the company may in its memorandum or articles of
association create a power to issue different classes of shares, including equity shares and
preference shares.
The various rights enjoyed by shareholders can be classified in two categories: individual
rights and collective rights. Every shareholder can enforce her individual rights singly but
collective rights can be enforced only by a certain collection of shareholders.

INDIVIDUAL RIGHTS OF EQUITY SHAREHOLDERS
Individual rights are those rights which are enjoyed by every shareholder against the
company and co-shareholders. The Companies Act itself has conferred upon the
shareholders a large number of individual rights. In addition, some individual rights also
arise out of the Article of Association. If such rights are breached, even a single shareholder
can bring action against the majority decision of the company. In Joseph vs. Jos, the Kerala
High Court has held that individual shareholders can insist on strict observance of legal
rules, statutory provisions in the Memorandum and Article, which can not be waived by a
bare majority of shareholders. Every shareholder can assert such right in his own name.
Transfer Of Shares
A members shares in a company are transferable. In a private company however,
restrictions must be placed on the transfer of shares. This restriction is normally
implemented by granting the directors of a private company the discretion to refuse to
register the transfer of shares to a person of whom they do not a prove and/or requiring the
shareholder who wishes to sell their shares to first offer those shares for sale to the existing
members of the company.
Right To A Dividend When Declared.
A dividend is a distribution of certain of the companys assets to its shareholders. The
directors can only propose dividends. Where the directors propose a dividend, it must then
be approved by the members. There is no legal obligation on a company to declare a
dividend even where there are sufficient distributable profits available, unless its articles or
memorandum of association require it to. However, once a dividend is declared on a
shareholders share, that shareholder is entitled to payment and in the event of non-
payment can sue the company for arrears in the same way as any ordinary creditor may sue
for a debt.
Pre -Emption Rights
The law also gives the existing members of a company a statutory pre-emption right. This
means that, where new shares in the company are issued, the existing shareholders have an
automatic right of first refusal to purchase these shares in proportion to their existing
shareholdings. The issue of such shares is also called as a rights issue. Parties other than
the existing shareholders will, therefore, only be entitled to purchase newly issued shares in
the company if the existing shareholders decline to exercise their pre-emption rights.
Right To Participate In Winding Up
A shareholder has the right to participate in the winding up of a company (a winding up is
the orderly termination resulting in the legal dissolution of the company). Once the
creditors and expenses of the liquidator (the liquidator is the person appointed to conduct
the dissolution of the company) have been paid, any remaining funds are returned to the
shareholders in proportion to their shareholdings, unless the articles of association provide
otherwise.
Rights Regarding Members Meetings
The members of a company exercise control over the company at its meetings. All
companies must in each year hold an annual general meeting (AGM) and not more than
fifteen months should elapse between AGMs. Any meeting of a company that is not an AGM
is known as an extraordinary general meeting (EGM). To be valid, a meeting must be
properly convened by notice, a quorum must be present and the meeting must be presided
over by a Chairman. Shareholders are conferred with a number of rights with respect to
general meeting, including right to receive notices to meeting, right to appoint a proxy and
right to vote.
At least 21 days notice must be given in writing of an AGM. In the case of an EGM 14 days
notice is required, however, 21 days is usually required in order to pass a special resolution,
unless 95 per cent of the members of the company agree to a shorter notice.
A member of a club was expelled by a resolution passed by committee. One member of the
committee had not been sent a notice of the meeting, because she had informed the
chairman that she would be unable to attend. Held: Failure to send her notice of the
meeting invalidated the proceedings and made the expulsion void.
However, accidental omission to send notice is not fatal. A company failed to give notice of
a meeting to some of its members because plates were inadvertantly left out of a machine
used for addressing envelopes. This was held to be an accidental omission, so the
proceedings of the meeting were not invalidated. Any member of the company who is
entitled to vote at a general meeting of the company can appoint a proxy. A proxy is a
person nominated by the member to attend the meeting and to exercise the members vote
on their behalf. The proxy must be nominated in writing and the appointment must be
submitted to the company at least 48 hours prior to the meeting.
Decisions of the members at a general meeting are made by resolution. All resolutions must
be passed in accordance with the requirements of the Act and the articles of association.
Most of the usual business conducted at AGMs is carried out by way of ordinary resolution,
which merely requires a simple majority, that is, a majority in excess of 50 per cent of those
members voting.
Members Right To Information
A member of a company has the right to certain information concerning the company.
Members are entitled, among other thing, to: (i) a copy of the memorandum and articles of
association of the company; (ii) inspect and obtain copies of the minutes of general
meetings and resolutions; (iii) inspect and obtain copies of the various registers kept by the
company, including the register of members, (iv) obtain a copy of the financial statements,
directors report and auditors reports; (v) obtain copies of the financial statements of any
subsidiary company.

COLLECTIVE RIGHTS OF EQUITY SHAREHOLDERS
Collective rights are those which can be exercised only by a group of
shareholders and no single member can enjoy such rights individually.
Collective rights come into play when a stipulated number of members join
hands to assert their rights. Concept of collective rights stresses common
goals, interdependence and sociability.
The following are some of the collective rights conferred by the law on the shareholders.
Right To Requisition An Extraordinary General Meeting
Directors may generally call an extraordinary general meeting (EGM) where they see fit, for
example where they wish to obtain the prior approval of members before taking a certain
course of action. A member or several members of a company, who together hold not less
than 10 per cent of the paid up share capital with voting rights in the company or in the case
of a company not having share capital, representing not less than 10 per cent of the voting
rights of the company, can requisition the directors of the company to call an EGM. To do
so, they deposit a signed requisition at the companys registered office, stating the purpose
of the EGM.
Once this is done, the directors must convene an EGM within 21 days of the date of
requisition, and the meeting must be held within two months. If the directors do not do so,
the requisitionists or any of them representing over half the voting rights of the
requisitionists may themselves convene a meeting which must be held within three months.
Right To Petition For The Winding Up Of A Company
A member has the right to petition the High Court for the winding up of a company on a
number of grounds (subject to certain exceptions). A member will usually exercise this right
where, for example: there is a deadlock in the management of the company; where the
objectives of the company can no longer be achieved; where the company has illegal
objects; or where the company is being used as an instrument of fraud.
Right To Apply For Investigation
When members are of the opinion that the affairs of the company are run in a manner that
warrants investigation, they may make an application to the Court for ordering such
investigation. Such an application is required to be made by not less than 200 members or
such number of members holding not less than one-tenth of the total voting rights in the
company .
Right To Apply For Ordering An Investigation Into The Affairs Of The Company
At least 200 shareholders or shareholders holding at least 10 per cent of voting power can
make an application for investigating into the affairs of the company. If the company has no
share capital, then at least 20 per cent of the members must make an application. It has
been held that even one member holding more than 10 per cent shares in a company can
apply for investigation, as singular includes plural and vice versa.
The application from the shareholders must be supported by evidence. The Central
Government may require the applicant to provide security up to Rs.1000 towards cost of
investigation. The shareholders can act under this provision when there is enough ground to
form an opinion that the affairs of the company are being mismanaged. The court has held
that investigation is a serious matter and can not be ordered lightly. It can be ordered only
after proper preliminary scrutiny by the Company Law Board. In Punjab Agro vs. Superior
Genetics, it was observed that there should be sufficient material to form a prima facie
opinion that the affairs of a company require to be investigated.
Right To Petition For Relief In Cases Of Oppression
A member of a company can petition the court for relief when the affairs of the company
are being conducted, or the powers of the directors are being exercised, in a manner
oppressive to that member or to any of the members or is in disregard of their interests as
members. Oppressive conduct is the exercise of the companys authority in a manner that is
burdensome, harsh and wrong. The types of conduct that may give rise to such an
application include: (i) fraudulent and unlawful transactions; (ii) oppressive management;
and (iii) exclusion of the member from the management of the company.
Right To Present Petition For Relief In Cases Of Mismanagement
The Board of Directors of a company is required to take decisions, which are in the interest
of the company and not of directors or any particular group of members. But if a damage or
injury is caused to the company by fraudulent acts of the directors they can be held
responsible. In such cases, only the company can bring actions against the director and not
the individual shareholders because the company is the injured party. However if the
directors control majority shareholding, they will also control the company and there is a
possibility that the company will not take any action against the erring directors. So, when
the company property is being misused and the company is being mismanaged for the
personal gains of a few controlling shareholders, the minority shareholders will be just
helpless spectators. To deal with such issues the law provides right to minority shareholders
to make a petition for prevention of mismanagement.
Dissatisfaction With Scheme For Reconstruction And Amalgamation
When the majority of the shareholders give consent to a scheme of Reconstruction and
amalgamation and the group of minority shareholders do not approve the same they may
apply to the court to prevent compulsory Acquisition of their shares.

VOTING RIGHTS OF EQUITY SHAREHOLDERS
Decisions of the shareholders at a general meeting are made by passing a resolution. All
resolutions must be passed in accordance with the requirements of the law and the articles
of association. A shareholder may exercise her voting rights for many purposes, such as
election of directors, declaration of dividends, adoption of accounts and appointment of
auditors.
The company cannot prevent a shareholder from exercising her voting rights on grounds
such as:
The shareholder does not hold a given number of shares
The shareholder did should have held the shares for a given period of time
The shares are pledged or attached by the courts
The shareholder is declared as insolvent
However, a shareholder who has not paid calls on his shares for six month beyond the last
date for payment cannot vote at the general meeting. Further, in case the shareholder is a
foreigner and his country is at war with India, she is considered as an alien enemy and,
therefore, her voting rights and right to receive notices are suspended during the period of
war.

VOTING RIGHTS OF THE PREFERENCE SHAREHOLDERS
Generally, preference shareholders do not have any voting rights. However, they can vote
on matters directly relating to the rights attached to the preference share capital. Any
resolution for winding up of the company or for the reduction or repayment of the share
capital shall be deemed to affect directly the rights attached to preference shares.
When the company does not pay dividends on preference shares, the holders of these
shares get entitled to voting rights on all matters just like the equity shareholders. The rules
regarding this are as follows:
Cumulative Preference Shares
Where the preference shares are cumulative (in respect of dividend) and the dividend
thereon has remained unpaid for an aggregate period of two years before date of any
meeting of the company, the preference shareholders will have right to vote on any
resolution.
Non Cumulative Preference Shares
In case of non-cumulative preference shares, preference shareholders have right to vote on
every resolution if dividend due on their capital remains unpaid, either in respect of period
of not less than two years ending with the expiry of the financial year immediately
preceding the commencement of the meeting or in respect of aggregate period of not less
than three years comprised in six years ending with the expiry of concerned financial year.

SHAREHOLDERS' AGREEMENT
A shareholders' agreement is an agreement between the some of the shareholders of a
company relating to the ownership and management of the company. Such agreements are
common in case of joint ventures, foreign collaborations and where few shareholders hold
large chunks of shares.
Scope Of Shareholders Agreements
Shareholders' agreements obviously vary enormously between different commercial fields.
However, in a characteristic joint venture a shareholders' agreement would normally be
expected to regulate the following matters:

Regulating the ownership and voting rights of the shares in the company, including:
Lock up provisions
Restrictions on transferring shares
Granting security interests over shares
Pre-emption rights and rights of first refusal in relation to any shares issued by the
company
Tag-along and drag-along rights

Control and management of the company, which may include:
Power for certain shareholders to designate individual for election to the board of
directors
Imposing super-majority voting requirements for "reserved matters" which are of key
importance to the parties
Imposing requirements to provide shareholders with accounts or other information that
they might not otherwise be entitled to by law
Making provision for the resolution of any future disputes between shareholders,
including deadlock provisions and provisions for resolving dispute.

Shareholder agreements, often also provide for the following:
Nature and amount of initial contribution (whether capital contribution or other) to the
company
Proposed nature of the business
How any future capital contributions are to be made
Ethical practices or environmental practices
Allocation of key roles or responsibilities

Why Shareholders Agreements?
There are a number of reasons why the shareholders must wish to supplement (or
supersede) the companys constitutional documents (memorandum and articles of
association) in this way:
A company's constitutional documents are normally available for public inspection,
whereas the terms of a shareholders' agreement, as a private law contract, are normally
confidential between the parties.
Contractual arrangements are generally cheaper and less formal to form, administer,
revise or terminate.
Shareholders might wish to provide for disputes to be resolved by arbitration, or in the
courts of a foreign country.
Greater flexibility; the shareholders may anticipate that the company's business requires
regular changes to their arrangements, and it may be unwieldy to repeatedly amend the
corporate constitution.
Corporate law may not provide sufficient protection for minority shareholders, who may
seek to better protect their position by using a shareholders' agreement
Provide mechanisms for removing minority shareholders which preserve the company as
a going concern.

Validity Of Shareholders Agreement
The shareholders agreement is a binding agreement amongst the contracting parties. The
agreement between the parties is enforceable amongst each other under the general law of
contracts. It is accepted that shareholders agreement is binding amongst the parties, but
are such agreements binding on the company?
The shareholders agreement is separate and distinct from the companys articles of
association. The agreement does not become a regulation of the company, or be binding on
the transferees of the parties to it, or upon any new or non-assenting shareholders. An
agreement between shareholders regarding issue of shares by the company cannot bind the
company unless such an agreement is incorporated into the articles of association of the
company. This, in keeping with the contractual rule of privity of parties; the contract is
binding as to the parties of the agreement.
An important case on this point was: Rolta India Ltd. Vs. Venire Industries Ltd (2000).
The following rules of law emerged from this case:
As against outside parties, only the constitutional documents regulate the company's
powers and proceedings.
As between the company and its shareholders, a breach of the shareholders' agreement
which does not breach the constitutional documents will still be a valid corporate act, but it
may sound in damages against the party who breaches the agreement.
As between the company and its shareholders, a breach of the constitutional documents
which does not breach the shareholders' agreement will nonetheless usually be an invalid
corporate act.
Courts will not grant an injunction or award specific performance in relation to a
shareholders' agreement where to do so would be inconsistent with the company's
constitutional documents.


SECURITIES EXCHANGE BOARD OF INDIA (SEBI)
INTRODUCTION:
In 1998 the Securities Exchange Board of India was established by the Government
of India through an executive resolution and was subsequently upgraded as a fully
autonomous body (a statutory board) in the year 1992 with the passing of the securities
Exchange Board of India Act, 1992 on 30
th
January, 1992. In the place of Government
control, a statutory and autonomous regulatory board with defined responsibilities, to cover
both development and regulation in the market, and independent powers have been set up.
Paradoxily this is the positive outcome of the security scam of 1990-91. SEBI which is an
abbreviation for Securities and Exchange Board of India has functions similar to the SEC or
Securities Exchange Commission in the USA. In other words, the SEBI regulates the working
of the financial markets in India, vis--vis investor protection and laying down of ethical
standards for the working of the financial markets in India. This is why SEBI is also called as
the watchdog of the Indian Markets. Presently Upendra Kumar Sinha was appointed
chairman on February 18, 2011 replacing C. B. Bhave.
The basic objectives of Securities Exchange Board of India are:
i. To protect the interests of investors in securities;
ii. To promote the development of the securities market;
iii. To regulate the securities market;
iv. And for matters connected therewith and incidental thereto.
Relatively with a brief act containing 7 chapters and 35 sections the SEBI Act governs
all the Stock Exchanges and the Securities Transactions in India.
CHAPTER I (Preliminary)
CHAPTER II (Establishment Of The Securities And Exchange Board Of India)
CHAPTER III (Transfer Of Assets, Liabilities, etc., Of The Existing Securities And Exchange
Board To The Board)
CHAPTER IV (Powers And Functions Of The Board)
CHAPTER V (Registration Certificate)
CHAPTER VA (Prohibition Of Manipulative And Deceptive Devices, Insider Trading And
Substantial Acquisition Of Securities Or Control)
CHAPTER VI (Finance, Accounts And Audit)
CHAPTER VIA (Penalties and Adjudication)
CHAPTER VIB (Establishment, Jurisdiction, Authority and Procedure of Appellate Tribunal
CHAPTER VII (Miscellaneous)
ESTABLISHMENT OF THE SECURITIES EXCHANGE BOARD OF INDIA:
Chapter two of the SEBI Act deals with the establishment of the Securities and
Exchange Board of India. Section 3 says about the establishment and incorporation of
Board. Sub section 1 says that a Board by the name of Securities Exchange Board of India
shall be established. The Board shall be a body corporate by the name Securities Exchange
Board of India which will have perpetual succession and a common seal, with power to
acquire, hold and dispose of property, both movable and immovable, and to enter in to
contract and can sue or be sued by the said name. The head office of the Board shall be at
Bombay. The Board may establish other offices at any other places in India.
The management of the Board is mentioned in section 4 of the Act. The Board shall
consist of the following members, namely:
(a) a Chairman;
(b) two members from amongst the officials of the Ministry of the Central Government
dealing with Finance and administration of the Companies Act, 1956(1 of 1956);
(c) one member from amongst the officials of 7[the Reserve Bank];
(d) five other members of whom at least three shall be the whole-time members, who shall
be appointed by the Central Government.
The general superintendence, direction and management of the affairs of the Board
shall vest in a Board of members, which may exercise all powers and do all acts and things
which may be exercised or done by the Board. The Chairman shall also have powers of
general superintendence and direction of the affairs of the Board and may also exercise all
powers and do all acts and things which may be exercised or done by that Board. The
Chairman and members shall be appointed by the Central Government and members from
amongst the officials of the Reserve Bank of India and five other members shall be
nominated by the Central Government and the Reserve Bank respectively. The chairman
and the other member shall be persons of ability, integrity and standing who have the
capacity in dealing with problems relating to securities market or have special knowledge or
experience of law, finance, economics, accountancy, administration or in any other
discipline which, in the opinion of the Central Government, shall be useful to the Board.
Section 5 says about term of office and conditions of service of Chairman and
members of the Board. The term of office and other conditions of service of the Chairman
and members shall be as prescribed by the Board. The Central Government shall have the
right to terminate the services of the Chairman or a member appointed under section 4 at
any time before the expiry of the period prescribed, by giving him notice of not less than
three months in writing or three months salary and allowances in lieu thereof, and the
Chairman or a member, as the case may be, shall also have the right to relinquish his office
at any time before the expiry of the period prescribed by giving to the Central Government
notice of not less than three months in writing.
The removal of the office has been mentioned in section 6. The Central Government
shall remove a member from the office if he-
i. Is or at any time has been adjudicated as insolvent,
ii. Is of unsound mind and stands so declared by the competent person,
iii. Has been convicted of an offence which in the opinion of the Central Government
involves moral turpitude,
iv. In the opinion of the Central Government the member has abused his position as to
tender his continuation detrimental to the public interest. It is also provided that no
member shall be removed under this section unless he has been given an
opportunity of being heard.
Regarding meetings, section 7 says that the Board shall meet at such places and shall
observe such rules of procedure in regard to the transaction of business at its meetings,
including quorum as may be provided by the regulations. If the Chairman is unable to attend
any of the meeting of the Board, any other member chosen by the members present from
amongst themselves at the meeting shall preside at the meeting. All questions which come
up to any meeting of the Board shall be decided by the majority votes of the members
present and voting and in the event of equality of votes, the Chairman or in his absence, the
person presiding shall have a second or casting vote.
But any member who is a director of a company and who as such director has any
direct or indirect pecuniary interest in any matter coming up for consideration at a meeting
of the board, shall disclose the nature of his interest at such meeting and such disclosure
shall be recorded in the proceedings of the Board and the member shall not take part in any
deliberation or decision of the Board with respect to that matter. (Section 7A)
No act or proceeding of the Board shall be invalid merely by reason of any vacancy in
or any defect in the constitution of the Board, or any defect in the appointment of a person
acting as a member of the board, or any irregularity in the procedure of the Board not
affecting the merits of the case (Section 8).
TRANSFER OF ASSETS, LIABILITIES ETC. OF THE EXISTING SECURITIES AND EXCHANGE
BOARD TO THE BOARD:
Chapter three deals with the transfer of assets, liabilities etc. of the existing Securities and
Exchange Board to the Board. Section 10 says the on and from the date of establishment of
the Board,
i. any reference to the existing Securities and Exchange Board in any law other than
this Act or in any contract or other instrument shall be deemed as a reference to the
Board;
ii. all properties and assets, movable and immovable, of, or belonging to, the existing
Securities and Exchange Board, shall vest in the Board;
iii. all rights and liabilities of the existing Securities and Exchange Board shall be
transferred to, and be the rights and liabilities of, the Board;
iv. without prejudice to the provisions of clause (c), all debts, obligations and liabilities
incurred, all contracts entered into and all matters and things engaged to be done
by, with or for the existing Securities and Exchange Board immediately before that
date, for or in connection with the purpose of the said existing Board shall be
deemed to have been incurred, entered into or engaged to be done by, with for, the
Board;
v. all sums of money due to the existing Securities and Exchange Board immediately
before that date shall be deemed to be due to the Board;
vi. all suits and other legal proceedings instituted or which could have been instituted
by or against the existing Securities and Exchange Board immediately before that
date may be continued or may be instituted by or against the Board; and
vii. every employee holding any office under the existing Securities and Exchange Board
immediately before that date shall hold his office in the Board by the same tenure
and upon the same terms and conditions of service as respects remuneration, leave,
provident fund, retirement and other terminal benefits as he would have held such
office if the Board had not been established and shall continue to do as so an
employee of the Board or until the expiry of the period of six months from that date
if such employee opts not to be the employee of the Board within such period.
POWER AND FUNCTIONS OF THE SECURITIES EXCHANGE BOARD OF INDIA:
Chapter four of the SEBI Act, 1992 deals with the powers and function of the
Securities Exchange Board of India. The functions of the securities Exchange Board of India
has been dealt in section 11. Sub-section (1) of section 11 declares that it shall be the duty
of the Securities Exchange Board of India:
i. to protect the interest of investors in securities and
ii. to promote the development of and
iii. to regulate the securities market by such measures as the Board thinks fit and
iv. for matters connected therewith and incidental thereto.
The Board is entrusted with two functions, namely:
A. Regulatory functions and
B. Developmental functions.
A. Developmental Functions: The Board is responsible for:
i. regulating the business in stock exchanges and any other securities markets;
ii. registering and regulating the working of stock brokers, sub-brokers, share transfer
agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant
bankers, underwriters, portfolio managers, investment advisers and such other
intermediaries who may be associated with securities markets in any manner;
iii. registering and regulating the working of the depositories, participants, custodians of
securities, foreign institutional investors, credit rating agencies and such other
intermediaries as the Board may, by notification, specify in this behalf;
iv. registering and regulating the working of venture capital funds and collective
investment schemes],including mutual funds;
v. promoting and regulating self-regulatory organisations;
vi. prohibiting fraudulent and unfair trade practices relating to securities markets;
vii. promoting investors' education and training of intermediaries of securities markets;
viii. prohibiting insider trading in securities;
ix. regulating substantial acquisition of shares and take-over of companies;
x. calling for information from, undertaking inspection, conducting inquiries and audits
of the stock exchanges, mutual funds, other persons associated with the securities
market intermediaries and self- regulatory organisations in the securities market;
xi. calling for information and record from any bank or any other authority or board or
corporation established or constituted by or under any Central, State or Provincial
Act in respect of any transaction in securities which is under investigation or inquiry
by the Board;
xii. performing such functions and exercising such powers under the provisions of the
Securities Contracts (Regulation) Act, 1956 (42 of 1956), as may be delegated to it by
the Central Government;
xiii. levying fees or other charges for carrying out the purposes of this section;
xiv. conducting research for the above purposes;
xv. calling from or furnishing to any such agencies, as may be specified by the Board,
such information as may be considered necessary by it for the efficient discharge of
its functions and
xvi. performing such other functions as may be prescribed.
B. Developmental Functions:
i. Promoting investors education
ii. Training of intermediaries
iii. Conducting research and publishing information useful to all market participants.
iv. Promotion of fair practices
v. Promotion of self regulatory organizations

Beside these above mentioned functions, the Board may take measures to
undertake inspection of any book or register or any other document or record of any listed
public company which intends to get its securities listed on any recognised stock exchange
where the Board has reasonable grounds to believe that such company has been indulging
in insider trading or fraudulent and unfair trade practices relating to securities market.
The Board shall also have the power of a civil court. Sub-section (3) of section 11 says
that the Board shall have the same powers as are vested in a civil court under the Civil
Procedure Code, 1908 (5 of 1908), while trying suit in respect of the following matters:
i. the discovery and production of books of account and other documents, at such
place and such time as may be specified by the Board;
ii. summoning and enforcing the attendance of persons and examining them on oath;
iii. inspection of any books, registers and other documents of any person referred to in
section 12, at any place;
iv. inspection of any book, or register, or other document or record of the company
referred to in sub-section (2A);
v. issuing commissions for the examination of witnesses or documents.
In addition to the above mentioned powers, the Board may, by an order, in writing,
iin the interest of investors or securities market, take any of the following measures, either
pending investigation or inquiry or inquiry or on completion of such investigation or inquiry,
namely:
i. suspend the trading of any security in a recognised stock exchange;
ii. restrain persons from accessing the securities market and prohibit any person
associated with securities market to buy, sell or deal in securities;
iii. suspend any office-bearer of any stock exchange or self- regulatory organisation
from holding such position;
iv. impound and retain the proceeds or securities in respect of any transaction which is
under investigation;
v. attach, after passing of an order on an application made for approval by the Judicial
Magistrate of the first class having jurisdiction, for a period not exceeding one
month, one or more bank account or accounts of any intermediary or any person
associated with the securities market in any manner involved in violation of any of
the provisions of this Act, or the rules or the regulations made thereunder. Provided
that only the bank account or accounts or any transaction entered therein, so far as
it relates to the proceeds actually involved in violation of any of the provisions of this
Act, or the rules or the regulations made thereunder shall be allowed to be attached;
vi. direct any intermediary or any person associated with the securities market in any
manner not to dispose of or alienate an asset forming part of any transaction which
is under investigation. The Board before passing any of the above orders shall give
an opportunity of being heard to such intermediaries or persons concerned.
SEBI has to be responsive to the needs of three groups, which constitute the market:
i. the issuers of securities
ii. the investors
iii. the market intermediaries.
SEBI has three functions rolled into one body: quasi-legislative, quasi-judicial and
quasi-executive. It drafts regulations in its legislative capacity, it conducts investigation and
enforcement action in its executive function and it passes rulings and orders in its judicial
capacity. Though this makes the Board very powerful, there is an appeals process to create
accountability. There is a Securities Appellate Tribunal which is a three-member tribunal and
is presently headed by a former Chief Justice of a High Court Mr. Justice N.K. Sodhi. A
second appeal lies directly to the Supreme Court. SEBI has enjoyed success as a regulator by
pushing systemic reforms aggressively and successively (e.g. the quick movement towards
making the markets electronic and paperless). SEBI has also been active in setting up the
regulations as required under law.
Again the Securities Exchange Board of India has several powers. They are:
i. Power to call periodical returns from recognized stock exchanges.
ii. Power to compel listing of securities by public companies.
iii. Power to levy fees or other charges for carrying out the purposes of regulation.
iv. Power to call information or explanation from recognized stock exchanges or their
members.
v. Power to grant approval to bye-laws of recognized stock exchanges.
vi. Power to control and regulate stock exchanges.
vii. Power to direct enquiries to be made in relation to affairs of stock exchanges or their
members.
viii. Power to make or amend bye-laws of recognized stock exchanges.
ix. Power to grant registration to market intermediaries.
x. Power to declare applicability of Section 17 of the Securities Contract (Regulation)
Act 1956, in any State or area, to grant licenses to dealers in securities.
As the primary object of the SEBI is the protection of the investors, accordingly
section 11A gives the power to Board to regulate or prohibit the issue of prospectus, offer
document or advertisement soliciting money for issue of securities. For the protection of
investors the Board may specify by regulations -
i. the matters relating to issue of capital, transfer of securities and other matters
incidental thereto and
ii. the manner in which such matters shall be disclosed by the companies; and by
general or special orders
i. prohibit any company from issuing prospectus, any offer document, or
advertisement soliciting money from the public for the issue of securities;
ii. specify the conditions subject to which the prospectus, such offer document or
advertisement, if not prohibited, may be issued.
The Board may also specify the requirements for listing and transfer of securities and
any other matter incidental thereto. The Board is also having power to issue directions to
any such persons or any company.
Section 11C deals with investigation power of the Board. Sub-section (1) says that
where the Board has reasonable ground to believe that
i. the transactions in securities are being dealt with in a manner detrimental to the
investors or the securities market; or
ii. any intermediary or any person associated with the securities market has violated
any of the provisions of this Act or the rules or the regulations made or directions
issued by the Board thereunder, the Board may, at any time by order in writing,
direct any person specified in the order to investigate the affairs of such
intermediary or persons associated with the securities market and to report thereon
to the Board.
It shall be the duty of every manager, managing director, officer and other employee
of the company and every intermediary or every person associated with the securities
market, to produce to Investigating Authority or any other person authorised by the Board,
all the books, registers, other documents and record of or relating to the company or
relating to the intermediary. The Investigating Authority may require any intermediary or
any person associated with securities market in any manner to furnish such information to,
or produce such books, or registers, or other documents, or record before it or any person
authorised by it in this behalf as it may consider necessary if the furnishing of such
information or the production of such books, or registers, or other documents, or record is
relevant or necessary for the purposes of its investigation. The Investigating Authority may
keep in its custody any books, registers, other documents and record produced for six
months and thereafter shall return the same to any intermediary or any person associated
with securities market by whom or on whose behalf the books, registers, other documents
and record are produced. It is also provided that the Investigating Authority may call for any
book, register, other document and record if they are needed again. It is provided further
that if the person on whose behalf the books, registers, other documents and record are
produced requires certified copies of the books, registers, other documents and record
produced before the Investigating Authority, it shall give certified copies of such books,
registers, other documents and record to such person or on whose behalf the books,
registers, other documents and record were produced.
If any person fails without reasonable cause or refuses
i. to produce to the Investigating Authority or any person authorised by it in this behalf
any book, register, other document and record which is his or
ii. to furnish any information which is his duty to furnish or
iii. to appear before the Investigating Authority personally when required to do so or to
answer any question which is put to him by the Investigating Authority or
iv. to sign the notes of any examination, he shall be punishable with imprisonment for a
term which may extend to one year or with fine, which may extend to one crore
rupees, or with both, and also with a further fine which may extend to five lakh
rupees for every day after the first during which the failure or refusal continues.
The Investing Authority shall keep in its custody the books, registers, other
documents and record seized under this section for such period not later than the
conclusion of the investigation as it considers necessary and thereafter shall return the
same to the company or the other body corporate, or, as the case may be, to the managing
director or the manager or any other person, from whose custody or power they were
seized.
REGISTRATION CERTIFICATE:
A person willing to operate as stock broker, sub broker, share agent, banker to an
issue, trustee of trust deed, register to an issue, merchant banker, underwriter, portfolio
manager, investment advisor and such other intermediary can do so only if he gets himself
registered under the SEBI Act, 1992. Unless he is registered under SEBI an intermediary
cannot deal with securities market or cannot even buy or sell or deal in securities.
Section 12 of Chapter five deals with registration of stock brokers, sub-brokers, share
transfer agents, etc. It says no stock-broker, sub- broker, share transfer agent, banker to an
issue, trustee of trust deed, registrar to an issue, merchant banker, underwriter, portfolio
manager, investment adviser and such other intermediary who may be associated with
securities market shall buy, sell or deal in securities except under and in accordance with the
conditions of a certificate of registration obtained from the Board in accordance with the
regulations made under this Act. It is also provided that a person buying or selling securities
or otherwise dealing with the securities market as a stock- broker, sub-broker, share
transfer agent, banker to an issue, trustee of trust deed, registrar to an issue, merchant
banker, underwriter, portfolio manager, investment adviser and such other intermediary
who may be associated with securities market immediately before the establishment of the
Board for which no registration certificate was necessary prior to such establishment, may
continue to do so for a period of three months from such establishment or, if he has made
an application for such registration within the said period of three months, till the disposal
of such application.
Sub-section (1A) of section 12 also mentions about registration of depository,
participant, custodians, etc. It says that no depository, participant, custodian of securities,
foreign institutional investor, credit rating agency or any other intermediary associated with
the securities market as the Board may by notification in this behalf specify, shall buy or sell
or deal in securities except under and in accordance with the conditions of a certificate of
registration obtained from the Board in accordance with the regulations made under this
Act. It is prohibited to run any venture capital funds or any collective investment schemes
unless the same is registered under SEBI Act, 1992. Sub-section (1B) says that no person
shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture
capital funds or collective investment schemes including mutual funds unless he obtains a
certificate of registration from the Board in accordance with the regulations. All these
application for registration shall be in such manner and on payment of such fees as may be
determined by the regulations.
PROHIBITION OF MANIPULATIVE AND DECEPTIVE DEVICES, INSIDER TRADING AND
SUBSTANTIAL ACQUISITION OF SECURITIES OR CONTROL:
Securities and Exchange Board of India has prohibited insider trading, substantial
acquisition of securities or control. Insider trading can be defined as securities trading by
insiders based on material non public information in violation of a fiduciary or similar duty
of trust and confidence to the company issuing the security to the companys shareholders
or to the source of information. The main benefit of the insider trading goes to the insider.
An insider can be the directors, officers, shareholders holding substantial number of shares,
persons who are not employed by the corporation but receive confidential information from
a corporation while providing services to the corporation like professional advisors, lawyers,
investment bankers. In other words, the knowledge of unpublished price sensitive
information in hands of persons connected to the companies which put them in an
advantageous position over others who lack it, such information can be used to make gains
by buying shares a cheaper rate anticipating that it might rise and it can be used to insulate
themselves against losses by selling shares before the prices fall down, such kind of
transaction entered into by persons having access to any unpublished information is called
Insider Trading. Consequently, SEBI banned insider trading and laid down the SEBI
(Prohibition of Insider Trading) Regulation 1992. Similarly, substantial acquisition of shares
and take-overs has also been prohibited by SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997.
Accordingly section 12A says that No person shall directly or indirectly-
i. use or employ, in connection with the issue, purchase or sale of any securities listed
or proposed to be listed on a recognised stock exchange, any manipulative or
deceptive device or contrivance in contravention of the provisions of this Act or the
rules or the regulations made thereunder;
ii. employ any device, scheme or artifice to defraud in connection with issue or dealing
in securities which are listed or proposed to be listed on a recognised stock
exchange; engage in any act, practice, course of business which operates or would
operate as fraud or deceit upon any person, in connection with the issue, dealing in
securities which are listed or proposed to be listed on a recognised stock exchange,
in contravention of the provisions of this Act or the rules or the regulations made
thereunder;
iii. engage in insider trading;
iv. deal in securities while in possession of material or non-public information or
communicate such material or non-public information to any other person, in a
manner which is in contravention of the provisions of this Act or the rules or the
regulations made thereunder;
v. acquire control of any company or securities more than the percentage of equity
share capital of a company whose securities are listed or proposed to be listed on a
recognised stock exchange in contravention of the regulations made under this Act.
The penalty for insider trading is given under section 15G. If any person
i. either on his own behalf or on behalf of any other person, deals in securities of a
body corporate listed on any stock exchange on the basis of any unpublished price
sensitive information; or
ii. communicates any unpublished price- sensitive information to any person, with or
without his request for such information except as required in the ordinary course of
business or under any law; or
iii. counsels, or procures for any other person to deal in any securities of any body
corporate on the basis of unpublished price-sensitive information, shall be liable to a
penalty 50[of twenty-five crore rupees or three times the amount of profits made
out of insider trading, whichever is higher.
Penalty for non-disclosure of acquisition of shares and takeovers is given in section
15H. If any person, who is required under this Act or any rules or regulations made
thereunder, fails to -
i. disclose the aggregate of his shareholding in the body corporate before he acquires
any shares of that body corporate; or
ii. make a public announcement to acquire shares at a minimum price;
iii. make a public offer by sending letter of offer to the shareholders of the concerned
company; or make payment of consideration to the shareholders who sold their
shares pursuant to letter of offer, he shall be liable to a penalty twenty-five crore
rupees or three times the amount of profits made out of such failure, whichever is
higher.
Section 15HA provides for the penalty for fraudulent and unfair trade practices. If
any person indulges in fraudulent and unfair trade practices relating to securities, he shall
be liable to a penalty of twenty-five crore rupees or three times the amount of profits made
out of such practices, whichever is higher.
ESTABLISHMENT, JURISDICTION, AUTHORITY AND PROCEDURE OF APPELLATE TRIBUNAL:
Establishment, jurisdiction, authority and procedure of appellate tribunal has been
given under chapter VIB. The Securities Appellate Tribunal has been established under
section 15K of the Act. The Central Government shall, by notification, establish one or more
Appellate Tribunals to be known as the Securities Appellate Tribunal to exercise the
jurisdiction, powers and authority conferred on such Tribunal by or under this Act or any
other law for the time being in force. The Central Government shall also specify in the
notification the matters and places in relation to which the Securities Appellate Tribunal
may exercise jurisdiction.
The composition of the Securities Appellate Tribunal has been dealt under section
15L. A Securities Appellate Tribunal shall consist of a Presiding Officer and two other
Members, to be appointed, by notification, by the Central Government. Provided that the
Securities Appellate Tribunal, consisting of one person only, established before the
commencement of the Securities and Exchange Board of India (Amendment) Act, 2002, shall
continue to exercise the jurisdiction, powers and authority conferred on it by or under this
Act or any other law for the time being in force till two other Members are appointed under
this section.
The qualifications for becoming a member of Securities Appellate Tribunal are given
in section 15M. A person shall not be qualified for appointment as the Presiding Officer of a
Securities Appellate Tribunal unless he is a sitting or retired Judge of the Supreme Court or a
sitting or retired Chief Justice of a High Court. Provided that the Presiding Officer of the
Securities Appellate Tribunal shall be appointed by the Central Government in consultation
with the Chief Justice of India or his nominee. Sub-section (2) says that A person shall not be
qualified for appointment as Member of a Securities
Appellate Tribunal unless he is a person of ability, integrity and standing who has
shown capacity in dealing with problems relating to securities market and has qualification
and experience of corporate law, securities laws, finance, economics or accountancy.
Provided that a member of the Board or any person holding a post at senior management
level equivalent to Executive Director in the Board shall not be appointed as Presiding
Officer or Member of a Securities Appellate Tribunal during his service or tenure as such
with the Board or within two years from the date on which he ceases to hold office as such
in the Board.
The Presiding Officer and every other Member of a Securities Appellate Tribunal
shall hold office for a term of five years from the date on which he enters upon his office
and shall be eligible for re-appointment. Provided that no person shall hold office as the
Presiding Officer of the Securities Appellate Tribunal after he has attained the age of sixty-
eight years. It is provided further that no person shall hold office as Member of the
Securities Appellate Tribunal after he has attained the age of sixty-two years.
APPEAL TO SECURITIES APPELLATE TRIBUNAL:
Section 15T says about appeal to the Securities Appellate Tribunal. Any person
aggrieved:
i. by an order of the Board made, on and after the commencement of the Securities
Laws (Second Amendment) Act, 1999, under this Act, or the rules or regulations
made thereunder; or
ii. by an order made by an adjudicating officer under this Act, may prefer an appeal to a
Securities Appellate Tribunal having jurisdiction in the matter.
Sub-section (2) says that no appeal shall lie to the Securities Appellate Tribunal from an
order made:
i. by the Board on and after the commencement of the Securities Laws (Second
Amendment) Act, 1999;
ii. by an adjudicating officer, with the consent of the parties. Every appeal shall be filed
within a period of forty-five days from the date on which a copy of the order made
by the Board or the adjudicating officer, as the case may be, is received by him and it
shall be in such form and be accompanied by such fee as may be prescribed.
Provided that the Securities Appellate Tribunal may entertain an appeal after the
expiry of the said period of forty-five days if it is satisfied that there was sufficient
cause for not filing it within that period.
On receipt of an appeal, the Securities Appellate Tribunal may, after giving the
parties to the appeal, an opportunity of being heard, pass such orders thereon as it thinks
fit, confirming, modifying or setting aside the order appealed against. The Securities
Appellate Tribunal shall send a copy of every order made by it to the Board, the parties to
the appeal and to the concerned Adjudicating Officer. The appeal filed before the tribunal
shall be dealt with by it as expeditiously as possible and endeavour shall be made by it to
dispose of the appeal finally within six months from the date of receipt of the appeal.
APPEAL TO THE SUPREME COURT:
Any person aggrieved by any decision or order of the Securities Appellate Tribunal
may file an appeal to the Supreme Court within sixty days from the date of communication
of the decision or order of the Securities Appellate Tribunal to him on any question of law
arising out of such order. It is also provided that the Supreme Court may, if it is satisfied that
the applicant was prevented by sufficient cause from filing the appeal within the said
period, allow it to be filed within a further period not exceeding sixty days. (Section 15Z)
PROCEDURE AND POWERS OF THE SECURITIES APPELLATE TRIBUNAL:
The powers and procedures of the Securities Appellate Tribunal have been given
under section 15U. The Securities Appellate Tribunal shall not be bound by the procedure
laid down by the Code of Civil Procedure, 1908(5 of 1908), but shall be guided by the
principles of natural justice and, subject to the other provisions of this Act and of any rules,
the Securities Appellate Tribunal shall have powers to regulate their own procedure
including the places at which they shall have their sittings. The Securities Appellate Tribunal
shall have, for the purposes of discharging their functions under this Act, the same powers
as are vested in a civil court under the Code of Civil Procedure, 1908(5 of 1908), while trying
a suit, in respect of the following matters, namely:
i. summoning and enforcing the attendance of any person and examining him on oath;
ii. requiring the discovery and production of documents;
iii. receiving evidence on affidavits;
iv. issuing commissions for the examination of witnesses or documents;
v. reviewing its decisions;
vi. dismissing an application for default or deciding it ex parte;
vii. setting aside any order of dismissal of any application for default or any order passed
by it ex parte; any other matter which may be prescribed.
Every proceeding before the Securities Appellate Tribunal shall be deemed to be a
judicial proceeding within the meaning of sections 193 and 228, and for the purposes of
section 196 of the Indian Penal Code (45 of 1860), and the Securities Appellate Tribunal shall
be deemed to be a civil court for all the purposes of section 195 and Chapter XXVI of the
Code of Criminal Procedure, 1973(2 of 1974).
The appellant in the Securities Appellate Tribunal may either appear in person or
authorise on or more chartered accountants or company secretaries or cost accounts or
legal practitioners or any of its officers to present his or its case before the Securities
Appellate Tribunal. No civil court shall have jurisdiction to entertain any suit or proceeding
in respect of any matter which an adjudicating officer appointed under this Act is
empowered by or under this Act to determine and no injunction shall be granted by an
court or other authority in respect of any action taken or to be taken in pursuance of any
power conferred by or under this Act.
The Board also prescribes, under its authority, various rules/regulations/circulars etc.
which are applicable to public companies or the companies whose shares are going to be
listed. The rules and regulations prescribed by the SEBI are obviously connected with the
issue and the trading at the primary and the secondary market. The SEBI does commendable
job by co-coordinating with the Government, Reserve Bank of India, various other organs,
Intermediaries, Financial Institutions, World Stock Exchanges and various other recognized
stock exchanges in India.
Some important rules/regulations/guidelines prescribed by the SEBI are given
hereunder:
1. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009
2. SEBI (Central Listing Authority) Regulations, 2003
3. SEBI (Delisting of Securities) Guidelines, 2003
4. SEBI (Employees Stock Option Scheme and Employees Stock Purchase Scheme)
Guidelines, 1999
5. SEBI (Issue of Sweat Equity) Regulations, 2002
6. SEBI (Buy-Back of Securities) Regulations, 1998
7. SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997
8. SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Markets) Regulations, 2003
9. SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Markets) Regulations, 1995
10. SEBI (Mutual Funds) Regulations, 1996
11. SEBI (Collective Investment Schemes) Regulations, 1999
12. SEBI Guidelines for Foreign Institutional Investors
13. SEBI (FIIs) Regulations, 1995
14. SEBI (Venture Capital Funds) Regulations, 1996
15. SEBI (Foreign Venture Capital Funds) Regulations
16. SEBI (Depositories and Participants) Regulations, 1996
17. SEBI (Custodian of Securities) Regulations, 1996
18. SEBI (Credit Rating Agencies) Regulations, 1999
19. SEBI (Merchant Bankers) Rules, 1992
20. SEBI (Merchant Bankers) Regulations, 1992/SEBI (Registrars to an issue and Share
Transfer Agents) Rules, 1993
21. SEBI (Registrars to an issue and Share Transfer Agents)Regulation, 1993
22. SEBI (Underwriters) Rules, 1993
23. SEBI (Underwriters) Regulations, 1993
24. SEBI (Debenture Trustees) Rules, 1993
25. SEBI (Debenture Trustees) Regulations, 1993/SEBI (Bankers to an Issue) Rules, 1994
26. SEBI (Bankers to an Issue) Regulations, 1994
27. SEBI (Stock Brokers and Sub-Brokers) Rules, 1992
28. SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992
29. SEBI (Portfolio Manager) Rules, 1993
30. SEBI (Portfolio Manager) Regulations, 1993
31. SEBI (Ombudsman) Regulations, 2003.
Apart from very few prominent rules and regulations framed or prescribed by the
SEBI, there are numerous circulars etc. issued by the SEBI for effective discharge of its
functions. Among all, the SEBI (Issue of Capital and Disclosure Requirements) Regulations,
2009 or ICDR Regulations, 2009 will be of great significance when it comes to initial issue.
Again, the SEBI will discharge the most of important function of Takeovers and has to
prevent the indirect takeovers floating the rules and regulations. Again, insider trading,
various schemes, mutual funds etc. the rule and regulations in respect of the public
companies like buyback of securities etc. will be effectively prescribed and administered by
SEBI. Like RBI which is burdened with the sensitive and complicated functions, the SEBI too
discharges a commendable job it was assigned to.
CONCLUSION
The enactment of the SEBI Act within the context of other statutes such as the
Companies Act, Depositories Act and Securities Contracts Regulation Act has provided a
strong regulatory framework for the Indian market. Subsequently much of the growth of the
Indian market can be attributed to the robust processes for issuance, pricing, allotment and
listing of securities enabled by SEBI. Strengthening SEBI's power in the investigative,
administrative and legal aspects of enforcement would enable it to speedily address legal
challenges such as those faced during dematerialization or disclosure requirements. In the
future, SEBI should adopt more transparency to gain higher public confidence.

Procedure for recognition of stock exchanges
For recognition of stock exchanges following procedure is necessary to follow. Firstly
application for recognition of stack exchange (section 3 of Securities Contracts Regulation
Act, 1956 )and grant of recognition (section 4 of Securities Contracts Regulation Act, 1956 )
-:
Application for recognition of stock exchanges
According to section 3 of Securities Contracts Regulation Act, 1956-
Any stock exchange, which is desirous of being recognised for the purposes of this Act may
make an application in the prescribed manner to the Central Government.
Every application under sub- section (1) shall contain such particulars as may be prescribed,
and shall be accompanied by a copy of the bye- laws of the stock exchange for the
regulation and control of contracts and also a copy of the rules relating in general to the
constitution of the stock exchange and in particular, to-
a. the governing body of such stock exchange, its constitution and powers of
management and the manner in which its business is to be transacted;
b. the powers and duties of the office bearers of the stock exchange;
c. the admission into the stock exchange of various classes of members, the
qualifications, for membership, and the exclusion, suspension, expulsion and
re-admission of members therefrom or thereinto;
d. the procedure for the registration of partnerships as members of the stock
exchange in cases where the rules provide for such membership; and the
nomination and appointment of authorised representatives and clerks.
Grant of recognition to stock exchanges
According to section 4 of Securities Contracts Regulation Act, 1956
If the Central Government is satisfied, after making such inquiry as may be necessary in this
behalf and after obtaining such further information, if any, as it may require:
(a) that the rules and bye-laws of a stock exchange applying for registration are in
conformity with such conditions as may be prescribed with a view to ensure fair
dealing and to protect investors;

(b) that the stock exchange is willing to comply with any other conditions (including
conditions as to the number of members) which the Central Government, after
consultation with the governing body of the stock exchange and having regard to the
area served by the stock exchange and its standing and the nature of the securities
dealt with by it, may impose for the purpose of carrying out the objects of this Act;
and

(c) that it would be in the interest of the trade and also in the public interest to grant
recognition to the stock exchange;
it may grant recognition to the stock exchange subject to the conditions imposed
upon it as aforesaid and in such form as may be prescribed.
The conditions which the Central Government may prescribe under clause (a) of sub-section
(1) for the grant of recognition to the stock exchanges may include, among other matters,
conditions relating to-
(i) the qualifications for membership of stock exchanges;
(ii) the manner in which contracts shall be entered into and enforced as
between members;
(iii) the representation of the Central Government on each of the stock
exchanges by such number of persons not exceeding three as the Central
Government may nominate in this behalf; and
(iv) the maintenance of accounts of members and their audit by chartered
accountants whenever such audit is required by the Central Government.
Every grant of recognition to a stock exchange under this section shall be published in the
Gazette of India and also in the Official Gazette of the State in which the principal office as
of the stock exchange is situate, and such recognition shall have effect as from the date of
its publication in the Gazette of India.
No rules of a recognised stock exchange relating to any of the matters specified in sub-
section (2) of section 3 shall be amended except with the approval of the Central
Government.Withdrawal of recognition 5. If the Central Government is of the opinion that
the recognition granted to a stock exchange under the provisions of this Act should, in the
interest of the trade or in the public interest, be withdrawn, the Central Government may
serve on the governing body of the stock exchange a written notice that the Central
Government is considering the withdrawal of the recognition for the reasons stated in the
notice and after giving an opportunity to the governing body to be heard in the matter, the
Central Government may withdraw, by notification in the Official Gazette, the recognition
granted to the stock exchange:
Provided that no such withdrawal shall affect the validity of any contract entered into or
made before the date of the notification, and the Central Government may, after
consultation with the stock exchange, make such provision as it deems fit in the notification
of withdrawal or in any subsequent notification similarly published for the due performance
of any contracts outstanding on that date. Power of Central Government to call for
periodical returns or direct inquiries to be made 6. (1) Every recognised stock exchange shall
furnish to the [Securities and Exchange Board of India such periodical returns relating to its
affairs as may be prescribed.
(2) Every recognised stock exchange and every member thereof shall maintain and
preserve for such periods not exceeding five years such books of account, and other
documents as the Central Government, after consultation with the stock exchange
concerned, may prescribe in the interest of the trade or in the public interest, and such
books of account, and other documents shall be subject to inspection at all reasonable
times by the [Securities and Exchange Board of India].
(3) Without prejudice to the provisions contained in sub- sections (1) and (2),
the [Securities and Exchange Board of India], if it is satisfied that it is in the interest of the
trade or in the public interest so to do, may, by order in writing,-
a. call upon a recognised stock exchange or any member thereof to furnish in writing
such information or explanation relating to the stock exchange as the [Securities and
Exchange Board of India]

may require; or
b. appoint one or more persons to make an inquiry in the prescribed manner in relation
to the affairs of any of the members of the stock exchange in relation to the stock
exchange and submit a report of the result of such inquiry to the [Securities and
Exchange Board of India].
(4) Where an inquiry in relation to the affairs of a recognised stock exchange or the affairs
of any of its members in relation to the stock exchange has been undertaken under sub-
section (3),-
(a) every director, manager, secretary or other officer of such stock exchange;
(b) every member of such stock exchange;
(c) if the member of the stock exchange is a firm, every partner, manager, secretary
or other officer of the firm; and
(d) every other person or body of persons who has had dealings in the course of
business with any of the persons mentioned in clauses (a), (b) and (c) whether
directly or indirectly;
shall be bound to produce before the authority making the inquiry all such books of
account, and other documents in his custody or power relating to or having a
bearing on the subject-matter of such inquiry and also to furnish the authorities
within such time as may be specified with any such statement or information
relating thereto as may be required of him.
Annual reports to be furnished to Central Government by stock exchanges 7. Every
recognised stock exchange shall furnish the Central Government with a copy of the annual
report, and such annual report shall contain such particulars as may be prescribed. Power of
recognised stock exchange to make rules restricting voting rights, etc. 7A. (1) A recognised
stock exchange may make rules or amend any rules made by it to provide for all or any of
the following matters, namely:
(a) the restriction of voting rights to members only in respect of any matter placed
before the stock exchange at any meeting;
(b) the regulation of voting rights in respect of any matter placed before the stock
exchange at any meeting so that each member may be entitled to have one vote
only, irrespective of his share of the paid-up equity capital of the stock exchange;
(c) the restriction on the right of a member to appoint another person as his proxy to
attend and vote at a meeting of the stock exchange; and
(d) such incidental, consequential and supplementary matters as may be necessary
to give effect to any of the matters specified in clauses (a), (b) and (c).
(2) No rules of a recognised stock exchange made or amended in relation to any matter
referred to in clauses (a) to (d) of sub-section (1) shall have effect until they have been
approved by the Central Government and published by that Government in the Official
Gazette and, in approving the rules so made or amended, the Central Government may
make such modifications therein as it thinks fit, and on such publication, the rules as
provided by the Central Government shall be deemed to have been validly made,
notwithstanding anything to the contrary contained in the Companies Act, 1956 (1 of
1956). Power of Central Government to direct rules to be made or to make rules 8. (1)
Where, after consultation with the governing bodies of stock exchanges generally or with
the governing body of any stock exchange in particular, the Central Government is of the
opinion that it is necessary or expedient so to do, it may, by order in writing together with a
statement of the reasons therefor, direct recognised stock exchanges generally or any
recognised stock exchange in particular, as the case may be, to make any rules or to amend
any rules already made in respect of all or any of the matters specified in sub-section (2) of
section 3 within a period of [two months]

from the date of the order.
(2) If any recognised stock exchange fails or neglects to comply with any order made under
sub-section (1) within the period specified therein, the Central Government may make the
rules for, or amend the rules made by, the recognised stock exchange, either in the form
proposed in the order or with such modifications thereof as may be agreed to between the
stock exchange and the Central Government.
(3) Where in pursuance of this section any rules have been made or amended, the rules so
made or amended shall be published in the Gazette of India and also in the Official Gazette
or Gazettes of the State or States in which the principal office or offices of the recognised
stock exchange or exchanges is or are situate, and, on the publication thereof in the Gazette
of India, the rules so made or amended shall, notwithstanding anything to the contrary
contained in the Companies Act, 1956 (1 of 1956), or in any other law for the time being in
force, have effect as it they had been made or amended by the recognised stock exchange
or stock exchanges, as the case may be. Power of recognised stock exchange to make bye-
laws 9. (1) Any recognised stock exchange may, subject to the previous approval of
the [Securities and Exchange Board of India],

make bye-laws for the regulation and control
of contracts.
(2) In particular, and without prejudice to the generality of the foregoing power, such bye-
laws may provide for:
(a) the opening and closing of markets and the regulation of the hours of trade;
(b) a clearing house for the periodical settlement of contracts and differences
thereunder, the delivery of and payment for securities, the passing on of delivery
orders and the regulation and maintenance of such clearing house;
(c) the submission to the [Securities and Exchange Board of India]

by the clearing
house as soon as may be after each periodical settlement of all or any of the
following particulars as the [Securities and Exchange Board of India]
17
may, from
time to time require, namely:

(i) the total number of each category of security carried over from one
settlement period to another.
(ii) the total number of each category of security, contracts in respect of
which have been squared up during the course of each settlement period.
(iii) the total number of each category of security actually delivered at each
clearing;

(d) the publication by the clearing house of all or any of the particulars submitted to
the [Securities and Exchange Board of India]
18
under clause (c) subject to the
directions, if any, issued by the [Securities and Exchange Board of India]
19
in this
behalf;
(e) the regulation or prohibition of blank transfers;
(f) the number and classes of contracts in respect of which settlements shall be
made or differences paid through the clearing house;
(g) the regulation, or prohibition of badlas or carry-over facilities;
(h) the fixing, altering or postponing of days for settlements;
(i) the determination and declaration of market rates, including the opening, closing,
highest and lowest rates for securities;
(j) the terms, conditions and incidents of contracts, including the prescription of
margin requirements, if any, and conditions relating thereto, and the forms of
contracts in writing;
k) the regulation of the entering into, making, performance, rescission and
termination, of contracts, including contracts between members or between a
member and his constituent or between a member and a person who is not a
member, and the consequences of default or insolvency on the part of a seller or
buyer or intermediary, the consequences of a breach or omission by a seller or
buyer, and the responsibility of members who are not parties to such contracts;
(l) the regulation of taravani business including the placing of limitations thereon;
(m) the listing of securities on the stock exchange, the inclusion of any security for
the purpose of dealings and the suspension or withdrawal of any such securities, and
the suspension or prohibition of trading in any specified securities;
(n) the method and procedure for the settlement of claims or disputes, including
settlement by arbitration;
(o) the levy and recovery of fees, fines and penalties;
(p) the regulation of the course of business between parties to contracts in any
capacity;
(q) the fixing of a scale of brokerage and other charges;
(s) the emergencies in trade which may arise, whether as a result of pool or
syndicated operations or cornering or otherwise, and the exercise of powers in such
emergencies including the power to fix maximum and minimum prices for securities;
(t) the regulation of dealings by members for their own account;
(u) the separation of the functions of jobbers and brokers;
(v) the limitations on the volume of trade done by any individual member in
exceptional circumstances;
(w) the obligation of members to supply such information or explanation and to
produce such documents relating to the business as the governing body may require.
(3) The bye-laws made under this section may:
(a) specify the bye-laws, the contravention of which shall make a contract entered
into otherwise than in accordance with the bye- laws void under sub-section (1) of
section 14;
(b) provide that the contravention of any of the bye-laws shall render the member
concerned liable to one or more of the following punishments, namely:

(i) fine,
(ii) expulsion from membership,
(iii) suspension from membership for a specified period,
(iv) any other penalty of a like nature not involving the payment of money.
(4) Any bye-laws made under this section shall be subject to such conditions in regard to
previous publication as may be prescribed, and, when approved by the [Securities and
Exchange Board of India],

shall be published in the Gazette of India and also in the Official
Gazette of the State in which the principal office of the recognised stock exchange is situate,
and shall have effect as from the date of its publication in the Gazette of India: Provided
that if the [Securities and Exchange Board of India]

is satisfied in any case that in the
interest of the trade or in the public interest any bye-laws should be made immediately, it
may, by order in writing specifying the reasons therefor, dispense with the condition of
previous publication. Power of [Securities and Exchange Board of India]

to make or amend
bye-laws of recognised stock exchanges 10. (1) The [Securities and Exchange Board of India]


may, either on a request in writing received by it in this behalf from the governing body of a
recognised stock exchange or on its own motion, if it is satisfied after consultation with the
governing body of the stock exchange that it is necessary or expedient so to do and after
recording its reasons for so doing, make bye-laws, for all or any of the matters specified in
section 9 or amend any bye-laws made by such stock exchange under that section.
(2) Where in pursuance of this section any bye-laws have been made or amended, the
bye-laws so made or amended shall be published in the Gazette of India and also in the
Official Gazette of the State in which the principal office of the recognised stock exchange is
situate, and on the publication thereof in the Gazette of India, the bye-laws so made or
amended shall have effect as if they had been made or amended by the recognised stock
exchange concerned.
(3) Notwithstanding anything contained in this section, where the governing body of a
recognised stock exchange objects to any bye-laws made or amended under this section by
the[Securities and Exchange Board of India]

on its own motion, it may, within [two
months] of the publication thereof in the Gazette of India under sub-section (2), apply to
the [Securities and Exchange Board of India] for revision thereof the [Securities and
Exchange Board of India]

may, after giving an opportunity to the governing body of the
stock exchange to be heard in the matter, revise the bye-laws so made or amended, and
where any bye-laws so made or amended are revised as a result of any action taken under
this sub- section, the bye-laws so revised shall be published and shall become effective as
provided in sub-section (2).
(4) The making or the amendment or revision of any bye-laws under this section shall in all
cases be subject to the condition of previous publication:
Provided that if the [Securities and Exchange Board of India] is satisfied in any case that in
the interest of the trade or in the public interest any bye-laws should be made, amended or
revised immediately, it may, by order in writing specifying the reasons therefor, dispense
with the condition of previous publication. Power of Central Government to supersede
governing body of a recognised stock exchange 11. (1) Without prejudice to any other
powers vested in the Central Government under this Act, where the Central Government is
of the opinion that the governing body of any recognised stock exchange should be
superseded, then, not withstanding anything contained in any other law for the time being
in force, the Central Government may serve on the governing body a written notice that the
Central Government is considering the supersession of the governing body for the reasons
specified in the notice and after giving an opportunity to the governing body to be heard in
the matter, it may, by notification in the Official Gazette declare the governing body of such
stock exchange to be superseded, and may appoint any person or persons to exercise and
perform all the powers and duties of the governing body, and, and where more persons
than one are appointed, may appoint one of such persons to be the chairman and another
to be the vice- chairman thereof.
(2) On the publication of a notification in the Official Gazette under sub-section (1), the
following consequences shall ensue, namely:-
(a) the members of the governing body which has been superseded shall, as from
the date of the notification of supersession, cease to hold office as such members;

(b) the person or persons appointed under sub-section (1) may exercise and perform
all the powers and duties of the governing body which has been superseded;

(c) all such property of the recognised stock exchange as the person or persons
appointed under sub-section (1) may, by order in writing, specify in this behalf as
being necessary for the purpose of enabling him or them to carry on the business of
the stock exchange, shall vest in such person or persons.
(3) Notwithstanding anything to the contrary contained in any law or the rules or bye-laws
of the recognised stock exchange the governing body of which is superseded under sub-
section (1), the person or persons appointed under that sub-section shall hold office for
such period a may be specified in the notification published under that sub-section and, the
Central Government may from time to time, by like notification, vary such period.
(4) The Central Government may at any time before the determination of the period of
office of any person or persons appointed under this section call upon the recognised stock
exchange to reconstitute the governing body in accordance with its rules and on such re-
constitution all the property of the recognised stock exchange which has vested in, or was in
the possession of, the person or persons appointed under sub- section (1), shall re-vest, as
the case may be, in the governing body so re- constituted:
Provided that until a governing body is so re- constituted, the person or persons appointed
under sub- section (1), shall continue to exercise and perform their powers and
duties. Power to suspend business of recognised stock exchanges 12. If in the opinion of the
Central Government an emergency has arisen and for the purpose of meeting the
emergency the Central Government considers it expedient so to do, it may, by notification
in the Official Gazette, for reasons to be set out therein, direct a recognised stock exchange
to suspend such of its business for such period not exceeding seven days and subject to such
conditions as may be specified in the notification, and if, in the opinion of the Central
Government, the interest of the trade or the public interest requires that the period should
be extended may, by like notification extend the said period from time to time.
Provided that where the period of suspension is to be extended beyond the first period, no
notification extending the period of suspension shall be issued unless the governing body of
the recognised stock exchange has been given an opportunity of being heard in the matter.


SECURITIES CONTRACTS (REGULATION) ACT, 1956
The government enacted the Securities Contracts (Regulation) Act in 1956s which was
characterized by the establishment of a network for the development of financial
institutions and state financial corporations.The Securities Contracts (Regulation) Act, 1956,
has defined Stock Exchange as an "association, organization or body of individuals, whether
incorporated or not, established for the purpose of assisting, regulating and controlling
business of buying, selling and dealing in Securities".
Stock exchange as an organized security market provides marketability and price continuity
for shares and helps in a fair evaluation of securities in terms of their intrinsic worth. Thus it
helps orderly flow and distribution of savings between different types of investments. This
institution performs an important part in the economic life of a country, acting as a free
market for securities where prices are determined by the forces of supply and demand.
Apart from the above basic function it also assists in mobilizing funds for the Government
and the Industry and to supply a channel for the investment of savings in the performance
of its functions.
The Stock Exchanges in India as elsewhere have a vital role to play in the development of
the country in general and industrial growth of companies in the private sector in particular
and helps the Government to raise internal resources for the implementation of various
development programmes in the public sector. As a segment of the capital market it
performs an important function in mobilizing and channelising resources which remain
otherwise scattered. Thus the Stock Exchanges tap the new resources and stimulate a broad
based investment in the capital structure of industries.
The Act recognizes stock exchanges with different legal structure. Presently the stock
exchanges which are recognised under the Securities Contracts (Regulation) Act in India,
could be segregated into two broad groups 20 stock exchanges which were set up as
companies, either limited by guarantees or by shares, and the 3 stock exchanges which are
functioning as associations of persons (AOP) viz. BSE, Ahmedabad Stock Exchange and
Indore Stock Exchange. The 20 stock exchanges which are companies are: the stock
exchanges of Bangalore, Bhubaneswar, Calcutta, Cochin, Coimbatore, Delhi, Gauhati,
Hyderabad, Interconnected SE, Jaipur, Ludhiana, Madras, Magadh, Managalore, NSE, Pune,
OTCEI, Saurashtra-Kutch, Uttar Pradesh, and Vadodara. Of these, the stock exchanges of
Ahmedabad, Bangalore, BSE, Calcutta, Delhi, Hyderabad, Madhya Pradesh, Madras and
Gauhati were given permanent recognition by the Central Government at the time of
setting up of these stock exchanges. Apart from NSE, all stock exchanges whether
established as corporate bodies or Association of Persons (AOPs), are non-profit making
organizations.
Powers that may be exercised by the Stock Exchange
The powers of the stock exchange are to be exercised as per provisions in its bye-law. As per
SCRA Act any recognised stock exchange may, subject to the previous approval of
the[Securities and Exchange Board of India make bye-laws for the regulation and control of
contracts. The bye-laws can provide for the exercise of following powers by the stock
exchange

a. The opening and closing of markets and the regulation of the hours of trade;

b. Set up a clearing house for the periodical settlement of contracts and differences
thereunder, the delivery of and payment for securities, the passing on of delivery orders and
the regulation and maintenance of such clearing house;
c. The regulation or prohibition of blank transfers;
d. The regulation or prohibition of badlas or carry-over facilities;
e. The fixing, altering or postponing of days for settlements;
f. The determination and declaration of market rates, including the opening, closing, highest
and lowest rates for securities;
g. The terms, conditions and incidents of contracts, including the prescription of margin
requirements, if any, and conditions relating thereto, and the forms of contracts in writing;

h. The regulation of the entering into, making, performance, rescission and termination, of
contracts, including contracts between members or between a member and his constituent
or between a member and a person who is not a member, and the consequences of default
or insolvency on the part of a seller or buyer or intermediary, the consequences of a breach
or omission by a seller or buyer, and the responsibility of members who are not parties to
such contracts;
i. The regulation of taravani business including the placing of limitations thereon;
j. The listing of securities on the stock exchange, the inclusion of any security for the
purpose of dealings and the suspension or withdrawal of any such securities, and the
suspension or prohibition of trading in any specified securities;
k. The method and procedure for the settlement of claims or disputes, including settlement
by arbitration;
l. The levy and recovery of fees, fines and penalties
m. The regulation of the course of business between parties to contracts in any capacity;
n. The exercise of powers in emergencies in trade(which may arise, whether as a result of
pool or syndicated operations or cornering or otherwise) including the power to fix
maximum and minimum prices for securities;
o. The regulation of dealings by members for their own account;
p. The separation of the functions of jobbers and brokers;
q. The limitations on the volume of trade done by any individual member in exceptional
circumstances;
r. Fixing the obligation of members to supply such information or explanation and to
produce such documents relating to the business as the governing body may require.

Demutualisation of stock exchanges
The concept of demutualisation
Demutualization is gaining increasing importance in the structural reform of securities
exchanges throughout the world. The process of demutualisation involves the bifurcation of
members rights in a stock exchange into 2 parts - ownership rights and trading rights. It
thereby changes the relation between members and the stock exchanges and alters the
position of stock exchanges, as they would not retain their voluntary, not-for-profit
character, but become for profit corporate bodies. The process of transition from a
mutually-owned association to a company owned by shareholders or, in other words, the
transformation of the legal structure from a mutual form to a business corporation is
referred to as 'demutualisation'. The company so constituted as a result of the process may
be listed or unlisted.

Stock Exchanges in India
Trading in securities has been prevalent in India right from the 18th century with the
establishment of the Native Share and Stock Brokers Association, now better known as the
Bombay Stock Exchange. By the end of the Second World War, the securities market in India
had undergone several rallies and India emerged as a supply base for all manufacturing
activities. These events led to the emergence and development of stock exchanges in major
cities around the country.
Today, the growth of the exchanges in India can be attributed to the increase in the number
of instruments offered, the large number of listed companies and a tight credit policy of
banks. As a result, the Indian corporate sector has been largely relying upon the capital
markets for raising funds for their needs. The daily turnover of the exchanges has shot up
significantly.

The Bombay Stock Exchange
Established in 1875, the Bombay Stock Exchange (BSE) is the oldest and the largest
exchange in India. The BSE was the first stock exchange to be recognised by the Government
of India and is the only one that has had the privilege of getting permanent membership.
The BSE is a voluntary non-profit making Association of Persons (AOP). The members of the
stock exchange collectively hold the assets of the exchange in trust and the beneficiaries are
also the members. The basic character of the BSE is that it is a voluntary, not for profit
mutual entity being controlled, owned and governed by exchange members who are usually
stock-brokers. It is on this ground that the BSE claims tax exemptions.
Under the present management structure, the governing board of the BSE comprises of 19
persons made up of 1 Executive Director, 2 SEBI nominees, 1 RBI nominee, 5 public
representatives and 9 selected members.
The present system of membership is based on the concept of membership cards for its
members which offers trading rights against deposits. This membership card can be
transferred for a consideration after the required approval is sought. Cards can be sold by
members and also by the stock exchange when new members are introduced.
The National Stock Exchange
Incorporated in November 1992, the National Stock Exchange (NSE) has been demutualised
since its inception and is the only functioning demutualised exchange in India. The NSE is a
company limited by shares, registered under the Companies Act, 1956, with various banks
and financial institutions as its shareholders. The NSE is a for-profit company and the
shares are almost equally distributed among all the shareholders with there being no single
largest shareholder.
The total permitted strength of the Board is 22 persons while the present strength is 19
persons, comprising of 2 SEBI nominees, 4 public represen-tatives, 4 independent directors,
1 managing director and 8 shareholder representatives. Presently, there are no brokers on
the Board. Thedirectors are selected in accordance with the relevant provisions of the
Companies Act, 1956, and 2 of the public representatives are also approved by SEBI.
Other stock exchanges
Stock exchanges such as the Hyderabad, Madras, Guwahati and the Magadh stock
exchanges are companies limited by guarantee. Others, such as the Bangalore, Kolkata,
Ludhiana and Delhi stock exchange are companies limited by shares. Only the Ahmedabad,
Bombay (BSE) and Madhya Pradesh stock exchanges are voluntary non-profit making AOPs.
The present system of membership that exists in the stock exchanges is that the exchanges
have the concept of membership cards for their membersexcept the NSE, which offers
trading rights against deposits.
The need of demutualisation
In recent years, dramatic changes have occurred in financial markets. Developments in
computing power and application have changed markets to a great extent. Stock markets
are facing increasing competition under pressure from the forces of technological
advancement and globalisation. Technological advancements and developments have also
changed the conditions of competition in the securities markets, and as a result, stock
exchanges are facing growing domestic and international competition from other firms. This
has put an increasing requirement on stock exchanges to be cost efficient, transparent and
more widely accountable. Stock Exchanges have, therefore, been forced to redefine their
roles. Market reforms are resulting in exchanges ceasing to be feasible as stand-alone
entities and the traditional functions of the stock exchange, i.e., clearing, settlement and
listing are under potential competitive threat. To meet these threats, exchanges are being
driven to organise themselves and behave like commercial enterprises. This, in turn, calls for
the modernisation, demutualisation and a radical change of the organizational structure and
outline of the existing exchanges, thereby allowing a more rapid response to these
developments. Exchanges also need to meet the demand from their customers for lower
transaction costs, more efficient services and new products. The only credible way to meet
the requirements of the customer is by investing in new technology that would reduce the
role of the brokers. Further, the aspect of conflict of interest also increases the need for a
demutualised stock exchange. A mutualised exchange is in all cases subject to conflict of
interest. In such cases, the decisions of the exchange could affect the interest of the
members either individually or collectively. The BSE was witness to such a conflict in the
Anand Rathi's case, where the accused was charged of passing information from the
surveillance department to trade on the exchange. Such events of conflicts and its impact on
the market have led the Union Budget of 2002-2003 to emphasise on the demutualisation
of the stock exchanges.
The basic objective of demutualisation of stock exchanges is to do away with the
involvement of brokers in the management of the Exchanges, to convert the Exchanges into
business entities so that they are professionally managed, to eliminate insider trading and
an effort to continue capital market reforms. This idea would also ensure that the
Government has greater control in the administration of the countrys capital market.

Modality of demutualisation - Recommendation of Justice Kania Committee
The Government of India has announced the corporatisation of the stock exchanges due to
which ownership rights and trading membership will be segregated from each other. The
Justice Kania Committee on Demutualization and Corporatisation of the Exchanges (the
Group) has been set up to aid, advise, recommend and facilitate the process of
demutualisation. The process of demutualisation would have to take place through
corporatisation of the stock exchange and will involve three steps, whereby all the
exchanges will have one uniform legal structure: The steps that have been suggested by the
Group are:
a.The corporatization of the stock exchanges of Bombay, Ahmedabad and Madhya Pradesh.
b.The conversion of the stock exchanges limited by guarantees to one limited by shares.
c.The incorporation in the Memorandum and Articles of Association of the existing stock
exchanges set up, of relevant provisions to give effect to the groups
recommendations.
For the purpose of the segregation of ownership and trading rights, the Group envisages
that the deposit system may have more advantages as opposed to the present card system.
Presently, except for the NSE, which offers trading rights against deposits, all the other stock
exchanges have the concept of the card system and provide for membership cards for their
members. Under the card system, the trading right is exercised through the ownership of a
trading card which, subject to the required approval, may be transferred for a consideration
or may also be sold by the exchanges when new members are introduced. The introduction
of the deposit system in place of the card system would provide for a source of funding for
the stock exchange which needs to make large investments in technology to cope with the
increasing competition. The money deposited by the member would enable him to obtain
trading rights. The deposits would also be considered as the right to trade and the excess
value of the card over the deposit amount would be considered as the value of the right to a
share in the net assets and goodwill of the stock exchange. This is opposed to the card
system where the amount invested by the member is not considered for any purpose. If the
member wishes to terminate his membership, he may demand the refund of his deposit,
but in order to maintain and ensure the liquidity of the stock exchange, there would be a
lock-in-period of 3 years.
With the emergence of demutualisation, the need for a strong management of the stock
exchanges is of high importance. Therefore, the roles of the chairman and the Chief
Executive Officer (CEO) would have to be segregated. The chairman of the board would not
be allowed to be a practising broker. The CEO would be responsible for the day-to-day
functioning of the exchange, including compliance with risk management practices. A
whole-time director would also be appointed to strengthen the management of the stock
exchange. Also, the demutualized stock exchange would have to follow the relevant norms
of corporate governance applicable to listed companies such as the constitution of the audit
committee, standards of financial disclosure and accounting standards, disclosure in the
annual reports, disclosures to shareholders and management systems and procedures. In
addition, the exchanges may appoint a Chief Functioning Officer (CFO) who need not be a
member of the stock exchange board. This appointment would be optional. It is important
that the board does not constitute any committee whose effect would be to dilute the
independence of the CEO of the stock exchange and its day-to-day functioning.
Further, keeping in mind the public interest and the efficient functioning of the stock
exchanges, it would be important that no single entity or groups of related entities should
be allowed to control the stock exchange. Therefore a ceiling of 5 per cent of the voting
rights is proposed, which can be exercised by a single entity or groups of related entities,
irrespective of the size of ownership of the shares.
Regarding the issues pertaining to the conflict of interest, the Group suggests that it could
be addressed by building up strong management teams and putting in place the appropriate
systems and procedures, which would ensure that the brokers would not be able to
interfere in the day-to-day functioning of the stock exchanges. The Group, therefore,
recommends that there should be three stakeholders; the shareholders, the brokers and the
investing public through a regulatory body. All three should be equally represented on the
governing body of the exchange. There should be specific vacancies on the board for each
group of stake-holders, the broker representatives should not be functioning brokers, the
representatives should be elected by the shareholders from among the brokers of the stock
exchange, the representatives of the investing public would be nominated by SEBI from
among the panel comprising of professionals, academicians, industry representatives, public
figures and investors associations, none of whom should have any interest in the broking
firm. Further, adequate disclosures about the background of the directors should be
provided to the shareholders at the annual general meetings and the annual reports. The
maximum number of directors on the board would be governed by the relevant provisions
under the Companies Act 1956.


Advantages of the process
Stock exchanges owned by members tend to work towards the interest of the members
alone, which could be detrimental to the rights of other stakeholders. The division of the
ownership between the members and outsiders would lead to a balanced approach, remove
conflicts of interest, create greater management accountability and take into consideration
the interest of other members.
The amount of funds that would be raised by the member-owned stock exchanges would
have limitations while the publicly-owned exchanges would be able to tap capital markets.
Publicly-owned stock exchanges can also be more professional when compared to member-
owned organisations. Further, as a result of the role played by the shareholders,
strengthening of the management and the organisation, there is transparency in the
dealings, greater accountability and more market discipline. Management flexibility would
be enhanced. A publicly-held company would be better equipped to respond to changes
when compared to a closely-held mutually owned organisation.

Possible challenges
With demutualization of the stock exchanges coming into the limelight, there may arise
various challenges that may slow the process down.
Financial concerns - The process of demutualization may give rise to the diversification of
the corporate structure and the setting up other business operations. These opportunities
provided by the process may, in turn, give rise to a conflict of interest. The methods to deal
with these kinds of conflicts and internal segregation need to be decided.
Governance - One of the issues regarding the governance is whether the demutualised
corporate structure would compromise the position of the stock exchanges as a public
entity. The inclusion of outside directors would be useful to serve as a check and would
promote integrity.
Transferability of shares - The issue that would arise is whether the shares of the listed stock
exchange would be freely transferable like the stocks of any other listed company. If these
shares would be transferable, the question that is raised is about the consequences if, after
a takeover, the interests of the new shareholder are not aligned with the role of the
exchange as a public entity.
Self-listing - A conflict of interest may arise if the exchange lists its shares on itself. An
exchange may benefit by listing its own shares due to the enhanced visibility and reputation,
accountability, transparency and market discipline. The question that arises is whether the
exchange can be self-regulated and whether this, in turn, would conflict with the other
competing companies that are also listed on the exchanges.
Effects of Corporatization and demutualization
Corporatization and demutualization of the stock exchanges would bring about the basic
conversion of the stock exchange from a not-for-profit entity to a commercial body. The
process would result in the distribution of assets and the Group feels that, in turn, an
amendment in the Income-tax Act, 1961 would be necessary. The Income-tax Act has
already made some provisions to facilitate the corporatization of the stock exchanges.
Section 47(viii) has been substituted to include any transfer of a capital asset to a company
in the course of corporatization of a recognized stock exchange in India, as a result of which,
an association of persons or a body of individuals is succeeded by such company. Further,
the words or of the association of persons or body of individuals have been added to
proviso (a). Clause (e) was added to the proviso to carry out the corporatization of a
recognized stock exchange in India in accordance with a scheme of corporatization
approved by SEBI. Corresponding amendments have been made to sections 43(1) and 43(6)
of the Income-tax Act. The amendments would be useful so that the past profits of the stock
exchange which were not taxed when it had the character of a not-for-profit entity, should
not be taxed when the character changes. However, the shareholder would be taxed at the
net applicable rate. Secondly, the bye-laws, rules and the articles of the stock exchange
would be amended to provide for the allotment of shares and trading rights upon
corporatization and upon demutualization.
Further, the Indian Stamp Act, 1899 and Securities Contract (Regulations) Act, 1956 would
also need to have provisions added to them to exempt the transfer of the assets from the
mutual stock exchange and the issuance of shares of the new demutualized for profit
company from stamp duty and sales tax.
For the segregation of the trading rights and ownership rights, the deposit system may be
brought about as opposed to the card system that is presently used. Although this would be
optional, it may be beneficial for the stock exchanges to opt for this method.
The governance of the stock exchange would also radically change from a predominantly
member based board to an equally distributed board comprising of shareholders, brokers
and the investing public.
Case Study:
1. [2010] 97 SCL 261 (AP) HIGH COURT OF ANDHRA PRADESH
Harikishore Bhattad v. Union of India
P.S. NARAYANA, J.
WRIT PETITION NO. 18384 OF 2007
JANUARY 17, 2008
Section 4B, read with section 5, of the Securities Contracts (Regulation) Act, 1956
Procedure for corporatization and demutualization Petitioners were member brokers of
Hyderabad Stock Exchanges Ltd (HSEL). In year 2005, SEBI, as a part of its efforts to
improve governance in stock exchanges notified a scheme, namely, Hyderabad Stock
Exchanges Ltd (Corporatization and Demutualization) Scheme, 2005. In terms of clause
9(ii) of said scheme, company is to ensure that at least 51 per cent of equity shares are
held by public other than shareholders having trading rights in manner and period
specified in section 4B(8). HSEL was required to comply with above condition within a
period of 12 months of publication of orders. As HSEL failed to comply with shareholding
conditions, SEBI issued a proceeding to HSEL to effect that if HSEL was unable to
demutualise by specified date, then as per section 5(2), recognition granted to it would
stand withdrawn. Impugned proceedings were challenged in instant petition on ground
that same were arbitrary, illegal and contrary to provisions of Act as regulations were
issued belatedly and more time should be granted by SEBI for completing
demutualization process. Whether since section 5(2) is not controlled by section 4B (8)
and section 5(2) being mandatory, same would be operative and, hence, impugned order
could not be found fault with. Held, yes whether merely because regulations had been
notified at a later date, by that itself it could not be said that operation of section 5(2)
could be controlled or restricted.
2. [2006] 67 SCL 1 (SC) SUPREME COURT OF INDIA
Securities and Exchange Board of India v. Mangalore Stock Exchange
MRS. RUMA PAL AND ARUN KUMAR, JJ.
CIVIL APPEAL NO. (S) 1685 OF 2005
APRIL 1, 2005
Section 15T of the Securities and Exchange Board of India Act, 1992, read with section 4(4)
of the Securities Contracts (Regulation) Act, 1956 Securities Appellate Tribunal, Appeals to
in appellate proceedings, a question was raised as to whether appeal against order passed
by Board under section 4(4) of 1956 Act was maintainable before Tribunal under 1992 Act
Tribunal, without disposing of said issue, passed an interim order directing SEBI to consider
application made by respondent for corporatization and demutualization de hors order
under section 4(4). Whether impugned order was to be stayed until Tribunal disposed of
issue of maintainability, Held, yes
3. [2008] 144 COMP. CAS. 687 (AP) HIGH COURT OF ANDHRA PRADESH
Harikishore Bhattad v. Union of India
P.S. NARAYANA, J.
W. P. NO. 18384 OF 2007
JANUARY 17, 2008
Section 4B of the Securities Contracts (Regulation) Act, 1956 Procedure for corporatization
and demutulisationSection 5(2) is not controlled by section 4B (8).In the year 2005, the SEBI,
as part of its efforts to improve governance in stock exchanges notified a scheme called as
the Hyderabad Stock Exchange Ltd. (Corporatization and Demutualization) Scheme, 2005.
One of the key measures of the demutualization exercise was to ensure induction of non-
trading shareholders to the extent of 51 per cent of the aggregate equity capital of the
exchange post-demutualization. In terms of clause 9(ii) of the Scheme, 2005, the company
was to ensure that at least 51 per cent of its equity shares were held by the public other
than shareholders having trading rights in the manner and within the period prescribed in
sub-section (8) of section 4B. The fourth respondent, HSEL was required to comply with the
condition with respect to shareholding as above in the manner specified in the regulations
made by the SEBI within a period of 12 months of the date of publication of the order. The
initial period of 12 months came to an end on 29-8-2006, since the Scheme, 2005 was
notified and approved of on 29-8-2005, by the SEBI.
In those circumstances in exercise of the powers conferred on the SEBI, it extended the
period for a further period of 12 months ending on 28-8-2007. Further, for implementation
of the Scheme, 2005 the SEBI notified the Securities Contracts (Regulation) (Manner of
Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations,
2006 (hereinafter referred to in short as Regulations, 2006) on 13-11-2006. HSEL could not
complete the process of demutualization before 28-8-2007 and, therefore, by operation of
law, i.e., under section 5(2) its recognition stood automatically withdrawn with effect from
29-8-2007. The petitioners members of HSEL contended that if sub-sections (8) and (7) of
section 4B were read carefully along with the regulations governing the fields, without
permitting the time specified by the Act, with effect from the date of regulations being
notified, any action taken could not be sustained.
Held that the petitioners contention could not be accepted for the reason that section 5(2)
is not controlled by section 4B(8) and section 5(2) being mandatory, the same would be
operative, and hence, in the light of the same, the impugned order could not be faulted
with.

Conclusion
Though there has been a trend for Indian Companies to tap foreign markets for capital and
list on foreign exchanges, the reverse trend, i.e., foreign companies listing on the Indian
exchanges, is not being discussed. Though various legislative and policy changes may be
required for foreign companies to list, one does not even hear about a demand for the
same. Perhaps this is a reflection of the confidence that our capital market system inspires.
The process of demutualisation may be the first step towards bringing in efficiency and
building trust in the capital markets. One may say that it is still early to determine whether
such a goal may be achieved. However, the process of demutualisation can definitely be
looked upon as a ray of light at the end of the dark tunnel.


INTRODUCTION
The Indian stock Market is one of the oldest stock markets in Asia; the Indian Stock Markets
have a 200 years old history. Stock markets refer to a market place where investors can buy
and sell stocks. The price at which each buying and selling transaction takes is determined
by the market forces (i.e. demand and supply for a particular stock). Indian Stock Exchanges
allow trading of securities of only those public limited companies that are listed on the
Exchanges.
INITIAL PUBLIC OFFER
When the new companies emerge they float their shares in the market for the very first time
in order to increase their capital as well as to publicise them for people's attraction. When
an unlisted company for the very first time issue its share in the primary market it is known as
initial public offer (IPO).
LISTING OF SECURITIES
DEFINITION OF LISTING
Section 2(23A) of the Companies Act, 1956 defines the term listed public companies which
means a public company, which has any of its securities listed in any recognized stock
exchange(s) in India.
HOW TO GET LISTED?
Companies desirous of getting their securities listed are required to enter into listing
agreement with stock exchanges, make certain disclosures and perform certain acts. Listing
agreement is of great importance and is executed under the common seal of a company.
WHY LISTINGS ARE REQUIRED?
Listing of securities provides ready marketability to companies and free transferability of
securities. The listing rules and regulations have been designed (a) to safeguard the interests
of investors and (b) to ensure transparency, proper supervision and control over dealings in
the conduct of listed companies.



DISCLOSURE REQUIREMENTS
Continuous disclosures by listed companies to stock exchanges is in the interest of the
shareholders and to ensure that the companies adopt high level of corporate governance
and compliance.
WHAT IS EXPECTED FROM THE LISTED COMPANIES?
Listed companies are constantly under watch by the regulatory authorities like stock
exchanges and the Securities and Exchange Board of India (SEBI) and their compliance is
being monitored regularly by these Regulators. Under listing agreement, a company
undertakes, amongst other things, to provide facilities for:
Prompt transfer of company securities;
Registration of company securities whenever lodged within the prescribed time-
limits;
Sub-division and consolidation of securities;
To give proper notice of closure of transfer books and record dates;
To forward copies of unabridged/full annual reports and balance sheets to the
shareholders of the company;
To file distribution schedule with stock exchanges as required under the listing
agreement on quarterly basis and also annually;
To furnish financial results on a quarterly basis with limited review;
Intimate promptly to stock exchanges, about happenings, which are likely to
materially affect the financial performance of the company and its stock prices;
To comply with the conditions of corporate governance and to furnish compliance of
corporate governance on a quarterly basis as required under clause 49 of the listing
agreement.

CONDITIONS PRECEDENT TO LISTING
Any company desirous of listing its securities on stock exchanges, shall have to adhere to
conditions precedent to listing as prescribed in:
Securities Contracts (Regulation) Act, 1956,
Companies Act, 1956, and Securities and Exchange Board of India Act, 1992,
Any rules and/or regulations framed under forgoing statutes,
Any circular, clarifications, guidelines issued by the appropriate authority under
forgoing statutes.
LEGAL PROVISIONS FOR LISTING
There are several legal provisions governing the listing of the securities of the companies
and each such provision under different regulations is to be met with. These are as under:
COMPANIES ACT, 1956- The various sub-sections of section 73 of the Companies Act, 1956
provide for the requirements on this subject which could be summarized as under:
(a) Section 73(1) - Every company intending to offer shares or debentures to the public for
subscription by the issue of a prospectus shall, before such issue, make an application
to one or more recognized stock exchanges for permission for the shares or debentures
intending to be so offered to be dealt with in the stock exchange(s).
(b) Section 73(1A) - The prospectus shall state the names of the stock exchange(s) where
application for listing has been made and any allotment of securities made on the basis
of such prospectus shall be void if permission of listing is not granted by the stock
exchange(s) before the expiry of 10 weeks from the closure of the issue.
(c) Section 73(2) - If the application for listing is not made or the permission is not granted,
the company shall forthwith (within 8 days) repay without interest all money received
from the applicants. If the money is not refunded within 8 days as stated, the company
and every director of the company who is officer in default shall, from the expiry of
the 8th day, be jointly and severally liable to repay that money with interest (presently
at the rate of 15 per cent per annum).
(d) Section 5 - Officer-in-default means the managing director(s), whole-time director(s),
manager, secretary and any person, who has given consent to be charged by the Board
of Directors with the responsibility of complying with that provision. Where any
company does not have any managing director(s), whole-time director(s) or manager,
all the directors of the company are deemed to be officer who is in default for the
purpose of the Companies Act, unless any director(s) is/are specified by the Board of
Directors in this behalf.
SECURITIES CONTRACTS (REGULATION) ACT 1956 (SCRA)- In India, the SCRA deals, inter
alia, with the granting of recognition to the stock exchanges and empowers the Central
Government to accord such recognition, which power has been delegated by the
Government to the SEBI. SCRA provides the legal framework for listing of securities by stock
exchanges. The concerned provisions are as under:
(a) Section 9 - It empowers the recognized stock exchanges to make bye-laws. Such bye-
laws may, among other things, provide for the listing of securities on the stock
exchanges, the inclusion of any security for the purpose of dealings and the suspension
or withdrawal of any such securities and the suspension or prohibition of trading in any
specified securities.
(b) Section 21 - It deals with conditions for listing and states that where securities are
listed on the application of any person in any recognized stock exchange, such person
shall comply with the conditions of the listing agreement with that stock exchange.
(c) Section 22A - It deals with right of appeal against refusal of stock exchanges to list
securities of public companies and states that
Where a recognized stock exchange, acting in pursuance of any power given to it
by its bye-laws, refuses to list the securities of any company, the company shall be
entitled to be furnished with reasons for such refusal, and may :
(a) Within fifteen days from the date on which the reasons for such refusal are
furnished to it, or
(b) where the stock exchange has omitted or failed to dispose of, within the time
specified in sub-section (1) of section 73 of the Companies Act, 1956 (1 of 1956)
(hereafter in this section referred to as the specified time), the application for
permission for the shares or debentures to be dealt with on the stock exchange,
within fifteen days from the date of expiry of the specified time or within such
further period, not exceeding one month, as the Securities Appellate Tribunal
may, on sufficient cause being shown, allow, appeal to the Securities Appellate
Tribunal having jurisdiction in the matter against such refusal, omission or
failure as the case may be, and thereupon the Securities Appellate Tribunal
may, after giving the stock exchange an opportunity of being heard :
(i) Vary or set aside the decision of the stock exchange; or
(ii) Where the stock exchange has omitted or failed to dispose of the
application within the specified time, grant or refuse the permission,
(iii) And where the Securities Appellate Tribunal sets aside the decision of the
recognized stock exchange or grants the permission, the stock exchange
shall act in conformity with the orders of the Securities Appellate Tribunal.
(d) Rule 19 of the Securities Contracts (Regulation) Rules, 1957 (SCRR) - It states the
requirements with respect to the listing of securities on a recognized stock exchange.
(e) Section 23(2) of SCRA - It prescribes punishment for violation of section 21. Thus,
exchanges can take necessary action under said section for any violation of section 21
due to non-compliance of the provisions of listing agreement. Under said section if a
listed company is convicted, upon prosecution by stock exchange, it can be punished
with imprisonment up to ten years or with fine up to rupees twenty five crores or with
both.
WHAT ARE THE DIFFERENT TYPES OF LISTING
Initial listing
A company securities are not listed earlier on a recognised stock exchange, if desirous of
listing its securities, has to follow procedures applicable for initial listing.
Listing of public issue of shares & debentures
A company whose shares are listed on a recognised stock exchange may issue shares & /
debentures to the public for subscription. In such cases the company, under the LA, has to
submit necessary application to the stock exchanges for listing of its securities. It may also
so happen that a green field company, i.e. a company shortly after incorporation may issue
its shares & / debentures to the public for subscription. In that event, it has to comply with
the formalities applicable to initial listing.
Listing of rights issue of shares & / debentures
Companies whose securities are already listed may issue shares &/ debentures by way of
rights to the existing shareholders. Under listing agreement, such companies have to list
shares &/ debentures allotted by way of rights to the shareholders with the stock
exchanges.
Listing of bonus issue of shares
Companies which issue bonus shares by capitalisation of its reserves, pursuant to the listing
agreement should enlist with the stock exchanges bonus shares issued by submitting
necessary application form for official quotation of the bonus shares so issued.
Listing of shares issued on amalgamation, mergers, etc.
An amalgamated company which issues shares to the shareholders of amalgamating
company has to get the shares listed on the stock exchanges to enable erstwhile
shareholders of amalgamating company for dealing in shares of the amalgamated company.
Listing of shares by private placement
Under the Listing Agreement, the listed companies are obliged to get listed the shares (or
other securities) issued by them by private placement to only some of their shareholders or
even to persons who are not existing shareholders. The Listing Agreement, which casts this
obligation, provides that the company agrees to make an application to the stock exchange
for the listing of any new issue of shares or securities & of the provisional documents
relating thereto. The company will also be required to list its new issues of shares &
debentures, whether right or otherwise within the stipulated period which may be provided
in the listing guidelines.
Listing of shares issued on conversion of loan/ debentures
If a listed company issues new equity shares against conversion of debentures (including
FCCBs), loans etc. such shares are required to be listed
Listing of shares underlying the depository receipts
If a company issue depository receipts (ADR, GDR etc.) abroad against issue of new equity
shares, such shares are required to be listed, irrespective of whether the depository receipts
are listed or unlisted abroad. In terms of the Foreign Currency Convertible Bonds & Ordinary
shares (Through Depository Receipt Mechanism) Scheme, 1993, as amended in 2005, even
an unlisted company needs to list its shares on a recognised stock exchange in India
simultaneous or prior to issue of depository receipts.
WHAT ARE THE LISTING FEES PAYABLE TO STOCK EXCHANGE?
The fees payable by a company for listing of securities on a stock exchange are of two types,
that is;
(a) Initial listing fee; and
(b) Annual listing fee.
While the initial listing fee is payable at the time of listing of securities initially along with the
listing application, the annual fee is payable before 30th April every year. The rates of the
listing fees payable have been fixed by the SEBI and initial listing fee is to be paid for the
entire year irrespective of the date of listing.
WHAT IS LISTING AGREEMENT?
All companies seeking listing of their securities on the Exchange are required to enter into a
formal listing agreement with the Exchange. The agreement specifies all the quantitative
and qualitative requirements to be continuously complied with by the issuer for continued
listing. The Exchange monitors such compliance and companies who do not comply with the
provisions of the listing agreement may be suspended from trading on the Exchange. The
agreement is being increasingly used as a means to improve corporate governance.
We can say that listing agreement is an agreement entered into between the issuer and the
stock exchanges where the securities of the issuer are listed/ intended to be listed.Our concept of
Listing Agreement is perhaps based on the practice followed in US.
Under Section 21of the Securities Act where securities are listed on the application of any
person in any recognised stock exchange, such person shall comply with the conditions of the
listing agreement with that stock exchange. Thus, under this provision, violation of the listing
agreement is an offence.
DELISTING OF SHARES
What is delisting of shares?
The term delisting of securities means permanent removal of securities of a listed company
from a stock exchange. It is, therefore, different from suspension or withdrawal of
admission to dealings of listed securities, which the stock exchanges can resort to for a
limited period. Delisting is also different from buy back of securities in which the securities
of a company are extinguished with consequent reduction of capital of the company. In the
case of delisting there is no reduction of capital. This distinction is of no mean significance,
for it implies, in the first place, that in the case of buy back of securities, the company itself
is the acquirer & hence, provides the funds for buy back. In the case of delisting, the
securities are acquired by a person other than the company & who could be the promoter,
majority shareholder or a person in control of the management & the funds have to be
provided by that acquirer. As the two processes are fundamentally different, the concerns &
safeguards for the shareholders should also be necessarily different.
Lastly, I want to say that Delisting is totally the reverse of listing. To delist means
permanent removal of securities of a listed company from a stock exchange. As a
consequence of delisting, the securities of that company would no longer be tradeable at
that stock exchange.
DELISTING = STOCK EXCHANGES - COMPANY


DELISTING PROCEDURE IN INDIA
VOLUNTARY DELISTING
It can be enforced by the promoter or any other person, excepting the stock exchange. Prior
to delisting, it requires approval of shareholders by a special resolution, make a public
announcement, the content of which should include proposed methodology for
determination of offer price, historical data relating to securities market price & volume,
shareholding pattern, necessity & objective of delisting, etc. An exit opportunity, at a
minimum floor price is to be offered to the shareholders. The shareholder can bid/ demand
a higher price than the one offered through the reverse book-building process. The offer
may fall if it fails to receive minimum quantity required or if the offeree refuse to revise the
purchase price upwards as discovered.
On the other hand we can say that Securities may voluntarily be delisted in accordance with
the delisting guidelines issued by SEBI. In terms of the SEBI Guidelines, voluntary delisting is
subject inter alia to the following conditions;
a. Obtaining prior approval of the holders of the securities, sought to be delisted, by a
special resolution passed at a General Meeting of the company.
b. Making a public announcement.
c. Offering an exit opportunity to the holders of securities in the region where the stock
exchange is located unless the same is exempted under the Guidelines.
d. Applying the delisting exchanges & complying with the additional conditions, if any, as
prescribed by such exchanges.
DELISTING PURSUANT TO TAKEOVER REGULATINON
Companies can get their securities delisted from all the stock exchanges by virtue of
Regulation 21 (3) of SEBI (Substantial Acquitions of Shares & Takeovers) Regulations, 1997.
In terms of these Regulations, if the public shareholding in a company is reduced to 10% or
less of its voting capital or if the public offer is in respect of a company where the public
shareholding is already less than 10 per cent, the acquirer who has made the public offer,
shall have to options:
a. Make an offer to buy the outstanding shares remaining with the shareholders in
accordance with the Delisting Guidelines.
b. Undertake to disinvest through an offer for sale or by a fresh issue of capital to the public,
which shall open within a period of 6 months from the date of closure of the public offer,
such number of shares so as to satisfy the listing requirements.
Thus, by exercise the first option, securities may be completely delisted from all the stock
exchanges.
In terms of clause 4.1 (b) of the SEBI Delisting Guidelines, these Guidelines shall be
applicable inter alia to any acquisition of shares of the company (either by a promoter or by
any other person), consequent to which the public shareholding falls below the minimum
limit specified in the listing conditions or listing agreement (at present 10% or 25 %) that
may result in delisting of securities.

DELISTING PURSUANT TO MERGERS & AMALGAMATIONS
Also in scenarios like merger & amalgamations & under legal directions for sick companies
under the Board for Industrial & Financial Reconstruction companies can be delisted.
For instance, company X & company Z are two listed companies. Now, if company Z
amalgamates with company X, the separate entity of company Z ceases to exist. All the
securities of company Z are tendered back & extinguished. Security holders of company Z, in
turn, get the composition, in the form as decided earlier. Such an act of amalgamation has
the effect of delisting the securities of company Z.
By virtue of clause 4.1(b) of the SEBI Delisting Guidelines, all schemes of mergers,
amalgamation, and reconstruction etc., which has the effect of reducing public shareholding
below the minimum prescribed level (at present 10% or 25 % ), would be subject to
compliance with the Guidelines. Further, in terms of a circular (SBIE/SMD/Policy/List/Cir-
17/2003), issued by SEBI on 08/05/2003, any scheme/petition proposed to be filed before
any court or Tribunal under section- 391, 394 & 101 of the Companies Act (i.e.
schemes/petitions relating to Mergers & Amalgamations, Arrangements, Reconstructions
etc. ):
a. Shall be filed with the stock exchange, for approval, at least a month before it is
presented to the Court or Tribunal.
b. Does not in any way violate, override or circumscribe the provisions of securities laws or
the stock exchange requirements.
Further, the company shall disclose the pre and post-arrangement or amalgamation
(expected) capital structure and shareholding pattern in the explanatory statement forwarded by
it to the shareholders under Section 393 or accompanying a proposed resolution to be passed
under Section 100 of the Companies Act.
In terms of the aforesaid Circular, three copies of all notices of meetings convened under
Sections 391 or 394 of the Companies Act, together with Annexures thereto, shall also be
sent to the stock exchanges.
DELISTING CONSEQUENT TO CONSOLIDATION OF HOLDINGS
Consolidation of holdings in a company by a person in control of management may have
the effect of company being delisted.
The provisions of the SEBI Delisting Guidelines apply, by virtue of Clause 4.1(d), to the
cases where a person in control of the management is seeking to consolidate his holdings
in a company, in a manner which would result in the public shareholding in the company
falling below the limit specified in the listing conditions or in the listing agreement.
Consolidation of holdings, which may have the effect of company being delisted, may be
done in different ways. One such way is further issue of shares on preferential basis.
Shares can be issued on a preferential basis resulting in concentration of holdings in the
hands of few.
Clause 40A of the Listing Agreement provides that if a further Issue of securities causes the
public holding to fall below the minimum prescribed level, the promoters or persons in
control of the management shall comply with the relevant provisions of the delisting
guidelines.
Clause 40A and Clause 4.1(d) of the SEBI Delisting Guidel ines make all cases of
consolidation of holdings sought by further issue of shares reducing the public shareholding
below the minimum prescribed level, subject to compliance with the relevant provisions
of the Guidelines & also Clause 17 of the Guidelines covers all such cases.

DELISTING BY WAY OF BUY-BACK OF SECURITIES
Buy-back of securities, as permitted under Section 77A of the Companies Act, also has the
effect of delisting the securities, bought back by the company from their holders.
However, this method of delisting has now been specifically prohibited. Hence, a
company shall not be permitted to use the buy-back provision specifically as a method to
delist its securities.
As pointed out by Kar Committee, the objective of buying back shares out of surplus
funds is to enhance the shareholder value, which would be entirely defeated, if the
shares of remaining shareholders do not continue to have liquidity which listing
ensures. It was also brought to the notice of the Committee, that companies usually
propose buy back proposal or proposal for delisting when the share prices are low.
While this would make commercial sense to the company, it is perceived by investors to be
against their interest as they may get a very low price compared to the value of the
company.

COMPULSORY DELISTING BY THE STOCK EXCHANGE
Compulsory delisting, on the other hand, can be done by stock exchange as per the norms
laid down, which includes noncompliance of the terms of the Listing Agreement by a
company. Prior to delisting, show-cause notices are to be sent to the company but no
intimation & exit option is required to be given to the non-promoter shareholders. Only
wide public notices through newspapers & notice boards are to be issued by the Stock
Exchange. Post-delisting, the shareholders are entitled to get fair value of their securities
but the mode & manner laid down for enforcement of the same is still not clear.
On the other hand we can say that the Stock Exchanges themselves can, under certain
circumstances and on compliance with conditions as prescribed by SEBI,
compulsorily delist securities of a company.
At the time of admitting securities for listing, companies are required to enter into an
agreement with the concerned Stock Exchange. The agreement, known as Listing
Agreement, contains various conditions and requirements, which shall have to be
complied with by all listed companies.
The stock exchange may delist securities of a company, which has committed breach of
any of the conditions prescribed under the Listing Agreement. Stock Exchange may also
resort to compulsory delisting on various other grounds like illiquidity, instability, unfair
and fraudulent trading etc.
By virtue of the clause 4.1(e) of the SEBI Delisting Guidelines, compulsory delisting of
securities by the stock exchanges is also subject to the provisions of the Guidelines and all
the relevant provisions shall be complied with.
It has also been recommended by the Kar Committee that the Department of
Company Affairs may be requested to amend the Companies Act for allowing the stock
exchanges to make an application for winding up of the company. However, such
petitions against companies should be filed by the stock exchanges only on the basis of
investor complaints.
DELISTING BY OPERATION OF LAW
Companies may also be delisted mandatorily by operation of law. It can
happen on account of directions under BIFR (now National Company Law
Tribunal).
A company may also be ordered to be delisted under the SEBI
(Ombudsman) Regulations, 2003, issued by SEBI recent ly.
In terms of Regulation 22(2) of the said Regulations, if any person fails to
implement the award or order passed under the regulations, without
reasonable cause:
(a) He shall be deemed to have failed to redress investors' grievances
and liable to a penalty under Section 15C of the SEBI Act;
(b) He shall also be liable for -
An action under Section 11(4) of the SEBI Act; or
Suspension or delisting of securities; or
Being disqualified from accessing the securities market; or
Being prohibited from dealing in securities;
An action for suspension or cancelation of certificate of registration;
Such other action permissible which may be deemed appropriate in the facts.

COMPARISION BETWEEN OLD (2003) & NEW REGULATION (2009):
Definition- The Public shareholding is the shareholding in a company other than by
the Promoters, Persons Acting in concert with the Promoter

Definition- Along with the Promoters, Persons Acting in concert with the Promoter,
holders of Depositors receipts and the custodian thereof are also included.
Inapplicability- Not mentioned exclusively and separately.
Inapplicability- Separate section is made. The exemption is available to the
companies which have been declared sick & their reconstruction scheme provides
the delisting including the provisions of the exit option to the shareholders.
Shareholders Resolution - Special resolution to be passed through the shareholders
is compulsory.
Shareholders Resolution -Now the requirement of special resolution for the delisting
without Exit route is deleted. Only public announcement and the disclosure in the
first annual report after delisting will suffice the requirement.
No time limit was prescribed for the exchanges for disposal of the Delisting
application filed by the companies.
A 30 days time period after the receipt of Application complete in all respect, given
to the exchanges for disposing of the application of delisting.
Small Companies-No special provisions are there for the small companies.
Small Companies-Special provisions under the separate section be given for the
small companies and winding up companies.
Reinstatement of securities-The companies cannot be relisted at the exchange for a
period of 2 years from the period of delisting.
Reinstatement of securities- The companies delisted voluntarily cannot be relisted
for a period 5 years and the companies compulsorily delisted cannot be relisted for a
period of 10 years from the date of delisting

COMPARISION BETWEEN UK, US
Unlike India, the US & 25 member countries of European Union adopted a two-tier,
autonomous regulation of companies: through the regulator & the stock exchange. In US,
the regulator, Securities & Exchange Commission (SEC) grants registration of Securities. In
UK, listing is granted by Financial Services Authority (FSA), through its arm UK Listing
Authority (UKLA). This registration/ listing is a pre-requisite for getting the securities
admitted for trading on any of the nine national securities exchanges including New York
Stock Exchange (NYSE) in the US & London Stock Exchange (LSE) in the UK. UKLA & SEC
displays a list of companies listed with it, whereas SEBI does not.
UNDER UK LAWS
In UK post-listing, the companies have to comply with various regulatory obligations &
furnish information to their respective regulator & stock exchange separately. FSA listing
rules including that a listed company must act with integrity & communicate information to
holders or potential holders so as to avoid creation or continuation of a false market in such
listed securities.
On a breach, FSA & LSE have independent power to suspend listing, impose sanctions &
cancel listing. For late filing of reports to FSA by companies, financial penalties can be
imposed, which are based on the annual listing of delay. The penalty for delay up to 28 days
ranges from 10 times to 60 times of the annual listing fees for each breach & higher for
delay beyond 28 days. In addition, disciplinary action can be taken against the management.
Further, the disciplinary committee of the LSE is empowered to impose any or all of the
sanctions, viz., censure, unlimited fine, order that issuer makes restitution to pay any person
(when the issuer has profited from a breach at that persons expense ) & cancellation to
have its securities listed on the exchange.
UNDER US LAWS
NYSE requires listed companies to meet original listing criteria & maintain continued listing
standards. An elaborate procedure has been laid down for exchange initiated (compulsory)
delisting. On non-compliance, the company is given an opportunity, in most of the cases, to
submit a plan for compliance within 18 months. For delisting, at least 10 days prior public
notice by the exchange is mandatory after which the SEC registration & its disclosure/ filing
requirements continue. Similarly, procedure adopted for deregistration by SEC has in-built
mechanism for dissemination of prior information to investors so as to provide them an exit
option.
CONCLUSION:
There is no doubt about the positive impacts of this move, but a few alterations can be
made for benefit of everyone concerned. In the era of Globalisation there is investment
boom in the every corner of the world, so as in India. Since SEBI has been given the task of
market regulator and responsibility to protect common investor, hence the operating part
of new Rule 21 of SCR Rules would merit annulment at once. A number of lacunae in the old
SEBI (Delisting of Securities) Guidelines, 2003 have been fixed, but the regulator has clearly
sent a signal that delisting of securities may occur only in the rarest of rare cases.
Nevertheless, the intent and attempt of the regulator appears to be in the positive direction
and the new framework seems to achieve the critical balance between protection of Public
shareholders and private interests of the promoters. Listing and delisting are commercial
decisions and should be based on business considerations.


DERIVATIVES

Introduction: In Companies Act, 1956, section 2(12) B gives the definition of derivatives as
Derivative has the same meaning as in clause (ac) of section 2 of the Securities Contracts
(Regulation) act, 1956.
Section 2 of the Securities Contracts (Regulation) act, 1956 says, Derivatives includes-
A) A security derived from a debt instrument, share, loan whether secured or unsecured,
risk instrument or contract for differences or any other form of security;
B) A contract which derives its value from the prices, or index of prices, of underlying
securities.
derivative is a financial instrument (or, more simply, an agreement between two parties)
that has a value, based on the expected future price movements of the asset to which it is
linkedcalled the underlying asset for ex. share or a currency. The most common kind of
derivatives are swaps, future, and option
Derivatives are usually broadly categorized by:
1) the relationship between the underlying asset and the derivative (e.g., forward, option,
swap);
2) the type of underlying asset (e.g., equity derivatives, foreign exchange derivatives,
interest rate derivatives, commodity derivatives or credit derivatives);
3) the market in which they trade (e.g., exchange-traded or over-the-counter);
An equity derivative, for example, might give you the right to buy a particular share at a
stated price up to a given date. And in these circumstances the value of that right will be
directly related to the price of the "underlying" share: if the share price moves up, then the
right to buy at a fixed price becomes more valuable; if it moves down, the right to buy at a
fixed price becomes less valuable.
This is but one example of a particular kind of derivative contract. However, the close
relationship between the value of a derivative contract and the value of the underlying asset
is a common feature of all derivatives.There are many different types of derivative contract,
based on lot of different financial instruments; share prices, foreign exchange, interest
rates, the difference between two different prices, or even derivatives of derivatives. The
possible combinations of products are almost limitless.
Before discussing derivatives, its important to describe their basis. All derivatives are based
on some underlying cash products hence the name derivatives. These cash products are-
Spot Foreign Exchange: This is the buying and selling of foreign currency at the exchange
rates that you see quoted on the news. As these rates change relative to your home
currency, so you make or lose money.
Commodities: These includes grain, pork bellies, coffee beans, orange juice, etc
Equities:(termed stocks in the US). Generally the common shares of various companies
Bonds of various different varieties: (e.g., they may be Eurobonds, domestic bonds, fixed
interest/ floating rate notes,etc) Bonds are medium to long- term negotiable debt securities
issued by Government, Government Agencies, Federal Bodies (states), supra-national
organisations such as the World-bank, and companies. Negotiable means that they may be
freely traded without reference to the issuer of the security. That they are debt securities
means that in the event that the company goes bankrupt, Bondholders will be repaid their
debt in full before the holders of unsecuritised debt get any of their principal back.
Short term, (money market) negotiable debt securities such as T-Bills (issued by
governments), commercial paper (issued by companies) or Bankers Acceptance .These are
much like bonds, differing mainly in their maturity short term is usually defined as being
up to 1year in maturity. Medium term is commonly taken to mean from 1 to 5 years in
maturity, and long term, anything above that.
Over the Counter (OTC) money market productssuch as loans/ deposits. These products
are based upon borrowing or lending. They are known as over the counter because each
trade is an individual contract between the 2 counter parties making the trade. They neither
negotiable nor securitised.
.Derivatives products are contracts, which have been constructed, based on one of the
cash products described above. Examples of these products include options and futures.
Derivatives can be considered as providing a form of insurance in hedging, which is itself a
technique that attempts to reduce risk.
Derivatives allow risk related to the price of the underlying asset to be transferred from one
party to another. For example, a wheat farmer and a miller could sign a futures contract to
exchange a specified amount of cash for a specified amount of wheat in the future. Both
parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and
for the miller, the availability of wheat. However, there is still the risk that no wheat will be
available because of events unspecified by the contract, such as the weather, or that one
party will renege on the contract. Although a third party, called a clearing house( is a
financial institution that provides clearing and settlement services for financial and
commodities derivatives and securities transactions) insures a futures contract, not all
derivatives are insured against counter-party risk.
From another perspective, the farmer and the miller both reduce a risk and acquire a risk
when they sign the futures contract: the farmer reduces the risk that the price of wheat will
fall below the price specified in the contract and acquires the risk that the price of wheat
will rise above the price specified in the contract (thereby losing additional income that he
could have earned). The miller, on the other hand, acquires the risk that the price of wheat
will fall below the price specified in the contract (thereby paying more in the future than he
otherwise would have) and reduces the risk that the price of wheat will rise above the price
specified in the contract. In this sense, one party is the insurer (risk taker) for one type of
risk, and the counter-party is the insurer (risk taker) for another type of risk.
FUTURES:
Roughly speaking, a future is an agreement to buy (or sell) some commodity at a fixed price
on a fixed date Futures are commonly available in the following flavours(defined by the
underlying cash product)
1) Commodity future: for ex. An orange juice future contract, gives you the right to buy
(or sell) some huge amount of orange juice at a fixed price on some date.
2) Stock index future: since you cant really buy an index, these are settled in cash.
3)Interest rate futures (including deposit futures, bill futures and government bond furures)
these are usually settled in cash as well.
Futures are explicitly designed to allow the transfer of risk from those who want less risk to
those who want more risk, as we already see in the above example.
OPTION:
An option is a derivative financial instrument that establishes a contract between two
parties concerning the buying or selling of an asset at a reference price. The buyer of the
option gains the right, but not the obligation, to engage in some specific transaction on the
asset, while the seller incurs the obligation to fulfil the transaction if so requested by the
buyer.
An option is a contract between a buyer and seller. The option is connected to something,
such as a listed stock, an exchange index, futures contracts, or real estate. We will discuss
only options connected to listed stocks. An option gives its owner the right to buy or sell an
underlying asset on or before a given date at a fixed price. For ex: you may enjoy the option
to buy a certain apartment on or before 31
st
December of this year for 500,000 /- Rs. On
that date even if the market price is more than 500,000/- Rs ( say 600,000), the option write
will be compelled to sell the house. On the other hand if the price is less than 500,000/- Rs(
say 400,000/-), the option holder is not obliged to buy the house. Options represents a
special kind of financial contract under which the option holder enjoys the right, but has no
obligation, to do something.
Now let us understand how this instrument originates. The owner of the house may expect
that the price of the house will go down ( below 500.000/-). At the same time buyer expects
that the price will go up. Since the owner wants 500.000/- for the house, he is willing to
write an option. He may sell the option for say 100/-Rs. Now if the price goes below
500,000/- on the expiry date, the buyer will not exercise the option and instead will buy
another house for the going market price. The loss is only the price of the option i.e. 100/-
Rs. On the other hand if the price goes up then he he will exercise the option and buy the
house for 500,000/-. If the market price is 600,000/- he will make a profit of 99,900/-Rs
(100,000-100). On the other hand the owner gets lower than the market price. However
remember that he was willing to sell it for 500,000/- and was afraid that the price may go
down. Hence this instrument originates due to varying perception of the buyer and sellers.
In the real life option are written for shares, index etc.
Key Terms:
Option holder and option writer: The option holder is the buyer of the option and the writer
is the seller of the option (Remember, option is nothing but a contract which binds both
buyer and the seller to do a specific act on a certain date)
Exercise price and the strike price:The price at which the option holder can buy and / or sell
the underlying asset is called the exercise or the strike price. In the above example strike
price is 500,000/-
Expiration date or Maturity date: The date when the option expires or matures is referred to
as the expiration date or maturity date. After this date the option is worth less. In the above
example 31
st
Dec is the expiry date.
Exercising the option: The act of buying or selling the underlying asset as per the option
contract.
European and American option: A European option can be exercised only on the date of
expiry, whereas the American option can be exercised on or before the date of expiry.
The option is designated by:
1) Name of the associated stock
2) Strike price
3) Expiration date
4) The premium paid for option, plus brokers commission
The two most popular types of options are Calls and Puts.
Call option:A call option, often simply labelled a "call", is a financial contract between two
parties, the buyer and the seller of this type of option. The buyer of the call option has the
right, but not the obligation to buy an agreed quantity of a particular commodity or
financial instrument (the underlying) from the seller of the option at a certain time (the
expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to
sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee
(called a premium) for this right.
Call options are most profitable for the buyer when the underlying instrument moves up,
making the price of the underlying instrument closer to, or above, the strike price. The call
buyer believes it's likely the price of the underlying asset will rise by the exercise date. The
risk is limited to the premium. The profit for the buyer can be very large, and is limited by
how high underlying's spot rises. When the price of the underlying instrument surpasses the
strike price, the option is said to be "in the money".
The call writer does not believe the price of the underlying security is likely to rise. The
writer sells the call to collect the premium. The total loss, for the call writer, can be very
large, and is only limited by how high the underlying's spot price rises.
Example:
* The current price of ABC Corp stock is $45 per share, and investor 'Chris' expects it will
go up significantly. Chris buys a call contract for 100 shares of ABC Corp from 'Steve,' who is
the call writer/seller. The strike price for the contract is $50 per share, and Chris pays a
premium up front of $5 per share, or $500 total. If ABC Corp does not go up, and Chris does
not exercise the contract, then Chris has lost $500.

* ABC Corp stock subsequently goes up to $60 per share before the contract is expired.
Chris exercises the call option by buying 100 shares of ABC from Steve for a total of $5,000.
Chris then sells the stock on the market at market price for a total of $6,000. Chris has paid a
$500 contract premium plus a stock cost of $5,000, for a total of $5,500. He has earned back
$6,000, yielding a net profit of $500. Steve, however, did not do so well. Steve did not
already own ABC Corp stock, so when Chris exercised the contract, Steve had to buy the
stock on the open market for $6,000. Steve had already earned the $500 premium for the
contract and $5,000 from Chris on selling the stock, so the total loss for Steve was $500.

* If, however, the ABC stock price drops to $40 per share by the time the contract expires,
Chris will not exercise the option (i.e., Chris will not buy a stock at $50 per share from Steve
when he can buy it on the open market at $40 per share). Chris loses his premium, a total of
$500. Steve, however, keeps the premium with no other out-of-pocket expenses, making a
profit of $500.
Put option:The other common option is the put, If you buy a put from me, you gain the right
to sell me your stock at the strike price on or before the expiration date. Puts are almost
mirror-image of calls.What Does Put Option Mean?
An option contract giving the owner the right, but not the obligation, to sell a specified
amount of an underlying security at a specified price within a specified time. This is the
opposite of a call option, which gives the holder the right to buy shares.
A put becomes more valuable as the price of the underlying stock depreciates relative to the
strike price. For example, if you have one Mar 08 Taser 10 put, you have the right to sell 100
shares of Taser at $10 until March 2008 (usually the third Friday of the month). If shares of
Taser fall to $5 and you exercise the option, you can purchase 100 shares of Taser for $5 in
the market and sell the shares to the option's writer for $10 each, which means you make
$500 (100 x ($10-$5)) on the put option. Note that the maximum amount of potential profit
in this example ignores the premium paid to obtain the put option.
Covered puts are a simple means of locking in profits on the covered security, although
there are also some tax implications for this hedging move.
The expression of options contributes to the once-per-quarter triple-witching-day. Which
is a day on which three derivative instruments all expire on the same day. Stock index
futures, stock index options and options on individual stocks all expire on this day and
because of this, trading volume is usually especially high on the stock exchanges that day. In
1987, the expiration of key index contracts was changed from the close of trading on that
day to the open of trading on that day, which helped reduce the volatility of the markets
somewhat by giving specialists more time to match orders.
You will frequently hear about both volume and open interest in reference to options (really
any derivative contract). Volume is quite simply the number of contracts traded on a given
day. The open interest is slightly more complicated. The open interest figure for a given
option is the number of contracts outstanding at a given time. The open interest increases
when trader A opens a new position by buying an option from trader B who did not
previously hold a position in that option (B wrote the option, or in the lingo, was short the
option). When trader A closes out the position by selling the option, the open interest with
either remains the same or go down. If A sells to someone who did not have a position
before, or was already long, the open interest does not change. If A sells to someone who
had a short position, the open interest decreases by one.


FORWARD CONTRACT REGULATION ACT, 1953

Evolution of Commodity Derivative Markets in India:
Commodity Derivative markets started in India in Cotton in 1875 and in oilseeds in 1900 at
Bombay. Forward trading in raw jute and jute goods started at Calcutta in 1912. Forward
Markets in Wheat had been functioning at Hapur in 1913 and in Bullion at Bombay since
1920. In 1919, the Government of Bombay passed Bombay Contract Control (War Provision)
Act and set up the Cotton Contracts Board. With a view to restricting speculative activity in
cotton market, the Government of Bombay issued an Ordinance in September 1939
prohibiting option business. Bombay Options in Cotton Prohibition Act, 1939, later replaced
the Ordinance. In 1943, the Defence of India Act was utilized on large scale for the purpose
of prohibiting forward trading in some commodities and regulating such trading in others on
all India basis. In the same year oilseeds forward contracts prohibition order was issued and
forward contracts in oilseeds were banned. Similarly orders were issued banning forward
trading in foodgrains, spices, vegetable oils, sugar and cloth. These orders were retained
with necessary modifications in the Essential Supplies Temporary Powers Act 1946, after the
Defence of India Act had lapsed. With a view to evolving the unified systems of Bombay
enacted the Bombay Forward Contract Control Act 1947.
Legal Framework
After Independence, the Constitution of India adopted by Parliament on 26th January, 1950
placed the subject of "Stock Exchanges and Futures Market" in the Union list and therefore
the responsibility for regulation of forward contracts devolved on Government of India. The
Parliament passed Forward Contracts (Regulation) Act, 1952 which presently regulated
forward contracts in commodities all over India. The features of the Act are as follows:
1. The Act applies to goods, which are defined as any movable property other than
security, currency, actionable claims.
2. The very preamble of the Act announces the intention of the legislature to prohibit
options in goods. By a specific provision, section 19, such agreements are prohibited.
(The proposal to regulate options in goods is under consideration of Government)
3. The Act classifies contracts/agreements into two broad categories, viz., ready
delivery contract and forward contract. Ready delivery contract are those where
delivery of goods and full payment of price therefore is made within a period of
eleven days. (The proposal to extend the period to thirty days is under consideration
of Government). It is further clarified that notwithstanding the period of
performance contract, if the contract is performed by payment of money difference
it would not be a ready delivery contract
4. The Act defines forward contract as the contract for delivery of goods which is not a
ready delivery contract
5. Forward contracts are implicitly classified into two broad categories, viz., specific
delivery contract and nonspecific delivery contract or standardized contract.
Though, defacto, the focus of the regulation are standardized contracts i.e., futures
contracts, these are not defined in the present Act (it is proposed to introduce
definition of "futures contract" in the Act) .Specific delivery contracts (where the
terms of the contracts are specific to each contract customized contracts) in which,
the buyer does not transfer the contract by merely transferring document of title to
the goods and exchanging money difference between the sale and purchase price,
termed as Nontransferable Specific Delivery Contract are normally outside the
purview of the Act, but there is an enabling provision empowering the Government
to regulate or prohibit such contracts.
6. The Act provides for either regulation of the other forward contract in specified
commodities or prohibition of specified commodities. Such contracts in the
commodities which do not figure in regulated or prohibited categories are outside
the purview of the Act, except when they are organized by some Exchange.
7. The Act envisages threetier regulation. The Exchange which organizes forward
trading in regulated commodities can prepare its own rules (articles of association)
and byelaws and regulate trading on a daytoday basis. The Forward Markets
Commission approves those rules and Byelaws and provides regulatory oversight. It
also acquires concurrent powers of regulation either while approving the rules and
byelaws or by making such rules and byelaws under the delegated powers. The
Central Government Department of Consumer Affairs, Ministry of Consumer
Affairs, Food and Public Distribution is the ultimate regulatory authority. Only
those associations, which are granted recognition by the Government, are allowed
to organize forward trading in regulated commodities. Presently the recognition is
commodityspecific. Government has original powers to suspend trading, call for
information, require the Exchanges to submit periodical returns, nominate directors
on the Boards of the Exchanges, supersede Board of Directors of the Exchange etc.
Most of these powers are delegated to the FMC; otherwise the role of FMC is
recommendatory in nature. (The Government has full control over the FMC, which is
the subordinate office of the Department of Consumer Affairs, depending upon the
budget allocation for its existence. The FMC also is subject to the rules and
regulations relating to all matters including appointment of staff and officers,
incurring office expenses and conducting tours etc. as are applicable to any
Government Department.)
8. Only police authorities have powers to enforce illegal trading in prohibited
commodities and options in goods. FMC can merely forward information and render
technical assistance to police. The penalties provided under the Act are nominal and
does not have deterrent effect. Since judicial magistrate first class has jurisdiction to
try offences under this Act, the fine cannot exceed Rs.10,000. The minimum fine
prescribed for the second offence is Rs. 1,000 only. There is no provision to relate
the penalty to the amount involved in the offence. (The Government is considering
amending the Act to raise the fine to Rs.5000)

Structure and composition of the commodity market regulator:
The current regulatory structure of the commodities market comprises the Forwards
Markets Commission (FMC), which, in turn, holds a reporting relationship with the
Department of Consumer Affairs in the Ministry of Consumer Affairs, Food & Public
Distribution of the Government of India
27
. The Department of Consumer Affairs, in turn,
derives its authority to regulate the commodity futures markets from the Forward Contracts
(Regulation) Act, 1952 (FCRA)
28
.
To provide a growth impetus to the existing market, the need of the hour was the
establishment of a regulator which was equipped with adequate resources and
empowerment. As mentioned above, the exercise of delegated powers by the FMC or the
recommendatory nature of the role it plays, have been by and large inadequate to grasp the
development of markets.
29
FMC, today, remains a subordinate office of the Department of
Consumer Affairs and has failed to garner the resources it needs to discharge the
responsibility expected of it as a regulator.
30

Policy Liberalization:
Forward trading was banned in 1960's except for Pepper, Turmeric, Castorseed and Linseed.
Futures trading in Castorseed and Linseed was suspended in 1977. Apparently on the basis
of the recommendations made by Khusro Committee forward trading in Potato and Gur was
allowed in early 1980's and in Castorseed in 1985. After the process of liberalization of the
economy started in 1990, the Government set up a Committee under the Chairmanship of
Prof. K. N. Kabra in 1993 to examine the role of futures trading in the context of
liberalization and globalization. The Kabra Committee recommended allowing futures
trading in 17 commodity groups. It also recommended strengthening of Forward Markets

27
The Potential Effects of Government Intervention in a Market Economy, Scholarly research for the
consideration of: The Expert Committee to Examine the Impact of Futures Trading on Price-rise in
Agricultural Commodities(Abhijit Sen Committee)
28
Id
29
USAID/India Commodity Futures Markets Project: FINAL REPORT, Submitted by Financial Markets
International, Inc., USAID Contractor, December 7, 2007
30
See Generally, USAID/India Commodity Futures Markets Project: FINAL REPORT, Submitted by
Financial Markets International, Inc., USAID Contractor, December 7, 2007

Commission and amendments to Forward Contracts (Regulation) Act, 1952. The major
amendments include allowing options in goods, increase in outer limit for delivery and
payment from 11 days to 30 days for the contract to remain ready delivery contract and
registration of brokers with Forward Markets Commission. The Government accepted most
of these recommendations and futures trading has been permitted in all recommended
commodities except Bullion and Basmati Rice. Additional staff was provided to the FMC and
the post of Chairman was upgraded to the legal of Additional Secretary to the Government
of India. The recommendations to set up Regional office at Lucknow, Delhi and Kochi were
kept in abeyance for the time being.
In para 44 of the National Agricultural Policy announced by the Government in the year
1999 it was stated that the Government will enlarge the coverage of futures market to
minimize the wide fluctuations in commodity prices, as also for hedging their risk. It was
mentioned that an endeavor would be to cover all important agricultural products under
futures trading in the course of time. An expert Committee on Agricultural Marketing
headed by Shri Shankerlal Guru recommended linkage of spot and forward markets,
introduction of electronic warehouse receipt system, inclusion of more and more
commodities under futures trading and promotion of national system of warehouse receipt.
The subgroup on forward and futures markets formed under the chairmanship of Dr.
Kalyan Raipuria, Economic Adviser, Department of Consumer Affairs to examine the
feasibility of implementing the recommendations made by the Expert Committee chaired by
Shankerlal Guru recommended that the commodity specific approach to the grant of
recognition should be given up. The Exchanges, which meet the criteria to be stipulated by
the Government, should be able to trade contracts in any permitted commodity. In the
Budget speech made on 28th February 2002, the Finance Minister announced expansion of
futures and forward trading to cover all agricultural commodities. The economic survey for
the year 20002001 indicated the intention of the Government to allow futures trading in
Bullion. The policy statements announced by the Government indicate its resolve to
introduce reforms in commodity sector. A number of initiatives were also taken to decontrol
the spot markets in commodities. The number of commodities listed as essential
commodities has been pruned down to 17.
Efficacy of imposing nontraditional best systems and practices:
The long period of prohibition on forward trading in major commodities like cotton and
oilseeds complex has a enduring impact on the development of commodity derivative
markets in India and the futures markets in commodities find themselves left far behind the
derivative markets in the developed countries, which have been functioning
uninterruptedly. Even in the securities market in India has grown rapidly and introduced
modern infrastructure, systems and regulations. The challenge before the commodity
markets is to make up for the loss of growth and development during the three decades of
government policies which had the effect of restricting the growth of derivatives markets.
To facilitate leapfrogging, the immediate policy response in FMC and also in the
Government was to impose world's best systems and practices on the commodity
Exchanges that had just emerged from three decades of hibernation.

Accordingly the FMC imposed some of the regulatory measures being implemented in the
developed markets like:
1. Daily mark to market margining;
2. Time stamping of trades
3. Novation of contracts and creation of trade guarantee fund;
4. Backoffice computerization for the existing single commodity Exchange and online
trading for the new Exchanges;
5. Demutualization for the new Exchanges;
6. Onethird representation of independent Directors on the Boards of existing
Exchanges.

The United States and The United Kingdom Frameworks:
1. The United States Regulatory Framework
In the U.S., the growth of the commodities market has been one of the biggest success
stories to follow in the international arena. While there have been debates on convergence
in the U.S., a compromise was arrived at between the regulators in 1982.
31
In brief the
compromise meant that, the CFTC was given exclusive jurisdiction over all commodity
futures trading on any instrument, except that single stock futures were prohibited, joining
onions as the only commodity on which futures trading was banned.
32
The Shad-Johnson
accord as it was termed would also mean that the spot market regulator would get the right
to regulate the bond markets, and the derivatives market regulator would be given the duty
to regulate interest rate futures.
33
In addition to this the Securities Exchange Commission
(SEC), the Securities markets regulator, was given what amounted to a veto over commodity
futures contracts on indexes, and retained jurisdiction over options trading on the stock
exchanges, including options on indexes.
34
The jurisdictional squabbles of the SEC and the

31
See Generally, Jerry w. Markham , Super Regulator: A Comparative Analysis of Securities and
Derivatives Regulation in the United States, the United Kingdom, and Japan, 28 Brooklyn j.
Int'l l. 319, 2003.
32
7 U.S.C. 2 (2000).
33
CFTC and SEC Jurisdictional Agreement: Proposed Legislation, Comm. Fut. L. Rep. (CCH) <para> 21,332
(Feb. 2, 1982).
34
See generally Don L. Horwitz & Jerry W. Markham, Sunset on the Commodity Futures Trading Commission:
Scene II, 39 Bus. Law, 67, 73-74 (1983) (describing scope of Shad-Johnson Accords and veto authority of
CFTC over derivative regulation have not ended in any real sense despite the understanding
reached.
35
Lately, there have been discrepancies and practical difficulties in implementing
this approach and the structure has come under review again in the light of global
contagion.
36
Recently, the US Treasury Department, citing industry convergence, among
other things recommended what it called an optimal regulatory structure for the future.
The Treasury noted:
The growing institutionalization of the capital markets has provided markets
with liquidity, pricing efficiency, and risk dispersion and encouraged product
innovation and complexity. At the same time, these institutions can employ
significant degrees of leverage and more correlated trading strategies with
the potential for broad market disruptions. Finally, the convergence of
financial services providers and financial products has increased over the past
decade. Financial intermediaries and trading platforms are converging.
Financial products may have insurance, banking, securities, and futures
components.
These developments are pressuring the U.S. regulatory structure, exposing
regulatory gaps as well as redundancies, and compelling market participants
to do business in other jurisdictions with more efficient regulation. The U.S.
regulatory structure reflects a system, much of it created over seventy years
ago, grappling to keep pace with market evolutions and, facing increasing
difficulties, at times, in preventing and anticipating financial crises.
37

Such broad based opinion and framework envisioned by the Treasury points to the
possibility of having a structure similar to the Financial Services Authority (FSA) in the United
Kingdom.
2. The United Kingdom Regulatory Approach:
The Financial Services Authority (FSA), the main statutory regulator for the UK, was set up
on 20 May 1997. The Securities and Investment Board (SIB), the almost reluctant and
ineffective regulator
38
having similar functions as the soon to be established FSA, formally

SEC on indexes); Edward J. Kane, Regulatory Structure in Futures Markets: Jurisdictional Competition
between the SEC, the CFTC, and Other Agencies, 4 J. Fut. Markets 367, 375 (1984).
35
Wallison, Peter J., Convergence in Financial Services Markets: Likely Effects on Insurance Regulation,
American Enterprise Institute, July 9, 2008, Available at
http://www.aei.org/docLib/20080707_WallisonConvergencein.pdf
36
Statement of Gary Gensler Chairman, Commodity Futures Trading Commission Before the Senate
Committee on Agriculture, Nutrition and Forestry, June 4, 2009.
Available t: http://www.nytimes.com/2009/06/02/business/02regulate.html?_r=1
37
The Department of the Treasury, Blueprint For a Modernized Financial Regulatory Structure, March 2008,
p.4
38
Richard Northedge, Scandals Led to New Legislation for London Financial District, Sunday Bus. (London),
Nov. 20, 2001, available at LEXIS, News Group File
changed its name to the Financial Services Authority in October 1997.
39
By virtue of the
Bank of England Act, 1998, the responsibility of banking supervision was transferred to the
FSA, and through the Financial Services and Markets Act, 2000 (FSM Act)
40
the FSA took
over the responsibilities of several other regulatory and self-regulating organizations.
41
The
FSA is financed by the financial services industry and regulates 29,000 firms ranging from
global investment banks to very small businesses, and around 165,000 individuals.
42

The FSA formally gained its powers under the FSM Act on 1 December 2001.
43
Since the FSM
Act, Parliament has extended the responsibilities of the FSA to include mortgage lending
and insurance broking.
44
The members of the FSA board are appointed by the Treasury. The
Board sets the overall policy of the FSA, but day-to-day decisions and management of the
staff are the responsibility of the executive.
45
The regulatory objectives of the FSA are
described as follows by the FSM Act:
(a) market confidence;
(b) public awareness;
(c) the protection of consumers; and
(d) the reduction of financial crime.
46

In discharging these functions, the FSA must have regard to certain principles, e.g. the
principle that a burden or restriction which is imposed on a person, or on the carrying on of
any activity, should be proportionate to the benefits, considered in general terms, which are
expected to result from the imposition of that burden or restriction.
47
The agency was given
responsibility to regulate virtually every aspect of finance, assuming the same roles played
in the U.S. by the SEC, the CFTC, federal bank regulators, and state banking, insurance and
securities commissions, as well as the SROs.
48

Conclusion:

39
Thomas Sims, Single Regulators Are Catching on in Europe, Wall St. J. (International), Mar. 6, 2001, at A14.
40
Margaret Cole, Director of Enforcement, Fin. Servs. Auth., Speech at Fordham Law School, New York: The
UK FSA: Nobody Does It Better? (Oct. 17, 2006) (transcript available at
http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2006/1017 mc.shtml)
41
See generally Eilis Ferran, Examining the United Kingdom's Experience in Adopting the Single Financial
Regulator Model, 28 Brook. J. Int'l L. 257 (2003) (exploring the U.K.'s adoption of a single-regulator
model).
42
Supra note 76
43
Supra note 177.
44
See James Mackintosh, FSA Is Safely Delivered after Difficult and Long Labour, Finanical Times, June 14,
2000, at 1.
45
Harold S. Bloomenthal and Samuel Wolff, International Capital Markets and Securities Regulation, Database
updated April 2010, 10 Int'l Cap. Markets & Sec. Reg. 1:41
46
Supra note 76
47
Financial Services Modernization Act, At 2(3)(a). 2(3)(b), 2(3)(c), 2(3)(d), 2(3)(e), 2(3)(e), (f),
(g)
48
Silvia Ascarelli, Britain's Fiscal Watchdog to Bite as Well as Bark, Wall St. J., Nov. 30, 2001, at A13.
To sum up, keeping in view the fact of past baggage being carried by the existing Exchanges,
the objective of catching up with the developed countries can be achieved by continuing
with the policy liberalisation, initiating new development policies and coupled with
regulatory pressure exerted not directly by the regulator but indirectly by the competitive
marketfriendly policies.


COMMODITY DERIVATIVES
Trading in derivatives first started to protect farmers from the risk of the value of their crop
going below the cost price of their produce. Derivative contracts were offered on various
agricultural products like cotton, rice, coffee, wheat, pepper, et cetera.

The first organized exchange, the Chicago Board of Trade (CBOT) -- with standardised
contracts on various commodities -- was established in 1848. In 1874, the Chicago Produce
Exchange -- which is now known as Chicago Mercantile Exchange -- was formed (CME).
CBOT and CME are two of the largest commodity derivatives exchanges in the world.
The Indian scenario
Commodity derivatives have had a long and a chequered presence in India. The commodity
derivative market has been functioning in India since the nineteenth century with organized
trading in cotton through the establishment of Cotton Trade Association in 1875. Over the
years, there have been various bans, suspensions and regulatory dogmas on various
contracts.
There are 25 commodity derivative exchanges in India as of now and derivative contracts on
nearly 100 commodities are available for trade. The overall turnover is expected to touch Rs
5 lakh crore (Rs 5 trillion) by the end of 2004-2005.
National Commodity and Derivatives Exchange (NCDEX) is the largest commodity derivatives
exchange with a turnover of around Rs 3,000 crore (Rs 30 billion) every fortnight.
It is only in the last decade that commodity derivatives exchanges have been actively
encouraged. But, the markets have suffered from poor liquidity and have not grown to any
significant level, till recently.
However, in the year 2003, four national commodity exchanges became operational;
National Multi-Commodity Exchange of India (NMCE), National Board of Trade (NBOT),
National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange
(MCX).
The onset of these exchanges and the introduction of futures contracts on new
commodities by the Forwards Market Commission have triggered significant levels of trade.
Now the commodities futures trading in India is all set to match the volumes on the capital
markets.

Investing in commodity derivatives
Commodity derivatives, which were traditionally developed for risk management purposes,
are now growing in popularity as an investment tool. Most of the trading in the commodity
derivatives market is being done by people who have no need for the commodity itself.
They just speculate on the direction of the price of these commodities, hoping to make
money if the price moves in their favour.
The commodity derivatives market is a direct way to invest in commodities rather than
investing in the companies that trade in those commodities.
For example, an investor can invest directly in a steel derivative rather than investing in the
shares of Tata Steel. It is easier to forecast the price of commodities based on their demand
and supply forecasts as compared to forecasting the price of the shares of a company --
which depend on many other factors than just the demand -- and supply of the products
they manufacture and sell or trade in.
Also, derivatives are much cheaper to trade in as only a small sum of money is required to
buy a derivative contract.
Let us assume that an investor buys a tonne of soybean for Rs 8,700 in anticipation that the
prices will rise to Rs 9,000 by June 30, 2005. He will be able to make a profit of Rs 300 on his
investment, which is 3.4%. Compare this to the scenario if the investor had decided to buy
soybean futures instead.
Before we look into how investment in a derivative contract works, we must familiarize
ourselves with the buyer and the seller of a derivative contract. A buyer of a derivative
contract is a person who pays an initial margin to buy the right to buy or sell a commodity at
a certain price and a certain date in the future.
On the other hand, the seller accepts the margin and agrees to fulfil the agreed terms of the
contract by buying or selling the commodity at the agreed price on the maturity date of the
contract.
Now let us say the investor buys soybean futures contract to buy one tonne of soybean for
Rs 8,700 (exercise price) on June 30, 2005. The contract is available by paying an initial
margin of 10%, i.e. Rs 870. Note that the investor needs to invest only Rs 870 here.
On June 30, 2005, the price of soybean in the market is, say, Rs 9,000 (known as Spot Price --
Spot Price is the current market price of the commodity at any point in time).
The investor can take the delivery of one tonne of soybean at Rs 8,700 and immediately sell
it in the market for Rs 9,000, making a profit of Rs 300. So the return on the investment of
Rs 870 is 34.5%. On the contrary, if the price of soybean drops to Rs 8,400 the investor will
end up making a loss of 34.5%.
If the investor wants, instead of taking the delivery of the commodity upon maturity of the
contract, an option to settle the contract in cash also exists. Cash settlement comprises
exchange of the difference in the spot price of the commodity and the exercise price as per
the futures contract.
At present, the option of cash settlement lies only with the seller of the contract. If the
seller decides to make or take delivery upon maturity, the buyer of the contract has to fulfil
his obligation by either taking or making delivery of the commodity, depending on the
specifications of the contract.
In the above example, if the seller decides to go for cash settlement, the contract can be
settled by the seller paying Rs 300 to the buyer, which is the difference in the spot price of
the commodity and the exercise price. Once again, the return on the investment of Rs 870 is
34.5%.
The above example shows that with very little investment, the commodity futures market
offers scope to make big bucks. However, trading in derivatives is highly risky because just
as there are high returns to be earned if prices move in favour of the investors, an
unfavourable move results in huge losses.
The most critical function in a commodity derivatives exchange is the settlement and
clearing of trades. Commodity derivatives can involve the exchange of funds and goods. The
exchanges have a separate body to handle all the settlements, known as the clearing house.
For example, the seller of a futures contract to buy soybean might choose to take delivery of
soyabean rather than closing his position before maturity. The function of the clearing
house or clearing organisation, in such a case, is to take care of possible problems of default
by the other party involved by standardising and simplifying transaction processing between
participants and the organisation.
In spite of the surge in the turnover of the commodity exchanges in recent years, a lot of
work in terms of policy liberalisation, setting up the right legal system, creating the
necessary infrastructure, large-scale training programs, et cetera still needs to be done in
order to catch up with the developed commodity derivative markets.
Also, trading in commodity options is prohibited in India. The regulators should look
towards introducing new contracts in the Indian market in order to provide the investors
with choice, plus provide the farmers and commodity traders with more tools to hedge their
risks.

Conclusion
India is one of the top producers of a large number of commodities, and also has a long
history of trading in commodities and related derivatives. The commodities derivatives
market has seen ups and downs, but seem to have finally arrived now. The market has made
enormous progress in terms of technology, transparency and the trading activity.
Interestingly, this has happened only after the Government protection was removed from a
number of commodities, and market forces were allowed to play their role. This should act
as a major lesson for the policy makers in developing countries, that pricing and price risk
management should be left to the market forces rather than trying to achieve these through
administered price mechanisms. The management of price risk is going to assume even
greater importance in future with the promotion of free trade and removal of trade barriers
in the world.

CURRENCY DERIVATIVES
Each country has its own currency through which both national and international
transactions are performed. All the international business transactions involve an
exchange of one currency for another.
For example, If any Indian firm borrows funds from international financial market in US
dollars for short or long term then at maturity the same would be refunded in particular
agreed currency along with accrued interest on borrowed money. It means that the
borrowed foreign currency brought in the country will be converted into Indian currency,
and when borrowed fund are paid to the lender then the home currency will be
converted into foreign lenders currency. Thus, the currency units of a country involve
an exchange of one currency for another. The price of one currency in terms of other
currency is known as exchange rate.
The foreign exchange markets of a country provide the mechanism of exchanging
different currencies with one and another, and thus, facilitating transfer of purchasing
power from one country to another.
With the multiple growths of international trade and finance all over the world, trading in
foreign currencies has grown tremendously over the past several decades. Since the
exchange rates are continuously changing, so the firms are exposed to the risk of
exchange rate movements. As a result the assets or liability or cash flows of a firm which
are denominated in foreign currencies undergo a change in value over a period of time
due to variation in exchange rates.
This variability in the value of assets or liabilities or cash flows is referred to exchange
rate risk. Since the fixed exchange rate system has been fallen in the early 1970s,
specifically in developed countries, the currency risk has become substantial for many
business firms. As a result, these firms are increasingly turning to various risk hedging
products like foreign currency futures, foreign currency forwards, foreign currency
options, and foreign currency swaps.

The Underlying Securities for Derivatives are :
1. Commodities: Castor seed, Grain, Pepper, Potatoes, etc.
2. Precious Metal : Gold, Silver
3. Short Term Debt Securities : Treasury Bills
4. Interest Rates
5. Common shares/stock
6. Stock Index Value : NSE Nifty
7. Currency : Exchange Rate

TYPES OF FINANCIAL DERIVATIVES
Financial derivatives are those assets whose values are determined by the value of some
other assets, called as the underlying. Presently there are Complex varieties of derivatives
already in existence and the markets are innovating newer and newer ones continuously.
For example, various types of financial derivatives based on their different properties like,
plain, simple or straightforward, composite, joint or hybrid, synthetic, leveraged, mildly
leveraged, OTC traded, standardized or organized exchange traded, etc. are available in the
market. Due to complexity in nature, it is very difficult to classify the financial derivatives,
so in the present context, the basic financial derivatives which are popularly in the market
have been described. In the simple form, the derivatives can be classified into different
categories which are shown below :

DERIVATIVES


Financials Commodities

Basics Complex

1. Forwards 1. Swaps
2. Futures 2.Exotics (Non STD)
3. Options
4. Warrants and Convertibles

One form of classification of derivative instruments is between commodity derivatives and
financial derivatives. The basic difference between these is the nature of the underlying
instrument or assets. In commodity derivatives, the underlying instrument is commodity
which may be wheat, cotton, pepper, sugar, jute, turmeric, corn, crude oil, natural gas, gold,
silver and so on. In financial derivative, the underlying instrument may be treasury bills,
stocks, bonds, foreign exchange, stock index, cost of living index etc. It is to be noted that
financial derivative is fairly standard and there are no quality issues whereas in commodity
derivative, the quality may be the underlying matters.

Another way of classifying the financial derivatives is into basic and complex. In this, forward
contracts, futures contracts and option contracts have been included in the basic derivatives
whereas swaps and other complex derivatives are taken into complex category because
they are built up from either forwards/futures or options contracts, or both. In fact, such
derivatives are effectively derivatives of derivatives.




Derivatives are traded at organized exchanges and in the Over The Counter ( OTC ) market
:

Derivatives Trading Forum


Organized Exchanges Over The Counter

Commodity Futures Forward Contracts
Financial Futures Swaps
Options (stock and index)
Stock Index Future

Derivatives traded at exchanges are standardized contracts having standard delivery dates
and trading units. OTC derivatives are customized contracts that enable the parties to select
the trading units and delivery dates to suit their requirements.

A major difference between the two is that of counterparty riskthe risk of default by
either party. With the exchange traded derivatives, the risk is controlled by exchanges
through clearing house which act as a contractual intermediary and impose margin
requirement. In contrast, OTC derivatives signify greater vulnerability.


DERIVATIVES INTRODUCTION IN INDIA

The first step towards introduction of derivatives trading in India was the promulgation of
the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on
options in securities. SEBI set up a 24 member committee under the chairmanship of Dr.
L.C. Gupta on November 18, 1996 to develop appropriate regulatory framework for
derivatives trading in India, submitted its report on March 17, 1998. The committee
recommended that the derivatives should be declared as securities so that regulatory
framework applicable to trading of securities could also govern trading of derivatives.

To begin with, SEBI approved trading in index futures contracts based on S&P CNX Nifty and
BSE-30 (Sensex) index. The trading in index options commenced in June 2001 and the
trading in options on individual securities commenced in July 2001. Futures contracts on
individual stocks were launched in November 2001.

HISTORY OF CURRENCY DERIVATIVES

Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972.The
contracts were created under the guidance and leadership of Leo Melamed, CME Chairman
Emeritus. The FX contract capitalized on the U.S. abandonment of the Bretton Woods
agreement, which had fixed world exchange rates to a gold standard after World War II. The
abandonment of the Bretton Woods agreement resulted in currency values being allowed to
float, increasing the risk of doing business. By creating another type of market in which
futures could be traded, CME currency futures extended the reach of risk management
beyond commodities, which were the main derivative contracts traded at CME until then.
The concept of currency futures at CME was revolutionary, and gained credibility through
endorsement of Nobel-prize-winning economist Milton Friedman.

Today, CME offers 41 individual FX futures and 31 options contracts on 19 currencies, all of
which trade electronically on the exchanges CME Globex platform. It is the largest
regulated marketplace for FX trading. Traders of CME FX futures are a diverse group that
includes multinational corporations, hedge funds, commercial banks, investment banks,
financial managers, commodity trading advisors (CTAs), proprietary trading firms; currency
overlay managers and individual investors. They trade in order to transact business, hedge
against unfavorable changes in currency rates, or to speculate on rate fluctuations.
Source: - (NCFM-Currency future Module)

UTILITY OF CURRENCY DERIVATIVES

Currency-based derivatives are used by exporters invoicing receivables in foreign currency,
willing to protect their earnings from the foreign currency depreciation by locking the
currency conversion rate at a high level. Their use by importers hedging foreign currency
payables is effective when the payment currency is expected to appreciate and the
importers would like to guarantee a lower conversion rate. Investors in foreign currency
denominated securities would like to secure strong foreign earnings by obtaining the right
to sell foreign currency at a high conversion rate, thus defending their revenue from the
foreign currency depreciation. Multinational companies use currency derivatives being
engaged in direct investment overseas. They want to guarantee the rate of purchasing
foreign currency for various payments related to the installation of a foreign branch or
subsidiary, or to a joint venture with a foreign partner.

A high degree of volatility of exchange rates creates a fertile ground for foreign exchange
speculators. Their objective is to guarantee a high selling rate of a foreign currency by
obtaining a derivative contract while hoping to buy the currency at a low rate in the future.
Alternatively, they may wish to obtain a foreign currency forward buying contract, expecting
to sell the appreciating currency at a high future rate. In either case, they are exposed to the
risk of currency fluctuations in the future betting on the pattern of the spot exchange rate
adjustment consistent with their initial expectations.

The most commonly used instrument among the currency derivatives are currency forward
contracts. These are large notional value selling or buying contracts obtained by exporters,
importers, investors and speculators from banks with denomination normally exceeding 2
million USD. The contracts guarantee the future conversion rate between two currencies
and can be obtained for any customized amount and any date in the future. They normally
do not require a security deposit since their purchasers are mostly large business firms and
investment institutions, although the banks may require compensating deposit balances or
lines of credit. Their transaction costs are set by spread between bank's buy and sell prices.
Exporters invoicing receivables in foreign currency are the most frequent users of these
contracts. They are willing to protect themselves from the currency depreciation by locking
in the future currency conversion rate at a high level. A similar foreign currency forward
selling contract is obtained by investors in foreign currency denominated bonds (or other
securities) who want to take advantage of higher foreign that domestic interest rates on
government or corporate bonds and the foreign currency forward premium. They hedge
against the foreign currency depreciation below the forward selling rate which would ruin
their return from foreign financial investment. Investment in foreign securities induced by
higher foreign interest rates and accompanied by the forward selling of the foreign currency
income is called a covered interest arbitrage.
Source :-( Recent Development in International Currency Derivative Market by Lucjan

INTRODUCTION TO CURRENCY DERIVATIVES

Each country has its own currency through which both national and international
transactions are performed. All the international business transactions involve an exchange
of one currency for another.
For example, If any Indian firm borrows funds from international financial market in US
dollars for short or long term then at maturity the same would be refunded in particular
agreed currency along with accrued interest on borrowed money. It means that the
borrowed foreign currency brought in the country will be converted into Indian currency,
and when borrowed fund are paid to the lender then the home currency will be converted
into foreign lenders currency. Thus, the currency units of a country involve an exchange of
one currency for another.

The price of one currency in terms of other currency is known as exchange rate.

The foreign exchange markets of a country provide the mechanism of exchanging different
currencies with one and another, and thus, facilitating transfer of purchasing power from
one country to another.

With the multiple growths of international trade and finance all over the world, trading in
foreign currencies has grown tremendously over the past several decades. Since the
exchange rates are continuously changing, so the firms are exposed to the risk of exchange
rate movements. As a result the assets or liability or cash flows of a firm which are
denominated in foreign currencies undergo a change in value over a period of time due to
variation in exchange rates.

This variability in the value of assets or liabilities or cash flows is referred to exchange rate
risk. Since the fixed exchange rate system has been fallen in the early 1970s, specifically in
developed countries, the currency risk has become substantial for many business firms. As
a result, these firms are increasingly turning to various risk hedging products like foreign
currency futures, foreign currency forwards, foreign currency options, and foreign currency
swaps.


INTRODUCTION TO CURRENCY FUTURE
A futures contract is a standardized contract, traded on an exchange, to buy or sell a certain
underlying asset or an instrument at a certain date in the future, at a specified price. When
the underlying asset is a commodity, e.g. Oil or Wheat, the contract is termed a

commodity
futures contract

. When the underlying is an exchange rate, the contract is termed a

currency futures contract

. In other words, it is a contract to exchange one currency for

another currency at a specified date and a specified rate in the future.
Therefore, the buyer and the seller lock themselves into an exchange rate for a specific
value or delivery date. Both parties of the futures contract must fulfill their obligations on
the settlement date.
Currency futures can be cash settled or settled by delivering the respective obligation of the
seller and buyer. All settlements however, unlike in the case of OTC markets, go through the
exchange.

CURRENCY DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are forwards,
futures, options and swaps.

1. FORWARD : The basic objective of a forward market in any underlying asset is to fix
a price for a contract to be carried through on the future agreed date and is intended
to free both the purchaser and the seller from any risk of loss which might incur due
to fluctuations in the price of underlying asset.
A forward contract is customized contract between two entities, where settlement
takes place on a specific date in the future at todays pre-agreed price. The
exchange rate is fixed at the time the contract is entered into. This is known as
forward exchange rate or simply forward rate.

2. FUTURE : A currency futures contract provides a simultaneous right and obligation to
buy and sell a particular currency at a specified future date, a specified price and a
standard quantity. In another word, a future contract is an agreement between two
parties to buy or sell an asset at a certain time in the future at a certain price. Future
contracts are special types of forward contracts in the sense that they are
standardized exchange-traded contracts.

3. SWAP : Swap is private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolio of
forward contracts.

The currency swap entails swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than those in the
opposite direction. There are a various types of currency swaps like as fixed-to-fixed
currency swap, floating to floating swap, fixed to floating currency swap.

In a swap normally three basic steps are involve___

Initial exchange of principal amount
Ongoing exchange of interest
Re - exchange of principal amount on maturity.

4. OPTIONS : Currency option is a financial instrument that give the option holder a
right and not the obligation, to buy or sell a given amount of foreign exchange at a
fixed price per unit for a specified time period ( until the expiration date ). In other
words, a foreign currency option is a contract for future delivery of a specified
currency in exchange for another in which buyer of the option has to right to buy
(call) or sell (put) a particular currency at an agreed price for or within specified
period. The seller of the option gets the premium from the buyer of the option for
the obligation undertaken in the contract. Options generally have lives of up to one
year, the majority of options traded on options exchanges having a maximum
maturity of nine months. Longer dated options are called warrants and are
generally traded OTC.

FOREIGN EXCHANGE SPOT (CASH) MARKET

The foreign exchange spot market trades in different currencies for both spot and forward
delivery. Generally they do not have specific location, and mostly take place primarily by
means of telecommunications both within and between countries. It consists of a network
of foreign dealers which are oftenly banks, financial institutions, large concerns, etc. The
large banks usually make markets in different currencies.
In the spot exchange market, the business is transacted throughout the world on a continual
basis. So it is possible to transaction in foreign exchange markets 24 hours a day. The
standard settlement period in this market is 48 hours, i.e., 2 days after the execution of the
transaction.
The spot foreign exchange market is similar to the OTC market for securities. There is no
centralized meeting place and no fixed opening and closing time. Since most of the business
in this market is done by banks, hence, transaction usually do not involve a physical transfer
of currency, rather simply book keeping transfer entry among banks.
Exchange rates are generally determined by demand and supply force in this market. The
purchase and sale of currencies stem partly from the need to finance trade in goods and
services. Another important source of demand and supply arises from the participation of
the central banks which would emanate from a desire to influence the direction, extent or
speed of exchange rate movements.

NEED FOR EXCHANGE TRADED CURRENCY FUTURES

With a view to enable entities to manage volatility in the currency market, RBI on April 20,
2007 issued comprehensive guidelines on the usage of foreign currency forwards, swaps
and options in the OTC market. At the same time, RBI also set up an Internal Working Group
to explore the advantages of introducing currency futures. The Report of the Internal
Working Group of RBI submitted in April 2008, recommended the introduction of exchange
traded currency futures. Exchange traded futures as compared to OTC forwards serve the
same economic purpose, yet differ in fundamental ways. An individual entering into a
forward contract agrees to transact at a forward price on a future date. On the maturity
date, the obligation of the individual equals the forward price at which the contract was
executed. Except on the maturity date, no money changes hands. On the other hand, in the
case of an exchange traded futures contract, mark to market obligations is settled on a daily
basis. Since the profits or losses in the futures market are collected / paid on a daily basis,
the scope for building up of mark to market losses in the books of various participants gets
limited.

The counterparty risk in a futures contract is further eliminated by the presence of a
clearing corporation, which by assuming counterparty guarantee eliminates credit risk.
Further, in an Exchange traded scenario where the market lot is fixed at a much lesser size
than the OTC market, equitable opportunity is provided to all classes of investors whether
large or small to participate in the futures market. The transactions on an Exchange are
executed on a price time priority ensuring that the best price is available to all categories of
market participants irrespective of their size. Other advantages of an Exchange traded
market would be greater transparency, efficiency and accessibility.
Source :-( Report of the RBI-SEBI standing technical committee on exchange traded
currency futures) 2008.

RATIONALE FOR INTRODUCING CURRENCY FUTURE
Futures markets were designed to solve the problems that exist in forward markets. A futures
contract is an agreement between two parties to buy or sell an asset at a certain time in the
future at a certain price. But unlike forward contracts, the futures contracts are standardized
and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies
certain standard features of the contract. A futures contract is standardized contract with
standard underlying instrument, a standard quantity and quality of the underlying instrument that
can be delivered, (or which can be used for reference purposes in settlement) and a standard
timing of such settlement. A futures contract may be offset prior to maturity by entering into an
equal and opposite transaction.
The standardized items in a futures contract are:
Quantity of the underlying
Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement

The rationale for introducing currency futures in the Indian context has been outlined in the
Report of the Internal Working Group on Currency Futures (Reserve Bank of India, April 2008)
as follows;
The rationale for establishing the currency futures market is manifold. Both
residents and non-residents purchase domestic currency assets. If the exchange
rate remains unchanged from the time of purchase of the asset to its sale, no
gains and losses are made out of currency exposures. But if domestic currency
depreciates (appreciates) against the foreign currency, the exposure would
result in gain (loss) for residents purchasing foreign assets and loss (gain) for
non residents purchasing domestic assets. In this backdrop, unpredicted
movements in exchange rates expose investors to currency risks. Currency
futures enable them to hedge these risks. Nominal exchange rates are often
random walks with or without drift, while real exchange rates over long run are
mean reverting. As such, it is possible that over a long run, the incentive to
hedge currency risk may not be large. However, financial planning horizon is
much smaller than the long-run, which is typically inter-generational in the
context of exchange rates. As such, there is a strong need to hedge currency
risk and this need has grown manifold with fast growth in cross-border trade
and investments flows. The argument for hedging currency risks appear to be
natural in case of assets, and applies equally to trade in goods and services,
which results in income flows with leads and lags and get converted into
different currencies at the market rates. Empirically, changes in exchange rate
are found to have very low correlations with foreign equity and bond returns.
This in theory should lower portfolio risk. Therefore, sometimes argument is
advanced against the need for hedging currency risks. But there is strong
empirical evidence to suggest that hedging reduces the volatility of returns and
indeed considering the episodic nature of currency returns, there are strong
arguments to use instruments to hedge currency risks.

FUTURE TERMINOLOGY

1. SPOT PRICE :
The price at which an asset trades in the spot market. The transaction in which securities
and foreign exchange get traded for immediate delivery. Since the exchange of securities
and cash is virtually immediate, the term, cash market, has also been used to refer to spot
dealing. In the case of USDINR, spot value is T + 2.

2. FUTURE PRICE :
The price at which the future contract traded in the future market.

3. CONTRACT CYCLE :
The period over which a contract trades. The currency future contracts in Indian market
have one month, two month, three month up to twelve month expiry cycles. In NSE/BSE will
have 12 contracts outstanding at any given point in time.

4. VALUE DATE / FINAL SETTELMENT DATE :
The last business day of the month will be termed the value date /final settlement date of
each contract. The last business day would be taken to the same as that for inter bank
settlements in Mumbai. The rules for inter bank settlements, including those for known
holidays and would be those as laid down by Foreign Exchange Dealers Association of India
(FEDAI).
5. EXPIRY DATE :
It is the date specified in the futures contract. This is the last day on which the contract will
be traded, at the end of which it will cease to exist. The last trading day will be two business
days prior to the value date / final settlement date.

6. CONTRACT SIZE :
The amount of asset that has to be delivered under one contract.
Also called as lot size. In case of USDINR it is USD 1000.

7. BASIS :
In the context of financial futures, basis can be defined as the futures price minus the spot
price. There will be a different basis for each delivery month for each contract. In a normal
market, basis will be positive. This reflects that futures prices normally exceed spot prices.

8. COST OF CARRY :
The relationship between futures prices and spot prices can be summarized in terms of
what is known as the cost of carry. This measures the storage cost plus the interest that is
paid to finance or carry the asset till delivery less the income earned on the asset. For
equity derivatives carry cost is the rate of interest.

9. INITIAL MARGIN :
When the position is opened, the member has to deposit the margin with the clearing house
as per the rate fixed by the exchange which may vary asset to asset. Or in another words,
the amount that must be deposited in the margin account at the time a future contract is
first entered into is known as initial margin.

10. MARKING TO MARKET :
At the end of trading session, all the outstanding contracts are reprised at the settlement
price of that session. It means that all the futures contracts are daily settled, and profit and
loss is determined on each transaction. This procedure, called marking to market, requires
that funds charge every day. The funds are added or subtracted from a mandatory margin
(initial margin) that traders are required to maintain the balance in the account. Due to this
adjustment, futures contract is also called as daily reconnected forwards.

11. MAINTENANCE MARGIN :
Members account are debited or credited on a daily basis. In turn customers account are
also required to be maintained at a certain level, usually about 75 percent of the initial
margin, is called the maintenance margin. This is somewhat lower than the initial margin.

This is set to ensure that the balance in the margin account never becomes negative. If the
balance in the margin account falls below the maintenance margin, the investor receives a
margin call and is expected to top up the margin account to the initial margin level before
trading commences on the next day.

USES OF CURRENCY FUTURES
1. Hedgi ng:
Presume Entity A is expecting a remittance for USD 1000 on 27 August 08. Wants to lock
in the foreign exchange rate today so that the value of inflow in Indian rupee terms is
safeguarded. The entity can do so by selling one contract of USDINR futures since one
contract is for USD 1000.
Presume that the current spot rate is Rs.43 and

USDINR 27 Aug 08 contract is trading

at Rs.44.2500. Entity A shall do the following:
Sell one August contract today. The value of the contract is Rs.44,250.
Let us assume the RBI reference rate on August 27, 2008 is Rs.44.0000. The entity shall
sell on August 27, 2008, USD 1000 in the spot market and get Rs. 44,000. The futures
contract will settle at Rs.44.0000 (final settlement price = RBI reference rate).
The return from the futures transaction would be Rs. 250, i.e. (Rs. 44,250 Rs. 44,000).
As may be observed, the effective rate for the remittance received by the entity A is
Rs.44. 2500 (Rs.44,000 + Rs.250)/1000, while spot rate on that date was Rs.44.0000.
The entity was able to hedge its exposure.
2. Speculation: Bullish, buy futures
Take the case of a speculator who has a view on the direction of the market. He would like
to trade based on this view. He expects that the USD-INR rate presently at Rs.42, is to
go up in the next two-three months. How can he trade based on this belief? In case he
can buy dollars and hold it, by investing the necessary capital, he can profit if say the
Rupee depreciates to Rs.42.50. Assuming he buys USD 10000, it would require an
investment of Rs.4,20,000. If the exchange rate moves as he expected in the next three
months, then he shall make a profit of around Rs.10000. This works out to an annual
return of around 4.76%. It may please be noted that the cost of funds invested is not
considered in computing this return.
A speculator can take exactly the same position on the exchange rate by using futures
contracts. Let us see how this works. If the INR- USD is Rs.42 and the three month
futures trade at Rs.42.40. The minimum contract size is USD 1000. Therefore the
speculator may buy 10 contracts. The exposure shall be the same as above USD 10000.
Presumably, the margin may be around Rs.21, 000. Three months later if the Rupee
depreciates to Rs. 42.50 against USD, (on the day of expiration of the contract), the futures
price shall converge to the spot price (Rs. 42.50) and he makes a profit of Rs.1000 on an
investment of Rs.21, 000. This works out to an annual return of 19 percent. Because of the
leverage they provide, futures form an attractive option for speculators.

3. Speculation: Bearish, sell futures
Futures can be used by a speculator who believes that an underlying is over-valued and is
likely to see a fall in price. How can he trade based on his opinion? In the absence of a
deferral product, there wasn
'
t much he could do to profit from his opinion. Today all he
needs to do is sell the futures.
Let us understand how this works. Typically futures move correspondingly with the
underlying, as long as there is sufficient liquidity in the market. If the underlying price rises,
so will the futures price. If the underlying price falls, so will the futures price. Now take the
case of the trader who expects to see a fall in the price of USD-INR. He sells one two-
month contract of futures on USD say at Rs. 42.20 (each contact for USD 1000). He pays a
small margin on the same. Two months later, when the futures contract expires, USD-INR
rate let us say is Rs.42. On the day of expiration, the spot and the futures price converges.
He has made a clean profit of 20 paise per dollar. For the one contract that he sold, this
works out to be Rs.2000.

4. Arbitrage:
Arbitrage is the strategy of taking advantage of difference in price of the same or similar
product between two or more markets. That is, arbitrage is striking a combination of
matching deals that capitalize upon the imbalance, the profit being the difference
between the market prices. If the same or similar product is traded in say two different
markets, any entity which has access to both the markets will be able to identify price
differentials, if any. If in one of the markets the product is trading at higher price, then the
entity shall buy the product in the cheaper market and sell in the costlier market and thus
benefit from the price differential without any additional risk.
One of the methods of arbitrage with regard to USD-INR could be a trading strategy
between forwards and futures market. As we discussed earlier, the futures price and
forward prices are arrived at using the principle of cost of carry. Such of those entities
who can trade both forwards and futures shall be able to identify any mis-pricing between
forwards and futures. If one of them is priced higher, the same shall be sold while
simultaneously buying the other which is priced lower. If the tenor of both the contracts is
same, since both forwards and futures shall be settled at the same RBI reference rate, the
transaction shall result in a risk less profit.


REGULATORY FRAMEWORK FOR CURRENCY FUTURES

With a view to enable entities to manage volatility in the currency market, RBI on April 20,
2007 issued comprehensive guidelines on the usage of foreign currency forwards, swaps
and options in the OTC market. At the same time, RBI also set up an Internal Working Group
to explore the advantages of introducing currency futures. The Report of the Internal
Working Group of RBI submitted in April 2008, recommended the introduction of exchange
traded currency futures. With the expected benefits of exchange traded currency futures, it
was decided in a joint meeting of RBI and SEBI on February 28, 2008, that an RBI-SEBI
Standing Technical Committee on Exchange Traded Currency and Interest Rate Derivatives
would be constituted. To begin with, the Committee would evolve norms and oversee the
implementation of Exchange traded currency futures. The Terms of Reference to the
Committee was as under:

1. To coordinate the regulatory roles of RBI and SEBI in regard to trading of Currency
and Interest Rate Futures on the Exchanges.

2. To suggest the eligibility norms for existing and new Exchanges for Currency and
Interest Rate Futures trading.

3. To suggest eligibility criteria for the members of such exchanges.

4. To review product design, margin requirements and other risk mitigation measures
on an ongoing basis.

5. To suggest surveillance mechanism and dissemination of market information.

6. To consider microstructure issues, in the overall interest of financial stability.

COMPARISION OF FORWARD AND FUTURES CURRENCY CONTRACT

BASIS FORWARD FUTURES
Size Structured as per
requirement of the parties
Standardized
Delivery
date
Tailored on individual
needs
Standardized
Method of
transaction
Established by the bank or
broker through electronic
media
Open auction among buyers and seller
on the floor of recognized exchange.
Participants Banks, brokers, forex
dealers, multinational
companies, institutional
investors, arbitrageurs,
traders, etc.
Banks, brokers, multinational
companies, institutional investors, small
traders, speculators, arbitrageurs, etc.
Margins None as such, but
compensating bank
balanced may be required
Margin deposit required
Maturity Tailored to needs: from one
week to 10 years
Standardized
Settlement Actual delivery or offset
with cash settlement. No
separate clearing house
Daily settlement to the market and
variation margin requirements
Market
place
Over the telephone
worldwide and computer
networks
At recognized exchange floor with
worldwide communications
Accessibility Limited to large customers
banks, institutions, etc.
Open to any one who is in need of
hedging facilities or has risk capital to
speculate
Delivery More than 90 percent
settled by actual delivery
Actual delivery has very less even below
one percent
Secured Risk is high being less
secured
Highly secured through margin deposit.


CONCLUSIONS

By far the most significant event in finance during the past decade has been the
extraordinary development and expansion of financial derivative. These instruments
enhances the ability to differentiate risk and allocate it to those investors most able and
willing to take it- a process that has undoubtedly improved national productivity growth and
standards of livings.

The currency future gives the safe and standardized contract to its investors and individuals
who are aware about the forex market or predict the movement of exchange rate so they
will get the right platform for the trading in currency future. Because of exchange traded
future contract and its standardized nature gives counter party risk minimized.

Initially only NSE had the permission but now BSE and MCX has also started currency future.
It is shows that how currency future covers ground in the compare of other available
derivatives instruments. Not only big businessmen and exporter and importers use this but
individual who are interested and having knowledge about forex market they can also invest
in currency future.
Exchange between USD-INR markets in India is very big and these exchange traded contract
will give more awareness in market and attract the investors.

The Insider Trading Regulations In India
ABSTRACT
It deals with the different implications of the insider trading as well as the efficacy of the
existing regulatory mechanism in place in the shape of SEBI (Prevention of Insider Trading)
Regulation Act, 1992 to deal with this problem. The Hindustan Liver Limited Case has been
dealt at length which necessitated changes in the definition of the insider trading through
the incorporation of a deeming provision. In fact the SEBI (Prevention of Insider Trading)
Regulation, 1992 is being inspired from the United States.
INTRODUCTION
The term insider trading is popularly used in the negative sense as it is perceived that the
persons having access to the price sensitive and unpublished information used the same for
their personal gains. However insider trading per se does not mean any illegal conduct. It
encompasses both legal as well as illegal conduct. The legal version is when corporate
insiders officers, directors, and employees buy and sell stock in their own companies. In
order to legalize their transactions, the directors and employees of the company should
inform about their dealing with the securities to the SEBI. However, commonly often we
associate this term with the breach of a fiduciary duty or other relationship of trust and
confidence, while in possession of material, non public information about the security.
Insider trading is defined by the Blacks Law Dictionary in the following words -The use of
material non public information in trading the shares of the company by a corporate insider
or any other person who owes a fiduciary duty to the company.
A study by the international consultants Ernst & Young (E&Y) is reported to have noted that
India has a low rate of fraud perpetrated by company insiders. Around 84% of the fraud
involves the hand in glove relationship between the employees and a third party. Therefore,
the surveillance mechanism in countries United States is quite tough to even rule out such a
probability. However, lower rates of employee fraud do not mean that Indian company
managements are honest and that shareholders get a better deal in India than elsewhere.
Ernst and Young also came out with an interesting observation that in India company
insiders with privileged access to information indulge in rampant insider trading for personal
gains rather than to benefit the shareholders. Therefore, the obvious conclusion drawn by
Economic Times was that the controlling interests and not the employees who take the
shareholders for a ride.
SEBI is the watchdog of all the stock exchanges in India. It has been obligated to protect the
interest of the investors in the securities market and to regulate the stock market through
such other regulations as it deems fit. The SEBI acts as the regulator in the share market by
taking all precautionary measures in order to repose the confidence of the investors who
are investing in the market. The author has conducted an extensive research on the
disclosure and divulging of the price sensitive information which would affect the share
prices and disturb the equations in the share market. It is due to the very fact that the
investors invest on the shares being speculative, but when the prices of the shares could be
predicted well before in hand then they may take a decision accordingly. Hence, pre
determined price may result in undesired consequences as people may buy huge amount of
shares whose value may appreciate.
The SEBI has dealt with a wide ranging plethora of cases on insider trading concerning the
following aspects. The secret agreement often involves individuals who have a relationship.
It may be family relationship or a business relationship. Some of them are mentioned below:
Corporate officers, directors, and employees who traded the corporations securities
after learning of significant, confidential corporate developments;
Friends, business associates, family members, and other tippees of such officers,
directors, and employees, who traded the securities after receiving such
information;
Employees of law, banking, brokerage and printing firms who were given such
information to provide services to the corporation whose securities they traded;
Government employees who learned of such information because of their
employment by the government; and
Other persons who misappropriated, and took advantage of, confidential
information from their employers.
Because insider trading undermines investor confidence in the fairness and integrity
of the securities markets, the SEBI has treated the detection and prosecution of
insider trading violations as one of its enforcement priorities.
NEED FOR PREVENTING INSIDER TRADING
The ideal securities market is concerned with the allocation of capital in the economy. This
function is enabled by market efficiency, the situation where the market price of each
security accurately reflects the risk and return in its future. The primary function of
regulation and policy is to foster market efficiency, hence we must evaluate the impact of
insider trading upon market efficiency. Insider trading appears to be biased especially to the
speculators who invest in the market expecting there would be an appreciation in the value
of the shares. The individual and institutional speculators are badly hit due to insider
trading. Indeed, inside traders competing with professional traders is not unlike foreign
goods competing on the domestic market -- the economy at large benefits even though one
class of economic agents suffers.
CODE OF BUSINESS PRINCIPLES
The Code of Business Principles is the Company's statement of values and represents the
standard of conduct which all the employees are expected to meet in their business
endeavours. This code of business is also reflective of the ethical and moral standards which
are expected from the employee in discharging their duty. The commitment of the company
to foster a healthy climate of transparency, and fairness is reflected in this code of conduct.
SHARE DEALING CODE
In furtherance of the SEBI (Prohibition of Insider Trading) Regulations, 1992, the Company
has established systems and procedures to prohibit insider trading. The Share Dealing Code
of the Company is an important governance code to prevent any insider trading activity by
dealing in shares of the Company. The Code restricts the Directors of the Company and
other specified employees to deal in the securities of the Company on the basis of any
unpublished price sensitive information available to them by virtue of their position in the
Company. The objective of this Code is:
To protect the interest of shareholders at large,
To prevent misuse of any price sensitive information and to prevent any insider
trading activity by dealing in shares of the Company by its Directors and employees.
The Securities and Exchange Board of India (prohibition of insider trading) Regulations, 1992
is a regulatory mechanism is put in place to oversee the fact that there is no leakage of such
information. According to the regulations two things should be established in order to
establish the fact that there is a disclosure of the price sensitive information. First and
foremost the fact that there is a divulgence of the price sensitive information concerning the
issuer company and secondly the person who dealt had the information in a position of
trust or was tipped about so much information by a person in fiduciary capacity or in any
position of trust.
At the outset it is pertinent to define the person who may be treated as an insider within
the scope and ambit of the regulation of the Securities Exchange Board of India. Section 2
(e) of the SEBI (Prohibition of Insider Trading) Regulations, 1992 defines insider in the
following words. Insider means any person who, is or was connected with the company or
is deemed to have been connected with the company, and who is reasonably expected to
have access to unpublished price sensitive information in respect of securities of
company, or who has received or has had access to such unpublished price sensitive
information.
REGULATORY MECHANISM IN INDIA: HISTORICAL BACKDROP
Insider trading continued unabated until 1970 which in sum and substance would imply that
it was practiced for 125 years in a country like India. The security market in India developed
through the establishment of the Bombay Stock Exchange was way back in 1875. It was
realized that such a system is detrimental to the interest of the Indian stock exchange. In
1979, the Sachar committee said in its report that company employees like directors,
auditors, company secretaries etc. may have some price sensitive information that could be
used to manipulate stock prices which may cause financial misfortunes to the investing
public. The company recommended that there should be amendments in the companies Act
in order to curb and prevent such practice. In 1986, the Patel committee recommended that
the securities contracts (Regulations) Act, 1956 may be amended to make curb insider
trading through a regulatory mechanism. In 1989 the Abid Hussain Committee also
recommended that the insider trading activities may be penalized by civil and criminal
proceedings and also suggested that the SEBI formulate the regulations and governing
codes to prevent unfair dealings.
Complying with the recommendations by these committees, India through Securities and
Exchange Board of India (Insider Trading) Regulations 1992 prohibited this mal practice. A
person convicted of this offence is punishable under Section 24 and Section 15G of the SEBI
Act 1992. These regulations were drastically amended in 2002 and renamed as SEBI
(Prohibition of Insider Trading) Regulations 1992. These acts are stringent to quit an extent
as they impose sanctions and punish the offender. All the listed companies and market
intermediaries have to comply with the directions of these regulations. The merchant
bankers and the professional firms also comply with it.
NEED FOR AN INSIDER TRADING REGULATIONS: TAKING A LEAF OUT OF LESSON FROM
UNITED STATES
The United States has been the leading country in prohibiting insider trading. It has set
benchmarks in having a regulatory regime for insider trading. United States has the
distinction of being the first and the foremost country in the world to have a comprehensive
legislation on insider trading in place. It has tackled these menacing problems effectively
and efficiently. Therefore it is imperative that we should have a conceptual understanding
about the insider trading from the American Perspective. Unlike Indi where we find that the
insider trading regulations came into being as late as 1992, insider trading regulations were
in vogue in America from1929. The year 1929 has a special significance due to the fact that
the great economic depression which engulfed the entire world came into effect from this
year. It engulfed the entire world. Due to the economic debacle Congress gave mandate to
protect the investors and keep markets free from fraud. This catastrophe led to the
enactment of the Securities Exchange Act of 1933.
Section 17 Securities Exchange Act, 1933 contained prohibitions to deal with the fraud in the
sale of the securities in the most stringent manner possible. The Act addressed insider
trading directly through Section 16(b) and indirectly through Section 10(b). Section 16(b) of
the Securities Exchange Act, 1934 prohibits the purchase and sale of the shares within six
month period involving the directors, officers, stock holders owning more than 10% of the
shares of the company. The rationale behind the incorporation of this provision is that it is
only the substantial shareholders and the persons concerned with the decision and
management of the company who can have access to the price sensitive information and
therefore there should be bar upon them to transact in securities. Section 10(b) of the
Securities Act, 1933, SEC Rule 10b-5 prohibits fraud related to trading in the securities.
Furthermore the Insider Trading Sanctions Act of 1984 and the Insider Trading and
Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading.
The penalties are indeed burdensome and stringent in nature. It may be as high as three
times the profit gained or the loss avoided from the illegal trading.
ANALYTICAL APPRASIAL OF THE SEBI (PROHIBITION OF INSIDER TRADING REGULATIONS,
1992
The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations,
1992, say, insider is any person who, is or was connected with the company, and who is
reasonably expected to have access to unpublished price-sensitive information about the
stock of that particular company, or who has access to such unpublished price sensitive
information.
Therefore, as per the definition the person should be either now in connected to the
company or was connected to the company.
The concerned person enjoys such status and position that there is every likelihood
that he may have access to price sensitive unpublished information.
The concerned person should have access to such unpublished price sensitive
information of the company.
An important amendment has been brought to the definition of insider, no word has been
added or deleted but by dropping a comma and breaking the definition into two parts, a
significant change has been made.
Before the amendment, an Insider had to, firstly, be a person connected or deemed
to be connected to the Company. Such connected person should then either
reasonably expected to have access to unpublished price sensitive information
(UPSI) or should have received it or had access to it.
This definition was ambiguous. A person merely receiving UPSI or merely having
access to it could also be said to be an Insider, as per one interpretation. It is
probably this ambiguity that the amendment tackles though by changing the
definition upside down.
DEFINITION OF INSIDER AFTER THE AMENDMENT: DEEMED INSIDER AS THE NEW
CATEGORY
Now, the amendment says that an Insider: -
A person connected or deemed to be connected to the Company and who can be
reasonably expected to have access to UPSIU, or
A person who receives or has access to UPSI.
Thus, a new category of, what one could call, deemed insiders has been created
UNPUBLISHED PRICE SENSITIVE INFORMATION
It means such information which is not in the public domain or the market is not aware
about it. Such information has a material effect on the price of the shares and the value of
the securities of the company. For instance the value of the shares of the company may
undergo change after the acquisition or merger of the company. The scope of such
information is very wide as there are many microscopic details in the course of the
administration of the company which has a direct or indirect impact on the prices of the
shares. The ambit of such information is mentioned in a nutshell below.
A significant business development or a proposed change in the nature of the
Companys business
Details of material contracts that are being negotiated by the Company
Potential litigation that would have a substantial effect on the Company
Proposed change in the share capital structure of the Company
A proposed change in the Companys dividend policy
A major change to the board or senior management
Price sensitive information means any information which relates directly or indirectly to a
company and which if published is likely to materially affect the price of securities of
company.
The following information would be considered as the price sensitive information within the
purview of the SEBI regulations.
Periodical financial results of the company
Intended declaration of dividends (both interim and final)
Issue of securities or buy-back of securities
Any major expansion plans or execution of new projects
Amalgamation, mergers or takeovers
Disposal of the whole or substantial part of the undertaking
Significant changes in policies, plans or operations of the company
CONNECTED PERSON
The Act defines connected person as the director as anyone who is deemed to be the
director of the company under section 2(13) of the Companies Act, 1956. He may be
deemed to be a Director of that company by virtue of section 310 (10) of the Companies
Act. Any person occupying the position of an officer or an employee of the company or
holds a position involving a professional or business relationship between himself and the
company would be deemed to be a company. It is immaterial whether the person
concerned happens to be temporarily or permanently involved in the company. The most
important factor which determines the price of the product is that the concerned employee
should have an access to such price sensitive information involving the company. Officer of
the company would mean any person as defined in clause (30) section 2 of Companies Act,
1956 including an auditor of the company.
Merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker,
portfolio manager, Investment Advisor, sub-broker, Investment Company, employees of the
Board of Trustees of the Mutual Fund are also considered to be connected person.
Members of the Board of Directors of the Asset management Company or the company or
an employee having fiduciary relationship is considered to be a connected person. Relative
of any of the above persons would be also considered to be connected person.
A relative of the connected is also considered to be the connected person who is related to
the decision making and the administration of the company. It is clear from the above
comprehensive definition that SEBI has not left any stone unturned to give a broad and all
comprehensive definition of the insider trading. Relative of the person who is involved in
the company is also considered to be the connected person.
UNITED STATES PERSPECTIVE ON INSIDER TRADING
The United States Sanction Act, 1984 imposes fines up to three times the profit gained or
loss avoided by use of such material non-public information. It is not out of place to mention
here that Section 16 of the Exchange Act, requires all officers and directors of a company
and beneficial owners of more than 10 per cent of its registered equity securities to
mandatorily file an initial report with the commission as well as with the exchanges on
which the stock may be listed,. They should disclose their holdings of each of the company's
equity securities. The United States law is much more stringent in comparison to the Indian
regulations which are often being castigated as paper tiger for its lack of efficacy in curbing
such insider trading. It is pertinent to mention here that the United States law provides that
the profits obtained from the purchases and sales from such securities within any six month
period may be recovered by the company or by any security holder on its behalf.
The United States Supreme Court in US Vs Hogan has expanded the concept of the insider
trading by approving the MISAPPROPRIATION THEORY and stating that a person commits
insider trading when he obtains material confidential information and uses it in securities
transactions in breach of fiduciary duty or similar relationship of confidence to the source of
information but not necessarily to the shareholders of the company whose stock are traded.
It is noteworthy to mention here that in the United States the finance market is well
developed and the regulatory regime is also stringent which is able to cope up with different
difficulties concerning adherence to strict corporate governance norms.
In SEC v. Texas Gulf Sulphur Co a federal circuit court held that anyone in possession of
inside information must either disclose the information or refrain from trading. In 1984, the
Supreme Court of the United States ruled in the case of Dirks v. SEC

that the (tippers)
receivers of the second hand information are liable if they have reason to believe that there
is a breached fiduciary duty in disclosing confidential information and the tipper had
received personal benefits for the same. Since Dirks disclosed the information in order to
expose a fraud, rather than for personal gain, nobody was liable for insider trading
violations in his case. This case holds significance owing to the fact that the courts are
dynamic in judging the culpability of the insider. In the instant case since the insider has
acted with good faith and without any vested and parochial interest for personal gains,
hence the court did not find him guilty.
The Dirks case also defined the concept of constructive insiders. Constructive insiders are
like whistle blowers who bring to the public forefront any corrupt practice which is
prevalent in their organization. The lawyers and investment bankers who bring such corrupt
practice into light are not considered to be guilty due to the very fact that they disclose the
internal fact to prevent the leakage and punish the culprit. Constructive insiders are also
liable for insider trading violations if the corporation expects the information to remain
confidential, since they acquire the fiduciary duties of the true insider.
In United States v. Carpenter the U.S. Supreme Court cited an earlier ruling while
unanimously uphold mail and wire fraud convictions for a defendant who received his
information from a journalist rather than from the company itself. The journalist was also
convicted, on the grounds that he had misappropriated information belonging to his
employer. The employer in this case happened to be the Wall Street Journal. In that widely
publicized case, Winans traded in advance of "Heard on the Street" columns appearing in
the Journal.
The court ruled in Carpenter: "It is well established, as a general proposition, that a person
who acquires special knowledge or information by virtue of a confidential or fiduciary
relationship with another is not free to exploit that knowledge or information for his own
personal benefit but must account to his principle for any profits derived there from."
ESSENTIAL CONDITIONS FOR INSIDER TRADING UNDER UK LAW
As per the United Kingdom law the insider trading regulations would come into picture only
when the four essential ingredients are present. These are the principles on the touchstone
of which the regulations are applied.
It must relate to the securities and the particular issue of the securities and not just
be concerned with the securities and issuer of securities in general. Thus information
would constitute insider information if it relates to the particular industry even if it
does not relate to the issuer.
However, the information pertaining to the Government economic policy and bank
rate would not come within the purview of the unpublished information.
Information may be either specific or precise. The information regarding the
takeover bid is specific information but the price at which the bid would take place is
precise information.
Information must not have been made public.
One interesting aspect of the Act in UK is that the prohibition extends to dealing in the
securities of a company, apart from that with which the individual is connected, if the
information relates to another company or to any other transaction involving both
companies. Furthermore, the recipient of such unpublished price sensitive information is
also prohibited from dealing, with the exception of certain circumstances.
INDIAN CASE LAWS
The facts of the Case of the Rakesh Aggarwal Vs SEBI are explained in brief. Rakesh Agarwal,
the Managing Director of ABS Industries Ltd. (ABS), was involved in negotiations with Bayer
A.G (a company registered in Germany), regarding their intentions to takeover ABS. Being
the Managing Director with such high portfolio it goes without saying that he has access to
the price sensitive information. Rakesh Aggarwal in order to escape from the vigilant eyes of
SEBI played a trick. He wanted to circumvent the provisions of law through tactful manner.
Before the announcement of the merger is made public through announcement, he made a
collusive agreement with his brother to take over the shares of ABS from the market.
Thereafter he tendered the same shares through the open offer making a huge profit. These
clandestine agreements could be traced by SEBI through their thread bare investigation.
Bayer AG subsequently acquired ABS. Further he was also an insider as far as ABS is
concerned.
The secretive agreement entered between Rakesh Aggarwal and brother in law to acquire
the shares before the merger is carried out is a violation of section 3 and 4 of the Securities
Exchange Board of India prohibition of Insider Trading Regulations, 1992. Rakesh Aggarwal
vehemently denied the allegations leveled against him by the SEBI stating that he has acted
in such a manner for the benefits of the company and he has no intention to have personal
gains. He said that he wanted to acquire 51 percent shares of the company of ABS through
Bayer and he wanted to plan to be executed in clinical precision. The SEBI directed Rakesh
Agarwal to deposit Rs. 34, 00,000 with Investor Education & Protection Funds of Stock
Exchange, Mumbai and NSE (in equal proportion i.e. Rs. 17, 00,000 in each exchange) to
compensate any investor which may make any claim subsequently.
A case against Rakesh Aggarwal is made out under section 24 of the SEBI Act.
Adjudication proceedings under section 15I read with section 15 G of the SEBI Act
against Rakesh Aggarwal.
Rakesh Aggarwal made an appeal to Securities Appellate Tribunal, Mumbai. The Tribunal
held that the part of the order of the SEBI directing Rakesh Agarwal to pay Rs. 34, 00,000
couldnt be sustained, on the grounds that Rakesh Agarwal did that in the interests of the
company (ABS), as is mentioned in the facts above.
In the case of Samir.C.Arora vs. SEBI, Mr. Arora was prohibited by the SEBI in its order not
to buy, sell or deal in securities, in any manner, directly or indirectly, for a period of five
years. Also, if Mr. Arora desired to sell the securities held by him, he required a prior
permission of SEBI. Mr. Arora in contested this order of SEBI in the Securities Appellate
Tribunal. SAT set aside the order of SEBI on grounds of insufficient evidence to prove the
charges of insider trading and professional misconduct against Mr. Arora.
These cases testify the fact that the SEBI lacks the thorough investigative mechanism and a
vigilant approach due to which the culprits are able to escape from the clutches of law. In
most of the cases, SEBI failed to adduce evidence and corroborate its stance before the
court. Unlike the balance of probabilities that is required in proving a civil liability, a case
involving criminal liability requires the allegations to be proved beyond reasonable doubts.
Therefore there should be thread bare investigation and all the loopholes if any should be
properly plugged in.

HINDUSTAN LIVER LIMITED Vs SEBI
Hindustan Liver Limited happens to be the subsidiary of the Unilever Limited. The merger of
the HLL with BBILL was on the cards. The controversy involved purchase of 8 lakhs shares of
Brooke Bond Lipton India Limited two weeks prior to the public announcement of the
merger of the two companies. SEBI suspecting foul play conducted investigation. After a
comprehensive investigation spanning 15 months SEBI issued a show cause notice to the
Chairman, all Executive Directors, the Company Secretary and the then Chairman of HLL.
Later in March 1998 SEBI passed an order charging HLL with insider trading.
SEBI felt that there is something wrong in the entire scheme of things. SEBI sensed that HLL
had access to some un published and price sensitive information and therefore issued show
cause notice showing that there was prima facie evidence that the company was indulging
in insider trading through the use of 'Unpublished price sensitive information' prior to its
merger with Brooke Bond India Lipton Limited. It was indeed a danger bell which was rang
by SEBI asking them to desist from indulging in such nefarious activities. It was only after
about 15 months of detailed analysis that SEBI issued a notice to HLL asking why it shouldn't
be slapped with an insider trading charge.
The Hindustan Liver Limited faced the music from all quarters as it was found to divulge
price sensitive information. Hindustan Liver Limited was about entering into a merger
agreement with the Brooke Bond Upton India Limited. Before the merger was actually
effected, Hindustan Liver Limited purchased the shares of the Brooke Bond Upton India
Limited. It goes without saying that HLL had knowledge and information about the impact of
the merger on the value of the shares of the company. In March 1998, SEBI passed an
exhaustive order which sent shockwaves down the spine in the corporate sector. The SEBI
analyzed the facts in the touchstone of the SEBI (Prohibition of Insider Trading) Regulations,
1992. HLL had access to price sensitive and unpublished information as a result of which
found guilty of insider trading. SEBI directed HLL to pay UTI Rs 3.4 crore in compensation,
and also initiated criminal proceedings against the five common directors of HLL and BBLIL:
S.M. Datta, K.V. Dadiseth, R. Gopalakrishnan, A. Lahiri, and M.K. Sharma, who were on the
core team which discussed the merger.
The Securities and Exchange Board of India's (SEBI) decision to prosecute country's second
largest corporate, Hindustan Lever, and its five senior directors has brought into sharp focus
the grey areas of insider trading laws as well as the absence of any corporate transparency
and governance among Indian companies. There is a divergence between the corporate
lawyers and the former justices regarding the definition of the insider. The counsel for SEBI
interpreted the term insider in such a manner so that they would be in a position to prove
the fact there is insider trading in the instant case involving Hindustan Liver Limited.
The term insider is still considered to be a grey area in our country. The brokers had a
different story to tell in the context of the case. According to the brokers, nobody made any
profits through the insider trading. It was a negotiated deal at a price above the market
price. The deal helped the Unilever to retain 51 percent stake in the HLL after the merger
with the Brooke Bond Lipton India. The SEBI is of the firm opinion that HLL acted as an
insider. However, Former Chief Justice of India P.N Bhagwati had a different view point
altogether. He was of the opinion that the SEBI should take some technical assistance from
the Securities Exchange Commission of the United States so as to streamline our insider
trading regulations.
With the SEBI, HLL, former justices (hired by the multinational), and corporate lawyers
interpreting `insider trading' to suit their requirements, it has confused the common
investors and shareholders who have been witnessing insider trading almost on a daily basis
on the Indian bourses. In March 1998, SEBI announced criminal prosecution of five HLL
directors for insider trading and asked it to pay Rs. 3.04 crores to UTI as compensation.
One of the recent cases that can illustrate this trend is allegation against Reliance
Petroleum, that it has indulge in insider trading activity on large scale, which is evident from
the fluctuation in its share price in the past fifty two weeks, the share has fluctuated in a
wide range of between sixty seven rupees and two hundred ninety five rupees, as per
information available with the stock exchange. But according to company sources 'the sale
of Reliance Petroleum shares was conducted by transactions through the Stock Exchanges
and has helped to further broad base the shareholding pattern of Reliance Petroleum'.
It will be interesting to find out whether SEBI, will be able to prosecute the insiders involved
in the case or they would be let off for the want of evidence. The insiders often escape
stating that their action is actuated by a good motive which is often not the case but the law
becomes soft on them which is really the plightful side of the story. It is high time that we
should make an introspection regarding the fact that the regulations should serve the
purpose rather than being paper tigers. Thread bare investigation should be done in a
systematic manner. As a result the Enforcement of restrictions upon insider trading runs the
risk of either being ineffective or being a witch hunt.
CONCLUSION
The Securities Exchange Board of a country has a central objective i.e., protecting the
interests of the investors and regulating the business in stock markets and other securities
markets. The Indian Exchange Commission, i.e., SEBI seeks to look after and secure the
same. The Primary function of SEBI is to ensure that the interest of the innocent investors
are protected since they repose complete faith and trust on SEBI as an able and efficient
regulator. The prevention of an insider trading is a is just an extension of its primary
function of safeguarding the interest of the investors. The principle of business standards
and ethics demands that some discipline and decorum should be followed in the
administration of the company as well as the stock market. From the point of view of the
internal administration of the company, it is really an uphill task to keep an eagle eye on the
use of sensitive information for personal gains since the people at the helm of the affairs
such as directors who owe a fiduciary duty to keep the company in proper shape are the
one who give preference to their vested interest over the interest of the company.
In the modern era of Liberalization, Privatization and Globalization, there is heavy inflow of
Foreign Direct investment where we find that there is participation from foreign companies
and all. The disclosure of price sensitive information before the publication really casts
aspersion on the role of the SEBI as an efficient regulator. India has to strengthen its
enforcement of recently amended insider trading act, so as to prove to both the domestic
and foreign investor that they are investing in fair and transparent securities market, where
strict compliance of the prohibition is ensured by the enforcement agencies.
It is seen that the insider trading is done under disguised names and entities so that they
can maintain a shareholding over and above the trigger limit of SEBI without making it
public. Such kind of ill founded and mischievous design should be dealt with iron hands and
precautionary measures should be undertaken. Prevention is always better than cure.
Enforcement of insider trading can be made more efficient in India, if the time limit for
disclosure of holding to the company by any person having a holding of more than five
percent (four days) and further the disclosure by the company to the stock exchange of
information received about the above transaction (five days), should be reduced to one day
in total. Also like other developed countries the above stated disclosure should be made to
both exchanges and the regulator, instead of exchange alone.
Further, there should be a provision of civil penalties, like in US, where the penalties are
based on the profit made or loss avoided, also SEC lets off the offender, if he pays without
admitting to offence, but merely publishes the settlement, which acts as a deterrent to the
society and prevents cases from being locked up in the court. Additionally, the maximum
penalty limit of five lakh106 rupees should be increased, as the profit reaped by the insider
runs into a huge amount.
Finally, preventing insider trading is not about a set of rules or filling alleged loopholes. It is
about a determination to go after illicit trades and the power to punish offenders. Until SEBI
shows it is serious about checking insider trading, the activity will continue to thrive
unchecked. For that the regulatory authority has to ensure that the SEBI Regulations on
Insider trading is a separate code by itself. Preferably, it must be made into a separate Act
as a part of general law relating to frauds, as is the case in the US. This will ensure that SEBI
does not have to draw concepts and principles from the UK and US laws to strengthen its
case. At the same time it must also avoid the impression that there is ambiguity or weakness
in the Indian Insider Trading Regulations.

DEPOSITORIES ACT
INTRODUCTION

The advent of online automated trading in India brought with it several associated benefits
such as transparency in trading and equal opportunity for market players all over the
country but the problems related to settlement of trades such as high instances of bad
deliveries and long settlement cycles continued. As an answer to these settlement
problems and in order to provide a safe and efficient system of trading and settlement,
Depositories Act, 1996 was enacted. SEBI notified Regulations in order to provide the
regulatory framework for the depositories. Depositories gave a new dimension and a new
scope for conducting transactions in capital market primary as well as secondary, in more
efficient and effective manner, in a paperless form on an electronic book entry basis. It
provided electronic solution to the aforementioned problems of bad deliveries and long
settlement cycles.
DEPOSITORY
A depository is an organisation like a central bank where the securities of a shareholder are
held in the electronic form at the request of the shareholder through the medium of a
Depository Participant. To utilise the services offered by a Depository, the investor has to
open an account with the Depository through a Depository Participant. According to section
2(e) of the Depositories Act, 1996.
Depository means a company formed and registered under the companies act, 1956 and
which has been granted a certificate of registration under section 12(1A) of the Securities
and Exchange Board of India Act, 1992.
As per section 2(10) of the companies act, 1956, a company means a company as defined in
section 3 of the act. According to section 3 company means a company formed and
registered under the companies act, 1956. A depository cannot act as a depository unless it
obtains a certificate of commencement of business from SEBI.

At present there are two depositories in India.

1. National securities depositary Ltd. (NSDL)
2. Central depositary services (India) Ltd. (CDSL)

NSDL was formed and registered under the companies act 1956 during December 1995 and
commenced operations during november1996. NSDL was promoted by Industrial
Development Bank of India (IDBI)-the largest development bank in India, Unit trust of India
(UTI)-the largest mutual fund in India and National stock exchange (NSE)-the largest stock
exchange in India. Some of the prominent banks in the country also have a stake in NSDL .
Central Depository services (India) limited which commenced operations during February
1999.CSDL was promoted by stock exchange, Mumbai in association with Bank of Baroda,
Bank of India, State Bank of India and HDFC Bank.
All the securities held by a depository shall be dematerialized and shall be in a fungible form.
To utilize the services offered by a depository, the investor has to open an account with the
depository through a participant, similar of that bank. Registrations, 1996 and is a
precondition to the functioning of the depository. Depository and depository participant
both are regulated by Securities and Exchange Board of India.

There are essentially four players in the depository system:

1. The Depositary
2. The participant
3. The issuer
4. The Beneficial owner/investor


DEMATERIALISATION: PLAYERS AND PROCESS

Dematerialisation is the process by which physical certificates of an investor are converted
to an equivalent number of securities in electronic form and credited in the investors
account with its depository participant. The securities are not identified by numbers or a
certificate or title. There are mainly four players involved in the dematerialisation process:
Depository
A depository is the chief player in the system and is basically organised as a company. The
depository may not engage itself in the process unless it is registered with SEBI under the
SEBI (Depositories and Participants Regulation), 1996 . It is an organisation where the
securities of an investor are held in electronic form through the medium of Participants. It
enables surrender and withdrawal of securities to and from the depository through the
process of demats and remats. Every depository is obliged to maintain constant continuous
electronic means of communication with all its participants, issuer, clearing houses and
clearing corporations. In India, two depositories have come up so far. They are the National
Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). NSDL is
an organisation promoted by UTI and National Stock Exchange of India Ltd with its
headquarters in Mumbai. The aim is to provide facilities for holding and handling securities
in electronic form . As a depository, NSDL (1) acts as a custodian as well as legally transfer
beneficial ownership, (2) reduces settlement risk by minimising the paper work involved in
trading, and settling and transferring securities. CDSL is the second depository in the
country, after NSDL promoted by the Bombay Stock Exchange (BSE), Bank of India, Bank of
Baroda, HDFC Bank, State bank of India offering services similar to NSDL .
Participant
A participant is assigned the role to act as the agent of the depository under the enactment
and may not act unless registered with the SEBI. In fact, the Depositories Act, 1996 defines a
participant as a person registered as such under SEBI Act, 1992, s. 12, sub-s. 1A . A
participant may belong to one of the following categories:
(1) A public financial institution as defined in the Companies Act, 1956, s. 4A;
(2) A Bank as per the RBI Act, 1934, sch. II;
(3) A foreign bank operating in India;
(4) A state financial corporation;
(5) An institution promoted by any of the institutions in sub-clauses (1) to (4) above;
(6) A custodian of securities recognised by SEBI;
(7) A clearing corporation or clearing house of a stock exchange;
(8) A stock broker registered with SEBI having net worth as prescribed;
(9) A non-banking finance company as specified; and
(10) A registrar or share transfer agent as specified.
A participant is a first point of contact with the investor. The depository participant serves a
link between the investor and the company through the depository in dematerialisation of
shares and other electronic transactions . As the depository is operated electronically, every
participant shall at all times have adequate automatic data processing systems, adequate
and competent staff, risk management systems and procedures .
Issuer
The issuer is the company which issues the security . DIP Guidelines, 2000, cls. 2.1. provides
that if a company makes a right issue of a value exceeding Rs. 50 lakhs or a public issue, it
will enter into an agreement with a depository for dematerialising its shares or other
securities . In case of the listed companies, which have shares already in the physical form,
SEBI is making them enter into agreements with a depository to have their securities
converted into dematerialised form.

Beneficial Owner
In the case of shares, the beneficial owner is the person who is known as the member of a
company holding shares and share certificates in the physical mode. In case of a demat
account, the situation is a bit different. By a legal fiction, the depository is the registered
owner and the person to whom the share is allotted as the beneficial owner . The
Depositories Act, 1996 defines a beneficial owner as a person whose name is recorded as
such with a depository . For facilitation of transfer and avoidance of scrips, the depository
has the power to affect transfers without referring the matter to the issuer. Other than this,
the beneficial owner is entitled to the same rights and obligations due to a member of the
company under the Companies Act, 1956.

LEGAL FRAMEWORK

The legal framework for a depository system has been laid down by the Depositories Act,
1996 and is regulated by SEBI. The depository business in India is regulated by-
The Depositories Act, 1996
The SEBI ( Depositories and Participants) Regulations, 1996
Bye laws of Depository
Business Rules of Depository.
Apart from the above, Depositories are also governed by certain provisions of :
The Companies Act, 1956
The Indian Stamp Act, 1899
Securities and Exchange Board of India Act, 1992
Benami Transaction( Prohibition) Act, 1988
Income Tax Act, 1961
Bankers Books Evidence Act, 1891
The legal framework for depository system as envisaged as envisaged in the Depositories
Act, 1996 provides for the establishment of single or multiple depositories. Anybody to be
eligible for providing depository services must be formed and registered as a company
under the companies Act, 1956 and seek registration with SEBI and obtain a certificate of
commencement of Business from SEBI on fulfilment of the prescribed conditions. The
investors opting to join depository mode are required to enter into an agreement with
depository through a participant who acts as an agent of depository. The agencies such as
custodians, banks, financial companies etc. act as participants of depositories. The
companies issuing securities are also required to enter into an agreement with the
Depository .

THE DEPOSITORIES ACT, 1996

The Depositories Act, 1996 shall be deemed to have come into force on 20
th
Sept., 1995
(becausethe Government of India promulgated the depositorys ordinance in September,
1995). It extends to entire India and contains 31 sections divided into 6 chapters and a
schedule having 6 parts. This Act was amended by the Securities Laws (Amendment) Act,
2004 with effect from 12
th
October, 2004, as a result of which sections 19 A to19J were
added, most of which deal with theimposition of penalties/punishments.

CHAPTERS AND SCHEDULES OF THE ACT

Chapter I contains some definitions.
Chapter II lays down the requirements to be received by adepository from SEBI.
Chapter III deals with the rights and obligations of depositories,participants, issuers and
beneficial owners.
Chapter IV deals with the power of SEBI to call for informationand enquiry.
Chapter V contains penalties for various offences, and
Chapter VI contains miscellaneous provisions.
Part I of the schedule contains amendments to the Indian Stamp Act, 1899.
Part II contains amendments to the Companies Act, 1956.
Part III contains amendments to the Securities Contracts (Regulation) Act, 1956.
Part IV contains amendment to the Income Tax Act, 1961.
Part V contains amendment to the BenamiTransactions (Prohibition) to the Income Tax Act,
1961.

Part V contains amendments to Securities and Exchange Board of India, Act, 1992.

Objectives

The depositories legislation as per the statement of objects and reasons appended to the
depositories act, 1996 aims at providing for :

A legal basis for establishment of depositories to conduct the task of maintenance of
ownership records of securities and effect changes in ownership records through
book entry;

Dematerialisation of securities in the depositories mode as well as giving option to
an investor to choose between holding securities in physical mode and holding
securities in a dematerialised form in a depository;
Making the securities fungible;

Making the shares, debentures and any interest thereon of a public limited company
freely transferable; and


Exempting all shares within a depository from stamp duty.


Eligibility Condition for Depository Services


Any company or other institution to be eligible to provide depository services must :

Be formed and registered as a company under the Companies Act, 1956.


Be registered with SEBI as a depository under SEBI Act, 1992.

Has framed bye-laws with the previous approval of SEBI.

Has one or more participants to render depository services on its behalf.


Has adequate systems and safeguards to prevent manipulation of records and
transactions to the satisfaction of SEBI.

Complies with Depositories Act, 1996 and SEBI( Depositories and Participants)
Regulations, 1996.


Meets eligibility criteria in terms of constitution, network, etc.


IMPORTANT PROVISIONS OF THE ACT

Section 4: DP is an agent of the Depository: A DP is an agent of the depository, who provides
various services of the depository to investors. The DP has to enter into an agreement with
the depository to this effect. Any investor who would like to avail the services of a
depository has to enter into an agreement with any DP of his choice. The DP will then make
the depository services available to the investor.

Section 7: Free Transferability: The securities held by an investor in the depository are freely
transferable from one beneficial owner to another.

Section 8: Option to hold securities in demat form: In the depository system, every investor
subscribing to securities offered by an issuer has an option to receive the same in physical
form or dematerialised form. If an investor opts for receiving the securities in
dematerialised form, the issuer intimates the depository the details of allotment of security.
On receipt of this information, the depository enters the name of the allottee as the
beneficial owner of that security in its record.

Section 9: Securities held in a depository are fungible: All securities held by the depository
are in dematerialised and fungible form.

Section 10: Registered Owner and Beneficial Owner: The depository is deemed to be the
registered owner for the purpose of effecting transfer of ownership of security on behalf of
a beneficial owner. But as a registered owner, it does not have any voting rights or any other
rights in respect of those securities. The beneficial owner is entitled to all rights and benefits
as well as subject to all liabilities in respect of his securities held in the depository.
Section 14: Option to opt out of depository: A beneficial owner may opt out of a depository
in respect of any security by requisite intimation to the depository.
Section 16: Depositories to indemnify loss in certain cases
Any loss caused to the beneficial owner due to thenegligence of the depository or the
participant, wouldbe indemnified by the depository to such beneficialowner. Where the loss
due to the negligence of theparticipant is indemnified by the depository, thedepository has
the right to recover the same from suchparticipant.

Penalty
With a view to ensuring better compliance of various provisions of the Depositories Act and
the Rules and Regulations framed thereunder by SEBI, Sections 19 A to 19J have been
inserted in the Depositories Act by the Securities Laws(Amendment) Act, 2004 with effect
from 12-10-2004.
Penalty for failure to furnish information/return, etc.-Section 19 A .
Penalty for failure to enter into agreement-Section19B.
Penalty for failure to redress investors grievances-Section19C.
Penalty for delay in dematerialisation or issue of certificate of securities-
Section19D.
Penalty for failure to reconcile records-Section 19E.
Penalty for failure to comply with directions issued by Board under section
19 of the Act-Section 19F.
Sections 19A to 19 F provide that the guilty party shall be liable to a penalty of Rs.1 lakh for
each day during which the failure continues or Rs.1crore,whichever is less, for every failure.
Penalty for contravention where no separate penalty has been provided. Section19G
provides that whoever fails to comply with any provision of this Act, the rules or the
Regulation or by-laws made or directions issued by SEBI thereunder, for which no separate
penalty has been provided, shall beliable to a penalty which may extend to Rs.1crore.

SECTION 19(H)-POWER TO ADJUDICATE

For the purpose of adjudging under Section 19A to 19G, SEBI will appoint an officer not
below the rank ofa Division Chief of SEBI to be an Adjudicating Officerfor holding an enquiry
for the purpose of imposing any penalty under the said Sections. While holding an enquiry,
the Adjudicating Officer shall have power tosummon any person acquainted with facts
andcircumstances of the case, to give evidence or toproduce any document which may be
useful to thesubject matter of enquiry. If, on such enquiry, the Adjudicating Officer is
satisfied that the person whofailed to comply with the provisions of any of the Sections
specified earlier, he may impose such penaltyas he thinks fit in accordance with the
provisions ofany of those sections.

PUNISHMENT FOR OFFENCES
Section 20(1) provides that irrespective of any penalty imposed by the Adjudicating Officer
under this Act, ifany person contravenes or abets the contravention of the provisions of this
Act or rules or regulations or by-laws made thereunder, he shall be punishable
withimprisonment for a term which may extend to10 years,or with fine, which may extend
to Rs. 25 crores, or with both. Section 20(2) further provides that if any person fails topay
the penalty imposed by the adjudicating officer orfails to comply with any of his directions
or orders, heshall be punishable with imprisonment for a termwhich shall be not less than
one month but which may extend to 10 years, or with fine, which may extend to Rs.25
Crores, or with both.

SECTION 21-OFFENCES BY COMPANIES
Where an offence under this Act has been committed by acompany, the company itself as
well as every other personwho at the time when offence was committed was in chargeof,
and was responsible to, the company for the conduct ofits business like the Managing
Director or ExecutiveDirector, shall deemed to be guilty of offence and shall beliable to be
proceeded against and punished accordingly. Again, if it is proved that the offence was
committed withthe consent or connivance of, or is attributable to any neglecton the part of,
any director, manger, secretary, or otherofficer of the company, such person would also be
deemedto be guilty of that offence and shall be liable to beproceeded against and punished
accordingly. But a personwill not be liable in a case where he proves that the offencewas
committed without his knowledge, or that he hadexercised all due diligence to prevent the
commission ofsuch offence.

SECTION 22 -COGNIZANCE OF OFFENCES BY COURT
Section 22 provided that no court shall takecognizance of any offence punishable under this
Act or any rules or regulations or bye-lawsmade there under except on a complaint made by
the Central Government or State Government or the Securities and Exchange Board of India
or by any person. No court inferior to that of a Court of Session shall tryany offence
punishable under this Act.

POWER OF SECURITIES EXCHANGE OF INDIA TO MAKE REGULATIONS
Section 25 of the Depositories Act empowers SEBI to makeregulations consistent with the
provisions of this Act andthe rules made thereunder, in order to carry out the purposes of
this Act. Thus, in exercise of the powers conferred by Section 30 of the Securities and
Exchange Board of India Act, 1992 along with Section 25 of the Depositories Act, 1996, the
securities and Exchange Board of India has made the SEBI(Depositories& participants)
Regulations, 1996, which deal with the registration of adepository and participant, the form
and criteria uponwhich the certificate of commencement of business shall beissued to the
depository, the manner in which the certificateof security shall be surrendered, the manner
of creating apledge or hypothecation in respect of security owned by abeneficial owner,
rights and obligations of depositories,participants and issuers, and the eligibility criteria
foradmission of securities in the depository etc.

Any of the following may promote a depositor

1. A public financial Institution as defined in section 4A of the Companies Act, 1956;
2. A bank included in the Second Schedule to the Reserve Bank of India Act, 1934;
3. A foreign bank operating in India with the approval of the Reserve Bank of India;
4. A recognised stock exchange;
5. An institution engaged in providing financial services where not less than 75% of the
equity is held jointly or severally by these institutions;
6. A custodian of securities approved by Government of India, and
7. A foreign financial services institution approved by Government of India
The promoters of a depository are also known as its sponsors. A depository company must
have a minimum net worth of Rs. 100 crore. The sponsor(s) of the depository have to hold
at least 51% of the equity capital of the depository company. Participants of that depository,
if any can hold the balance of the equity capital. However, no single participant can hold, at
any point of time more than 5% of the equity capital. No foreign entity, individually or
collectively either as a sponsor and DP together, can hold more than 20% of the equity
capital of the depository.

FACILITIES OFFERED BY DEPOSITORY SYSTEM
Dematerialisation
Rematerialisation
Electronic settlement of trades in stock exchanges connected to depositories.
Pledging/ hypothecation of dematerialized securities.
Electronic credit of securities allotted in public, rights, bonus issue.
Nomination facility
Freezing of demat account, so that the debit from the dematerialisation are
not permitted.
Service related to change of address, nomination, mandate, transmission etc.
Other services viz. holding debt instrument in the same deamt account.
Availing stock lending/ borrowing facility, etc.



Benefits of Depository System

In the depository system, the ownership and transfer of securities takes place by means of
electronic book entries. At the outset, this system rids the capital market of the dangers
related to handling of paper. NSDL provides numerous direct and indirect benefits .

Elimination of Bad Deliveries
In the depository environment, once holdings of an investor are dematerialized, the
question of bad delivery does not arise i.e. they cannot be held "under objection". In the
physical environment, buyer was required to take the risk of transfer and face uncertainty of
the quality of assets purchased. In a depository environment good money certainly begets
good quality of assets.

Elimination of all risks associated with physical certificates
Dealing in physical securities have associated security risks of theft of stocks, mutilation of
certificates, loss of certificates during movements through and from the registrars, thus
exposing the investor to the cost of obtaining duplicate certificates and advertisements, etc.
This problem does not arise in the depository environment.

No Stamp Duty
There is no stamp duty for transfer of any kind of securities in the depository. This waiver
extends to equity shares, debt instruments and units of mutual funds.
Immediate Transfer and Registration of Securities
In the depository environment, once the securities are credited to the investors account on
pay out, he becomes the legal owner of the securities. There is no further need to send it to
the company's registrar for registration. Having purchased securities in the physical
environment, the investor has to send it to the company's registrar so that the change of
ownership can be registered. This process usually takes around three to four months and is
rarely completed within the statutory framework of two months thus exposing the investor
to opportunity cost of delay in transfer and to risk of loss in transit. To overcome this, the
normally accepted practice is to hold the securities in street names i.e. not to register the
change of ownership. However, if the investors miss a book closure the securities are not
good for delivery and the investor would also stand to loose his corporate entitlements.

Faster Settlement Cycle
The exclusive demat segments follow rolling settlement cycle of T+2 i.e. the settlement of
trades will be on the 2nd working day from the trade day. This will enable faster turnover of
stock and more liquidity with the investor.
Reduction in handling of huge volumes of paper
In the physical environment every entity involved in purchase or sell of securities was made
to handle the papers and pass on papers to the next entity. However, in depository
environment, except the delivery instruction to be given by the client/ broker, there is no
other paper movement.

Elimination of problems related to change of address of investor, transmission, etc.
In case of change of address or transmission of demat shares, investors are saved from
undergoing the entire change procedure with each company or registrar. Investors have to
only inform their DP with all relevant documents and the required changes are effected in
the database of all the companies, where the investor is a registered holder of securities.

Elimination of problems related to selling securities on behalf of a minor
A natural guardian is not required to take court approval for selling Demat securities on
behalf of a minor.


Conversion of a Private Company into a Public Company

The Companies Act (Sections 43, 43A,44), contains two procedures for such a conversion.

Conversion by default
The Companies (Amendment) Act,2000, stipulates that the Articles of a private company
shall provide for four restrictions:-
Restrictions on transfer of shares;
Restrictions on invitation to public to subscribe to the shares or debentures of the
company;
Restrictions on the maximum number of members which should not exceed 50
excluding members who are employees or ex-employees of the company; and
Prohibition on any invitation or acceptance of deposits from persons other than its
members, directors or their relatives.
If default is made by any private company in complying with any of the above restrictions,
such a private company shall cease to be entitled to the privileges and exemptions
conferred on a private company by the Act and all the provisions which are applicable to a
public company shall apply to such a private company.However, it is provided that the
company or any person interested may file a petition before the Central Government along
with the requisite fee, to grant relief in committing the default. The petition shall be
accompanied by the following documents:-

Copy of the Memorandum and Articles of Association;
Copy of the documents showing that the default has been committed in complying
with the conditions laid down under the Act;
Affidavit verifying the petition;
Bank draft evidencing the payment of requisite application fee;

Memorandum of appearance with copy of the Board Resolution or the executed
Vakalatnama, as the case may be.
The Central Government on being satisfied that the failure to comply with the conditions
envisaged under the Act was accidental or due to inadvertence or due to some other
sufficient cause, or that on other grounds it is just and equitable to grant relief, may
order that the company or any other person interested be relieved from the
consequences of default, on such terms and conditions as seem to the court just and
expedient.
From the date of the order, the company will again be entitled to all the privileges and
exemptions available to a private company. But during the intervening period, the
provisions of the Act as are applicable to a public company shall apply.

Conversion by an act of Volition

A private company may get itself converted into a public company voluntarily by following
the procedure for conversion:-

Convene a Board meeting and decide the time, place an agenda for convening a
general meeting to alter the Articles of Association and consequently, the name, by
Special Resolutions. It is, however, advisable to adopt a new set of Articles applicable
to a public company. This is necessary as there are other Articles like quorum for
general meetings; number of directors and the period of service of notice of a
general meeting, etc. which are also to be changed.

Send notice for the general meeting proposing the Special Resolutions along with
suitable Explanatory Statements.


If the quorum of two members personally present exists, then convene the general
meeting and pass the Special Resolution to the following effect:-

To delete those articles which are required to be included in the articles of a private
company only. Such other articles which do not apply to a public company, should be
deleted and those which apply should be inserted.
Consequent to the above changes, delete the word "private" from its name.

To raise the paid-up capital to minimum Rs. 5 lakhs. In case the authorised capital is
less than Rs. 5 lakhs than it shall also require to be increased.


To raise the capital from public.

File either the prospectus in the Form as prescribed under Schedule II or the
Statement in lieu of prospectus in the Form as prescribed under Schedule IV within
thirty days of passing of the above special resolutions.


Director's consent to act as such in e-Form 32 is not required to be filed by a private
company converted into a public company.


File the Special Resolutions passed and the Explanatory Statements with the
concerned Registrar of Companies(ROC) in e-Form 23 within thirty days of their
passing, along with the requisite fee.


Apply to the concerned ROC for the issue of a fresh certificate of incorporation in the
changed name i.e. the existing name with the word "private" deleted. On issue of
such a certificate, the change of name of the converted company shall be final and
complete.


If the company has less than three directors, then increase the number of directors
to atleast three. If the company has less then seven members, then increase them to
atleast seven.


Although the company becomes a public company as soon as the Special Resolution
to change the Articles to make it a public company is passed, the change in its name
becomes effective only on the issue of the fresh Certificate of Incorporation by the
concerned Registrar of Companies(ROC) in the changed name.


When a private company is converted into a public company, it is not required to
obtain a certificate of commencement of business.


A statutory meeting must be held if such a conversion is before six months of the
incorporation of the company.




Conversion of a Public Company into a Private Company

Under the Companies Act (Section31), all public companies, whether originally incorporated
as a public limited company or at any time converted into a public limited company (under
section 44 of the Act), may be converted into a private limited company, if the members so
desire. The essential conditions for such a conversion are:-
The company must not be listed on any recognised stock exchange. In case of a listed
company,it will have to wait for atleast one year after its delisting.


Shareholders' approval by special resolution for alteration of Articles of Association
for incorporation of the definition of a private company. The Articles shall be suitably
amended to include the basic restrictions applicable on a private company and other
provisions necessary thereto.


No resolution amending the Articles, which has the effect of converting a public
company into a private company, shall be effective unless it has been approved by
the Central Government.


After the alteration has been approved, a printed copy of the Article shall be filed
with the Registrar of Companies within one month of the date of receipt of the order
of approval.


The name of the company shall be amended to include the word 'private' on all its
documents.
The Companies Act contains the following procedure for the conversion:-
Convene a Board meeting for consideration of the proposal of conversion of the
company into a private company.


Prepare the proposal for alteration of Articles of Association or prepare a new set of
Articles of Association meeting the requirements of a private limited company.


Hold the Board meeting and get approval of the Board for the proposal, fix up the
day, date and time of holding the general meeting of the company, approve notice
and explanatory statement and authority to sign notice.


Hold the general meeting on the fixed day and pass the special resolution.


Fill e-Form 23 with the copy of special resolution, explanatory statement and
Memorandum and Articles (before and after alteration).


Pay the requisite application fee.


Publish a newspaper notice in two widely circulated dailies of the State where the
Regd. Office of the company is situated.


Get a no objection letter from major unsecured creditors and all secured creditors.


Apply to the Central Government in e-Form 1B.
Documents to be attached with the application are:-
Notice of extra-ordinary general meeting.

Minutes of extra-ordinary general meeting.

Copy of special resolution.

Copy of newspaper advertisement.

Affidavit that the company is not listed on any stock exchange.

Reference number, date of passing and date of filing the e-Form 23.

Payment of requisite application fee.


One copy each of the annual reports for the last three financial years.

Copy of the last annual return.

Altered Memorandum and Articles of Association.

No objection letters from major unsecured and all secured creditors supported by an
Affidavit.
Reasons for conversion.
Terms of appointment of all managerial personnel.

Power of attorney in favour of the authorised representative.
On receipt of application, the Registrar of Companies(ROC) shall examine:-
Whether the interest of the public and particularly that of the creditors will be adversely
affected.
Whether the company is listed.

Capital contribution by members.

Whether e-Form 23 has been passed and taken on record.

Whether the reasons for conversion are just and sufficient.

How many members voted for the resolution.

Whether any complaint against the company is pending.


Whether any show cause letter has been issued to the company or its Directors.

If there is any objection from members and creditors.
If the ROC approves the application, he refers it to Technical Section and Prosecution
Section for their report. The Technical Section reports on whether the relevant e-Form23
and the last years annual report and annual return has been filed and passed/taken on
record. The Prosecution Section reports on whether any complaint is pending from anybody
against the company. If during the scrutiny any adverse point arises, that has to be looked
into and the authorised representative should take the initiative to make good the default
or defect. If the reports are satisfactory, the ROC will issue a letter granting its approval for
conversion of a public company into a private company. The concerned ROC then issues
fresh certificates of incorporation consequent upon change of name after conversion of the
company from 'Public Company' to 'Private Company'.


FOREIGN EXCHANGE MANAGEMENT ACT (FEMA),1999
INTRODUCTION
The Foreign Exchange Management Act is an Indian law drafted in 1999 that replaces the
Foreign Exchange Regulation Act of 1973. The law regulates foreign exchange and enacts
civil penalties rather than criminal ones for offenders. It is seen as a more reasonable and
moderate replacement to the previous foreign exchange law, which was found to be
incompatible with liberalization policies in India that encourage foreign investment.
1. Geography
o The Foreign Exchange Management Act applies to all residents of the country
of India and is regulated by the Reserve Bank of India. It also applies to residents of India
who live outside of the country conducting relevant transactions under the law's purview.
History
o The Foreign Exchange Management Act was passed in 1999 by the
parliament of India. It replaced a previous and controversial bill called the Foreign Exchange
Regulation Act of 1973. The original Foreign Exchange Regulation Act was drafted to
regulate foreign exchange and external trade issues pertaining to the foreign exchange
market in India. The Foreign Exchange Regulation Act was problematic for a number of
reasons, the foremost being that any practice not specifically sanctioned by the legislation
was prohibited. Typically with laws, it is the opposite, whereby actions not addressed by the
law are considered legal as long as they do not contravene other sections of the law.
Coupled with criminal penalties if the law was broken, the previous exchange law saw many
Indian businessmen serve jail time.
Significance
o The Foreign Exchange Management Act substantially revises and changes the
character of the Foreign Exchange Regulation Act of 1973. Most importantly, the draconian
criminal penalties for violation of the original Foreign Exchange Regulation Act of 1973 have
been revised to civil offenses under the Foreign Exchange Management Act. The current law
still places strictures on the conduct of foreign exchange across all of India, both within the
country and by the country's nationals abroad.
Function
o The Foreign Exchange Management Act regulates (through the Reserve Bank
of India) actions ranging from the transfer of foreign securities by residents of India to
borrowing or lending done on a foreign exchange to deposits between citizens of India and
outside residents. Penalties for misconduct under the Foreign Exchange Management Act
can be up to three times the monetary value of the offending transaction.

After the upheavals of early 1990s the process of economic stabilization and structural
reforms gathered momentum. The agenda for changes in foreign exchange regulations were
initiated by the report of High Level Committee on Balance of Payments (Chairman Dr. C.
Rangarajan) 1993. The main recommendations of the Committee were as follows:
1) Introduction of market determined exchange rate regime.
2) Liberalisation of current account transactions leading to current account convertibility.
3) Compositional shift in capital flows away from debt creating to non debt creating flows.
4) Strict regulation of external commercial borrowings especially short term debts.
5) Discouraging volatile elements of flows.
6) Full freedom for outflows associated with inflows (i.e., principal, interest, dividends profit and
sales proceeds).
In 1993 the exchange rate of rupee was made market determined and in August 1994, India
accepted Article VIII of the Articles of Agreement of the International Monetary Fund and
adopted the cur
r
ent account convertibility.
The Foreign Exchange Management Act, 1999 (FEMA) has been enacted to consolidate and
amend the law relating to foreign exchange with the objective of facilitating external trade
and payments and for promoting the orderly development and maintenance of the foreign
exchange market in India. It replaces the Foreign Exchange Regulation Act, 1973 except as
provided in 9 hereunder. FEMA has come into effect from June 1, 2000.
With the coming into effect of FEMA India will have moved from a regulatory mechanism to
a management mechanism with respect to foreign exchange. It is a great change not only
structurally but also psychologically.
Broad Scheme of the FEMA
Section 3 - Prohibits dealings in foreign exchange except through an authorised person. This
Section says that no person can, without general or special permission of the RBI

a. Deal in or transfer any foreign exchange or foreign securities to any person not being an
authorised person (corresponding to sections 8 and 19 of FERA).
b. Make any payment to or for the credit of any person resident outside India in any manner
(corresponding to section 9(1)(a) of FERA).
c. Receive otherwise through an authorised person, any payment by order or on behalf of any
person resident outside India in any manner (corresponding to section 9(I ) (b) of FERA) and
d. Enter into any financial transaction in India as consideration for or in association with
acquisition or creation or transfer of a right to acquire, any asset outside India by any person
(corresponding to sections9(1)(f) & (g) of FERA).

Section 4 - restrains any person resident in India from acquiring, holding, owning, possessing
or transferring any foreign exchange, foreign security or any immovable property situated
outside India except as specifically provided in the Act.
Section 6 -deals with capital account transactions. This section allows a person to draw or
sell foreign exchange from or to an authorised person for a capital account transaction.
Section 7 - deals with export of goods and services. Every exporter is required to furnish to
the RBI or any other authority, a declaration etc. regarding full export value.
Section 8 - casts the responsibility on the persons resident in India who have any amount of
foreign exchange due or accrued in their favour to get same realised and repatriated to
India within the specific period and the manner specified by RBI.
Section 10 and 12 - deals with duties and liabilities of the Authorized persons. Authorised
person has been defined in Sec.2(c) of the Act which means an authorised dealer, money
changer, off shore banking unit or any other person for the time being authorized to deal in
foreign exchange or foreign securities.
Section 13 anti 15 - of the Act with penalties and enforcement of the orders of Adjudicating
Authority as well power to compound contraventions under the Act.
Section 36 to 37 - pertains to the establishment of Directorate of Enforcement and the
powers to investigate the violation of any provisions of Act, rule, regulation, notifications,
directions or order issued in exercise of the powers under this Act. The Director of
Enforcement and other officer of Enforcement not below the rank of Asstt. Director have
been empowered to take up investigations.
Primarily there are no restrictions on current account transactions related to foreign
exchange and a person may sell or draw foreign exchange freely for his current account
transactions, except in a few cases where caps have been prescribed (Section 5).
Capital account transactions, though freed to a great extent, continue to be regulated by
RBI, who will lay down the provisions as regards the extent of prohibition, restriction, and
regulation (Section 6). But there are two very important areas on which RBI cannot Impose
any restrictions viz. drawing of foreign exchange for the repayment of any loans and for
depreciation of direct investments in the ordinary course of business.
IMPORTANT TERMS UNDER FEMA
Capital Account Transaction means a transaction which:
Alters foreign assets and foreign liabilities (including contingent liabilities) of Indian residents.
Alters Indian assets and Indian liabilities of Non-residents. Specified transactions listed in section
6(3).
Investments, cross border loans and transfer of wealth across borders. RBI has been
empowered to regulate the capital account transactions. Unless the transaction is permitted
as per the regulations, foreign exchange cannot be drawn for the same.
Current Account Transaction means all transactions, which are not capital account
transactions, Specifically it includes: Business transactions between residents and non-
residents. Short-term banking and credit facilities in the ordinary
,
course of business.
Payments towards interest on loans and by way of income from investments.
Payment of expenses of parents, spouse or children living abroad or expenses on their foreign
travel, medical and education.
Gifts.
Some principles which can be considered to distinguish between capital and current account
transactions are:
If a transaction gives rise to any claim or obligation between a resident and a non-resident it
is a capital account transaction, e.g. if machinery is purchased on hire by a resident from a
non-resident he is obligated to the non resident. If on execution of a transaction there are
no outstanding financial obligations, then it is a current account transaction, e.g. if a non-
resident purchases machinery and pays for the same in cash, there is no further financial
obligation between the resident and non-resident. This is current account transaction.
The Central Government has the power to regulate the current account transactions. Unless
the transaction is restricted, foreign exchange.
Objectives
Broadly,the objectives of FEMA are: (i) To facilitate external trade and payments; and (ii) To
promote the orderly development and maintenance of foreign exchange market. The Act
has assigned an important role to the Reserve Bank of India (RBI) in the administration of
FEMA. The rules,regulations and norms pertaining to several sections of the Act are laid
down by the Reserve Bank of India, in consultation with the Central Government. The Act
requires the Central Government to appoint as many officers of the Central Government as
Adjudicating Authorities for holding inquiries pertaining to contravention of the Act. There is
also a provision for appointing one or more Special Directors (Appeals) to hear appeals
against the order of the Adjudicating authorities. The Central Government also establish an
Appellate Tribunal for Foreign Exchange to hear appeals against the orders of the
Adjudicating Authorities and the Special Director (Appeals). The FEMA provides for the
establishment, by the Central Government, of a Director of Enforcement with a Director and
such other officers or class of officers as it thinks fit for taking up for investigation of the
contraventions under this Act.
FEMA permits only authorised person to deal in foreign exchange or foreign security. Such
an authorised person, under the Act, means authorised dealer,money changer, off-shore
banking unit or any other person for the time being authorised by Reserve Bank. The Act
thus prohibits any person who:-
Deal in or transfer any foreign exchange or foreign security to any person not being
an authorized person;
Make any payment to or for the credit of any person resident outside India in any
manner;
Receive otherwise through an authorized person, any payment by order or on behalf
of any person resident outside India in any manner;
Enter into any financial transaction in India as consideration for or in association with
acquisition or creation or transfer of a right to acquire, any asset outside India by any person
is resident in India which acquire, hold, own, possess or transfer any foreign exchange,
foreign security or any immovable property situated outside India.
The Act deals with two types of foreign exchange transactions.
Important Features of FEMA
INVESTMENTS ABROAD BY INDIAN RESIDENTS
Joint Ventures Abroad
RBI has been granted powers to permit Indian investments abroad in Joint Ventures (JV) and
Wholly Owned Subsidiaries (WOS). Investments can be made under the automatic route, in
which case prior permission is not required, or the non-automatic route, in which case prior
permission is required. There are various options available for investment under both the
routes. General Guidelines:
1. Indian companies and partnership firms registered under the Indian Partnership Act, 1932 are
allowed to invest abroad. Individuals (except under ESOP schemes or by way of qualification
shares to act as Directors), HUFs, AOPs, etc. are not allowed to invest abroad.
2. Investments can be made in existing companies or new companies or for acquiring overseas
business.
3. The foreign entity can be engaged in any industrial, commercial, trading, service industry,
financial services such as insurance, mutual funds, etc.
4. Following activities are not permitted:
Portfolio Investment by Indian parties.
Investment in banking and real estate sectors.

5. Investment can be in equity, debentures, loans, or by way of guarantees. Guarantees are
considered @ 50% of the value to consider investment limits.
6. Remittance can be by way of cash, or export of goods and services. For contribution by way of
exports, no agency commission will be payable to the wholly owned subsidiary/Joint
Venture company.
7. Investment under automatic route will not be permitted to parties on RBI Caution List, or who
have defaulted to the banking system in India and whose names appear on the Defaulter's
list.

8. Investment under automatic route is not available where it is proposed to set up a holding
company or a special purpose vehicle which in turn will set up one or more step down
subsidiaries as operating units.

9. Dividends, royalties, etc. due to Indian investor should be repatriated to India in accordance
with the prevailing time limits.
10. Authorised dealers have been permitted to release offering exchange for feasibility studies
prior to actual investment.

Enforcement
o The Foreign Exchange Management Act, like its predecessor, is enforced by a
body called the Enforcement Directorate. Though the current law is considered a good deal
more lenient than its predecessor, the Enforcement Directorate still has considerable
powers under a variety of other laws and can go to great lengths to enforce the Foreign
Exchange Management Act. Some of these powers include gathering intelligence on
suspects, maintaining surveillance on suspects, searching people and premises, the power
to seize relevant documents in the course of investigation and to enact penalties once
suspects are convicted. The Enforcement Directorate has offices across the country.

CONCLUSION
Thus I would like to conclude by explaining in a gist that , when a business enterprise
imports goods from other countries, exports its products to them or makes investments
abroad, it deals in foreign exchange. Foreign exchange means 'foreign currency' and
includes:- (i) deposits, credits and balances payable in any foreign currency; (ii) drafts,
travellers' cheques, letters of credit or bills of exchange, expressed or drawn in Indian
currency but payable in any foreign currency; and (iii) drafts, travellers' cheques, letters of
credit or bills of exchange drawn by banks, institutions or persons outside India, but payable
in Indian currency.
FEMA emerged as an investor friendly legislation which is purely a civil legislation in the
sense that its violation implies only payment of monetary penalties and fines.

Foreign Direct Investment
Introduction
Investment is usually understood as financial contribution to the capital of an enterprise or
purchase of shares in the enterprise.
49
Foreign investment is investment in an enterprise by
a Non-Resident irrespective of whether this involves new capital or reinvestment of
earnings. Foreign investment is of two kinds (i) Foreign Direct Investment (FDI) and (ii)
Foreign Portfolio Investment. Foreign investment refers to the investments made by a
foreign investor into Indian capital market. The investment may be made directly, or
through portfolio investments, or though collective investment schemes like venture
capital.
50
A direct investment takes the form of a foreign firm or company starting a
subsidiary or taking control of an existing firm of the recipient country, thus retaining
control over the investment.
51
Foreign direct investment has been defined in the
Consolidated FDI Policy of India as
52
:

49
http://www.dipp.nic.in/ FDI_Circular/FDI_Circular_02of20 10.pdf

50
See RBI Master Circular on Foreign Investment in India, RBI/2010-11/13 Master Circular No. 13/2010-11
dated 1 July, 2010. See also K Sekhar, Guide to SEBI, Capital Issues, Debentures and Listing, Wadhwa & Co.,
Nagpur, (3rd Ed.) 2003 and R.R. Beedu, Foreign Direct Investment Policy and Procedures, Snow White
Publications Pvt. Ltd., Mumbai, 20

51
N. Gopalaswamy, Inside Capital Market, Deccan Publications Ltd., Madras, 1996
investment by non-resident entity/person resident outside India in the capital of the Indian
company under Schedule 1 of FEM(Transfer or Issue of Security by a Person Resident
outside India) Regulations 2000.
This, however, is a technical definition based on the regulatory regime in India. In order to
develop a conceptual understanding of foreign direct investment one has to turn to
juristic writings and reports of financial institutions and financial policy making/ review
committees, and conduct an analysis of the forms of FDI and its regulations. A brief
explanation of the conceptual underpinnings of the concept is attempted here with the help
of few scholarly works.


The Palgrave Dictionary of Economics defines foreign direct investment as follows:
53

Foreign direct investment (FDI) occurs when an individual or firm acquires a controlling
interest (typically defined as at least ten per cent ownership) in productive assets in another
country. This contrasts with portfolio investment, which includes purchases of foreign
bonds, currencies, and stock in amounts that do not provide control. The most common
method of FDI is through the acquisition of a firm. Construction of a new plant is also
common and typically referred to as greenfield FDI. Other forms of FDI include
partnerships in a foreign joint venture and earnings reinvested in an existing foreign
affiliate. Firms with affiliates in more than one country are termed multinational enterprises
(MNEs).
Most definitions, including the one quoted above take the help of the forms an investment
can take to explain the concept. For a clear conceptual understanding of investments which
are sought to be classified and regulated under the FDI law and policy throughout the world
can be found in the Balance of Payments Manual (hereinafter referred to as the BOP
Manual) of the IMF.
54
The focus is on what the primary distinguishing feature of an
investment that may be called direct as against indirect:
The primary distinguishing feature of direct investment is the significant influence that
gives the investor an effective voice in management. For the foreign-controlled sector, the
primary distinguishing feature is control.


52
http://www.dipp.nic.in/FDI_Circular/ FDI_Circular_02of2010.pdf
53
Bruce A Blonigen, foreign direct investment, in Steven N Durlauf and Lawrence E Blume (eds.) The
Palgrave Dictionary of Economics, Palgrave Macmillan New York, (2nd Ed.) 2008

54
http://www.imf.org/external/ np/sta/bop/bop man.pdf

The BOP Manual defines direct investment as: the category of international investment
that reflects the objective of a resident entity in one economy obtaining a lasting interest in
an enterprise resident in another economy. (The resident entity is the direct investor and
the enterprise is the direct investment enterprise.) The lasting interest implies the existence
of a long-term relationship between the direct investor and the enterprise and a significant
degree of influence by the investor on the management of the enterprise. Direct investment
comprises not only the initial transaction establishing the relationship between the investor
and the enterprise but also all subsequent transactions between them and among affiliated
enterprises, both incorporated and unincorporated.
The BOP Manual defines direct investment on the basis of the underlying conception of
what foreign direct investment is by laying emphasis on the structural/ administrative
outcome.
Types of Investment
A company which owns a firm-specific asset
55
might not want to reveal the asset fully before
finalising the contract with the prospective licensee and the licensee, in turn, would not be
willing to offer full value in negotiations due to the partial information available on the
asset. The company would then prefer to enter the foreign market directly by setting up its
own affiliate, either newly or by substantial acquisition of an existing establishment in the
foreign country. Internalisation is the term used to denote the process by which a company
avoids the inherent hold-up problem and enters the foreign market directly instead of
adopting franchisee presence.
(1) Vertical and Horizontal Investment
Where the production activity of a company can be divided on two level one requiring
high-skill innovation and the other requiring low-skill implementation and production, then
the company can separate its operation vertically by retaining the activity involving skill-
intensive innovation with the parent country headquarters and undertake production
requiring low-skill in the host country. Such an investment is commonly termed as vertical
FDI.

55
Firm-specific assets in this context refer to intangible strategic assets, like a process of production which is a
unique innovation of a company, or a secret formula. The concept of firm-specific assets may overlap with the
concept of trade secrets, the former relates to property and the latter includes even policies of the enterprise.
Firm-specific assets are a variety of assets including invisible assets like human resources knowledge base. For a
discussion on firm-specific assets and their role in the economy and success of companies, see Ahmet Kirca, et
al., Firm-Specific Assets, Multi-nationality and Financial Performance A Meta-Analysis Review and
Theoretical Integration, forthcoming in Academy of Management Journal, available at SSRN:
http://ssrn.com/abstract=1672973; Horstmann and Markusen, Firm-specific Assets and the Gains from Direct
Foreign Investment, 56 Economica 41 (1989); Rahul Kochhar, Strategic Assets, Capital Structure and Firm
Performance, 10 Journal of Financial and Strategic Decision 23 (1997) and Bruce Bolnigen, Firm-specific
Assets and the Link between Exchange Rates and Foreign Direct Investment, 87 The American Economic
Review 447 (1997).
In contrast to this, where such a separation in operation is not possible, or where the trade
costs (like transportation cost and trade barriers) are high, a company would choose to
replicate itself in the host country, leading into a horizontal FDI. These models, which are
the dominant forms of FDI, however, are true only in the case of MNCs.
(2) Inward and Outward Investment
This classification is made on the basis of direction or flow of investment. Investments
received from foreign investors are called inward investments, while investments made in
foreign capital market are known as outward investments.
Kinds of Investors
The predominant kinds of investors are individuals, incorporated or unincorporated private
or public enterprises, associated groups of individuals or enterprises, governments or
government agencies, estates and trusts.
56
However, the types of investors in each country
should be determined by the eligibility criteria of that country.
57

Methods of Inward Investment
The prominent methods of direct investment are starting a new enterprise in the host
country (which is known as greenfield investment), or incorporating a wholly owned
subsidiary, or by acquiring substantial voting rights in an established enterprise, or through
mergers, or through a joint venture. Technical collaboration and trademark agreements are
also mode through with direct investment can be made.
58

Governing Laws of FDI in India
India does not have one primary law governing FDI. This is, indeed, due to the complexity of
issues relating to the capital market. The primary laws covering this area can be found in the
following legislations and bye-laws:
The Companies Act, 1956 (especially relating to mergers )
The Foreign Exchange Management Act, 1999
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997 (as
amended up to 13 April, 2010) commonly known as the Takeover Code
FDI Policy of the Government
RBI Circulars and Notifications
In order to rationalise the law and policy relating to foreign direct investment and to make
the access to the regulations easier, the Government of India issued the Consolidated Policy

56
IMF, Balance of Payments Manual, 5th Ed. 1993 available at http://www.imf.org/external/np/sta/
bop/bopman.pdf at 87

57
The FDI eligibility policy in India is discussed below under Law, Policy and Procedure of FDI in India

58
http://www.dipp.nic.in/FDI_Circular/FDI_Circular_02of2010.pdf
on FDI in October, 2010. This, coupled with the Master Circular on Foreign Investment in
India, RBI/2010-11/13 Master Circular No. 13/2010-11 dated 1 July, 2010, serve as a
compendium of law and policy governing FDI in India.
Sector Specific Policy of FDI
India, the regulation of FDI is essentially sector or activity centric. FDI is permitted subject to
the law/ policy/ rules/ regulations/ security conditions applicable to that sector. Chapter 5
of the Consolidated FDI Policy provides for limits on FDI in relation to the sector/ activity.
The sectoral FDI cap, entry route and other conditions relating to the sector are given in a
tabulated format. FDI is prohibited completely in certain sectors/ activities, whereas in
certain sectors, equity participation of the foreign investor is capped at a certain
percentage. 100% FDI is permitted in sectors that do not fall under these two categories.
Some of the key sectors are discussed below:
(a) Retail: FDI is prohibited in multi-brand retailing; FDI upto 51% with prior approval of the
Foreign Investment Promotion Board (FIPB) is permitted in single-brand retailing 100%
FDI under the automatic route (i.e. no approval route) is permitted in case of wholesale cash
and carry.
(b) Telecom: 74% investment is permitted (all forms incl. FDI, FII) Automatic route upto
49%, FIPB approval required beyond 49%; Management control to be Indian.
(c) Print Media: 26% with approval of FIPB and Ministry of Information and Broadcasting;
100% in case of publication of scientific magazines/ specialty journals/ periodicals;
Management control to be Indian .
(d) Information Technology Enabled Services ( including BPO, LPO): 100% under automatic
route.
(e) Broadcasting: No automatic route available; permission of FIPB and Ministry of
Information and Broadcasting 20% for FM Radio (FDI+FII), 49% for Cable Network (FDI +
FII); 26% for Up-linking News and Current Affairs TV channel (FDI+FII); 100% for Up-linking
Non-News and Current Affairs TV channel .
(f) Manufacturing Items Reserved for Small Scale Sector: 24% foreign equity.
(g) Construction Development Projects: 100% FDI in construction development projects
under automatic route, subject to minimum capitalization and developed area restrictions
FDI permitted only in greenfield projects; lock-in of original investment for 3 years;
minimum capitalisation of US$ 10 million for wholly-owned subsidiaries and US$ 5 million
for JV; minimum developed area (10 hectares for housing plots, 50,000 sq. metres for
construction development projects)
(h) Special Economic zones: 100% FDI under automatic route regulated under the Special
Economic Zones Act 2005.


Foreign trade (development and regulation act) 1992
Introduction
Under British regime the import of goods from Great Britain was encouraged and the export
of goods from India and the import of goods from other developed countries was
discouraged by imposition of higher customs duties. The statutory mechanism for
controlling foreign trade was the Sea Customs Act, 1878. Regarding imports and exports the
Government of India Act, 1935 granted an exclusive power to the Centre to legislate on the
subject. But no specific enactment was passed by the Central Legislature. During the Second
World War, under the compulsive necessity created by the scarce foreign exchange
resources and the acute shortage of shipping space in the Indian ports, a notification under
the Defence of India Rules was issued in 1939, bringing under control the import of 68
commodities. Steadly other notifications were issued bringing more items under control. In
July, 1943 a consolidated notification was issued covering a wide range of controlled items.
With the end of the Second World War, the Defence of India Rules lapsed but the provisions
regarding import control instructions were continued by virtue of the Emergency Provisions
(Continuance) Ordinance, 1946 which was replaced, in so far as the imports and exports
control is concerned, by the Imports and Exports (Control) Act, 1947. It came into force for a
period of three years but was extended from time to time. In 1971 it became a permanent
statute. By the Imports and Exports (Control)(Amendment) Ordinance, 1975, changes of far-
reaching character were made in the Imports and Exports (Control) Act, 1947. The
Ordinance was replaced by the Imports and Exports (Control) (Amendment) Act, 1976.
Inspite of changes made by the Act of 1976 the Imports and Exports (Control) Act, 1947
continued to suffer from deficiencies. The legal regime set up under the Act, 1947 became
outdated and hindered the growth and development of Indias foreign trade. Consequently
on 19th June, 1992, the President of India promulgated the Foreign Trade (Development
and Regulation) Ordinance repealing the Imports and Exports (Control) Act, 1947. To replace
the Foreign Trade (Development and Regulation) Ordinance, 1992 the Foreign Trade
(Development and Regulation) Bill, 1992 was introduced in the Lok Sabha.
Statement of Objects and Reasons

It is now generally acknowledged that foreign trade is the driving force of economic activity.
Technology, investment and production are becoming increasingly interdependent upon
each other and foreign trade brings these elements together and spurs economic growth.
The Imports and Exports (Control) Act, 1947 was made in different circumstances. Although
it has been amended from time to time, the Act does not provide an adequate legal frame
work for the development and promotion of Indias foreign trade. Besides, in July, 1991 and
August, 1991, major changes in trade policy were made by the Government of India. The
goals of the new trade policy are to increase productivity and competitiveness and to
achieve a strong export performance. The Exports and Import Policy is a vital part of trade
policy. The basic law governing foreign trade must serve as an instrument to create an
environment that will provide a strong impetus to exports, facilitate imports and render
export activity more profitable.
It has, therefore, been considered necessary to enact a new law repealing the existing law.
The Act intends to achieve these objectives.
Chapter I: Preliminary

as per section 1 (1) this act is known as The Foreign Trade (Development and Regulation)
Act, 1992.
Section 2 of the act defines many terms used into the act such as
(a) "Adjudicating Authority" means the authority specified in, or under, section 13;
i.e. as per section 13

Director General or other officer as the Central Government may, by notification in the
Official Gazette, authorise in this behalf.

(b) "Appellate Authority" means the authority specified in, or under, sub-section (1) of
section 15.
I.e. as per section 15(1)
if decision is made by director general the appellate authority is central government
where the decision or order has been made by an officer subordinate to the Director
General, or the Director General or to any officer superior to the Adjudicating Authority
authorised by the Director General to hear the appeal,

within a period of forty-five days from the date on which the decision or order is served
on such person:

Provided that the Appellate Authority may, if it is satisfied that the appellant was
prevented by sufficient cause from preferring the appeal within the aforesaid period,
allow such appeal to be preferred within a further period of thirty days;

Provided further that in the case of an appeal against a decision or order imposing a
penalty or redemption charges, no such appeal shall be entertained unless the amount
of the penalty or redemption charges has been deposited by the appellant;

Provided also that, where the Appellate Authority is of opinion that the deposit to be
made will cause undue hardship to the appellant, it may, at its discretion, dispense with
such deposit either unconditionally or subject to such conditions as it may impose.

(c) "Conveyance" means any vehicle, vessel, aircraft or any other means of transport
including any animal;

(d) "Director General" means the Director General of Foreign Trade appointed under
section 6;

(e) "import" and "export" means respectively bringing into, or taking out of, India any
goods by land, sea or air;

(f) "Importer-Exporter Code Number" means the Code Number granted under section 7

(g) "Licence" means a licence to import or export and includes a customs clearance
permit and any other permission issued or granted under this Act;

(h) "Order" means any order made by the Central Government under section 3; and
I.e. the provisions made by the central government in regard to the import and export in
the country
(i) "Prescribed" means prescribed by rules made under this Act.

Power Of Central Government To Make Orders And Announce Export And Import Policy
And Import And Export Code Number And Licensing

As per section 3 under chapter 2 The central government is empowered to make rules
regarding the foreign trade enabling as well as cancellation and restrictions to the trade
under section 3 of the act.
But one thing important to note is that all the rules made under Imports and Exports
(Control) Act, 1947 ( 18 of 1947 ), and in force immediately before the commencement
of this Act shall, so far as they are not inconsistent with the provisions of this Act,
continue to be in force and shall be deemed to have been made under this Act. As per
section 4 of the act.
Section 3 and 5 of the act enable center government to make such rules and policies.
These sections read as follow
Section 3 Powers to make provisions relating to imports and exports:

(1) The Central Government may by Order published in the Official Gazette, make
provision for the development and regulation of foreign trade by facilitating imports and
increasing exports.

(2) The Central Government may also, by Order published in the Official Gazette, make
provision for prohibiting, restricting or otherwise regulating, in all cases or in specified
classes of cases and subject to such exceptions, if any, as may be made by or under the
Order the import or export of goods.

(3) All goods to which any Order under sub-section (2) applies shall be deemed to be
goods the import or export of which has been prohibited under section 11 of the
Customs Act, 1962 (52 of 1962) and all the provisions of that Act shall have effect
accordingly.

5. Export and Import Policy:

The Central Government may, from time to time, formulate and announce by
notification in the Official Gazette, the Export and Import Policy and may also, in like
manner, amend that policy.
Importer-Exporter Code Number and Licence

One importer and exporter number is being given to each person who wants to do trade in
import and exports in the country. This code is given by the director general or any other
person authorised by the director general for this. The section 7 under chapter 3 clearly
restricts the import or export without the import or export code.
Section 8 of the act provides law relating to suspension of the import and export code.
The law says the any person wherein he/she has contraviened any law relating to
Central Excise or
Customs or
Foreign Exchange or
or has committed any other economic offence under any other law for the time
being in force as may be specified by the Central Government by notification in the
Official Gazette or
the Director General has reason to believe that any person has made an export or
import in a manner gravely prejudicial to the trade relations of India with any foreign
country or to the interests of other persons engaged in imports or exports or has
brought disrepute to the credit or the goods of the country.
After giving a notice in writing and giving him/her opportunity of being heard the
director general ca suspend or cancel the import export code as per section 8 (1).
Where any Importer-Exporter Code Number granted to a person has been suspended or
cancelled under sub-section (1), that person shall not be entitled to import or export any
goods except under a special licence granted, in such manner and subject to such
conditions as may be prescribed, by the Director General to that person.
Apply for code number:
Director general of foreign trade through its Policy Circular No.15 (RE-2006)/2004-
2009 Date: 27
th
July, 2006 announce a new system of New System for issuance of
Importer-Exporter Code Number.
As per this circular
An applicant may now choose one of the two options for application submission:

File an online application and submit a physical copy of the application by
taking a printout of the online application.

Submit a physical copy of the application directly at the regional DGFT office.

Process of online application

i) Applicants can file an on-line application at the DGFT web-
site http://dgft.gov.in. On-line form has been designed to ensure
feeding of all the required information by prompting user wherever a
field is left blank. Applicant has to submit scanned copies of PAN and
bank certificate along with their application.

ii) There are 2 options for payment of fee. (A)If fee is paid by
Demand Draft, IEC will be generated only after receipt of the physical
copy of the application. (B) If IEC application fee is paid through
Electronic Fund Transfer facility, IEC number will be generated by the
licensing office automatically and the number can be viewed online by
the applicant.

iii) On the receipt of physical copy of the application, the same IEC
will be printed in 24 hours time and dispatched to the firm.

Issue, suspension and cancellation of Licence:

The director general or any other officer authorised under this act is empowered to suspend
or cancel a licence issued for export or import of good in accordance with this act for good
and sufficient reasons after giving the license holder reasonale opputunity of being heard.
Section 9 of the act deals with issue, suspension and cancellation of the licence. Section 9
read as follow
Issue ,suspension and cancellation of Licence :

(1) The Central Government may levy fees, subject to such exceptions, in respect of such
person or class of persons making an application for a licence or in respect of any licence
granted or renewed in such manner as may be prescribed.

(2) The Director General or an officer authorised by him may, on an application and after
making such inquiry as he may think fit, grant or renew or refuse to grant or renew a licence
to import or export such class or classes of goods as may be prescribed, after recording in
writing his reasons for such refusal.

(3) A licence granted or renewed under this section shall-

(a) be in such form as may be prescribed ;

(b) be valid for such period as may be specified therein; and

(c) be subject to such terms, conditions and restrictions as may be prescribed or as specified
in the licence with reference to the terms, conditions and restrictions so prescribed.

(4) The Director General or the officer authorised under sub-section (2) may, subject to such
conditions as may be prescribed, for good and sufficient reasons, to be recorded in writing
suspend or cancel any licence granted under this Act:

Provided that no such suspension or cancellation shall be made except after giving the
holder of the licence a reasonable opportunity of being heard.

(5) An appeal against an order refusing to grant, or renew or suspending or cancelling, a
licence shall lie in like manner as an appeal against an order would lie under section 15.
Search, inspection and seizure
Where any contravention of any condition of the license of authority under which any good
are imported is suspected or made any person authorised by the central government may
search, inspect and seize goods, documents, things and conveyances subject to such
requirements and conditions as may be prescribed. The relevant provisions regarding this
are given under section 10 and 11 of the act
Section 10 read as follows:
10. Power relating to search and seizure.(1) The Central Government may, by notification
in the Official Gazette, authorise any person for the purposes of exercising such powers with
respect to entering such premises and searching, inspecting and seizing of such goods,
documents, things and conveyances, subject to such requirements and conditions, as may
be prescribed.
(2) The provisions of the Code of Criminal Procedure, 1973 (2 of 1974) relating to searches
and seizures shall, so far as may be, apply to every search and seizure made under this
section.
The Government by notification can authorise any person to search, seize and inspect goods
and materials which might be suspected to be contraband.
Penalty of contravention

Where any person makes or abets or attempts to make any export or import in
contravention of any provision of this act or any rules or orders made under this act or the
exim policy, he shall be liable to a penalty not exceeding one thousand rupees or five times
the value of the goods involved, whichever is more. The relevant provisions are given under
section 11,12,13,14 of the act
Section 11 reads as follow
11. Contravention of provisions of this Act, rules, orders and export and import policy.
(1) No export or import shall be made by any person except in accordance with the
provisions of this Act, the rules and orders made thereunder and the export and import
policy for the time being in force.
(2) Where any person makes or abets or attempts to make any export or import in
contravention of any provision of this Act or any rules or orders made thereunder or the
export and import policy, he shall be liable to a penalty not exceeding one thousand rupees
or five times the value of the goods in respect of which any contravention is made or
attempted to be made, whichever is more.
(3) Where any person, on a notice to him by the Adjudicating Authority, admits any
contravention, the Adjudicating Authority may, in such class or classes of cases and in such
manner as may be prescribed, determine, by way of settlement, an amount to be paid by
that person.
(4) A penalty imposed under this Act may, if it is not paid, be recovered as an arrear of land
revenue and the Importer-exporter Code Number of the person concerned, may, on failure
to pay the penalty by him, be suspended by the Adjudicating Authority till the penalty is
paid.
(5) Where any contravention of any provision of this Act or any rules or orders made
thereunder or the export and import policy has been, is being, or is attempted to be, made,
the goods together with any package, covering or receptacle and any conveyances shall,
subject to such requirements and conditions as may be prescribed, be liable to confiscation
by the Adjudicating Authority.
(6) The goods or the conveyance confiscated under sub-section (5) may be released by the
Adjudicating Authority, in such manner and subject to such conditions as may be prescribed,
on payment by the person concerned of the redemption charges equivalent to the market
value of the goods or conveyance, as the case may be.
Sub-section (2) makes abetment at par with the main Act on omission. General Clauses Act,
1897, section 3(1) defines abetment; Ram Manorath v. State, 1971 Cr. LJ 1584.
Section 12 reads as follow:
12. Penalty or confiscation not to interfere with other punishment.No penalty imposed
or confiscation made under this Act shall prevent the imposition of any other punishment to
which the person affected thereby is liable under any other law for the time being in force.
13. Adjudicating Authority.Any penalty may be imposed or any confiscation may be
adjudged under this Act by the Director General or, subject to such limits as may be
specified, by such other officer as the Central Government may, by notification in the
Official Gazette, authorise in this behalf.
14. Giving of opportunity to the owner of the goods etc.No order imposing a penalty or
of adjudication of confiscation shall be made unless the owner of the goods or conveyance,
or other person concerned, has been given a notice in writing
(a) informing him of the grounds on which it is proposed to impose a penalty or to
confiscate such goods or conveyance; and
(b) to make a representation in writing within such reasonable time as may be specified in
the notice against the imposition of penalty or confiscation mentioned therein, and, if he so
desires, of being heard in the matter.
Section 13 and section 14 must be read together so that the procedure laid down in section
14 is attracted in all cases in which proceedings are intended to be taken under section
13;Rayala Corporation Private Ltd. v. Director of Enforcement, (1970) I SCR 639 : AIR 1970 SC
494 (498).

Appeal and revision

Section 15 of the act makes the provisions regarding appeal against any decision made by
adjudicating authority.
Section 15 read as following
15. Appeal.(1) Any person aggrieved by any decision or order made by the Adjudicating
Authority under this Act may prefer an appeal,
(a) where the decision or order has been made by the Director General, to the Central
Government;
(b) where the decision or order has been made by an officer subordinate to the Director
General, to the Director General or to any officer superior to the Adjudicating Authority
authorised by the Director General to hear the appeal,
within a period of forty-five days from the date on which the decision or order is served on
such person:
Provided that the Appellate Authority may, if it is satisfied that the appellant was prevented
by sufficient cause from preferring the appeal within the aforesaid period, allow such appeal
to be preferred within a further period of thirty days:
Provided further that in the case of an appeal against a decision or order imposing a penalty
or redemption charges, no such appeal shall be entertained unless the amount of the
penalty or redemption charges has been deposited by the appellant:
Provided also that, where the Appellate Authority is of opinion that the deposit to be made
will cause undue hardship to the appellant, it may, at its discretion, dispense with such
deposit either unconditionally or subject to such conditions as it may impose.
(2) The Appellate Authority may, after giving to the appellant a reasonable opportunity of
being heard, if he so desires, and after making such further inquiries, if any, as it may
consider necessary, make such orders as it thinks fit, confirming, modifying or reversing the
decision or order appealed against, or may send back the case with such directions, as it
may think fit, for a fresh adjudication or decision, as the case may be, after taking additional
evidence, if necessary:
Provided that an order enhancing or imposing a penalty or redemption charges or
confiscating goods of a greater value shall not be made under this section unless the
appellant has been given an opportunity of making a representation, and, if he so desires, of
being heard in his defence.
(3) The order made in appeal by the Appellate Authority shall be final.

Section 16 of the act gives the provision regarding revision, section 16 says that
In case of decisions any decisions except the decisions made in appeal
The central government in case decision is given by director general
Or director general in case decision is given by any officer subordinate to him
On his own or otherwise can call for and examine the records of any proceeding in which a
decision or an order imposing a
penalty or
redemption charges or
adjudicating confiscation
has been made and against which no appeal has been preferred, for the purpose of
satisfying itself or himself, as the case may be, as to the correctness, legality or propriety of
such decision or order and make such orders thereon as may be deemed fit
Provided that no decision or order shall be varied under this section so as to prejudicially
affect any person unless such person-

(a) has, within a period of two years from the date of such decision or order, received a
notice to show cause why such decision or order shall not be varied, and

(b) has been given a reasonable opportunity of making representation and, if he so desires,
of being heard in his defence.

Power of adjudicating authority and other authorities

Section 17 of the act give the scope of powers of adjudicating authority trying any suit under
the act.
Section 17 says that any adjudicating authority trying any suit under this act shall have
powers of a civil court given by code of civil procedure in respect of following matters
summoning and enforcing the attendance of witnesses;
requiring the discovery and production of any document;
requisitioning any public record or copy thereof from any court or office.
receiving evidence on affidavits; and
issuing commissions for the examination of witnesses or documents.
The adjudicating authority trying any suit or appeal or revision under this act is considered
as civil court under section 346 and 347 of the code of criminal procedure. Section 346
empowers the court to exercise its powers against contempt. The adjudicating authority
can take the person in custody in case of such cause.
Along with this the adjudicating authority can pass interim orders as it required by the court
and order the stay of the cause.
The authority has power to correct any kind of clerical mistake provided that where any
correction proposed to be made under this sub-section will have the effect of prejudicially
affecting any person, no such correction shall be made except after giving to that person a
reasonable opportunity of making a representation in the matter and no such correction
shall be made after the expiry of two years from the date on which such decision or order
was made.


Foreign Contribution (Regulation) Act, 2010
The Foreign Contribution (Regulation) Act, 2010 [FCRA] has been passed by both the houses
of Parliament to replace Foreign Contribution (Regulation) Act, 1976 [FCRA 1976] to
regulate the acceptance and utilization of foreign contribution [FC] or foreign
hospitality by specified persons and
prohibit acceptance and utilization of FC or foreign hospitality for any activities
detrimental to national interest.
FCRA 2010 would be brought into force from such date as the Central Government (CG) may
by notification in the Official Gazette appoint. Different dates may be appointed for bringing
into force different provisions of FCRA 2010.
Considering the flow of funds into the country for purposes other than business, the
Government has specified that acceptance of FC against national interest would not be
permissible, requiring persons accepting FC to be subject to enhanced scrutiny. The
measures include prior CG approval for accepting FC, registration and renewal, conditions
for end use of FC and for transfer of FC to other persons etc.
Salient changes between provisions of FCRA 2010 and FCRA 1976 are as under:
Modification of definition
FC would also inter alia include donation, delivery or transfer made by any foreign source of
any security as defined in section 2(h) of the Securities Contracts (Regulation) Act,
1956
interest accrued on FC deposited in bank, any other income derived from FC or
interest thereon.
Prohibition to accept FC:
Following persons have been prohibited from accepting FC:
(i) Association or company engaged in the production or broadcast of audio news or
audio visual news or current affairs programmes through any electronic mode or form or
any other mode of mass communication
(ii) Correspondent or columnist, cartoonist, editor, owner of the association or company
referred in (i) above.
(iii) Organization of political nature not being a political party, which may be specified by the
CG, would be banned from accepting FC as against earlier provision of obtaining prior
approval of CG for accepting FC.
Non applicability of FCRA 2010 to certain FC
FCRA 2010 will not apply to FC accepted
from a relative (under FCRA 1976 prior approval of CG is required for receipt of FC in
excess of ` 8000 p.a.)
by way of any scholarship, stipend or any payment of like nature
Prohibition to transfer FC to other Person
Person who is granted certificate of registration or has obtained prior permission
under FCRA 2010 and receives any FC is prohibited from transferring such FC to any other
person unless that other person is also granted certificate of registration or obtained prior
permission under FCRA 2010.
A part of FC can be transferred to any other person with prior approval of CG.
Restriction on utilization of FC
FCRA 2010 restricts utilization of
FC and any income arising from FC for speculative businesses
FC for payment in excess of 50% of FC towards administrative purpose in one
financial year
Registration with CG
Any person having definite cultural, economic, educational, religious or social programme
can accept FC only after obtaining
certificate of registration from CG; or
prior permission from CG
Certificate of registration would be valid for 5 years (under FCRA 1976 no end date of
validity of registration is specified) and prior permission would be valid for the specific
purpose or specific amount of FC proposed to be received. Any registration / permission
granted under FCRA 1976 would be valid for 5 years from the effective date.
CG shall within 90 days of receiving application grant the certificate of registration /
permission or communicate reasons for not granting such registration / permission (under
FCRA 1976 no timeframe is mentioned for disposal of application).
While granting registration / permission, CG would inter alia consider various factors
including
whether applicant is fictitious or benami,
whether applicant has been prosecuted / convicted for creating communal tension
or disharmony has been found guilty of diversion / mis-utilization of its funds etc.
acceptance of FC is not likely to affect prejudicially sovereignty and integrity of India,
public interest, freedom or fairness of election to any Legislature, friendly relation with any
foreign State, harmony between religious, racial, social, linguistic, regional groups, castes or
communities etc.
acceptance of FC shall not lead to incitement of an offence or endanger the life or
physical safety of any person etc.
in case the person being an individual, such individual has been convicted under any
law or prosecution for any offence is pending against him
in case the person other than an individual, any of its directors or office bearers has
been convicted under any law or prosecution for any offence is pending against him
Registration certificate can be suspended for a period upto 180 days or cancelled by CG on
various grounds like:
information in the application / renewal thereof is incorrect or false
holder of certificate has violated terms of the certificate
public interest
holder of certificate has violated any provisions of FCRA 2010
holder of certificate has not been engaged in any reasonable activity in its chosen
field for the benefit of the society for 2 consecutive years or has become defunct
Bank Account
FC shall be received only in a single bank account. However, multiple bank accounts can be
opened for utilization of FC.
Others
CG empowered to issue notification with regard to:
person or class of persons who shall obtain prior permission of CG before accepting
FC;
area in which FC shall be accepted and utilized with prior permission of CG
purpose for which FC shall be utilized with prior permission of CG
source from which FC shall be accepted with prior permission of CG


WHAT ARE DIP GUIDELINES?
The primary issuances are governed by SEBI in terms of SEBI (Disclosures and Investor
protection) guidelines. SEBI framed its DIP guidelines in 1992. Many amendments have been
carried out in the same in line with the market dynamics and requirements. In 2000, SEBI
issued Securities and Exchange Board of India (Disclosure and Investor Protection)
Guidelines, 2000 which is compilation of all circulars organized in chapter forms. These
guidelines and amendments thereon re issued by SEBI India under section 11 of the
Securities and Exchange Board of India Act, 1992. SEBI (Disclosure and investor protection)
guidelines 2000 are in short called DIP guidelines. It provides a comprehensive framework
for issuances buy the companies.
. How does SEBI ensure compliance with DIP?
The Merchant Banker are the specialized intermediaries who are required to do due
diligence and ensure that all the requirements of DIP are complied with while submitting
the draft offer document to SEBI. Any non-compliance on their part, attract penal action
from SEBI, in terms of SEBI (Merchant Bankers) Regulations. The draft offer document filed
by Merchant Banker is also placed on the website for public comments. Officials of SEBI at
various levels examine the compliance with DIP guidelines and ensure that all necessary
material information is disclosed in the draft offer documents.


A recent important development reinforces the resolution of the Securities and Exchange
Board of India (SEBI) to bring clarity and resolve identified lacunae in the securities and
investor protection laws.
SEBI (Disclosure and Investor Protection or DIP Guidelines, 2000) were to regulate the issue
of securities of a company to public, shareholders and institutional investors through the
primary market. Over the years, subsequent amendments to DIP Guidelines coupled with
several SEBI notifications and issue-specific SEBI observations made it a confusing and
disorganised piece of legislation.
The reliability of the guidelines was compromised by their dependence on SEBIs informal
guidance, which constituted an indicative viewpoint and not a binding interpretation.
To provide these guidelines a statutory backing, SEBI recently notified the SEBI (Issue of
Capital and Disclosure Requirements or ICDR Regulations, 2009) repealing the erstwhile DIP
Guidelines. The ICDR Regulations attempts to streamline the framework for public issues by
removing unnecessary stipulations, introducing market-driven procedures and simplifying
the clutter of legality.
Deliberating Key Changes A Comparative Analysis
The ICDR Regulations is not a fresh law regulating the public issue of securities. However,
certain changes in the regulations are worthy to be discussed owing to their practical
repercussions.
Eligibility to Access Public Money- Uniform Applicability
The exemptions available under the DIP Guidelines to certain banking and infrastructure
companies from eligibility norms for making initial public offers (IPOs) have been done away
with under ICDR Regulations, and thus eligibility norms have now been made applicable
uniformly to all types of issuers. This is a logical move since these companies are now
competitive and do not need such a privilege. Further, it now appears that, debarment from
accessing capital markets pursuant to any order or direction of SEBI only applies to public or
rights issue of specified securities i.e. equity shares/ convertible securities, unlike under the
DIP Guidelines where it applied to issue of all securities for all types of issues. This
qualification was needed as ICDR no longer governs the issue of debt securities.
Offer for Sale by Listed Companies Allowed
Under the DIP Guidelines, an offer for sale was permitted only for unlisted companies
proposing IPOs. The ICDR Regulations now permits an offer for sale even by listed
companies (subject to certain eligibility criteria) through a new definition of follow on
offer. ICDR Regulations provides that such offer for sale can be made if the shares are held
by the seller for a period of at least one year prior to the filing of draft offer document with
the SEBI. The holding period now includes the period when a convertible instrument was
held, which has subsequently been converted to an equity share. These changes are
desirable since there appeared no rationale for barring shareholders of listed companies
from accessing the market through an offer for sale and convertible instruments are
essentially equity and should be treated as such from the date the convertible instrument is
issued.
No More Firm Allotments
The DIP Guidelines provided for pre-IPO placements on firm basis to the maximum
percentage of 10% shares, a maximum of 10% of the issue amount for employees and a
maximum of 10% of the issue amount to the shareholders. The eligible subscribers for
allotment on firm basis under the DIP Guidelines included Indian Mutual Funds, Foreign
Institutional Investors (including non resident Indians and overseas corporate bodies),
Indian and Multilateral Development Institutions and Scheduled Banks. Firm allotment,
which was not frequently used by companies, has been removed in the ICDR Regulations
providing a level-playing field to subscribers of a public issue. Often such firm allotments are
bundled with several financial rights and privileges in favour of a single investor, which may
hamper management decisions of a company having public money, post IPO. Further,
introduction of alternatives like anchor investors portion, wherein, a company making a
public issue is permitted to allocate upto 30% of the issue reserved for Qualified
Institutional Buyers (QIBs) to anchor investors may serve the same purpose as firm
allotment, without hacking the issue size available to general public. An anchor investor is a
QIB, who is required to apply for a minimum issue of Rs. 10 crores and hold the securities
for a minimum period of 30 days after allotment. The concept of anchor investors seems to
have the same objective as of the firm allotment, i.e. to give initial stability to the issue.
Minimum Promoters Contribution
Under the erstwhile DIP Guidelines, minimum promoters contribution in a public issue
could be brought in by promoters/ persons belonging to promoter group/ friend/ friends,
relatives and the associates of the promoters. Under the ICDR Regulations, only promoters
are permitted to contribute the minimum promoters contribution. While this may
compromise the ability of promoters to make this contribution, this provision is more
meaningful since it recognises the importance of a promoter in a company by increasing the
onus on such person to show his commitment to the company, which is raising funds from
the public.
Underwriting
The ICDR Regulations explicitly provide that the underwriting obligations would not be
restricted to the minimum subscriptttion level but to the whole issue, where applicable. The
rationale to such change appears to be that while minimum subscriptttion clause is valid for
determining the success of any issue from legal point of view, an issuer may agree to have
the issue underwritten with an understanding to get the full amount of funds. Thus, where
100% of the offer through offer document is underwritten, the underwriting obligations
shall be for the entire amount underwritten, except cases where compulsory allotment to
QIBs is prescribed. This provision gives a public issue greater reliability.
Preferential Allotment
Though the ICDR Regulations have introduced a new exception for preferential issue of
equity shares pursuant to convertible debt instruments under sub sections (3) and (4) of
section 81 of the Companies Act, 1956. This exemption recognises the need to do away with
dual regulation since such conversion is subject to Central Government approval and
specific rules. The Stock Exchange is now empowered to order revaluation of non-cash
consideration for preferential allotment to promoters, their relatives, associates and related
entities for consideration other than cash, if the Stock Exchange is not satisfied by the
valuation submitted to it by the issuer This ensures genuine valuations and guards against
artificiality.
Efficient Procedure and Adequate Disclosures
Book Building Process: Under the DIP Guidelines, two type of book building was allowed,
being 100% book building and 75% book building. The ICDR Regulations does away with the
75% book built route which was hardly used.
Issue, allotment and Refund Period: Under the DIP Guidelines, in case there is a revision in
the price band in a book building issue, issue period was not clear but the ICDR Regulations
clarifying this lacuna has specifically provided the total issue period not to exceed 10 days,
including any revision in the price band. Further, 30 days period for allotment/ refund in
case of fixed price issue as provided under DIP Guidelines have been replaced with 15 days,
as there was no valid reason to give an extra 15 days to complete the process in case of a
fixed price issue, making the public issue process speedier and accountable to investors
interest.
Other Disclosures and Definitions: Unlike the DIP Guidelines, where in case of a fix price
public issue, the issuer was required to disclose price or price band for the shares, under the
ICDR Regulations there is no requirement to disclose the price or price band in the draft red
herring prospectus (DRHP). This is an important change from the issuers perspective as in a
fixed price issue it will allow the issuer to take into account market dynamics in determining
the price closer to the issue date.
Now the ICDR Regulations require that any pledge of shares by promoters should be
disclosed in the prospectus for the public issue. This change is in line with the recent
changes in the Equity Listing Agreement and in SEBI (Substantial Acquisitions of Shares and
Takeovers) Regulations, 1997 and is an important indicator of the level of control exercised
by the promoters in a company. This information coupled with the financial data would give
a reasonable indicator of the likelihood of the promoters losing control of the company to
the lenders/lender nominees.
The definition of employee under the ICDR Regulations excludes permanent employee
director of the subsidiary or holding company of the issuer and promoters and immediate
relatives of the promoters. So in an IPO, the employees reservation portion will only be
available to employee/ director of the issuer company and benefit of no-lock-in on
options allotted to employees shall extend only to employee/ director of the issuer
company and the group companies.
A controversial change in the ICDR Regulations is to prevent forecasts/projections to select
investors outside the offer document. This change is in line with US practice. This move is
being resisted by institutional investors who argue that in developing markets many
companies approaching the market lack a proven track record necessitating financial
projections to gauge company potential. The counter view is that a level-playing field is
necessary so that the same information is available to all prospective investors. SEBI is yet to
decide on the suitability of this change. A good via media may be to publish such projections
in the public domain rather than restrict such disclosures to certain investors.
With the notification of the ICDR Regulations, the dilemma which unnerved the market
players was on the status of the pending offer documents with the SEBI for proposed issue
of securities. However, maintaining the scale up on practicality, which seems to be the
highlight of the ICDR Regulations, no re-filing of draft offer documents is required by the
SEBI. A checklist of compliances for the already filed DRHPs can be submitted under the
ICDR Regulations, compliance of which is to be ensured at the stage of filing the red herring
prospectus by the issuer.
Though in the first reading, the ICDR Regulations may appear to be a mere reshuffle of the
old provisions, these Regulations appear to remove the fissures in the erstwhile DIP
Guidelines to protect investors. The ICDR Regulations represent a leaner and more
contemporary set of rules, which should stand the test of time in the vibrant world of capital
markets. Now only time will tell whether ICDR Regulations plug the loopholes on a stand
alone basis or whether frequent SEBI intervention would be required to address the
evolving issues.

The SEBI (Disclosure & Investor Protection) Guidelines amended on 24th February 2010
1. Time limit for bonus issue reduced to 15/60 days from the date of Board meeting
[erstwhile 6 months]
2. Enhanced the period of validity of observation letter issued by SEBI to 12 months
[erstwhile 3 months]
3. Floor price or price band can be announced after registration of RHP with RoC but 2
working days before issue opens
4. Enhanced the upfront amount payable on Preferential allotment from 10 to 25%
The brief of the amendments are as under:

Opening of Public Issue
An issue shall open within 12 months from the date of issuance of the observation letter by
SEBI, if any or within 3 months from the 31st day from the date of filing of the draft offer
document with SEBI, if no observation letter is issued.

Requirement of filing updated offer document
File an updated offer document with SEBI, highlighting all changes made in the document
and in case of 'significant changes' in the offer document, it shall be filed with SEBI atleast 1
month before filing final prospectus with RoC/SE;

Change in Timelines of Bonus Issue
Shall be completed WITHIN 60 days from the Date of Board Resolution, where-in bonus was
announced subject to Shareholders approval OR WITHIN 15
days from the Date ofBoard Resolution authorising such issue. Once resolved, the board
shall not have the option of changing the decision.

Option not to disclose the floor price or price band
Where the issuer has not disclosed floor price or price band in prospectus filed with RoC/SE,
it shall be disclosed atleast 2 working days before opening of the bid in case of IPO and
atleast 1 working day before the opening of the bid in case of FPO, by way of an
announcement in all thenewspapers in which the pre-issue advertisement was released by
the issuer or the merchant banker;
AMENDMENTS IN DIP
1. In exercise of the powers conferred under sub-section (1) of Section 11 of the
Securities and Exchange Board of India Act, 1992, SEBI has amended the SEBI
(Disclosure and Investor Protection) Guidelines, 2000 (hereinafter referred to as the
SEBI (DIP) Guidelines).


2. The salient features of the amendments are given in brief as under:


2.1 Compulsory listing of IPO on at least one stock exchange with nationwide
trading terminals


(a) At present, in terms of the Companies Act, 1956 and the SEBI (DIP) Guidelines,
there is no regulatory stipulation on an unlisted company making an IPO to
compulsorily list the securities being issued through the IPO on stock exchanges
having nationwide trading terminals.


2.(b) Listing of securities on stock exchanges having nationwide trading terminals
provides an active trading platform to investors, from all across the country, in
securities of the company.


(c) In view of the above, it has been decided to amend clause 2.1.4 of the SEBI (DIP)
Guidelines to provide that an unlisted company making an IPO shall list the securities
being issued through the IPO on at least one stock exchange having nationwide
trading terminals.


2.2 Equity shares considered eligible for offer for sale



(a) At present, in terms of the SEBI (DIP) Guidelines, a shareholder can make an offer
for sale of the equity shares if such equity shares have been held for a period of at
least one year as on the date of filing the draft offer document with SEBI.



(b) It has been decided to amend clause 4.14.2 of the SEBI (DIP) Guidelines to
provide that in case equity shares which are received on conversion of fully paid
compulsorily convertible securities, including depository receipts, are being offered
for sale, the holding period of such convertible securities as well as that of resultant
equity shares together shall be considered for the purpose of calculation of the
eligibility period.


3.2.3 Introduction of concept of Anchor Investor in public issues through book
building route


It has been decided to amend the SEBI (DIP) Guidelines to introduce a concept of
Anchor Investor in public issues through book building.

3. Applicability.

3.1 The amendment made by this circular shall be applicable as under:

a. Amendments to clause 2.1.4 and 4.14.2 of the SEBI (DIP) Guidelines shall be
applicable where draft offer documents for public issues are filed with SEBI on or
after the date of this circular.

b. Amendment to clause 11.3.5 of the SEBI (DIP) Guidelines shall be applicable to:

(i) all cases where draft red herring prospectuses are filed with SEBI on or after the
date of this circular;

(ii) all cases where draft red herring prospectuses have been filed with SEBI but SEBI
has not yet issued its observations; and

(iii) all cases where SEBI has issued observations but where the red herring
prospectus is yet to be filed with the Registrar of Companies.

CRITICAL ANALYSIS: (DIP Guidelines vs. ICDR Regulations)

Definitions:

DIP Guidelines:

1) Definition of Group Companies was not explained.
2) Definition of employeeincludes permanent employee/director of Subsidiary or
Holding Company of the Issuer.
3) Definition of Key Managerial Personnel not defined.
4) Definition of Anchor Investor not defined.

ICDR Regulations:

1) The term Group Companies explained to mean Companies, firms, ventures
promoted by the Promoters of the Issuers, irrespective of whether such entities
are covered under Section 370(1)(B) of the Companies Act, 1956.
2) Definition of employeeexcludes permanent employee/director of Subsidiary or
Holding Company of the Issuer and Promoters and immediate relatives of
Promoters. The definition reads as employee means a permanent and full time
employee of the issuer, working in India or abroad or a Director of the Issuer,
whether whole-time or part time and does not include Promoters and immediate
relatives of Promoters.
3) The Key Managerial Personnel has been defined to mean officers vested with
executive powers and officers at the level immediately below the Board of
Directors of the issuer and includes any other person whom the issuer may
declare as key managerial personnel.
4) Anchor Investor means QIB, who is required to apply for a value of Rs. 10 crore
or more in a public issue made through Book Building process and hold securities
for a minimum period of 30 days after allotment.

Prohibition on Issue of Issue of Captial

DIP Guidelines:



ICDR Regulations:



Transfer of Surplus money in Green Shoe Option (GSO) Bank Account

DIP Guidelines:



ICDR Regulations:



Issue period for Infrastructure Companies in Public Issues

DIP Guidelines:



ICDR Regulations:



Currency of Financial Statements disclosed in the offer Document

DIP Guidelines:



ICDR Regulations:


Financial Institution as a monitoring agency

DIP Guidelines:



ICDR Regulations:




Eligibility to access Public Money-Uniform Applicability

DIP Guidelines: Exemptions from eligibility norms to certain Banking & Infrastructure
Companies

ICDR Regulations: Uniform applicability of eligibility norms to all types of issues.

Offer for Sale by Listed Companies Allowed

DIP Guidelines: Offer for Sale was permitted only for unlisted Companies.

ICDR Regulations: Offer for Sale even by Listed Companies provided holding of
shares by seller for a period of at least 1 year prior to the filing of draft offer document
with the SEBI.

No More firm Allotments

DIP Guidelines: Firm allotment in public issues was permitted.

ICDR Regulations: allocation upto 30% of the issue reserved for QIBs to Anchor
investors. Anchor Investor is a QIB, who is required to apply for a minimum issue of Rs. 10
Crores and hold the securities for a minimum period of 30 days after allotment.

Minimum Promoters Contribution

DIP Guidelines: Promoters and Promoters group were permitted to contribute
the minimum Promoters Contribution.

ICDR Regulations: Only Promoters are permitted to contribute the minimum
Promoters Contribution.

Underwriting

DIP Guidelines:Underwriting obligation restricted to the minimum
subscription Level.

ICDR Regulations: Underwriting of whole issue

Preferential Allotment

ICDR Regulations:The Stock Exchange is now empowered to order
revaluation of non cash consideration for preferential allotment to promoters,
their relatives, associates and related entities for consideration other than cash, if the
Stock Exchange is not satisfied by the valuation submitted to it by the Issuer.

Efficient Procedure & Adequate Disclosures

Book Building Process

DIP Guidelines: 75% & 100% book building route were allowed.

ICDR Regulations: Only 100% book building route allowed.

Issue, Allotment & Refund Period

DIP Guidelines:

Issue period was not clear in case there is a revision in the price band.
30 days period for allotment/refund in case of fixed price issue.
It is required to disclose price or prince band in case of fixed price public
issue.

ICDR Regulations:

Total issue period not to exceed 10 days, including any revision in the price
band.
15 days period for allotment/refund in case of fixed price issue & Book Build
issue.
No requirement to disclose price or price band in the draft red herring
prospectus.
Pledge of shares by Promoters should be disclosed in the Prospectus for
Public Issue.

Timing of pre issue advertisement for public issue

DIP Guidelines:


ICDR Regulations:



Forfeiture of money on unexercised warrants in preferential issues

DIP Guidelines:



ICDR Regulations:





ICDR Regulation

The SEBI (Disclosure and Investor Protection) Guidelines, 2000 (the DIP Guidelines) were
introduced to battle the challenges of liberalization and securities frauds and to enhance
investor protection. The DIP Guidelines were a landmark framework of regulations and
served the regulatory environment of the country well for many years. However, with no
penal sanctions for violations DIP Guidelines, 2000 was not fully effective. Therefore, the DIP
Guidelines needed to be strengthened and streamlined. The SEBI (Issue of Capital and
Disclosure Requirements) Regulations, 2009 (the ICDR) were introduced to address these
needs and are more concise and systematic than DIP. We can say that ICDR is new version of
DIP.
SEBI In exercise of the powers conferred by section 30 of the Securities and Exchange Board
of India Act, 1992 (15 of 1992) on SECURITIES AND EXCHANGE BOARD OF INDIA (ISSUE OF
CAPITAL AND DISCLOSURE REQUIREMENTS) REGULATIONS, 2009 which came into force on
AUGUST 26, 2009. ICDR is very vast regulation. The ICDR Regulations have been made
primarily by repealing the SEBI (Disclosure and Investor Protection) Guidelines, 2000 . While
incorporating the provisions of the rescinded Guidelines into the ICDR Regulations, certain
changes have been made by removing the redundant provisions, modifying certain
provisions on account of changes necessitated due to market design and bringing more
clarity to the provisions of the rescinded Guidelines.

ISSUE OF CAPITAL AND DISCLOSURE REQUIREMENTS REGULATIONS, 2009 is a vary vast
regulation , it cosists 11 chapters and 111sections, it also contains schedule xiii .

CHAPTER I : PRELIMINARY

CHAPTER II :COMMON CONDITIONS FOR PUBLIC ISSUES AND RIGHTS ISSUES

CHAPTER III : PROVISIONS AS TO PUBLIC ISSUE

CHAPTER IV : RIGHTS ISSUE

CHAPTER V : MANNER OF DISCLOSURES IN THE OFFER DOCUMENTS

CHAPTER VI :GENERAL OBLIGATIONS OF ISSUER AND INTERMEDIARIES WITH RESPECT TO
PUBLIC ISSUE AND RIGHTS ISSUE

CHAPTER VII: PREFERENTIAL ISSUE

CHAPTER VIII: QUALIFIED INSTITUTIONS PLACEMENT

CHAPTER IX : BONUS ISSUE

CHAPTER X : ISSUE OF INDIAN DEPOSITORY RECEIPTS


CHAPTER XA: ISSUE OF SPECIFIED SECURITIES BY SMALL AND MEDIUM ENTERPRISES
(Inserted by SEBI (Issue of Capital and Disclosure Requirements) (Third Amendment)
Regulations, 2010, w.e.f. 13.04.10.)

CHAPTER XI MISCELLANEOUS

ICDR VS DIP
1. SEBI has been empowered in terms of section 11A(1)(a) of the Securities and Exchange
Board of India Act, 1992 (hereinafter referred to as the Act) to specify by regulations, for
the protection of investors, the matters relating to issue of capital, the manner in which such
matters shall be disclosed and other matters incidental thereto.

2. Accordingly, in exercise of powers conferred by section 30 of the Act, the Board has
framed the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 , which
have been notified on August 26, 2009.

3. The ICDR Regulations have been made primarily by conversion of the SEBI (Disclosure and
Investor Protection) Guidelines, 2000 (since rescinded) (hereinafter referred to as the
rescinded Guidelines).

4. While incorporating the provisions of the rescinded Guidelines into the ICDR Regulations,
certain changes have been made by removing the redundant provisions, modifying certain
provisions on account of changes necessitated due to market design and bringing more
clarity to the provisions of the rescinded Guidelines. The significant changes are listed in
Annexure I to this circular for easy reference. Merchant bankers are, however, advised to
refer to the exact provisions of the ICDR regulations for doing due diligence and ensuring
compliance with the ICDR regulations.

5. Merchant Bankers are also advised to continue to comply with the following instruction
circulars, contents of which do not form part of the ICDR Regulations and shall therefore
continue to remain in force. In this context, merchant bankers are advised to note that any
reference to the provisions of the rescinded Guidelines in these circulars shall be deemed to
be a reference to the corresponding provisions of the ICDR Regulations.

(i) Circular No. SEBI/CFD/DIL/DIP/01/2006/20/1 January 20, 2006 , Specifying the number of
centres for refunds through ECS, NEFT, etc.

(ii) Circular No SEBI/CFD/DIL/DIP/29/2008/01/02 February 1, 2008 Extending the number of
centres for refund through ECS, NEFT, etc.

(iii) Circular No SEBI/CFD/DIL/MB/IS/1/2008/11/03 March 11, 2008 , Requirements pertaining
to PAN for issue applications
Procedure for addressing issue related complaints

(iv) Circular No. SEBI/CFD/DIL/DIP/31/2008/30/7 July 30, 2008 Features of ASBA process

(v) Circular No. SEBI/CFD/MB/IS/3/2008/29/08 August 29, 2008
Effective date of ASBA process
Clarification of clause
2.8 of the rescinded Guidelines

(vi) SEBI/CFD/DIL/2008/25/09 September 25, 2008 Introduction of ASBA process in rights
issues

(vii) SEBI/CFD/DIL/MB/IS/5/2009/05/08 August 5, 2009 Clarification on payment of
commission in respect of ASBA applications

6. The rescinded Guidelines contained certain provisions pertaining to regulation of the
activities of merchant bankers, debenture trustees and registrars to an issue. These
provisions have now been incorporated in the respective regulations, through Schedule XX
of the ICDR Regulations.

7. The rescinded Guidelines also contained a provision relating to compliance of listing
conditions by a listed issuer. A circular of even date has been issued to all recognised stock
exchanges for amending their equity listing agreements.

8. Further, the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme)
Guidelines, 1999 (hereinafter referred to as the SEBI (ESOS and ESPS) Guidelines)
contained certain provisions which were required to be complied with by an unlisted issuer
at the time of making an initial public offer. These provisions have now been incorporated in
the ICDR Regulations and consequently removed from the SEBI (ESOS and ESPS) Guidelines,
through issuance of a circular of even date.

9. In terms of regulation 111 of the ICDR Regulations, any offer document, whether draft or
otherwise, filed under the rescinded Guidelines and pending before the Board or any
observation made in respect of any offer document, draft or otherwise, filed in respect of
the rescinded Guidelines shall be deemed to have been filed or made under the
corresponding provisions of the ICDR Regulations.


SIGNIFICANT CHANGES ICDR from DIP

1. Exemption from eligibility norms for making an IPO:
DIP Exemption available to banking company, corresponding new bank and infrastructure
company. ICDR :Exemption removed. Eligibility norms made applicable uniformly to all types
of issuers.

2. Debarment:
DIP :Company prohibited from making an issue of securities if it had been prohibited from
accessing the capital market under any order or direction passed by the Board.
ICDR: Issuer not to make public issue or rights issue of specified securities if:
(a) the issuer, any of its promoters, promoter group or directors or persons in control of the
issuer are debarred from accessing the capital market by the Board;
(b) if any of the promoters, directors or persons in control of the issuer was or also is a
promoter, director or person in control of any other company which is debarred from
accessing the capital market under any order or directions made by the Board.

3. Offer for sale by listed companies
DIP: No provision.
ICDR: Provided for.


4. OTCEI Issues and E-IPO
DIP:Contained in Chapter XIV and Chapter XI A.
ICDR:Omitted

5. Firm allotment in public issues
DIP: Permitted.
ICDR: Omitted

6. Reservation on competitive basis in public issues
DIP :(a) For Indian and multilateral development financial institutions, Indian mutual funds,
foreign institutional investors and scheduled banks.
ICDR: (a) Omitted.
DIP: For shareholders of the promoting companies in the case of a new company and
shareholders of group companies in the case of an existing company.
ICDR: For shareholders (other than promoters) in respect of listed promoting companies, in
case of a new issuer and listed group companies, in case of an existing issuer


7. Book building process
DIP :Book building process through 75% or 100% of issue size.
ICDR: 75% book building route omitted.

8. Allotment/ refund period in public issues
DIP :30 days for fixed price issues and 15 days for book built issues.
ICDR: 15 days for both fixed price and book built issues.

9. Disclosure of price or price band
DIP: Required in draft prospectus in case of fixed price public issues.
ICDR: Not required to be disclosed in draft prospectus

10. Transfer of surplus money in Green Shoe Option (GSO)
DIP: Bank Account Surplus money to be transferred to Investor Protection Fund of Stock
Exchanges.
ICDR: Surplus money to be transferred to Investor Protection and Education Fund (IPEF)
established by the Board.


11. Issue period for Infrastructure companies in public issues
DIP:21 days, as against 10 days for other issues.
ICDR:Uniform period of 10 days for all types of issuers.

12. Currency of financial statements disclosed in the offer document
DIP :Particulars as per audited financial statements not to be more than 6 months old from
the issue opening date for all issuers, except Government companies.
ICDR:Government and non-government issuers treated at par

13. Definition of Key Management Personnel
DIP: Not defined.
ICDR : Defined in section 2(s) this section says key management personnel means the
officers vested with executive powers and the officers at the level immediately below the
board of directors of the issuer and includes any other person whom the issuer may declare
as a key management personnel

14. Disclosure on pledge of shares by promoters
DIP:Not provided.
ICDR: Provided for


15. Extent of underwriting obligation
DIP :Not explicit.
ICDR:Where 100% of the offer through offer document is underwritten, underwriting
obligations shall be for the entire amount underwritten.

16. Financial institution as a monitoring agency
DIP :The term Financial Institution open to interpretation
ICDR:The term financial Institution replaced by public financial institution or a scheduled
commercial bank.


17. Definition of employee
DIP:Includes permanent employee/ director of subsidiary or holding company of the issuer.
ICDR:Excludes permanent employee/director of subsidiary or holding company of the issuer
and promoters and immediate relatives of promoters.



18.Restrictions on advertisements
DIP:If issue opening and closing advertisement contained highlights, then the advertisement
required to contain risk factors.
ICDR:If advertisement contains information other than the details specified in the format for
issue advertisement, the advertisement shall contain risk factors.

19. Forfeiture of money on unexercised warrants in preferential issues
DIP: Open to interpretation.
ICDR:Where the warrant holder exercises his option to convert only some of the warrants
held by him, upfront payment made against only such warrants can be adjusted. The balance
upfront payment made against the remaining unexercised warrants shall be forfeited.

20. Outstanding convertible instruments in case of initial public offer (IPO)
DIP:Compulsory conversion of outstanding convertible instruments and other rights held by
promoters or shareholders.
ICDR: Compulsory conversion of all outstanding convertible instruments held by any person.

21. Minimum promoters contribution
DIP: Could be brought in by promoters/ persons belonging to promoter group/friends,
relatives and associates of promoters.
ICDR: Shall be brought in only by promoters whose identity, photograph, etc are disclosed in
the offer document.

22. Issue period in case of public issues
DIP :Issue period not clear in case of revision in price band in book built public issues.
ICDR: Total issue period not to exceed 10 days, including any revision in price band.

23. Timing of prei-ssue advertisement for public issues
DIP: Pre-issue advertisement to be made immediately after receipt of observations from the
Board.
ICDR :Pre-issue advertisement to be made after registering of prospectus/ red herring
prospectus with Registrar of Companies before opening of the issue.
24. Documents to be attached with due diligence certificate
DIP: Documents such as memorandum of association and articles of association of the
company, audited balance sheet, checklist for compliance with the rescinded Guidelines etc.
ICDR:Only checklist to be attached.
25. Group companies
DIP: The term group companies not explained.
ICDR :The term group companies explained.

APPLICABILITY OF THE ICDR REGULATIONS IN RESPECT OF DRAFT OFFER DOCUMENTS
FILED UNDER THE RESCINDED GUIDELINES

1. Particulars .Draft offer documents filed, but observations yet to be issued by the Board :
Applicability of the ICDR Regulations: Such draft offer documents would be considered as
filed with the Board under the corresponding provisions of the ICDR Regulations. Merchant
bankers may, however, be required to submit a checklist confirming compliance with the
corresponding provisions of the ICDR Regulations.

2. Particulars. Observations issued by the Board under the rescinded Guidelines, but in-
seriatim reply yet to be filed by merchant bankers :
Applicability of the ICDR Regulations In-seriatim reply shall be filed in terms of the ICDR
Regulations and while doing so, merchant bankers shall submit a checklist, along with a
confirmation that all the provisions of the ICDR Regulations have been duly complied with.

3.Particulars (a) In-seriatim reply filed with the Board under the rescinded Guidelines
(b) Offer document yet to be registered with the Registrar of Companies (ROC) / filed with
the designated stock exchange (DSE), as the case may be
Applicability of the ICDR Regulations:Merchant bankers shall be required to submit a
checklist, along with a confirmation that all the provisions of the ICDR Regulations have been
duly
complied with, before registering/ filing the offer document with the ROC/ DSE, as the case
may be.

4. Particulars. Offer document registered with the ROC / filed with the designated stock
exchange, as the case may be
Applicability of the ICDR Regulations Merchant bankers may proceed with the issue.

Applicability of ICDR Regulations (section 3 of ICDR)
These regulations shall apply to the following:
(a) a public issue;
(b) a rights issue, where the aggregate value of specified securities offered is fifty lakh
rupees or more;
(c) a preferential issue;
(d) an issue of bonus shares by a listed issuer
(e) a qualified institutions placement by a listed issuer
(f) an issue of Indian Depository Receipts.







Eligibility Requirements
Eligibility norms are made uniformly to all companies under SEBI (ICDR) Regulations, 2009
irrespective of whether it is a banking company or infrastructure company which were given
exemptions under erstwhile SEBI (DIP) Guidelines. The following are the conditions for
making initial public offer
(a) The issuer has net tangible assets of at least three crore rupees in each of the preceding
three full years (of twelve months each), of which not more than fifty percent are held in
monetary assets and if more than fifty percent of the net tangible assets are held in
monetary assets, the issuer has made firm commitments to utilize such excess monetary
assets in its business or project;
(b) it has a track record of distributable profits in terms of section 205 of the Companies Act,
1956, for at least three out of the immediately preceding five years, excluding extraordinary
items.
(c) it has a net worth of at least one crore rupees in each of the preceding three full years (of
twelve months each);
(d) the aggregate of the proposed issue and all previous issues made in the same financial
year in terms of issue size does not exceed five times its pre-issue net worth as per the
audited balance sheet of the preceding financial year;
(e) if it has changed its name within the last one year, at least fifty percent of the revenue for
the preceding one full year has been earned by it from the activity indicated by the new
name. If the above conditions are not satisfied, the issuer may make a public offer, if
(a) (i) the issue is made through the book building process and the issuer undertakes to allot
at least fifty percent of the net offer to public to qualified institutional buyers and to refund
full subscription monies if it fails to make allotment to the qualified institutional buyers; or
(ii) at least fifteen per cent. of the cost of the project is contributed by scheduled commercial
banks or public financial institutions, of which not less than ten percent shall come from the
appraisers and the issuer undertakes to allot at least ten per cent. of the net offer to public
to qualified institutional buyers
and to refund full subscription monies if it fails to make the allotment to the qualified
institutional buyers

(b) (i) the minimum post-issue face value capital of the issuer is ten crore rupees; or
(ii) the issuer undertakes to provide market-making for at least two years from the date of
listing of the specified securities, subject to the following:
(A) the market makers offer buy and sell quotes for a minimum depth of three hundred
specified securities and ensure that the bid-ask spread for their quotes does not, at any time,
exceed ten per cent;
(B) the inventory of the market makers, as on the date of allotment of the specified
securities, shall be at least five percentof the proposed issue.

Who is not Eligible
(a) if the issuer, any of its promoters, promoter group or directors or persons in control of
the issuer are debarred from accessing the capital market by the Board;
(b) if any of the promoters, directors or persons in control of the issuer was or also is a
promoter, director or person in control of any other company which is debarred from
accessing the capital market under any order or directions made by the Board;
(c) if the issuer of convertible debt instruments is in the list of willful defaulters published by
the Reserve Bank of India or it is in default of payment of interest or repayment of principal
amount in respect of debt instruments issued by it to the public, if any, for a period of more
than six months;
(d) unless it has made an application to one or more recognised stock exchanges for listing of
specified securities on such stock exchanges and has chosen one of them as the designated
stock exchange: Provided that in case of an initial public offer, the issuer shall make an
application for listing of the specified securities in at least one recognised stock exchange
having nationwide trading terminals;
(e) unless it has entered into an agreement with a depository for dematerialisation of
specified securities already issued or proposed to be issued
(f) unless all existing partly paid-up equity shares of the issuer have either been fully paid up
or forfeited;
(g) unless firm arrangements of finance through verifiable means towards seventy five
percent. of the stated means of finance, excluding the amount to be raised through the
proposed public issue or rights issue or through existing identifiable internal accruals, have
been made.

Major IPO Compliance under SEBI(ICDR) Regulations 2009

1. Appointments of Intermediaries(section5 of ICDR)
issuer shall appoint one or more merchant bankers, at least one of whom shall be a lead
merchant banker and shall also appoint other intermediaries, in consultation with the lead
merchant banker, to carry out the obligations relating to the issue
issuer shall, in consultation with the lead merchant banker, appoint only those
intermediaries which are registered with the Board.
The issuer shall enter into an agreement with the lead merchant banker in the format
specified in Schedule II
Check whether the issuer appointed registrars who has connectivity with
both depositories.(ie NSDL/CDSL).
lead merchant banker shall not act as a registrar to the issue in which it is also handling
the post issue responsibilities( section 5(7) of ICDR)


2. Filings/approvals/submissions
the draft offer document is filed with SEBI at least thirty days prior to registering a
prospectus, red herring prospectus or shelf prospectus with ROC or filing the letter offer
with the registrar of companies.
the draft offer document is made available to the public for atleast 21 days from the date
of such filing with SEBI.
a statement on the comments received from public on draft offer document is filed with
SEBI.
the observations/suggestions of SEBI on draft offer documents has been carried out while
registering of prospectus with ROC.
a copy of letter of offer is filed with SEBI and with stock exchanges where the securities
are proposed to be listed, simultaneously while registering the prospectus with ROC /before
opening of the issue.
The merchant banker shall, while seeking in-principle approval for listing of the eligible
securities issued under qualified institutions placement, furnish to each stock exchange on
which the same class of equity shares of the issuer are listed, a due diligence certificate
stating that the eligible securities are being issued under qualified institutions placement
and that the issuer complies with requirements of this Chapter viii (section 83(2) of ICDR)
Ensure whether the issuer has filed necessary documents before opening of the issue
while
a. Filing the draft offer documents with SEBI
b. Required documents after issuance of observations by SEBI
c. Filing of draft offer document with stock exchanges where the securities
are proposed to be listed.
It may be noted that contents of offer documents hosted on Websites are the same as
printed versions filed with ROC. Further the information contained in the offer document
and particulars as per audited financial statements in
the offer document are not more than six months old from the opening of
the issue.
Ensure that the offer document/red herring prospectus, abridged prospectus
etc contain necessary disclosures.

3. Pre issue-Due Diligence Certificates
Ensure whether the lead merchant bankers has submitted die diligence certificate with SEBI
at the time of
(a) filing of draft offer document with SEBI
(b) At the time of Registering prospectus with ROC
(c) Immediately before opening of the issue
(d) After the opening of the issue and before its closure before it closes for subscription.

4. Time limitation in opening of issue
Ensure that subject to compliance of Section 60(4) of the Companies Act, 1956,
public/rights issue is opened within
(i) Twelve months from the date of issuance of observations from the SEBI on draft offer
document or
(ii) Within three months from the later of the following dates if there are not observations.
(a) Draft of Receipt of draft offer document by SEBI
(b) Date of receipt of satisfactory reply from the lead merchant bankers, where the SEBI has
sought for any clarification/information
(c) Date of receipt of clarification or information from any regulator or agency, where the
SEBI has sought for any such clarification/information
(d) Date of receipt of a copy of in-principle approval letter issued by the recognized stock
exchanges.
(iii) In case of Fast Track issues the issue shall be opened within 90 days from the registration
of prospectus with ROC.
(iv) In case of Shelf prospectus, the first issue may be opened within 3 months from the date
of observation of SEBI.

5. Dispatch of offer documents and other materials Ensure whether the offer document and
other issue related instruments is dispatched to Bankers, Syndicate Members, underwriters
etc in advance.

6. Underwriting for issue through book building Ensure whether the issue through book
building route is underwritten.

7. Minimum Subscription :Ensure whether the company has received minimum subscription
of 90% of the offer.

8. Minimum allottees: Ensure that the number of prospective allottees is at least one
thousand.

9. Monitoring agency : Ensure that the issue size of more than 500 crores has been
monitored by a Pubic Financial Institution or by ne of the scheduled commercial banks
named in the offer document as bankers of the issuer.

10. Time limitation for receiving the call money Ensure the subscription money if made in
calls, the outstanding subscription money is called within 12 months from the date of
allotment.

11. Time limit for allotment or refund of Subscription money Ensure that the securities are
allotted and the excess amounts are refunded within 15 days from the closure of the offer.

12. Pricing norms relating to price/price band, cap on price banks is complied with.
(1) The qualified institutions placement shall be made at a price not less than the average of
the
weekly high and low of the closing prices of the equity shares of the same class quoted on
the stock
exchange during the two weeks preceding the relevant date.
(2) Where eligible securities are convertible into or exchangeable with equity shares of the
issuer, the
issuer shall determine the price of such equity shares allotted pursuant to such conversion
or exchange
taking the relevant date as decided and disclosed by it while passing the special resolution.
(3) The issuer shall not allot partly paid up eligible securities:
Provided that in case of allotment of non convertible debt instruments along with warrants,
the
allottees may pay the full consideration or part thereof payable with respect to warrants, at
the time
of allotment of such warrants:
Provided further that on allotment of equity shares on exercise of options attached to
warrants,
such equity shares shall be fully paid up.
(4) The prices determined for qualified institutions placement shall be subject to appropriate
adjustments if the issuer:
(a) makes an issue of equity shares by way of capitalization of profits or reserves, other than
by
way of a dividend on shares;
(b) makes a rights issue of equity shares;
(c) consolidates its outstanding equity shares into a smaller number of shares;
(d) divides its outstanding equity shares including by way of stock split;
(e) re-classifies any of its equity shares into other securities of the issuer;
(f) is involved in such other similar events or circumstances, which in the opinion of the
concerned stock exchange, requires adjustments.





13. Promoters Contribution & restriction on transferability of their securities
Ensure that the promoters contribution is
(a) in case of an initial public offer, not less than twenty per cent. of the post issue capital
(b) in case of a further public offer, either to the extent of twenty per cent. of the proposed
issue size or to the extent of twenty percent of the post-issue capital;
(c) in case of a composite issue, either to the extent of twenty per cent. Of the proposed
issue size or to the extent of twenty percent. of the post-issue capital excluding the rights
issue component.
the promoters contribution is kept in an escrow account with a scheduled banks and
shall be released to the issuer along with the release of issue proceeds.
the securities ineligible for promoters contribution is not included while calculating
the above limits.
the minimum promoters contribution and excess promoters contribution is locked in
for 3 years and one year respectively.
For the computation of minimum promoters contribution, the following specified
securities(Equity Shares and Convertible Securities)shall not be eligible:
(a) specified securities acquired during the preceding three years, if they are:
(i) acquired for consideration other than cash and revaluation of assets or capitalisation of
intangible assets is involved in such transaction; or
(ii) resulting from a bonus issue by utilisation of revaluation reserves or unrealized profits of
the issuer or from bonus issue against equity shares which are ineligible for minimum
promoters contribution;
(b) Specified securities acquired by promoters during the preceding one year at a price lower
than the price at which specified securities are being offered to public in the initial public
offer subject to certain exemptions specified.
(c) Specified securities allotted to promoters during the preceding one year at a price less
than the issue price, against funds brought in by them during that period, in case of an issuer
formed by conversion of one or more partnership firms, where the partners of the erstwhile
partnership firms are the promoters
of the issuer and there is no change in the management:
(d) Specified securities pledged with any creditor.

14. Other lock in requirements
Ensure that the pre-issue capital held by persons other than promoters is subject to
lockin for the period of one year from the date of allotment, subject to speicified
exemptions.
Transferability of lock in shares Subject to the provisions of Securities and Exchange
Board of India (Substantial Acquisition of shares and Takeovers) Regulations, 1997,
then specified securities held by promoters and locked-in may be transferred to
another promoter or any person of the promoter group or a new promoter or a
person in control of the issuer and the specified securities held by persons other than
promoters and locked-in may be transferred to any other person holding the
specified securities which are locked-in along with the securities proposed to be
transferred: However, lock-in on such specified securities shall continue for the
remaining period with the transferee and such transferee shall not be eligible to
transfer them till the lock-in period stipulated in these regulations has expired.

15. Minimum offer to the Public
Subject to the provisions of sub-clause (b) of clause (2) of rule 19 of Securities Contracts
(Regulations) Rules, 1957, check the net offer to public:
(a) in case of an initial public offer, is at least ten percent or twenty five percent of the post-
issue capital, as the case may be; and
(b) in case of a further public offer, is at least ten per cent. or twenty five percentof the issue
size, as the case may be.
However Government companies and infrastructure Companies are exempted from these
provisions subject to exceptions.

16. Reservation on Competitive Basis
For issue made through the book building process
(1) In case of an issue made through the book building process, the issuer may make
reservation on competitive basis out of the issue size excluding promoters contribution and
net offer to public in favour of the following categories of persons:
(a) employees of the issuer including employees of the promoting companies in case of a
new issuer;
(b) shareholders (other than promoters) of:
(i) listed promoting companies, in case of a new issuer; and
(ii) listed group companies, in case of an existing issuer:
(c) persons who, as on the date of filing the draft offer document with the Board, are
associated with the issuer as depositors, bondholders or subscribers to services of the issuer
making an initial public
offer:
For issue made other than through the book building process In case of an issue
made other than through the book building process, the issuer may make
reservation on competitive basis out of the issue size excluding promoters
contribution and net offer to public in favour of the following categories of persons:
(a) employees of the issuer including employees of the promoting companies in case of a
new issuer;
(b) shareholders (other than promoters) of:
(i) listed promoting companies, in the case of a new issuer; and
(ii) listed group companies, in the case of an existing issuer:
Ensure that reservations have not been made in respect of the following persons who are
not eligible.
(a) In case of promoting companies being financial institutions or state and central financial
institutions, the shareholders of such promoting companies
(b) In case of issue made through book building process, the issue management team,
syndicate members, their promoters, directors and employees and for the group or associate
companies of the issue management team and syndicate members and their promoters,
directors and employees;

16. Allocation of net offer to public In case of issue through book building
(i) Not less than 35% to Retail individual investors
(ii) Not less than 15% to non-institutional investors
(iii) Nor more than 55% to qualified institutional buyers and 5% of which shall be allocated to
mutual funds.(up to 35% of the portion available for allocation of qualified institutional
buyers may be allocated to anchor investor)
However at least 50% of net offer is to be allocated to qualified institutional buyers if an
issuer has not satisfied the basic eligibility criteria and undertakes to allot so. Further if the
issuer is required to allot 60% of the net offer to the public to Qualified institutional Buyers
in terms of 19(2)(b) of Securities Contracts Regulation Rules, 1957, allocation to retail
individual investors and non institutional investors shall be 30% and 10% respectively.

In case of issue other than book building
(i) Minimum 50% to retail individual investors and
(ii) Remaining to individual applicants other than retail individual investors and Other
investors including corporate bodies or insitutiions, irrespective of the number of securities
applied for.

17. Period of subscription
Ensure that the public issue is kept open at least for three working days but nor mote than
ten working days including the days for which the issue is kept open in case of revision in
price band.

18. Advertisements
Pre issue
Ensure that after registering the red herring prospectus (in case of a book built issue) or
prospectus (in case of fixed price issue) with the Registrar of Companies, make a pre-issue
advertisement in the prescribed format and with required disclosures, in one English
national daily newspaper with wide
circulation, Hindi national daily newspaper with wide circulation and one regional language
newspaper with wide circulation at the place where the registered office of the issuer is
situated.
Issue opening and closing Ensure that the advertisement on issue opening and
closing is made in the specified format.
Post issue advertisement giving details relating to over subscription, basis of
allotment, number, value and percentage of all applications including ASBA, number,
value and percentage of successful allottees for all applications including ASBA, date
of completion of dispatch of refund orders or instructions to Self Certified Syndicate
Banks by the Registrar, date of dispatch of certificates and date of filing of listing
application, etc. is released within ten days from the date of completion of the
various activities in at least one English national daily newspaper with wide
circulation, one Hindi national daily newspaper with wide circulation and one
regional language daily newspaper with wide circulation at the place where
registered office of the issuer is situated.

Major issues to be taken care while issuing advertisement/publicity material(section60 of
ICDR)
Public communications, publicity materials, advertisements and research reports.
Any public communication including advertisement and publicity material issued by
the issuer or research report made by the issuer or any intermediary concerned with
the issue or their associates shall contain only factual information and shall not
contain projections, estimates, conjectures, etc. or any matter extraneous to the
contents of the offer document.
All public communications and publicity material issued or published in any media
during the period commencing from the date of the meeting of the board of
directors of the issuer in which the public issue or rights issue is approved till the
date of filing draft offer document with the Board shall be consistent with its past
practices: Provided that where such public communication or publicity material is
not consistent with the past practices of the issuer, it shall be prominently displayed
or announced in such public communication or publicity material that the issuer is
proposing to make a public or rights issue of specified securities in the near future
and is in the process of filing a draft offer document with the Board.
(3) All public communications and publicity material issued or published in any
media during the period commencing from the date of filing draft offer document
with the Board till the date of allotment of securities offered in the issue, shall
prominently disclose that: (a) the issuer is proposing to make a public issue or rights
issue of the specified securities and has filed a draft offer document with the Board
or has filed the red herring prospectus or prospectus with the Registrar of
Companies or the letter of offer with the designated stock exchange, as the case
may be. (b) the draft offer document, red herring prospectus or final offer
document, as the case may be, is available on the website of the Board, lead
merchant bankers or lead book runners.(4) The issuer shall make prompt, true and
fair disclosure of all material developments which take place during the following
period mentioned in this sub-regulation, relating to its business and securities and
also relating to the business and securities of its subsidiaries, group companies, etc.,
which may have a material effect on the issuer, by issuing public notices in all the
newspapers in which the issuer had issued pre-issue advertisement under
regulation 47 or regulation 55, as the case may be: (a) in case of public issue,
between the date of registering final prospectus or the red herring prospectus, as
the case may be, with the Registrar of Companies, and the date of allotment of
specified securities; (b) in case of a rights issue, between the date of filing the letter
of offer with the designated stock exchange and the date of allotment of the
specified securities. (5) The issuer shall not, directly or indirectly, release, during any
conference or at any other time, any material or information which is not contained
in the offer document. (6) In respect of all public communications, issue
advertisements and publicity materials, the issuer shall obtain approval from the
lead merchant bankers responsible for marketing the issue and shall also make
copies of all issue related materials available with the lead merchant bankers at least
till the allotment is completed.
Any advertisement or research report issued or caused to be issued by an issuer,
any intermediary concerned with the issue or their associates shall comply with the
following: (a) it shall be truthful, fair and shall not be manipulative or deceptive or
distorted and it shall not contain any statement, promise or forecast which is untrue
or misleading; (b) if it reproduces or purports to reproduce any information
contained in an offer document, it shall reproduce such information in full and
disclose all relevant facts and not be restricted to select extracts relating to that
information; (c) it shall be set forth in a clear, concise and understandable language;
(d) it shall not include any issue slogans or brand names for the issue except the
normal commercial name of the issuer or commercial brand names of its products
already in use; (e) if it presents any financial data, data for the past three years shall
also be included alongwith particulars relating to sales, gross profit, net profit, share
capital, reserves, earnings per share, dividends and the book values; (f) no
advertisement shall use extensive technical, legal terminology or complex language
and excessive details which may distract the investor; (g) no issue advertisement
shall contain statements which promise or guarantee rapid increase in profits; (h) no
issue advertisement shall display models, celebrities, fictional characters, landmarks
or caricatures or the likes; (i) no issue advertisement shall appear in the form of
crawlers (the advertisements which run simultaneously with the programme in a
narrow strip at the bottom of the television screen) on television; (j) in any issue
advertisement on television screen, the risk factors shall not be scrolled on the
television screen and the advertisement shall advise the viewers to refer to the red
herring prospectus or other offer document for details; (k) no issue advertisement
shall contain slogans, expletives or non-factual and unsubstantiated titles; (l) if an
advertisement or research report contains highlights, it shall also contain risk factors
with equal importance in all respects including print size of not less than point seven
size; (m) an issue advertisement displayed on a billboard shall not contain
information other than that specified in Parts A, B and C of Schedule XIII, as
applicable; (n) an issue advertisement which contains highlights or information
other than the details contained in the format as specified in Parts A and B of
Schedule XIII shall contain risk factors.
No advertisement shall be issued giving any impression that the issue has been fully
subscribedor oversubscribed during the period the issue is open for subscription.
An announcement regarding closure of issue shall be made only after the lead
merchant banker(s) is satisfied that at least ninety per cent. of the offer through
offer document has been subscribed and a certificate has been obtained to that
effect from the registrar to the issue: Provided that such announcement shall not be
made before the date on which the issue is to be closed.
No advertisement or distribution material with respect to the issue shall contain
any offer of incentives, whether direct or indirect, in any manner, whether in cash or
kind or services or otherwise.
No product advertisement shall contain any reference, directly or indirectly, to the
performance
of the issuer during the period commencing from the date of the resolution of the board of
directors of
the issuer approving the public issue or rights issue till the date of allotment of specified
securities
offered in such issue.
(12) A research report may be prepared only on the basis of information, disclosed to the
public by the
issuer by updating the offer document or otherwise.
(13) No selective or additional information or information which is extraneous to the
information
disclosed to the public through the offer document or otherwise, shall be given by the issuer
or any
member of the issue management team or syndicate to any particular section of the
investors or to any
research analyst in any manner whatsoever, including at road shows, presentations, in
research or sales
reports or at bidding centres.
Explanation: For the purpose of this regulation:
(I) public communication or publicity material includes corporate, product and issue
advertisements of the issuer, interviews by its promoters, directors, duly authorized
employees or representatives of the issuer, documentaries about the issuer or its promoters,
periodical reports and press releases.
(II) An issue advertisement shall be considered to be misleading, if it contains:
(a) Statements made about the performance or activities of the issuer without necessary
explanatory or qualifying statements, which may give an exaggerated picture of such
performance or activities.
(b) An inaccurate portrayal of past performance or its portrayal in a manner which implies
that
past gains or income will be repeated in the future.
the announcement regarding closure of the issue is made only after the receipt of
minimum subscription.
no product advertisement contains any reference, directly or indirectly, to the
performance of the issuer during the period commencing from the date of the resolution of
the board of directors of the issuer approving the public issue or rights issue till the date of
allotment of specified securities offered in such issue.
advertisement or distribution material with respect to the issue contains any offer of
incentives, whether direct or indirect, in any manner, whether in cash or kind or services or
otherwise.
the advertisement does not include any issue slogans or brand names for the issue
except the normal commercial name of the issuer or commercial brand names of its
products already in use.
advertisement uses extensive technical, legal terminology or complex language and
excessive details which may distract the investor.
Ensure that no issue advertisement contains statements which promise or guarantee
rapid increase in profits.
Ensure that no issue advertisement displays models, celebrities, fictional characters,
landmarks or caricatures or the likes.
Ensure that no issue advertisement appears in the form of crawlers (the advertisements
which run simultaneously with the programme in a narrow strip at the bottom of the
television screen) on television.
In any issue advertisement on television screen, the risk factors shall not be scrolled on
the television screen and the advertisement shall advise the viewers to refer to the red
herring prospectus or other offer document for details.
Ensure that no issue advertisement contains slogans, expletives or non-factual and
unsubstantiated titles.
If an advertisement or research report contains highlights, it shall also contain risk factors
with equal importance in all respects including print size of not less than point seven size;

19. Minimum Application Value
Ensure that Minimum application Value is kept between Rs.5000 to Rs. 7000.

20. Allotment procedure and basis of allotment
The allotment of specified securities to applicants other than anchor investors shall be on
proportionate basis within the specified investor categories and the number of securities
allotted shall be rounded off to the nearest integer, subject to minimum allotment being
equal to the minimum application size as determined and disclosed by the issuer
21. Appointment of Compliance officer The issuer shall appoint a compliance officer who
shall be responsible for monitoring the compliance of the securities laws and for redressal of
investors grievances.

22. Redressal of investor grievances
The post-issue lead merchant bankers shall actively associate himself with post-issue
activities such as allotment, refund, despatch and giving instructions to syndicate members,
Self Certified Syndicate Banks and other intermediaries and shall regularly monitor redressal
of investor grievances arising therefrom.

23. Post issue diligence
(1) The lead merchant bankers shall exercise due diligence and satisfy himself about all the
aspects of the issue including the veracity and adequacy of disclosure in the offer
documents.
(2) The lead merchant bankers shall call upon the issuer, its promoters or directors or in case
of an offer for sale, the selling shareholders, to fulfill their obligations as disclosed by them
in the offer document and as required in terms of these Regulations.
(3) The post-issue merchant banker shall continue to be responsible for postissue activities
till the subscribers have received the securities certificates, credit to their demat account or
refund of application moneys and the listing agreement is entered into by the issuer with the
stock exchange and listing/ trading permission is obtained.
(4) The responsibility of the lead merchant banker shall continue even after the completion
of issue process.

24. Post issue Reports
The lead merchant banker shall submit post-issue reports as follows:
(a) initial post issue report in specified form within three days of closure of the issue
(b) final post issue report in specified format within fifteen days of the date of finalisation of
basis of allotment or within fifteen days of refund of money in case of failure of issue. The
lead merchant banker shall also submit a due diligence certificate in the specified format
along with the final post issue report.


III. DUE DILIGENCE ISSUES OTHER THAN IPO/FPO
Companies might issue shares through routes other than IPO/FPO. It right include
preferential allotments, issue of shares through rights issue, bonus issue or ESOP scheme
etc. various important aspects to be taken case before and after the issue are diseased
below.

III-A. DUE DILIGENCE PREFERENTIAL ISSUE
Due diligence of preferential issue may be
(a) Due diligence of preferential issues by listed companies.
(b) Due diligence of preferential issues by unlisted companies.
Due diligence of preferential issues by listed companies
(a) Due Diligence Preferential issue of listed Companies- a Check list under
Non Applicability of Chapter VII of SEBI(ICDR) Regulations 2009
in following circumstances Chapter VII of SEBI(ICDR) Regulations 2009 will be not applicable
1. The provisions of this Chapter shall not apply where the preferential issue of equity shares
is made:
(a) pursuant to conversion of loan or option attached to convertible debt instruments in
terms of sub-sections (3) and (4) of sections 81 of the Companies Act, 1956;
(b) pursuant to a scheme approved by a High Court under section 391 to 394 of the
Companies Act, 1956;
(c) in terms of the rehabilitation scheme approved by the Board of Industrial and Financial
Reconstruction under the Sick Industrial Companies (Special Provisions) Act, 1985:
Provided that the lock-in provisions of this Chapter shall apply to such preferential issue of
equity shares.
(2) The provisions of this Chapter relating to pricing and lock-in shall not apply to equity
shares allotted to any financial institution within the meaning of subclauses (ia) and (ii) of
clause (h) of section 2 of the Recovery of Debts due to Banks and Financial Institutions Act,
1993 (51 of 1993).
(3) The provisions of regulation 73 (Disclosures)and regulation 76(Pricing) shall not apply to
a preferential issue of equity shares and compulsorily convertible debt instruments, whether
fully or partly, where the Board has granted relaxation to the issuer in terms of regulation
29A of the Securities and Exchange Board of India (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997, if
adequate disclosures about the plan and process proposed to be followed for identifying the
allottees are given in the explanatory statement to notice for the general meeting of
shareholders.
Check list for preferential issue of listed companies
1. Special Resolution
Check whether a special resolution has been passed by its shareholders;
The special resolution shall specify the relevant date on the basis of which
price of the equity shares to be allotted on conversion or exchange of
convertible securities shall be calculated relevant date means:
(a) in case of preferential issue of equity shares, the date thirty days prior
to the date on which the meeting of shareholders is held to consider the
proposed preferential issue:
Provided that in case of preferential issue of equity shares pursuant to
a scheme approved under the Corporate Debt Restructuring framework
of Reserve Bank of India, the date of approval of the Corporate Debt
Restructuring Package shall be the relevant date.
(b) in case of preferential issue of convertible securities, either the relevant
date referred to in clause (a) of this regulation or a date thirty days prior
to the date on which the holders of the convertible securities become
entitled to apply for the equity shares.
The issuer shall, in addition to the disclosures required under section 173 of
the Companies Act, 1956 or any other applicable law, disclose the following
in the explanatory statement to the notice for the general meeting proposed
for passing special resolution:
(a) the objects of the preferential issue;
(b) the proposal of the promoters, directors or key management personnel
of the issuer to subscribe to the offer;
(c) the shareholding pattern of the issuer before and after the preferential
issue;
(d) the time within which the preferential issue shall be completed;
(e) the identity of the proposed allottees, the percentage of post preferential
issue capital that may be held by them and change in control, if any, in
the issuer consequent to the preferential issue;
(f) an undertaking that the issuer shall re-compute the price of the specified
securities in terms of the provision of these regulations where it is required
to do so;
(g) an undertaking that if the amount payable on account of the recomputation
of price is not paid within the time stipulated in these
regulations, the specified securities shall continue to be locked- in till
the time such amount is paid by the allottees.
2. Compulsory Dematerialisation
Check whether all the equity shares, if any, held by the proposed allottees in the
issuer are in dematerialised form;
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3. Condition for continued listing
Check the issuer is in compliance with the conditions for continuous listing of
equity shares as specified in the listing agreement.
4. Permanent Account Number of allottees
Check whether the issuer has obtained the Permanent Account Number of the
proposed allottees.
5. Shares not to be allotted to persons who has sold any equity shares of the
issuer in preceding six months
Ensure that the issuer has not make preferential issue of specified securities to
any person who has sold any equity shares of the issuer during the six months
preceding the relevant date: However, in respect of the preferential issue of
equity shares and compulsorily convertible debt instruments, whether fully or
partly, the Board may grant relaxation from the requirements of this sub-regulation,
if the Board has granted relaxation in terms of regulation 29A of the Securities
and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997 to such preferential allotment.
6. Copy of the certificate of its statutory auditor
The issuer shall place a copy of the certificate of its statutory auditor before the
general meeting of the shareholders, considering the proposed preferential issue,
certifying that the issue is being made in accordance with the requirements of
these regulations.

7. Valuation by an independent qualified valuer
Where specified securities are issued on a preferential basis to promoters, their
relatives, associates and related entities for consideration other than cash, the
valuation of the assets in consideration for which the equity shares are issued
shall be done by an independent qualified valuer, which shall be submitted to
the recognised stock exchanges where the equity shares of the issuer are listed:
If the recognised stock exchange is not satisfied with the appropriateness of
the valuation, it may get the valuation done by any other valuer and for this
purpose it may obtain any information, as deemed necessary, from the issuer.
8. Time Limit for allotment
Allotment pursuant to the special resolution shall be completed within a period
of fifteen days from the date of passing of such resolution:
Exceptions
Where any application for exemption from the applicability of the Securities and
Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997 or any approval or permission by any regulatory authority or
the Central Government for allotment is pending, the period of fifteen days shall
be counted from the date of order on such application or the date of approval or
permission, as the case may be:
Where the Board has granted relaxation to the issuer in terms of regulation 29A
of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997,
the preferential issue of equity shares and compulsorily convertible debt
instruments, whether fully or partly, shall be made by it within such time as may
be specified by the Board in its order granting the relaxation:
Requirement of allotment within fifteen days shall not apply to allotment of
specified securities on preferential basis pursuant to a scheme of corporate
debt restructuring as per the corporate debt restructuring framework specified
by the Reserve Bank of India.
(2) If the allotment of specified securities is not completed within fifteen days
from the date of special resolution, a fresh special resolution shall be passed
and the relevant date for determining the price of specified securities under this
Chapter will be taken with reference to the date of latter special resolution.
9. Tenure of convertible securities
The tenure of the convertible securities of the issuer shall not exceed eighteen
months from the date of their allotment.
10. Pricing of equity shares
(a) If listed for more than 6 months
If the equity shares of the issuer have been listed on a recognised stock
exchange for a period of six months or more as on the relevant date, the
equity shares shall be allotted at a price not less than higher of the following:
(a) The average of the weekly high and low of the closing prices of the
related equity shares quoted on the recognised stock exchange during
the six months preceding the relevant date; or
(b) The average of the weekly high and low of the closing prices of the
related equity shares quoted on a recognised stock exchange during
the two weeks preceding the relevant date.
(b) If listed for less than 6 months
If the equity shares of the issuer have been listed on a recognised stock
exchange for a period of less than six months as on the relevant date, the
equity shares shall be allotted at a price not less than the higher of the
following:
(a) the price at which equity shares were issued by the issuer in its initial
public offer or the value per share arrived at in a scheme of arrangement
under sections 391 to 394 of the Companies Act, 1956, pursuant to
which the equity shares of the issuer were listed, as the case may be;
or
(b) the average of the weekly high and low of the closing prices of the
related equity shares quoted on the recognised stock exchange during
the period shares have been listed preceding the relevant date; or
(c) the average of the weekly high and low of the closing prices of the
related equity shares quoted on a recognised stock exchange during
the two weeks preceding the relevant date.
This price shall be recomputed by the issuer on completion of six months
from the date of listing on a recognised stock exchange with reference to
25
the average of the weekly high and low of the closing prices of the related
equity shares quoted on the recognised stock exchange during these six
months and if such recomputed price is higher than the price paid on allotment,
the difference shall be paid by the allottees to the issuer.
c. Preferential issue to qualified institutional buyer
Any preferential issue of specified securities, to qualified institutional buyers
not exceeding five in number, shall be made at a price not less than the
average of the weekly high and low of the closing prices of the related
equity shares quoted on a recognised stock exchange during the two weeks
preceding the relevant date.
stock exchange means any of the recognised stock exchanges in which
the equity shares are listed and in which the highest trading volume in
respect of the equity shares of the issuer has been recorded during the
preceding six months prior to the relevant date.
11. Payment of consideration
Full consideration of specified securities other than warrants issued under this
Chapter shall be paid by the allottees at the time of allotment of such specified
securities:
Exceptions
In case of a preferential issue of specified securities pursuant to a scheme of
corporate debt restructuring as per the corporate debt restructuring framework
specified by the Reserve Bank of India, the allottee may pay the consideration
in terms of such scheme.
An amount equivalent to at least twenty five per cent. of the consideration shall
be paid against each warrant on the date of allotment of warrants. The balance
seventy five per cent. of the consideration shall be paid at the time of allotment
of equity shares pursuant to exercise of option against each such warrant by
the warrant holder.
In case the warrant holder does not exercise the option to take equity shares
against any of the warrants held by him, the consideration paid in respect of
such shall be forfeited by the issuer.
12. Lock-in of specified securities
The specified securities allotted on preferential basis to promoter or promoter
group and the equity shares allotted pursuant to exercise of options attached
to warrants issued on preferential basis to promoter or promoter group, shall
be locked-in for a period of three years from the date of allotment of the
specified securities or equity shares allotted pursuant to exercise of the
option attached to warrant, as the case may be:
Exceptions/Conditions
Not more than twenty percentof the total capital of the issuer shall be lockedin
for three years from the date of allotment:
Equity shares allotted in excess of the twenty per cent. shall be locked-in for
one year from the date of their allotment pursuant to exercise of options or
otherwise, as the case may be.
26
The specified securities allotted on preferential basis to persons other than
promoter and promoter group and the equity shares allotted pursuant to exercise
of options attached to warrants issued on preferential basis to such persons
shall be locked in for a period of one year from the date of their allotment.
The lock-in of equity shares allotted pursuant to conversion of convertible
securities other than warrants, issued on preferential basis shall be reduced to
the extent the convertible securities have already been locked-in.
The equity shares issued on preferential basis pursuant to a scheme of corporate
debt restructuring as per the Corporate Debt Restructuring framework specified
by the Reserve Bank of India shall be locked-in for a period of one year from the
date of allotment: However partly paid up equity shares, if any, shall be lockedin
from the date of allotment and the lock-in shall end on the expiry of one year
from the date when such equity shares become fully paid up.
If the amount payable by the allottee, in case of re-calculation of price after completion
of six months from the date of listing, is not paid till the expiry of lock-in period,
the equity shares shall continue to be locked in till such amount is paid by the
allottee.
The entire pre-preferential allotment shareholding of the allottees, if any, shall
be locked-in from the relevant date upto a period of six months from the date of
preferential allotment.
13. Transferability of locked-in specified securities and warrants issued on
preferential basis
Subject to the provisions of Securities and Exchange Board of India (Substantial
Acquisition of shares and Takeovers) Regulations, 1997, specified securities
held by promoters and locked-in may be transferred among promoters or promoter
group or to a new promoter or persons in control of the issuer:
Provided that lock-in on such specified securities shall continue for the remaining
period with the transferee.
Due diligence Preferential issues of unlisted companies
Issue of preferential allotments by unlisted companies is mainly governed by Unlisted
Public Companies (Preferential Allotment) Rules, 2003. These rules are applicable to all
unlisted public companies in respect of preferential issue of equity shares, fully convertible
debentures, partly convertible debentures or any other financial instruments which would
be convertible into or exchanged with equity shares at a later date.
The following check list provides the details of compliances by unlisted companies.
(i) Check whether there is a provision in the Articles of Association authorizing the
Board to make preferential allotment.
(ii) Check whether there is adequate unissued capital
(iii) Ensure to pass necessary special resolution under Section 81(1A) of the
Companies Act, 1956 and necessary filings with ROC
(iv) Ensure that the explanatory statement to the notice for the general meeting as
required under section 173 of the Companies Act, 1956 contains the following:
(a) the price or price band at which the allotment is proposed;
(b) the relevant date on the basis of which price has been arrived at;
(c) the object/s of the issue through preferential offer;
(d) the class or classes of persons to whom the allotment is proposed to be
made;
(e) intention of promoters/directors/key management persons to subscribe to
the offer;
(f) shareholding pattern of promoters and others classes of shares before and
after the offer;
(g) proposed time within which the allotment shall be completed;
(h) whether a change in control is intended or expected
(v) Ensure that, in case of every issue of shares/warrants/fully convertible
debentures/partly convertible debentures or other financial instruments with
conversion option, the statutory auditors of the issuing company / company
secretary in practice certifies that the issue of the said instruments is being
made in accordance with these Rules and such certificate is being laid before
the meeting of the shareholders convened to consider the proposed issue.
(vi) Ensure to complete the allotment within 12 months of passing special resolution
(vii) Ensure to make necessary filings with ROC in respect of the said preferential
allotment.
III-B. DUE DILIGENCE EMPLOYEE STOCK OPTION
Issue of shares through Employee Stock Option Scheme/Employee Stock Purchase
scheme by listed companies are regulated by Securities And Exchange Board of India
(Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines,
1999. The following aspects are to be checked while issue of shares/options to employees
under ESOP scheme.
(a) Employee Stock Option
1. Eligibility to Participate
(i) An employee is eligible to participate in Employee Stock Option Scheme
(ESOS) of the company.
Where such employee is a director nominated by an institution as its
representative on the Board of Directors of the company
(i) the contract/agreement entered into between the institution
nominating its employee as the director of a company and the
director so appointed shall, inter alia, specify the following:
(a) whether options granted by the company under its ESOS can
be accepted by the said employee in his capacity as director of
the company;

(b) that options, if granted to the director, shall not be renounced in
favour of the nominating institution; and
(c) the conditions subject to which fees, commissions, ESOSs,
other incentives, etc. can be accepted by the director from the
company.
(ii) the institution nominating its employee as a director of a company
shall file a copy of the contract/agreement with the said company,
which shall, in turn, file the copy with all the stock exchanges on
which its shares are listed.
(iii) the director so appointed shall furnish a copy of the contract/
agreement at the first Board meeting of the company attended by
him after his nomination.
(ii) Check that employee is not a promoter nor belongs to the promoter
group.
(iii) Check that a director who either himself or through his relative or through
any body corporate, directly or indirectly holds more than 10% of the
outstanding equity shares of the company is not participating as he is
not eligible to participate in the scheme.
2. Compensation Committee
(i) Check that the disclosures, as specified in Schedule IV are made by
the company to the prospective option guarantees.
(ii) Check that the company has constituted a Compensation Committee
for administration and superintendence of the scheme.
(iii) Check that the Compensation Committee is a Committee of the Board
of Directors consisting of a majority of independent directors.
(iv) Check that the Compensation Committee has formulated the detailed
terms and conditions of the scheme including:
(a) the quantum of option to be granted under the scheme per employee
and in aggregate;
(b) the conditions under which option vested in employees may lapse
in case of termination of employment for misconduct;
(c) the exercise period within which the employee should exercise the
option and that option would lapse on failure to exercise the option
within the exercise period;
(d) the specified time period within which the employee shall exercise
the vested options in the event of termination or resignation of an
employee;
(e) the right of an employee to exercise all the options vested in him at
one time or at various points of time within the exercise period;
(f) the procedure for making a fair and reasonable adjustment to the
number of options and to the exercise price in case of corporate
actions such as rights issues, bonus issues, merger, sale of division

and others. In this regard, the following actions should be taken
into consideration by the compensation Committee:
(i) The number and the price of ESOS shall be adjusted in a manner
such that total value of ESOS remains the same after the
corporate action.
(ii) For this purpose global best practices in this area including the
procedures followed by the derivatives markets in India and
abroad shall be considered.
(iii) The vesting period and the life of the options shall be left
unaltered as far as possible to protect the rights of option holders.
(g) the grant, vest and exercise of option in case of employees who
are on long leave; and
(h) the procedure for cashless exercise of options.
(v) Check that suitable policies and systems have been framed by the
compensation committee to ensure that there is no violation of the
following by any employee
(a) Securities and Exchange Board of India (Insider Trading)
Regulations, 1992; and
(b) Securities and Exchange Board of India (Prohibition of Fraudulent
and Unfair Trade Practices Relating to the Securities Market)
Regulations, 1995.
3. Shareholders Approval
(i) Check that the approval of shareholders of the company has been
obtained by passing a special resolution in general meeting.
(ii) Check that the explanatory statement to the notice and the resolution
proposed to be passed in general meeting for scheme containing the
following information has also been sent:
(a) the total number of options to be granted;
(b) identification of classes of employees entitled to participate in the
scheme;
(c) requirements of vesting and period of vesting;
(d) maximum period within which the option shall be vested;
(e) exercise price or pricing formula;
(f) exercise period and process of exercise;
(g) the appraisal process for determining the eligibility of employees to
the scheme;
(h) maximum number of options to be issued per employee and in
aggregate;
(i) a statement to the effect that the company shall conform to the
accounting policies specified by SEBI in regard to ESOS;
30
(j) the method which the company uses to value its options, i.e., whether
fair value or intrinsic value.
(k) in case the company calculates the employees compensation cost
using the intrinsic value of the stock options, the difference between
the employees compensation cost so computed and employee
compensation cost that shall have been recognized, if it had used
the fair value of the options, shall be disclosed in the directors
report and also the impact of this difference on profits and on EPS
of the company shall be disclosed in directors report.
(iii) Check that approval of shareholders by way of a separate resolution in
the general meeting has been obtained by company in case of
(a) grant of option to employees of subsidiary or holding company and,
(b) grant of option to identified employees, during any one year, equal
to or exceeding 1% of the issued capital (excluding outstanding
warrants and conversions) of the company at the time of grant of
option.
4. Variation of Terms of ESOS
(i) Check that the company does not vary the terms of the Scheme in any
manner which may be detrimental to the interests of the employees.
(ii) However, if such variation is not prejudicial to the interests of the option
holders, Check that the company has passed a special resolution in a
general meeting to vary the terms of scheme.
(iii) the provisions of clause 3(iii) as above shall apply to such variation of
terms as they apply to the original grant of option.
(iv) Check that the notice for passing special resolution for variation of
terms of ESOS has been sent.
(v) Check that the notice discloses full details of the variation, the rationale
therefor and the details of the employees who are beneficiary of such
variation.
(vi) The companies have been given an option to reprice the options which
are not exercised if ESOSs were rendered unattractive due to fall in the
price of shares in the market. The company must ensure that such repricing
should not be detrimental to the interest of employees and
approval of shareholders in General Meeting has been obtained for such
pricing.
5. Pricing
The companies granting option to its employees pursuant to the scheme
have the freedom to determine the exercise price subject to adherence to
the accounting policies. In case the company calculates the employee
compensation cost using the intrinsic value of the stock options, the
difference between the employee compensation cost so computed and the
31
employee compensation cost that shall have been recognized if it had used
the fair value of the options, is required to be disclosed in the Directors
Report and also the impact of this difference on profits and on Earnings per
Share of the company shall also be disclosed in the Directors Report.
6. Lock-in-Period and Rights of the Option-holder
(i) Check that there exists a minimum period of one year between the
grant of options and vesting of option.
Also ensure that, in a case where options are granted by a company
under an ESOS in lieu of options held by the same person under an
ESOS in another company which has merged or amalgamated with the
first mentioned company, the period during which the options granted
by the transferor company were held by him shall be adjusted against
the minimum vesting period required under this clause.
(ii) The company has the freedom to specify the lock-in-period for the shares
issued pursuant to exercise of option.
(iii) Check that the employee does not have the right to receive any dividend
or to vote or in any manner enjoys the benefits of a shareholder in
respect of option granted to him, till shares are issued on exercise of
option.
7. Consequence of Failure to Exercise Option
(i) Check that amount payable by the employee, if any, at the time of
grant of option has been forfeited by the company if the option is not
exercised by the employee within the exercise period; or
(ii) Check that the amount has been refunded to the employee if the option
is not vested due to non-fulfilment of condition relating to vesting of
option as per the Scheme.
8. Non-Transferability of Option
(i) Check that option granted to an employee is not transferable to any
person.
(ii) (a) No person other than the employee to whom the option is granted
shall be entitled to exercise the option.
(b) Under the cashless system of exercise, the company may itself
fund or permit the empanelled stock brokers to fund the payment of
exercise price which shall be adjusted against the sale proceeds of
some or all the shares, subject to the provisions of the Companies
Act, 1956.
(iii) Check that the option granted to the employee is not pledged,
hypothecated, mortgaged or otherwise alienated in any other manner.
(iv) Check that in the event of the death of employee while in employment,
all the options granted to him till such date are vested in the legal heirs
or nominees of the deceased employee.
32
(v) Check that in case the employee suffers a permanent incapacity while
in employment, all the option granted to him as on the date of permanent
incapacitation, shall vest in him on that day.
(vi) Check that if an employee resigns or is terminated, all options not vested
as on that day expire. However, the employee shall, subject to the
terms and conditions formulated by compensation committee, be entitled
to retain all the vested options.
(vii) Check that, the options granted to a director, who is an employee of an
institution and has been nominated by the said institution, has not been
renounced in favour of institution nominating him.
9. Disclosure in the Directors Report
1. Check that the Board of Directors disclose either in the Directors Report
or in the Annexure to the Directors Report, the following details of the
Scheme:
(a) options granted;
(b) the pricing formula;
(c) options vested;
(d) options exercised;
(e) the total number of shares arising as a result of exercise of option;
(f) options lapsed;
(g) variation of terms of options;
(h) money realized by exercise of options;
(i) total number of options in force;
(j) employee-wise details of options granted to
(i) senior managerial personnel;
(ii) any other employee who receives a grant in any one year of
option amounting to 5% or more of option granted during that
year;
(iii) identified employees who were granted option, during any one
year, equal to or exceeding 1% of the issued capital (excluding
outstanding warrants and conversions) of the company at the
time of grant;
(k) diluted Earnings Per Share (EPS) pursuant to issue of shares on
exercise of option calculated in accordance with International
Accounting Standard (IAS) 33.
(l) Where the company has calculated the employee compensation
cost using the intrinsic value of the stock options, the difference
33
between the employee compensation cost so computed and the
employee compensation cost that shall have been recognized if it
had used the fair value of the options, shall be disclosed. The impact
of this difference on profits and on EPS of the company shall also
be disclosed.
(m) Weighted-average exercise prices and weighted-average fair values
of options shall be disclosed separately for options whose exercise
price either equals or exceeds or is less than the market price of
the stock.
(n) A description of the method and significant assumptions used during
the year to estimate the fair values of options, including the following
weighted average information:
(1) risk-free interest rate,
(2) expected life,
(3) expected volatility,
(4) expected dividends, and
(5) the price of the underlying share in market at the time of option
grant.
2. Ensure that until all options granted in the three years prior to the IPO
have been exercised or have lapsed, disclosures are made either in the
Directors Report or in an Annexure thereto of the information specified
above in respect of such options also.
3. Ensure that until all options granted in the three years prior to the IPO
have been exercised or have lapsed, disclosure are made either in the
Directors Report or in an Annexure thereto of the impact on the profits
and on the EPS of the company if the company had followed the
accounting policies specified under clause 13 of these guidelines in
respect of such options.
10. Accounting Policies
Check that the company which has passed a resolution for the scheme
complies wit the accounting policies specified by SEBI in regard to the
Scheme under Schedule I of the SEBI (Employee Stock Option Scheme
and Employee Stock Purchase Scheme) Guidelines, 1999.
11. Certificate from Auditors
Check that the Board of Directors of company present before the shareholders
at each AGM, a certificate from the auditors of the company that the Scheme
has been implemented in conformity with these guidelines and in accordance
with the resolution of the company in the general meeting.
(b) Employees Stock Purchase Scheme (ESPS)
1. Eligibility to Participate in the Scheme
(i) An employee eligible to participate in the scheme should be:
(a) a permanent employee of the company working in India or out of
India; or
34
(b) a director of the company, whether a whole time director or not;
(c) an employee as defined in sub-clauses (a) or (b) of a subsidiary, in
India or out of India, or of a holding company of the company.
(ii) Check that the employee is not a promoter nor belongs to the promoter
group.
(iii) Ensure that a director who either by himself or through his relatives or
through any body corporate, directly or indirectly holds more than 10%
of the outstanding equity shares of the company is not participating, as
he is not eligible to participate in the scheme.
2. Shareholder Approval
(i) Check that the Scheme has been approved by the shareholders by
passing a special resolution in the meeting of the general body of
shareholders.
(ii) Check that the explanatory statement to the notice has been sent to
the shareholders and it specifies
(a) the price of the shares and also the number of shares to be offered
to each employee;
(b) the appraisal for determining the eligibility of employee for the
scheme;
(c) total number of shares to be issued.
(iii) The number of shares offered may be different for different categories
of employees.
(iv) Check that special resolution states that the company shall conform to
the accounting policies as specified in Schedule II of the SEBI (Employee
Stock Option Scheme and Stock Purchase Scheme) Guidelines, 1999.
(v) Check that approval of shareholders have been obtained by way of
separate resolution in the general meeting in case of
(a) allotment of shares to employees of subsidiary or holding company
and;
(b) allotment of shares to identified employees, during any one year,
equal to or exceeding 1% of the issued capital (excluding outstanding
warrants and conversions) of the company at the time of allotment
of shares.
3. Pricing and Lock-in-period
(i) The company has the freedom to determine price of shares to be issued
under an ESPS, provided they comply with the accounting policies
specified.
(ii) Check that the shares issued under an ESPS are subject to lock-in for
a minimum period of one year from the date of allotment.
35
Also ensure that in a case where shares are allotted by a company
under a ESPS in lieu of shares acquired by the same person under an
ESPS in another company which has merged or amalgamated with the
first mentioned company, the lock-in-period already undergone in respect
of shares of the transferor company shall be adjusted against the lockin
required under this clause.
(iii) If the scheme is part of a public issue and the shares are issued to
employees at the same price as in the public issue, the shares issued
to employees under the scheme are not subject to any lock-in-period.
4. Disclosure and Accounting Policies
(i) Check that the Directors Report or Annexure thereto shall contain, inter
alia, the following disclosures:
(a) the details of the number of shares issued in the scheme;
(b) the price at which such shares are issued;
(c) employee-wise details of the shares issued to:
(i) senior managerial personnel;
(ii) any other employee who is issued shares in any one year
amounting to 5% or more shares issued during that year;
(iii) identified employees who were issued shares during any one
year equal to or exceeding 1% of the issued capital of the
company at the time of issuance;
(d) diluted Earning Per Share (EPS) pursuant to issuance of shares
under the scheme; and
(e) consideration received against the issuance of shares.
(ii) Check that every company that has passed a resolution for the scheme
complies with the accounting policies as specified in Schedule II to the
SEBI (Employee Stock Option Scheme and Employee Stock Purchase)
Guidelines, 1999.
5. Preferential Allotment
Nothing in these guidelines shall apply to shares issued to employees in
compliance with the Securities and Exchange Board of India Guidelines on
Preferential Allotment.
6. Listing
(i) The shares arising pursuant to an ESOS and shares issued under an
ESPS are required to be listed immediately upon exercise in any
recognized stock exchange where the securities of the company are
listed subject to compliance of the following:
(a) The ESOS/ESPS is in accordance with these Guidelines.
36
(b) In case of an ESOS the company has also filed with the concerned
stock exchanges, before the exercise of option, a statement as per
Schedule V and has obtained in-principle approval from such Stock
Exchanges.
(c) As and when ESOS/ESPS are exercised the company has notified
the concerned Stock Exchanges as per the statement as per
Schedule VI.
(ii) (a) Ensure that the shares arising after the IPO, out of options granted
under any ESOS framed prior to its IPO is being listed immediately
upon exercise in all the recognised stock exchanges where the
equity shares of the company are listed subject to compliance with
clause 15.3 (i.e. options outstanding at IPO) and, where applicable,
clause 22.2A (conditions for fresh grant of options prior to IPO).
(b) Ensure that any fresh grant of options under any ESOS framed
prior to its IPO and prior to the listing of its equity shares is
(i) in conformity with these guidelines; and
(ii) such pre-IPO scheme is ratified by its shareholders in general
meeting subsequent to the IPO. However such ratification may be
done any time prior to grant of new options under such pre-IPO
scheme.
(c) Ensure that no change shall be made in the terms of options issued
under such pre-IPO schemes, whether by repricing, change in
vesting period or maturity or otherwise, unless prior approval of the
shareholders is taken for such change. However, nothing in this
sub-clause shall apply to any adjustments for corporate actions
made in accordance with these guidelines.
(iii) For listing of shares issued pursuant to ESOS or ESPS the company is
required obtain the in-principle approval from Stock Exchanges where it
proposes to list the said shares.
(iv) The listed companies is required to file the ESOS or ESPS Schemes
through EDIFAR filing.
(v) When holding company issues ESOS/ESPS to the employee of its
subsidiary, the cost incurred by the holding company for issuing such
options/shares is required to be disclosed in the notes to accounts of
the financial statements of the subsidiary company.
In a case falling under above clause, if the subsidiary reimburses the
cost incurred by the holding company in granting options to the employees
of the subsidiary, both the subsidiary as well as the holding company
shall disclose the payment or receipt, as the case may be, in the notes
to accounts to their financial statements.
(vi) The company shall appoint a registered Merchant Banker for the
implementation of ESOS and ESPS as per these guidelines till the
37
stage of framing the ESOS/ESPS and obtaining in-principal approval
from the stock exchanges in accordance with these Guidelines.
7. ESOS/ESPS Through Trust Route
In case of ESOS/ESPS administered through a Trust, the accounts of the
company shall be prepared as if the company itself is administering the
ESOS/ESPS.
III-C DUE DILIGENCE- BONUS ISSUE
Checklist for issue of Bonus shares
Ensure that is authorised by its articles of association for issue of bonus shares,
capitalisation of reserves, etc.: If there is no such provision in the articles of
association, the issuer shall pass a resolution at its general body meeting making
provisions in the articles of associations for capitalisation of reserve;
Ensure that issuer has not defaulted in payment of interest or principal in
respect of fixed deposits or debt securities issued by it;
Ensure that the issuer has sufficient reason to believe that it has not defaulted
in respect of the payment of statutory dues of the employees such as contribution
to provident fund, gratuity and bonus;
Ensure that the partly paid shares, if any outstanding on the date of allotment,
are made fully paid up;
It may be noted that no issuer shall make a bonus issue of equity shares if it
has outstanding fully or partly convertible debt instruments at the time of making
the bonus issue, unless it has made reservation of equity shares of the same
class in favour of the holders of such outstanding convertible debt instruments
in proportion to the convertible part thereof;
The equity shares reserved for the holders of fully or partly convertible debt
instruments shall be issued at the time of conversion of such convertible debt
instruments on the same terms or same proportion on which the bonus shares
were issued.
The bonus issue shall be made out of free reserves built out of the genuine
profits or securities premium collected in cash only and reserves created by
revaluation of fixed assets shall not be capitalised for the purpose of issuing
bonus shares.
The bonus share shall not be issued in lieu of dividend.
An issuer, announcing a bonus issue after the approval of its board of directors
and not requiring shareholders approval for capitalisation of profits or reserves
for making the bonus issue, shall implement the bonus issue within fifteen days
from the date of approval of the issue by its board of directors:However, where
the issuer is required to seek shareholders approval for capitalisation of profits
or reserves for making the bonus issue, the bonus issue shall be implemented
within two months from the date of the meeting of its board of directors wherein
the decision to announce the bonus issue was taken subject to shareholders
approval.
38
Once the decision to make a bonus issue is announced, the issue can not be
withdrawn.
III-D. DUE DILIGENCE- RIGHTS ISSUE
1. Record Date
Ensure that the record date has been announced for the purpose of determining the
shareholders eligible to apply for specified securities in the proposed rights issue. It may be
noted that the issuer shall not withdraw rights issue after announcement of the record date.
If the issuer withdraws the rights issue after announcing the record date, it shall not make
an application for listing of any of its specified securities on any recognised stock exchange
for a period of twelve months from the record date announced. However, the issuer may
seek listing of its equity shares allotted pursuant to conversion or exchange of convertible
securities issued prior to the announcement of the record date, on the recognised stock
exchange where its securities are listed.

2. Restriction on rights issue
No issuer shall make a rights issue of equity shares if it has outstanding fully or partly
convertible debt instruments at the time of making rights issue, unless it has made
reservation of equity shares of the same class in favour of the holders of such outstanding
convertible debt instruments in proportion to the convertible part thereof. The equity shares
reserved for the holders of fully or partially convertible debt instruments shall be issued at
the time of conversion of such convertible debt instruments on the same terms on which the
equity shares offered in the rights issue were issued.

3. Letter of offer, abridged letter of offer
The abridged letter of offer, along with application form, shall be dispatched through
registered post or speed post to all the existing shareholders at least three days before the
date of opening of the issue. The letter of offer shall be given by the issuer or lead merchant
banker to any existing shareholder who
has made a request in this regard. The shareholders who have not received the application
form may apply in writing on a plain paper, along with the requisite application money. The
shareholders making application otherwise than on the application form shall not renounce
their rights and shall not utilise the application form for any purpose including renunciation
even if it is received subsequently. If any shareholder makes an application on application
form as well as on plain paper, the application is liable to be rejected.
4. Pricing
The issue price shall be decided before determining the record date which shall be
determined in consultation with the designated stock exchange.
5. Period of subscription
A rights issue shall be open for subscription for a minimum period of fifteen days and for a
maximum period of thirty days.

6. Pre-Issue Advertisement for rights issue.
The issuer shall issue an advertisement for rights issue disclosing the following:
(a) the date of completion of despatch of abridged letter of offer and the application form;
(b) the centres other than registered office of the issuer where the shareholders
or the persons entitled to receive the rights entitlements may obtain duplicate
copies of the application forms in case they do not receive the application
form within a reasonable time after opening of the rights issue;

7. Obligation of issuer/intermediaries
The obligation of issuer/intermediaries for a rights issuer, with respect to advertisement,
appointment of compliance offier, redressal of investor grievances, due diligence, post issue
reports, post issue advertisements etc is same as the public issue.

III- QUALIFIED INSTITUIONS PLACEMENT
1. Conditions for qualified institutions placement Ensure to satisfy the following conditions
conditions:
(a) a special resolution approving the qualified institutions placement has been passed by its
shareholders;
(b) the equity shares of the same class, which are proposed to be allotted through qualified
institutions placement or pursuant to conversion or exchange of eligible securities offered
through qualified institutions placement, have been listed on a recognised stock exchange
having nation wide trading terminal for a period of at least one year prior to the date of
issuance of notice to its shareholders for convening the meeting to pass the special
resolution:
However, where an issuer, being a transferee company in a scheme of merger, de-merger,
amalgamation or arrangement sanctioned by a High Court under sections 391 to 394 of the
Companies Act, 1956, makes qualified institutions placement, the period for which the
equity shares of the same class of the transferor company were listed on a stock exchange
having nation wide trading terminals shall also be considered for the purpose of
computation of the period of one year.
(c) it is in compliance with the requirement of minimum public shareholding specified in the
listing agreement with the stock exchange;
(d) in the special resolution, it shall be, among other relevant matters, specified that the
allotment is proposed to be made through qualified institutions placement and the relevant
date.
relevant date means:
(i) in case of allotment of equity shares, the date of the meeting in which the board of
directors of the issuer or the committee of directors duly authorised by the board of
directors of the issuer decides to open the proposed issue;
(ii) in case of allotment of eligible convertible securities, either the date of the meeting in
which the board of directors of the issuer or the committee of directors duly authorised by
the board of directors of the issuer decides to open the issue of such convertible securities
or the date on which the holders of such convertible securities become entitled to apply for
the equity shares.
2. Appointment of merchant banker
A qualified institutions placement shall be managed by merchant banker(s)
registered with the Board who shall exercise due diligence.
3. In-principle approval, due diligence certificate etc.
The merchant banker shall, while seeking in-principle approval for listing of the
eligible securities issued under qualified institutions placement, furnish to each
stock exchange on which the same class of equity shares of the issuer are
listed, a due diligence certificate stating that the eligible securities are being
issued under qualified institutions placement and that the issuer complies with
requirements under SEBI(ICDR)Regulations.
4. Placement Document
The qualified institutions placement shall be made on the basis of a placement
document which shall contain all specified material information.
The placement document shall be serially numbered and copies shall be circulated
only to select investors.
The issuer shall, while seeking in-principle approval from the recognised stock
exchange, furnish a copy of the placement document, a certificate confirming
compliance with the provisions of this Chapter along with any other documents
required by the stock exchange.
The placement document shall also be placed on the website of the concerned
stock exchange and of the issuer with a disclaimer to the effect that it is in
connection with a qualified institutions placement and that no offer is being
made to the public or to any other category of investors.
A copy of the placement document shall be filed with the Board for its record
within thirty days of the allotment of eligible securities.
5. Pricing
The qualified institutions placement shall be made at a price not less than the
average of the weekly high and low of the closing prices of the equity shares of
the same class quoted on the stock exchange during the two weeks preceding
the relevant date.
If eligible securities are convertible into or exchangeable with equity shares of
the issuer, the issuer shall determine the price of such equity shares allotted
Supplement to DD & CCM 41
pursuant to such conversion or exchange taking the relevant date as decided
and disclosed by it while passing the special resolution.
The issuer shall not allot partly paid up eligible securities. However, in case of
allotment of non convertible debt instruments along with warrants, the allottees
may pay the full consideration or part thereof payable with respect to warrants,
at the time of allotment of such warrants.In case of allotment of equity shares
on exercise of options attached to warrants, such equity shares shall be fully
paid up.
The prices determined for qualified institutions placement shall be subject to
appropriate adjustments if the issuer:
(a) makes an issue of equity shares by way of capitalization of profits or
reserves, other than by way of a dividend on shares;
(b) makes a rights issue of equity shares;
(c) consolidates its outstanding equity shares into a smaller number of shares;
(d) divides its outstanding equity shares including by way of stock split;
(e) re-classifies any of its equity shares into other securities of the issuer;
(f) is involved in such other similar events or circumstances, which in the
opinion of the concerned stock exchange, requires adjustments.
6. Restrictions on allotment.
Allotment under the qualified institutions placement shall be made subject
to the following conditions:
(a) Minimum of ten per cent. of eligible securities shall be allotted to mutual
funds:
If the mutual funds do not subscribe to said minimum percentage or
any part thereof, such minimum portion or part thereof may be allotted
to other qualified institutional buyers;
(b) No allotment shall be made, either directly or indirectly, to any qualified
institutional buyer who is a promoter or any person related to promoters
of the issuer:
If a qualified institutional buyer who does not hold any shares in the
issuer and who has acquired the said rights in the capacity of a lender
shall not be deemed to be a person related to promoters.
In a qualified institutions placement of non-convertible debt instrument along
with warrants, an investor can subscribe to the combined offering of nonconvertible
debt instruments with warrants or to the individual securities,
that is, either non- convertible debt instruments or warrants.
The applicants in qualified institutions placement shall not withdraw their
bids after the closure of the issue.
42
7. Minimum number of allottees
The minimum number of allottees for each placement of eligible securities made
under qualified institutions placement shall not be less than:
(a) two, where the issue size is less than or equal to two hundred and fifty crore
rupees;
(b) five, where the issue size is greater than two hundred and fifty crore rupees:
Provided that no single allottee shall be allotted more than fifty per cent. of
the issue size.
(2) The qualified institutional buyers belonging to the same group or who are
under same control shall be deemed to be a single allottee.
8. Validity of the special resolution
Allotment pursuant to the special resolution shall be completed within a period
of twelve months from the date of passing of the resolution.
The issuer shall not make subsequent qualified institutions placement until expiry
of six monthsfrom the date of the prior qualified institutions placement made
pursuant to one or more special resolutions.
9. Restrictions on amount raised.
The aggregate of the proposed qualified institutions placement and all previous
qualified institutions placements made by the issuer in the same financial year
shall not exceed five times the net worth of the issuer as per the audited balance
sheet of the previous financial year.
10. Tenure.
The tenure of the convertible or exchangeable eligible securities issued through
qualified institutions placement shall not exceed sixty months from the date of
allotment.
11. Transferability of eligible securities
The eligible securities allotted under qualified institutions placement shall not
be sold by the allottee for a period of one year from the date of allotment,
except on a recognised stock exchan

DUE DILIGENCE ISSUE OF DEBT INSTRUMENTS
SEBI (ICDR) Regulations, 2009 specified securities means equity shares and convertible
securities;
convertible security means a security which is convertible into or exchangeable with
equity shares of the issuer at a later date, with or without the option of the holder of the
security and includes convertible debt instrument and convertible preference shares; Thus,
the conditions specified under Chapter II regarding Due Diligence Equity shares is equally
applicable to public issue of convertible debt instruments also. Additionally, the issuer of
debt instruments has to comply with the following.
In addition to other requirements laid down in these regulations, an issuer making a public
issue or rights issue of convertible debt instruments shall comply with the following
conditions
(a) it has obtained credit rating from one or more credit rating agencies;
(b) it has appointed one or more debenture trustees in accordance with the provisions
of section 117B of the Companies Act, 1956 and Securities and Exchange
Board of India (Debenture Trustees) Regulations, 1993;
(c) it has created debenture redemption reserve in accordance with the provisions of section
117C of the Companies Act, 1956;
(d) if the issuer proposes to create a charge or security on its assets in respect of secured
convertible debt instruments, it shall ensure that:
(i) such assets are sufficient to discharge the principal amount at all times; (ii) such assets are
free from any encumbrance;
(iii) where security is already created on such assets in favour of financial institutions or
banks or the issue of convertible debt instruments is proposed to be secured by creation of
security on a leasehold land, the consent of such financial institution, bank or lessor for a
second or paripassu charge has been obtained and submitted to the debenture trustee
before the opening of the issue;
(iv) the security/asset cover shall be arrived at after reduction of the liabilities
having a first/prior charge, in case the convertible debt instruments are
secured by a second or subsequent charge.
The issuer shall redeem the convertible debt instruments in terms of the offer document.



Chapter VIII SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009
makes regulations for Indian Depository Receipts.


Definitions some Important definations of the ICDR (section2)
(1) In these regulations, unless the context otherwise requires:

(a) Act means the Securities and Exchange Board of India Act, 1992 (15 of 1992)

(b) advertisement includes notices, brochures, pamphlets, show cards, catalogues,
hoardings, placards, posters, insertions in newspaper, cover pages of offer documents,
pictures and films in any print media or electronic media, radio, television programme

(c) anchor investor" means a qualified institutional buyer who makes an application for a
value of ten crore rupees or more in a public issue made through the book building process
in accordance with these regulations;

(d) Application Supported by Blocked Amount (ASBA) means an application for subscribing
to a public issue or rights issue, along with an authorisation to Self Certified Syndicate Bank
to block the application money in a bank account

(e) Board means the Securities and Exchange Board of India established under section 3
of the Act

(f) book building means a process undertaken to elicit demand and to assess the price for
determination of the quantum or value of specified securities or Indian Depository
Receipts, as the case may be, in accordance with these regulations;

(g) book runner means a merchant banker appointed by the issuer to undertake the book
building process;

(h) composite issue means an issue of specified securities by a listed issuer on publiccum-
rights basis, wherein the allotment in both public issue and rights issue is proposed
to be made simultaneously

(i) control shall have the same meaning as assigned to it under clause (c) of sub-regulation
(1) of regulation 2 of the Securities and Exchange Board of India (Substantial Acquisitions of
Shares and Takeovers) Regulations, 1997;

(j) convertible debt instrument means an instrument which creates or acknowledges
indebtedness and is convertible into equity shares of the issuer at a later date at or without
the option of the holder of the instrument, whether constituting a charge on the assets of
the issuer or not

(k) convertible security means a security which is convertible into or exchangeable with
equity shares of the issuer at a later date, with or without the option of the holder of the
security and includes convertible debt instrument and convertible preference shares;

(L) designated stock exchange means a recognised stock exchange in which securities of
an issuer are listed or proposed to be listed and which is chosen by the issuer as a
designated stock exchange for the purpose of a particular issue of specified securities under
these regulations: Provided that where one or more of such stock exchanges have
nationwide trading terminals, the issuer shall choose one of them as the designated stock
exchange: Provided further that subject to the provisions of this clause, the issuer may
choose a different recognised stock exchange as a designated stock exchange for any
subsequent issue of specified securities under these regulations;

(m) employee means a permanent and full-time employee, working in India or abroad, of
the issuer or of the holding company or subsidiary company or of that material associate(s)
of the issuer whose financial statements are consolidated with the issuers financial
statements as per Accounting Standard 21, or a director of the issuer, whether whole time or
part time and does not include promoters and an immediate relative of the promoter (i.e.,
any spouse of that person, or any parent, brother, sister or child of that person or of the
spouse);

(n) further public offer means an offer of specified securities by a listed issuer to the public
for subscription and includes an offer for sale of specified securities to the public by any
existing holders of such securities in a listed issuer

(o) green shoe option means an option of allotting equity shares in excess of the equity
shares offered in the public issue as a post-listing price stabilizing mechanism

(p) initial public offer means an offer of specified securities by an unlisted issuer to the
public for subscription and includes an offer for sale of specified securities to the public by
any existing holders of such securities in an unlisted issuer

(q) issue size includes offer through offer document and promoters contribution;

(r) issuer means any person making an offer of specified securities;

(s) key management personnel means the officers vested with executive powers and the
officers at the level immediately below the board of directors of the issuer and includes any
other person whom the issuer may declare as a key management personnel

(t) listed issuer means an issuer whose equity shares are listed in a recognised stock
exchange;

(u) net offer to public means an offer of specified securities to the public but does not
include reservations
;
(v) net worth means the aggregate of the paid up share capital, share premium account,
and reserves and surplus (excluding revaluation reserve) as reduced by the aggregate of
miscellaneous expenditure (to the extent not adjusted or written off) and the debit balance
of the profit and loss account;

(w) non institutional investor means an investor other than a retail individual investor and
qualified institutional buyer

(x) offer document means a red herring prospectus, prospectus or shelf prospectus and
information memorandum in terms of section 60A of the Companies Act, 1956 in case of a
public issue and letter of offer in case of a rights issue

(y) "offer through offer document means net offer to public and reservations

(z) preferential issue means an issue of specified securities by a listed issuer to any select
person or group of persons on a private placement basis and does not include an offer of
specified securities made through a public issue, rights issue, bonus issue, employee stock
option scheme, employee stock purchase scheme or qualified institutions placement or an
issue of sweat equity shares or depository receipts issued in a country outside India or
foreign securities;

(za) promoter includes:
(i) the person or persons who are in control of the issuer;
(ii) the person or persons who are instrumental in the formulation of a plan or programme
pursuant to which specified securities are offered to public;
(iii) the person or persons named in the offer document as promoters
Provided that a director or officer of the issuer or a person, if acting as such merely in his
professional capacity, shall not be deemed as a promoter:
Provided further that a financial institution, scheduled bank, foreign institutional investor
and mutual fund shall not be deemed to be a promoter merely by virtue of the fact that ten
per cent. or more of the equity share capital of the issuer is held by such person;
Provided further that such financial institution, scheduled bank and foreign institutional
investor shall be treated as promoter for the subsidiaries or companies promoted by them or
for the mutual fund sponsored by them

(zb) promoter group includes:
(i) the promoter;
(ii) an immediate relative of the promoter (i.e., any spouse of that person, or any parent,
brother, sister or child of the person or of the spouse); and
(iii) in case promoter is a body corporate:
(A) a subsidiary or holding company of such body corporate;
(B) any body corporate in which the promoter holds ten per cent. or more of the equity
share capital or which holds ten percentor more of the equity share capital of the promoter;
(C) anybody corporate in which a group of individuals or companies or combinations thereof
which hold twenty per cent. or more of the equity share capital in that body corporate also
holds twenty per cent. or more of the equity share capital of the issuer; and
(iv) in case the promoter is an individual:
(A) anybody corporate in which ten per cent. or more of the equity share capital is held by
the promoter or an immediate relative of the promoter or a firm or Hindu Undivided Family
in which the promoter or any one or more of his immediate relative is a member;
(B) any body corporate in which a body corporate as provided in (A) above holds ten per
cent. or more, of the equity share capital;
(C) any Hindu Undivided Family or firm in which the aggregate shareholding of the promoter
and his immediate relatives is equal to or more than ten per cent. of the total; and
(v) all persons whose shareholding is aggregated for the purpose of disclosing in the
prospectus under the heading "shareholding of the promoter group": Provided that a
financial institution, scheduled bank, foreign institutional investor and mutual fund shall not
be deemed to be promoter group merely by virtue of the fact that ten per cent. or more of
the equity share capital of the issuer is held by such person: Provided further that such
financial institution, scheduled bank and foreign institutional investor shall be treated as
promoter group for the subsidiaries or companies promoted by them or for the mutual fund
sponsored by them

(zc) public issue means an initial public offer or further public offer

(zd) qualified institutional buyer means:
(i) a mutual fund, venture capital fund and foreign venture capital investor registered with
the Board;
(ii) a foreign institutional investor and sub-account (other than a sub-account which is a
foreign corporate or foreign individual), registered with the Board;
(iii) a public financial institution as defined in section 4A of the Companies Act, 1956;
(iv) a scheduled commercial bank;
(v) a multilateral and bilateral development financial institution;
(vi) a state industrial development corporation;
(vii) an insurance company registered with the Insurance Regulatory and Development
Authority;
(viii)a provident fund with minimum corpus of twenty five crore rupees;
(ix) a pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by resolution no. F. No. 2/3/2005-DDII dated
November 23, 2005 of the Government of India published in the Gazette of India;
(xi) insurance funds set up and managed by army, navy or air force of the Union of India

(ze) retail individual investor means an investor who applies or bids for specified securities
for a value of not more than one lakh rupees;

(zf) retail individual shareholder means a shareholder of a listed issuer, who:
(i) as on the date fixed for the purpose of determining shareholders eligible for reservation in
terms of 5[regulation 42] of these regulations, is holding equity shares which, on the basis of
the closing price of the equity shares on the
(ii) applies or bids for specified securities for a value of not more than one lakh rupees

(zg) rights issue means an offer of specified securities by a listed issuer to the shareholders
of the issuer as on the record date fixed for the said purpose

(zh) Schedule means schedule annexed to these regulations

(zi) Self Certified Syndicate Bank means a banker to an issue registered with the Board,
which offers the facility of Application Supported by Blocked Amount

(zj) specified securities" means equity shares and convertible securities

(zk) stabilising agent means a merchant banker who is responsible for stabilising the price
of equity shares under a green shoe option, in terms of these regulations;

(zl) syndicate member means an intermediary registered with the Board and who is
permitted to carry on the activity as an underwriter;

(zm) unlisted issuer means an issuer which is not a listed issuer.
(2) All other words and expressions used but not defined in these regulations, but defined in
the
Act or the Companies Act, 1956, the Securities Contracts (Regulation) Act, 1956, the
Depositories
Act, 1996 and/or the rules and regulations made thereunder shall have the same meaning as
respectively assigned to them in such Acts or rules or regulations or any statutory
modification or
re-enactment thereto, as the case may be.


BOOK BUILDING:
Book building means a process undertaken by which a demand for securities proposed to be
issued by a body corporate is elicited and built up and price for securities is assessed on the
basis of the bids obtained on the quantum of securities offered for subscription by the
issuer. This method provides an opportunity for the market to discover the price of
securities. It is a common practice used in most developed countries for marketing a public
offer of equity shares of a company. However, book building is a transparent and flexible
price discovery method of initial public offerings (IPOs) in which price of securities is fixed by
the issuer company along with the Book Running Lead Manager (BRLM) on the basis of
feedback received from investors as well as market intermediaries during a certain period.
Book Building is basically a capital issuance process used in Initial Public Offer (IPO)
which aids price and demand discovery. It is a process used for marketing a public offer of
equity shares of a company. It is a mechanism where, during the period for which the book
for the IPO is open, bids are collected from investors at various prices, which are above or
equal to the floor price. The process aims at tapping both wholesale and retail investors.
The offer/issue price is then determined after the bid closing date based on certain
evaluation criteria.
The Process of book building involves the following
The Issuer who is planning an IPO nominates a lead merchant banker as a 'book
runner'.
The Issuer specifies the number of securities to be issued and the price band for
orders.
The Issuer also appoints syndicate members with whom orders can be placed by the
investors.
Investors place their order with a syndicate member who inputs the orders into the
'electronic book'. This process is called 'bidding' and is similar to open auction.
A Book should remain open for a minimum of 5 days.
Bids cannot be entered less than the floor price.
Bids can be revised by the bidder before the issue closes.
On the close of the book building period the 'book runner evaluates the bids on the
basis of the evaluation criteria which may include -
a. Price Aggression
b. Investor quality
c. Earliness of bids, etc.
The book runner and the company conclude the final price at which it is willing to
issue the stock and allocation of securities.
Generally, the number of shares are fixed, the issue size gets frozen based on the
price per share discovered through the book building process.
Allocation of securities is made to the successful bidders.
Book Building is a good concept and represents a capital market which is in the
process of maturing.
Minimum number of days for which an IPO subscription list has to remain open:
. Except as otherwise provided in the SEBI ICDR Regulations 2009, public issue shall be
kept open for at least three working days but not more than ten working days including
the days for which the issue is kept open in case of revision in price band.

In case the price band in a public issue made through the book building process is
revised, the bidding (issue) period disclosed in the red herring prospectus shall be
extended for a minimum period of three working days, provided that the total bidding
period shall not exceed ten working days.

The public issue made by an infrastructure company, satisfying the requirements in
Clause 2.4.1 (iii) of Chapter II may be kept open for a maximum period of 21 working
days.
Allocation:In a book built issue, allocation to Retail Individual Investors (RIIs), Non
Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of
35:15: 50 respectively. In case the book built issues are made pursuant to the
requirement of mandatory allocation of 60% to QIBs in terms of Rule 19(2) (b) of SCRR,
the respective figures are 30:10:60.


Retail Individual Investors (RIIs)
Retail individual investor means an investor who applies or bids for securities of or for a
value of not more than Rs.1, 00,000.


Non Institutional Investors (NIIs)
All applicants, other than QIBs or individuals applying for less than Rs. 1, 00,000 are
considered as NIIs. Typically, this category includes High Net worth Individuals (HNIs)
and corporate bodies.

Qualified Institutional Buyers (QIBs)
Qualified Institutional Buyers are those institutional investors who are generally perceived
to possess expertise and the financial muscle to evaluate and invest in the capital markets.
In terms of clause 2.2.2B (v) of DIP Guidelines, a Qualified Institutional Buyer shall mean:
A . public financial institution as defined in section 4A of the Companies Act, 1956;
B . scheduled commercial banks;
C . mutual funds;
D . foreign institutional investor registered with SEBI;
E . multilateral and bilateral development financial institutions;
F . venture capital funds registered with SEBI.
G . foreign Venture capital investors registered with SEBI.
H . state Industrial Development Corporations.
I . insurance Companies registered with the Insurance Regulator and Development
Authority(IRDA).
J . provident Funds with minimum corpus of Rs. 25 crores
K . pension Funds with minimum corpus of Rs. 25 crores)
These entities are not required to be registered with SEBI as QIBs. Any entities falling under
the categories specified above are considered as QIBs for the purpose of participating in
primary issuance process.

Pure Auction as an Additional Bookbuilding Mechanism
SEBI has decided to introduce an additional method of book building, to start with, for FPOs,
in which the issuer would decide on a floor price and may mention the floor price in the red
herring prospectus. If the floor price is not mentioned in the red herring prospectus, the
issuer shall announce the floor price at least one working day before opening of the bid in
all the newspapers in which the pre-issue advertisement was released.

Qualified institutional buyers shall bid at any price above the floor price. The bidder who
bids at the highest price shall be allotted the number of securities that he has bided for and
then the bidder who has bided at the second highest price and so on, until all the specified
securities on offer are exhausted. Allotment shall be done on price priority basis for
qualified institutional buyers. Allotment to retail individual investors, non-institutional
investors and employees of the issuer shall be made proportionately as illustrated in
Schedule XI of SEBI ICDR Regulations 2009. Where, however the number of specified
securities bided for at a price is more than available quantity, then allotment shall be done
on proportionate basis. Retail individual investors, non-institutional investors and
employees shall be allotted specified securities at the floor price subject to provisions of
Clause (d) of Regulation 29 of SEBI ICDR Regulations 2009. The issuer may:-
(a) place a cap either in terms of number of specified securities or percentage of issued
capital of the issuer that may be allotted to a single bidder;
(b) decide whether a bidder be allowed to revise the bid upwards or downwards in terms of
price and/or quantity;
(c) decide whether a bidder be allowed single or multiple bids.

GREEN SHOE OPTION:
A Green Shoe option means an option of allocating shares in excess of the shares included in
the public issue and operating a post-listing price stabilizing mechanism for a period not
exceeding 30 days in accordance with the provisions of the issue of capital disclosure
requirements passed by the securities exchange board of India, which is granted to a
company to be exercised through a Stabilizing Agent. This is an arrangement wherein the
issue would be over allotted to the extent of a maximum of 15% of the issue size. From an
investors perspective, an issue with green shoe option provides more probability of getting
shares and also that post listing price may show relatively more stability as compared to
market.


CHARGES
Where immovable property of a person is made security for the payment of money
to another and the transaction is not a mortgage, there is creation of a charge. Charge on an
immovable property is created to secure payment of money. If payment is not made by the
person who is liable for such payment, it is made out of the property charged for this
purpose. Charge is, therefore, created for securing the recovery of some money, e.g.
maintenance allowance from the person whose property is so secured.
Mortgage is also made to secure a certain sum of money but by its very nature
mortgage is different from charge. Mortgage is transfer of interest in favour of mortgagee, it
is therefore transfer of property. Whereas charge does not amount to transfer of any
interest in favour of the charge-holder. The concept is that such charge-holder simply
entitled to recover his money from the property.
CHARGES UNDER THE COMPANIES ACT, 1956
Section 124 of the Companies Act, 1956 provides that for the purpose of registration
under the Act, charges includes mortgage. In the context of advances to companies a
charge may be classified as: (i) fixed charge and (ii) a floating charge.
i. Fixed charge: A charge is fixed when it is made specifically to cover definite and
ascertained assets of permanent nature such as land, building or heavy machinery. A
fixed charge passes legal title to certain specific assets, and the company loses the
right to dispose the property unencumbered, though the company retains
possession of the property. In other words, the creation of fixed charge precludes
the company from selling the property charged without the consent of the charge
holder.
ii. Floating charge: The floating charge is a charge on a class of assets, which may be
present or future, and which changes from time to time in the ordinary course of
business, e.g. stock in trade. The company can deal with property subject to a
floating charge in any manner it likes. There is no need to take permission from the
lender of money for disposing it of or converting it into some other assets. The
governing idea of floating security is to allow a company to carry on its business in
the ordinary course, as if no charge has been created. Thus, the company deals with
its property so charged in any manner it likes until the charge attaches or becomes
fixed or crystallises.
Characteristics of floating charge: The characteristics of floating charges are:
i. It is a charge o a class of assets, present or future,
ii. The class of assets charged is one which in the ordinary course of business is
changing from time to time,
iii. Until some steps are taken to enforce the charge, the company may continue to deal
with the assets charged in the ordinary course of business.
No particular form of words is necessary to create a floating charge. Any word which
show an intention to allow the company to deal with the assets by sale, mortgage, lease,
etc. in the course of its business will create a floating charge. The advantage of such charge
is that the company may continue to deal with the property charged. A floating charge can
be created only by an incorporated body. It is created by a deed and must be registered
with the registrar of companies.
Crystallisation of a floating charge: When the floating charge crystallises it becomes fixed
and the assets comprised therein are subject to the same restrictions as the fixed charge. A
floating charge crystallises and the security becomes fixed in the following cases:
i. When the company goes into liquidation,
ii. When the company ceases to carry on the business,
iii. When the creditors or the debenture holders take steps to enforce this security, e.g.
by appointing receiver to take possession of the property charged,
iv. On the happening of the event specified on the deed.
In the aforesaid circumstances, the floating charge is said to become fixed or
crystallise. Until the charge crystallise or attaches or becomes fixed the company can deal
with the property so charged in any manner it likes. The company may even sell its whole
undertaking if that is otherwise permissible as per the objects specified in the
memorandum.
Registration of charges (Section 125): A company having power to borrow money is
empowered also to create a charge on its assets, subject however, to any limitation in the
memorandum or articles. Even uncalled capital may be charged but for this purpose the
companys articles and memorandum must give the power. Further section 125 requires
that the following charges must be registered with the Register of Company within 30 days
after the date of their creation:
i. A charge for the purpose of securing any issue of the debenture,
ii. A charge on uncalled share capital of the company,
iii. A charge on any immovable property,
iv. A charge on any book debts of the company,
v. A charge not being a pledge on any immovable property of the company,
vi. A floating charge on the undertaking or any property of the company including
stock-in-trade,
vii. A charge on calls made but not paid,
viii. A charge on a ship or any share in a ship,
ix. A charge on a goodwill or patent or license under a patent or a trademark or a
copyright or license under a copyright.
It was held in Indian bank vs. Official liquidator, Chemmeens Exports (P.) Ltd. ([1998]
16 SCL 524) that where charge is created by operation of law or is created by an order or
decree of court, section 125 has no application.
Effect of non-registration: Section 125(1) about effect of non registration of charge. It says
that in case a registrable charge is not registered within the prescribed time, it becomes
void against the liquidator and any creditor of the company. It is mandatory for a company
to file the particulars of charge and failure to do so or contravene the provisions of section
125 are punishable under section 142 with fine extending up to Rs. 500 for every day of
default. In Antifriction Bearing Corporation Ltd. Vs. State of Maharashtra (1999) 20 SCL 373
(BOM) it was said that charges were void against the liquidator or creditor unless registered.
Date of notice of charge: Section 126 says that where any charge on any property of
company required to be registered under section 125 has been so registered, any person
acquiring such property or any part thereof or any share or interest therein shall be deemed
to have notice of the charge as from the date of such registration. For eg. If a charge was
created by company A on its building in favour of X and the charge was registered, then Y
the buyer of the building at a subsequent date will be deemed to have notice of the charge.
Register of Charge to be kept by Registrar: According to section 130, the registrar shall keep
a register containing all the charges requiring registration and shall on payment of the
prescribed fee, shall enter in the register the following particulars, namely:
i. The date of its creation,
ii. The amount secured by the charge,
iii. Short particulars of the property and
iv. The person entitled to the charge.
The register so kept shall be open for inspection by any person on payment of the
prescribed fee for each inspection. It is the duty of the Registrar to sign or initial each page
of the register and to return the instrument or its duly verified copy to the person filing the
charge after entry was made in the register. The registrar shall keep a chronological index, in
the prescribed form and with the prescribed particulars of the charges registered with him
in pursuance of the requirement of section 125 of the Act. Section 132 says that the
registrar shall give a certificate under is hand of the registration of a charge registered with
him, stating the amount secured. The certificate shall be conclusive evidence that the
requirements of the Companies Act as to the registration have been complied with. It was
held in Exeter Trust Ltd. Vs. Screen Ways Ltd. (1991) BCLC 888 that a certificate for
registration of a charge is a conclusive evidence that the relevant registration requirements
have been satisfied. The company, according to section 133, is required to cause a copy of
every certificate of registration to be endorsed on every debenture or certificate of
debenture stock which is issued by the company and the payment of which is secured by
the charge so registered. A person who knowingly permits the delivery of any debenture or
certificate of debenture-stock without the required certificate endorsed upon it shall be
punishable with fine which may extend up to Rs. 10,000.
Memorandum of satisfaction: On payment of or satisfaction of any charge in full, the
company must notify the fact to Registrar within 30 days from the date of such satisfaction.
The Registrar shall on receipt of such information cause a notice to be sent to the holder of
the charge calling upon to show cause within a time specified in such notice (not exceeding
14 days) as to payment or satisfaction should not be recorded as intimated to the Registrar.
If no cause is shown, the Registrar shall order that the memorandum of satisfaction shall be
entered in the Register of Charges. But if cause is shown, The Registrar shall record a note of
that effect in the register and shall inform the company that he has done so. Where the
Registrar enters a memorandum of satisfaction as above, he shall furnish the company with
a copy of the memorandum of satisfaction (Sections 138-140).
Rectification of Register of Charges by Central Government: Section 141 says about
rectification of Register of Charges by the Central Government. It says that the Central
Government is empowered to extend time for the registration of the charge or for giving
intimation about satisfaction of the charge or modification of the charge, etc. and to order
that the omission or mis-statement in the Register of Charges be rectified. The Central
Government has to be satisfied that the failure to register the charge or omission or mis-
statement:
i. was accidental or,
ii. was due to inadvertence or some other sufficient cause or,
iii. is not of such a nature as to prejudice the position of creditors or shareholders of the
company or,
iv. on other grounds it is just and equitable grounds it is just and equitable to grant.
Companys Register of Charge: Section 143 of the Act mentions about Register of Charge of
the company. It says that every company must keep at its registered office a Register of
Charges and enter therein all charges specifically affecting property of the company and all
floating charges on the undertaking, giving in each case:
i. a short description of the property charged;
ii. the amount of the charge;
iii. the names of the person entitled to charge except for bearer securities.
If any officer of the company knowingly omits or wilfully authorises or permits the
omission of any of the above entries, he shall be punishable with fine which may extend up
to Rs. 5000.
Where any person buys or acquires any property which is already under charge and
the charge was duly registered with the Register, it will be deemed that the buyer or the
acquirer has notice of the charge.


LIMITED LIABILITY PARTNERSHIP

Globalization in India has made many revolutions in every field. We are seeing Indian
companies working abroad as MNC, Few abroad acquisitions too. Thanks to Liberalization &
globalization, it opens new doors to our industries, made compete enough to grow across
global. But this liberalization also ask for some changes, eg: We are moving from Indian
Accounting Standards to IFRS to have international standard across world. We have another
change in the format of partnership LLP. This is newly introduced in India. This article is an
effort to give brief introduction on meaning, definition as per act. US LLP definitions &
Comparison study of US v/s Indian tax laws on LLP.

Meaning: A limited liability partnership (LLP) is a partnership in which partners have
limited liability. It therefore exhibits elements ofpartnerships and corporations. In an LLP
one partner is not responsible or liable for another partner's misconduct or negligence. This
is an important difference from that of a limited partnership. In an LLP, some partners have
a form of limited liability similar to that of the shareholders of a corporation.

Definition: The Limited Liability Partnership Act 2008 was published in the official Gazette of
India on January 9, 2009 and has been notified with effect from 31 March 2009. However,
the Act has been notified with limited sections only. The rules have been notified in the
official gazette on April 1, 2009. The Minister of Corporate Affairs had suggested that India
will have its first LLP by 1st April 2009. The promise has been kept and the LLP Act got
notified on 31 March 2009 and the first LLP was also incorporated in the first week of April
2009.
The salient features of the LLP Act, 2008 are as under:-
1. The LLP has an alternative corporate business vehicle that would give the benefits of
limited liability but allows its members the flexibility of organizing their internal structure as
a partnership based on an agreement.
2. The LLP Act does not restrict the benefit of LLP structure to certain classes of
professionals only and would be available for use by any enterprise which fulfils the
requirements of the Act.
3. While the LLP has a separate legal entity, liable to the full extent of its assets, the liability
of the partners would be limited to their agreed contribution in the LLP. Further, no partner
would be liable on account of the independent or un-authorized actions of other partners,
thus allowing individual partners to be shielded from joint liability created by another
partners wrongful business decisions or misconduct.
5. Provisions have been made for corporate actions like mergers, amalgamations etc.
7. While enabling provisions in respect of winding up and dissolutions of LLPs have been
made,
8. The Act also provides for conversion of existing partnership firm, private limited company
and unlisted p
4. LLP shall be a body corporate and a legal entity separate from its partners. It will have
perpetual succession. Indian Partnership Act, 1932 shall not be applicable to LLPs and there
shall not be any upper limit on number of partners in an LLP unlike an ordinary partnership
firm where the maximum number of partners cannot exceed 20, LLP Act makes a mandatory
statement where one of the partner to the LLP should be an Indian public company into a
LLP by registering the same with the Registrar of Companies (ROC)
9. Nothing Contained in the Partnership Act 1932 shall effect an LLP.
10. The Registrar of Companies (Roc) shall register and control LLPs also.
LLP in USA
A limited liability partnership (LLP) is a general partnership in which the individual liability
of partners for partnership obligations is substantially limited. LLPs were first designed in
Texas to afford certain professionals limited liability. These professions originally included
those such as physicians, architects, attorneys, certified public accountants, and
veterinarians. Unlike partners in a general partnership, who are liable for all partnership
obligations, partners in a limited liability partnership are not personally liable for
partnership obligations unless the obligations are attributable to the fault of the partner.
As for taxation, LLPs are a flow-through entity that does not pay federal income tax. Flow-
through entity (FTE) is a entity where income "flows through" to investors or owners, that is
the income of the entity is treated as the income of the investors or owners. Flow-through
entities are also known as pass-through entities or fiscally transparent entities. Depending
on the local tax regulations, this structure can avoid dividend tax and double
taxation because only owners or investors are taxed on the revenue. Technically, for tax
purposes, flow-through entities are considered "non-entities" because they are not taxed;
rather, tax "flows-through" to another tax return. LLP is required to file Form 1065, an
informational return & it will give K1s to partners.
As per the Budget 2009-10, LLP will be treated as Partnership firms for the purpose of
Income Tax and will be taxed like a partnership firm. Also made amendment to the
definitions on definitions -firm, partner & partnership to include feature of LLP.Tax rate will
be 30% flat tax rate + 3% education cess & No Minimum Alternate Tax & Dividend
Distribution Tax. LLP and general partnership is being treated as equivalent (except for
recovery purpose) in the Act, the conversion from a general partnership firm to an LLP will
have no tax implication, if the rights and obligation of the partners remain the same after
conversion and if there is no transfer of any asset or liability after conversion. If there is a
violation of these conditions, the provision of capital gain will apply.

Eligibility (section 184):
In order for Limited Liability Partnership to be assessed as firm as Income Tax Act, it has to
satisfy the following criteria
The LLP is evidenced by an instrument i.e. there is a written LLP Agreement.
The individual shares of the partners are very clearly specified in the deed.
A certified copy of LLP Agreement must accompany the return of income of the LLP
of the previous year in which the partnership was formed.
If during a previous year, a change takes place in the constitution of the LLP or in the
profit sharing ratio of the partners, a certified copy of the revised LLP Agreement shall be
submitted along with the return of income of the previous years in question.
There should not be any failure on the part of the LLP while attending to notices
given by the Income Tax Officer for completion of the assessment of the LLP
Comparison Study of USA & Indian Tax laws.

SI Particulars In USA In India
1 Type of entity Pass through entity Taxable Entity
2 Partners are taxable? YES NO
3 Tax form need to file Form 1065 ITR 5
4 Share of Income of LLP
in hands of partner is
taxable
YES Exempt u/s 10
5 Double Taxation Since Income flows to partners from LLP,
no question of double taxation
No, Exempted at
partners level
6 Special Allocation of
Income to partners
Possible Not possible


LLP is new born child in India, is yet to start having its footage in the
business/profession field. This is great opportunity for professionals like CAs, CS & others to
come together & start LLP to give all type of services to their clients. In my view, this is an
effort from government to make our professionals to make them competitive enough to
face challenges from big 4 companies E& Y, Delloite. Note that these big 4 companies are
basically registered as LLP

VENTURE CAPITAL IN INDIA
INTRODUCTION
What is venture capital?
Venture capital means funds made available for startup firms and small businesses
with exceptional growth potential.
Venture capital is money provided by professionals who alongside management
invest in young, rapidly growing companies that have the potential to develop into
significant economic contributors.
Venture Capitalists generally:
Finance new and rapidly growing companies
Purchase equity securities
Assist in the development of new products or services
Add value to the company through active participation.
Venture capital provides long-term, committed share capital, to help unquoted companies
grow and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business,
buy-out a business in which he works, turnaround or revitalize a company, venture capital
could help do this. Obtaining venture capital is substantially different from raising debt or a
loan from a lender. Lenders have a legal right to interest on a loan and repayment of the
capital, irrespective of the success or failure of a business. Venture capital is invested in
exchange for an equity stake in the business. As a shareholder, the venture capitalists return
is dependent on the growth and profitability of the business. This return is generally earned
when the venture capitalist "exits" by selling its shareholding when the business is sold to
another owner.
SEBI DEFINITION OF VENTURE CAPITAL
The SEBI has defined Venture Capital Fund in its Regulation 1996 as a fund established in
the form of a company or trust which raises money through loans, donations, issue of
securities or units as the case may be and makes or proposes to make investments in
accordance with the regulations.
HISTORY OF VENTURE CAPITAL:
Venture capital in the UK originated in the late 18th century, when entrepreneurs found
wealthy individuals to back their projects on an ad hoc basis. This informal method of
financing became an industry in the late 1970s and early 1980s when a number of venture
capital firms were founded. There are now over 100 active venture capital firms in the UK,
which provide several billion pounds each year to unquoted companies mostly located in
the UK.
EVOLUTION OF VENTURE CAPITAL
Venture Capital Industry in India Historical Evolution :

The development of the organized venture capital industry in India, as is in existence today,
was slow, circumscribed by resource constraints resulting from the overall framework of the
socialistic economic paradigms. Although funding for new businesses was available from
banks and government owned development financial institutions, it was provided as
collateral-based money on project-financing basis, which made it difficult for most new
entrepreneurs, especially those who were technology and services based, to raise money
for their ideas and businesses. Most entrepreneurs had to rely on their own financial
resources, and those of their families and well wishers or private financiers to realize their
entrepreneurial dreams.
Early Beginnings In 1972, a committee on Development of Small and Medium Enterprises
highlighted the need to foster venture capital as a source of funding new entrepreneurs and
technology. This resulted in a few incremental steps being taken over the next decade-and-
a-half to facilitate venture capital funds into needy technology oriented small and medium
Enterprises (SMEs), namely:
_ Risk Capital Foundation, sponsored by IFCI, was set-up in 1975 to promote and support
new technologies and businesses.
_ Seed Capital Scheme and the National Equity Scheme was set up by IDBI in 1976.
Programme for Advancement of Commercial Technology (PACT) Scheme was introduced by
ICICI in 1985.
These schemes provided some succour to a limited number of SMEs but the activity of
venture capital industry did not gather momentum as the funding was based on investment
evaluation processes that remained largely collateral based, rather than being holistic, and
the policy framework remained unaltered, without the instruments to inject dynamism in
the VC industry. Also, there was no policy in place to encourage and involve the private
sector in the venture capital activity.
Setting-up of TDICI and Regional Funds: 1987-1994
For all practical purposes, the organised venture capital industry did not exist in India till
almost 1986. The role of venture capitalists till then was played by individual investors and
development financial institutions. The idea of venture capital
gained momentum after it found mention in the budget of 1986-87. A 5% cess was levied on
all know-how imports to create the corpus of the venture fund floated by IDBI in 1987.
Later, a study was undertaken by the World Bank to examine the possibility of developing
venture capital in the private sector, based on which the Government of India took a policy
initiative and announced
guidelines for venture capital funds (VCFs) in India in 1988.
Soon many other funds followed. The pioneers of the Indian venture capital industry were
largely government-owned banks and financial institutions, with some contribution from
the financial services companies in the private sector.
Entry of Foreign Venture Capital Funds: 1995-1998
Thereafter, the Government of India issued guidelines in September 1995 for overseas
investment in venture capital in India. For tax-exemption purposes, guidelines were also
issued by the Central Board of Direct Taxes (CBDT) and the investments and flow of foreign
currency into and out of India was governed
by the Reserve Bank of Indias (RBI) requirements. Further, as a part of its mandate to
regulate and to develop the Indian capital markets, the Securities and Exchange Board of
India (SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996. These guidelines
were further amended in April 2000 with the objective of fuelling the growth of venture
capital activities in India.
CHARACTERISTICS:
Long time horizon
Lack of liquidity
Venture capital investments are illiquid, that is not subject to re[ayment on demand or
following a repayment schedule. Investors seek return ultimate means of capital gain when
the investment is sold at market place. The investment is realized only on enlisting of
security or if investment is liquidated for unsuccessful working.
High risk
Venture Capital financing is highly risky and chances are high as it provides long term start
up capital .Venture captal assumes four types of risk, these are:
1. Management risk : Inability of management teams to work
2. Market risk : Product may fail in the market
3. Product risk: Product may not be commercially viable.
4. Operatonal risk:Operation may not be cost effective, increased cost decreased
gross margin.
Equity participation
Innvestments are generally in equity and quasi equity Participation through purchase of
share ,options, convertible debentures where the debt holds option to convert the loan
instruments into stock of the borrower or a warrants to equity investment. The funds in the
form of equity help to raise loans that are cheaper source of funds.
Participation in management
Venture capital provides value addition by managerial support, monitoring and follow up
assistance. It monitors physical and financial progress and market development
initiative.They want one seat on the companys board of directorsand involvement in te
major decision affecting the direction of the company.based on experience other
companies, a venture capitalist advise the promoters on project planning .financial
management including working capital and public issue.Capital investors cannot interfere in
day today management of the enterprise bt keeps a close contact with the promoter.
ADVANTAGES:
Pros and Cons of Using Venture Capital Investments
Pros of Venture Capital
There are some benefits to venture capital funding. In many cases, the company that is able
to secure venture capital funds can receive services that may include:
Business Consultations - Many venture capital firms have consultants on their staffs
that are well versed in specific markets. This can help a start up firm avoid many of
the pitfalls that are often associated with start-up business ventures.
Management Consultations - Unfortunately, not all entrepreneurs are good
business managers. Since venture capital firms almost always require a percentage
of equity in the start-up firm, they likely will have a say in how the firm is managed.
For the non-management expert, this can be a significant benefit.
Human Resources - In terms of finding the best talent for start up firms, venture
capital firms often provide consultants who are specialists in hiring. This can help a
start up firm avoid the pitfalls of hiring the wrong people for their company.
Additional Resources - Starting a new business is fraught with concerns about legal
matters, payroll matters, and tax issues. It is not unusual for a venture capital firm to
take an interest in providing these resources since they have a vested interest in the
success of the company.
Advantages
It injects long term equity finance which provides a solid capital base for future
growth.
The venture capitalist is a business partner, sharing both the risks and rewards.
Venture capitalists are rewarded by business success and the capital gain.
The venture capitalist is able to provide practical advice and assistance to the
company based on past experience with other companies which were in similar
situations.
The venture capitalist also has a network of contacts in many areas that can add
value to the company.
The venture capitalist may be capable of providing additional rounds of funding
should it be required to finance growth.
Venture capitalists are experienced in the process of preparing a company for an
initial public offering (IPO) of its shares onto the stock exchanges or overseas stock
exchange such as NASDAQ.
Regulations of Venture Capital:
VCF are regulated by the SEBI (Venture Capital Fund) Regulations, 1996. The regulation
clearly states that any company or trust proposing to carry on activity of a VCF shall get a
grant of certificate from SEBI. Section 12 (1B) of the SEBI Act also makes it mandatory for
every domestic VCF to obtain certificate of registration from SEBI in accordance with the
regulations. Hence there is no way that an Indian Venture Capital Fund can exist outside
SEBI Regulations. However registration of Foreign Venture
SEBI Venture Capital Funds (VCFs) Regulations, 1996
A Venture Capital Fund means a fund established in the form of a trust/company; including
a body corporate, and registered with SEBI which (i) has a dedicated pool of capital raised in
a manner specified in the regulations and (ii) invests in venture capital undertakings (VCUs)
in accordance with these regulations.
A Venture Capital Undertaking means a domestic company (i) whose shares are not listed
on a recognised stock exchange in India and (ii) which is engaged in the business of
providing services/production/manufacture of articles/things but does not include such
activities/sectors as are specified in the negative list by SEBI with government approval-
namely, real estate, non-banking financial companies (NBFCs), gold financing, activities not
permitted under the industrial policy of the Government and any other activity which may
be specified by SEBI in consultation with the Government from time to time.
Registration
All VCFs must be registered with SEBI and pay Rs.25,000 as application fee and Rs. 5,00,000
as registration fee for grant of certificate.
Recommendations of SEBI (Chandrasekhar) Committee, 2000 SEBI appointed the
Chandrasekhar Committee to identify the impediments in the growth of venture capital
industry in the country and suggest suitable measures for its rapid growth. Its report was
submitted in January, 2000. The recommendations pertain to
1. Harmonisation of multiplicity of regulations
2. VCF structures
3. Resource raising
4. Investments
5. Exit
6. SEBI regulations
7. Company law related issues and
8. Other related issues.
Types of Venture Capital Funds
Generally there are three types of organised or institutional venture capital funds: venture
capital funds set up by angel investors, that is, high net worth individual investors; venture
capital subsidiaries of corporations and private venture capital firms/ funds. Venture capital
subsidiaries are established by major corporations, commercial bank holding companies and
other financial institutions. Venture funds in India can be classified on the basis of the type
of promoters.
1 . VCFs promoted by the Central govt. controlled development financial institutions such as
TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC) by the
Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.
2. VCFs promoted by the state government-controlled development finance
institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh
State Finance Corporation (APSFC) and Gujarat Venture Finance Company Limited (GVCFL)
by Gujarat Industrial Investment Corporation (GIIC)
3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-Cap by
State Bank of India.
4. VCFs promoted by the foreign banks or private sector companies and financial
institutionssuch as Indus Venture Fund, Credit Capital Venture Fund and Grindlay's India
Development Fund.
The Venture Capital Investment Process:
The venture capital activity is a sequential process involving the following six steps.

1. Deal origination
2. Screening
3. Due diligence Evaluation)
4. Deal structuring
5. Post-investment activity
6. Exist


Venture Capital Investment Process
Deal origination:
In generating a deal flow, the VC investor creates a pipeline of deals or investment
opportunities that he would consider for investing in. Deal may originate in various ways.
referral system, active search system, and intermediaries. Referral system is an important
source of deals. Deals may be referred to VCFs by their parent organisaions, trade partners,
industry associations, friends etc. Another deal flow is active search through networks, trade
fairs, conferences, seminars, foreign visits etc. Intermediaries is used by venture capitalists
in developed countries like USA, is certain intermediaries who match VCFs and the potential
entrepreneurs.
Screening:
VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the
basis of some broad criteria. For example, the screening process may limit projects to areas
in which the venture capitalist is familiar in terms of technology, or product, or market
scope. The size of investment, geographical location and stage of financing could also be
used as the broad screening criteria.
Due Diligence:
Due diligence is the industry jargon for all the activities that are associated with evaluating
an investment proposal. The venture capitalists evaluate the quality of entrepreneur before
appraising the characteristics of the product, market or technology. Most venture capitalists
ask for a business plan to make an assessment of the possible risk and return on the
venture. Business plan contains detailed information about the proposed venture. The
evaluation of ventures by VCFs in India includes;
Preliminary evaluation: The applicant required to provide a brief profile of the proposed
venture to establish prima facie eligibility.
Detailed evaluation: Once the preliminary evaluation is over, the proposal is evaluated in
greater detail. VCFs in India expect the entrepreneur to have:- Integrity, long-term vision,
urge to grow, managerial skills, commercial orientation.
VCFs in India also make the risk analysis of the proposed projects which includes: Product
risk, Market risk, Technological risk and Entrepreneurial risk. The final decision is taken in
terms of the expected risk-return trade-off as shown in Figure.
Deal Structuring:
In this process, the venture capitalist and the venture company negotiate the terms of the
deals, that is, the amount, form and price of the investment. This process is termed as deal
structuring. The agreement also include the venture capitalist's right to control the venture
company and to change its management if needed, buyback arrangements, acquisition,
making initial public offerings (IPOs), etc. Earned out arrangements specify the
entrequreneur's equity share and the objectives to be achieved.
Post Investment Activities:
Once the deal has been structured and agreement finalised, the venture capitalist generally
assumes the role of a partner and collaborator. He also gets involved in shaping of the
direction of the venture. The degree of the venture capitalist's involvement depends on his
policy. It may not, however, be desirable for a venture capitalist to get involved in the day-
to-day operation of the venture. If a financial or managerial crisis occurs, the venture
capitalist may intervene, and even install a new management team.
Exit:
Venture capitalists generally want to cash-out their gains in five to ten years after the initial
investment. They play a positive role in directing the company towards particular exit
routes. A venture may exit in one of the following ways:

1. Initial Public Offerings (IPOs)
2. Acquisition by another company
3. Purchase of the venture capitalist's shares by the promoter, or
4. Purchase of the venture capitalist's share by an outsider.
Methods of Venture Financing
Venture capital is typically available in three forms in India, they are:
Equity : All VCFs in India provide equity but generally their contribution does not exceed 49
percent of the total equity capital. Thus, the effective control and majority ownership of the
firm remains with the entrepreneur. They buy shares of an enterprise with an intention to
ultimately sell them off to make capital gains.
Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate
sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 to
15 percent; actual rate depends on other factors of the venture such as gestation period,
cost-flow patterns, riskiness and other factors of the enterprise.
Income Note : It is a hybrid security which combines the features of both conventional loan
and conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at
substantially low rates.
Other Financing Methods: A few venture capitalists, particularly in the private sector, have
started introducing innovative financial securities like participating debentures, introduced
by TCFC is an example.
A Case on Technology Development & Information Company Of India Ltd.
TDICI was incorporated in January 1988 with the support of the ICICI and the UTI. The
country's first venture fund managed by the TDICI called VECAUS ( Venture Capital Units
Scheme) was started with an initial corpus of Rs.20 crore and was completely committed to
37 small and medium enterprises. The first project of the TDICI was loan and equity to a
computer software company called Kale Consultants.
Present Status: At present the TDICI is administering two UTI mobilised funds under
VECAUS-I and II, totaling Rs.120 crore. the Rs.20 crore invested under the first fund,
VECAUS-I, has already yielded returns totaling Rs. 16 crore to its investors.
Some of the projects financed by the TDICI are discussed below.
MASTEK , a Mumbai based software firm, in which the TDICI invested Rs.42 lakh in equity in
1989, went public just three years later, in November 1992. It showed an annual growth of
70-80 percent in the turnover.
TEMPTATION FOODS, located in PUNE, which exports frozen vegetables and fruits, went
public in November 1992. The TDICI invested Rs.50 lakh in its equity.
RISHABH INSTRUMENTS of Nasik got Rs.40 lakh from the TDICI. It manufactures a range of
meters used in power stations in collaboration with the ABB Metra Watt of Germany. After
making cash losses totaling Rs.25 lakh in two bad years, it turned around in 1989 and
showed an increase of over 70 percent in the turnover.
SYNERGY ART FOUNDATION, which runs art galleries in Mumbai and Chennai and plans to
set up in Pune and Delhi too, had received Rs.25 lakh from the TDICI as convertible loans
which were converted into equity on march 31, 1994. Most of this money has been used for
the company's innovative art library scheme at least paintings to corporate clients.

Conclusion
In recent years the growth of Venture Capital Business has been drastically decreasing due
to many reasons. The regulator has to liberalize the stringent policies and pave the way to
the venture capital investors to park their funds in most profitable ventures. Though an
attempt was also made to raise funds from the public and fund new ventures, the venture
capitalists had hardly any impact on the economic scenario for the next few years. At
present many investments of venture capitalists in India remain on paper as they do not
have any means of exit. Appropriate changes have to be made to the existing systems in
order that venture capitalists find it easier to realize their investments after holding on to
them for a certain period of time.



INDIAN DEPOSITORY RECEIPTS
Introduction:
An IDR or Global Depository Receipts is an instrument denominated in Indian
Rupees in the form of a depository receipt created by a Domestic Depository (custodian of
securities registered with SEBI) against the underlying equity of the issuing company in
order to enable foreign companies to raise funds from the Indian securities markets. The
receipts are based on a ratio of shares equivalent to depository receipts. It is governed by
Companies (Issue of Indian Depository Receipts) Rules, 2004 (IDR Rules) pursuant to the
section 605 A of the companies Act. SEBI issued guidelines for disclosure with respect to
IDRs and notified the model listing agreement to be entered between exchange and the
foreign issuer specifying continuous listing requirements.
Eligibility of companies to issue IDRs:
The regulations relating to the issue of IDRs is contained in Securities and Exchange
Board of India (Issue of capital and disclosure requirements) Regulations, 2009, as revised
from time to time.
According to Clause 26 in Chapter III (Provisions as to public issue), the following are
required of any company intending to make a public issue in India:
it has net tangible assets of at least Indian Rupee three crore in each of the
preceding three full years (of twelve months each), of which not more than fifty per cent are
held in monetary assets: Provided that if more than fifty per cent of the net tangible assets
are held in monetary assets, the issuer has made firm commitments to utilise such excess
monetary assets in its business or project;
it has a track record of distributable profits in terms of section 205 of the Companies
Act, 1956, for at least three out of the immediately preceding five years: Provided that
extraordinary items shall not be considered for calculating distributable profits;
it has a net worth of at least INR one crore in each of the preceding three full years
(of twelve months each);
the aggregate of the proposed issue and all previous issues made in the same
financial year in terms of issue size does not exceed five times its pre-issue net worth as per
the audited balance sheet of the preceding financial year;
if it has changed its name within the last one year, at least fifty per cent. of the
revenue for the preceding one full year has been earned by it from the activity indicated by
the new name.
Further, Clause 97 in Chapter X stipulates additional requirements from a foreign company
intending to make an issue of IDRs: An issuing company making an issue of IDR shall also
satisfy the following:
the issuing company is listed in its home country;
the issuing company is not prohibited to issue securities by any regulatory body;
the issuing company has track record of compliance with securities market
regulations in its home country.
Procedure prior to issue of IDRs
The actual process for the issuance of IDRs by a foreign company is similar to
the process followed by companies looking at listing an ADR on American stock exchanges
and GDR on the European stock exchanges. The IDR is a negotiable instrument denominated
in Indian Rupees representing the underlying securities of the foreign company, which are
listed in an international stock exchange. Hence, the foreign company would issue its
securities in IDRs to an Overseas Custodian Bank, which in turn authorizes the Domestic
Depository in India to issue IDRs to investors. As part of the IDR process, the Issuing
Company will is required to appoint a Merchant Banker and file a due diligence report with
SEBI and the Registrar of Companies. Such a requirement is similar to the domestic IPO
process where Merchant Bankers are required to file due diligence reports in a prescribed
format per SEBI regulations prior to the IPO.



IDR issue Process:
According to SEBI guidelines, IDRs will be issued to Indian residents in the same
way as domestic shares are issued. The issuer company will make a public offer in India, and
residents can bid in exactly the same format and method as they bid for Indian shares. The
issue process is exactly the same: the company will file a draft red herring prospectus
(DRHP), which will be examined by SEBI. The general body of investors will get a chance to
read and review the DRHP as it is a public document, available on the websites of SEBI and
the book running lead managers. After SEBI gives its clearance, the company sets the issue
dates and files the document with the Registrar of Companies. In the next step, after getting
the Registrars registration ticket, the company can go ahead with marketing the issue. The
issue will be kept open for a fixed number of days, and investors can submit their
application forms at the bidding centres. The investors will bid within the price band and the
final price will be decided post the closure of the Issue. The receipts will be allotted to the
investors in their demat account as is done for equity shares in any public issue.
Eligibility for investors:
According to SEBI guidelines, the minimum bid amount in an IDR issue is Rs 20,000
per applicant. Like in any public issue in India, resident Indian retail (individual) investors can
apply up to an amount of INR 1,00,000 and Non-institutional investors (also called high net
worth individuals) can apply above INR 1,00,000 but up to applicable limits.
Reservations in IDR issues (clause 98, Chapter X):
According to current regulations, at least 50% of the Issue is to be allocated to
qualified Institutional Buyers (QIBs), 30% of the issue to the retail individual investors and
balance 20% of the issue to non-institutional investors and employees. The ratio of non-
institutional investors and employees is at the discretion of the company to decide. The
issue will fail if the company does not get QIB investors to the extent of 50% of the issue
size.
Benefits of IDRs for Indian Investors and Rights:
No resident Indian individual can hold more than $200,000 worth of foreign
securities purchased per year as per Indian foreign exchange regulations. However, this will
not be applicable for IDRs which gives Indian residents the chance to invest in an Indian
listed foreign entity.
Additional key requisites for investing in foreign securities such as a securities
trading account outside India to hold foreign securities, know your customer norms (KYC)
with foreign broker and foreign bank account to hold funds are generally too cumbersome
for most Indian investors. Such requirements are avoided in holding IDRs.
Whatever benefits accrue to the shares, by way of dividend, rights, splits or bonuses
would be passed on to IDR holders also, to the extent permissible under Indian law.
Benefits for International Issuers:
The main benefit would be in terms of branding, besides allowing foreign companies to
access Indian capital. IDRs also allow the creation of acquisition currency and a management
incentive tool. Issuers have the option to reserve a proportion of the issue for their
employees.
Challenges for IDRs:
There is the possibility of IDR issues being undersubscribed if they are not well
marketed or fail to catch the imagination of investors. In addition, the challenges
mentioned below are certain challenges with respect to the issuance of IDRs.
Stringent eligibility norms:
The stringent eligibility criteria, disclosure and corporate governance norms
(Although in the investors interests, they compare unfavourably with listing norms on other
tier II global exchanges such as Luxembourg, Londons Alternate Investment Market (AIM)
and Dubai. This could result in higher compliance costs for companies seeking to tap the
Indian capital markets).
Fungibility:
The GDR or ADR holders enjoy two-way fungibility option. Those are conversion of
GDR or ADR into underlying shares and vice versa while investors in IDRs can exercise the
option only after one year as per IDR Rules, 2004. Even after one year, retail investors are
required to sell off the shares obtained by redemption in the foreign stock exchange where
they are listed. Two-way fungibility enables an investor to benefit from any arbitrage
opportunities arising due to exchange rate fluctuations or quotation differences on the two
stock exchanges, i.e., when an investor invests through IDR and once he converts his
receipts into underlying equity shares, he cannot again convert those equity shares in
receipts because of this. He cannot take dual benefit because shares are listed in the issuers
home country as well as receipts are listed in India. So, here the price of shares and
depository receipts vary. Sometimes it might happen that the price of shares in foreign stock
exchange increase and the price of receipts in Indian market decreases and vice versa. So in
this condition if two-way fungibility was allowed, then he could have converted the
instrument as per his convenience, taking into consideration his benefit but an IDR investor
is denied of his opportunity.
Tax issues: Related to IDRs:
Indian investors need to consider the tax implications of investment in the IDRs. While
Section 605A of the Companies Act, 1956 (the Companies Act) discusses IDRs, there are
no specific provisions regarding capital gains taxation of IDRs in the Companies Act or in the
Income Tax Act, 1961. Therefore, the general rules relating to capital gains taxation apply
and no benefits for long term holders of IDRs (ie. if the Securities Transaction Tax is paid,
there is no capital gains tax on long term holders of listed securities) are available. It is
possible that the upcoming Direct Tax Code may clarify the issue but as of now the capital
gains tax treatment of IDRs is not favourable.
Conclusion:
IDRs are a significant step towards the internationalization of the Indian security markets
which would also be a potential benefit for the domestic investors in India. There remain a
number of challenges as detailed above. However, if the Standard Chartered IDR is
successful, it may herald a new trend of international companies listing IDRs in India. In the
future, India may become a source for capital for international issuers.







American Depository Receipts
Introduction:
An American Depositary Share ("ADS") is a U.S. dollar denominated form of equity
ownership in a non-U.S. company. It represents the foreign shares of the company held on
deposit by a custodian bank in the company's home country and carries the corporate and
economic rights of the foreign shares, subject to the terms specified on the ADR certificate.
An ADR is a negotiable instrument that represents an ownership interest in securities of a
non-US company. ADRs enable investors to invest in non-US securities without concern for
often complex and expensive cross-border transactions, and offer substantially the same
economic, corporate and voting rights enjoyed by domestic shareholders of the non-US
issuer. ADRs are quoted and traded in US dollars, and are settled according to procedures
governing the US market. To the extent dividends are paid on the underlying securities,
ADRs pay dividends in US dollars.
ADRs are listed and traded in USA:
ADRs can be listed on any of the U.S. exchanges, such as the New York Stock
Exchange (NYSE), the American Stock Exchange (AMEX), or Nasdaq. They can
also be traded on the OTC Bulletin Board or in the over-the-counter Pink
Sheets. ADRs can also be privately placed and traded as Rule 144A securities.
Finally, the concept of the ADR has been extended to other geographical
markets, resulting in global depositary receipts (GDRs), international depositary
receipts (IDRs), and European depositary receipts (EDRs), which are generally
traded or listed in one or more international markets.
Benefits for companies in issuing ADRs:
Companies issuing ADRs have found that the ADRs provide numerous advantages, in two
main categories, financial advantages and commercial advantages, including:
Broadening and diversifying a companys US investor base
Enhancing a companys visibility, status and profile in the US and internationally, among
investors, consumers and customers
Increasing US liquidity, and potentially total global issuer liquidity by attracting new
investors
Developing and/or increasing institutional research coverage in the United States
Offering a new avenue for raising equity capital, often at highly competitive rates
(depending on the ADR program selected)
Enhancing communications with shareholders in the United States
Facilitating the creation of incentives for US employees including stock purchase and
option plans
By enabling a company to tap U.S. equity markets, the ADR offers a new avenue for raising
capital, often at highly competitive costs. For companies with a desire to build a stronger
presence in the United States, an ADR program can help finance U.S. initiatives or facilitate
U.S. acquisitions.
ADRs provide an easy way for U.S. employees of non-U.S. companies to invest in their
companies' employee stock purchase plans.
Features such as dividend reinvestment and direct purchase programs can help ensure a
continual stream of investment into an issuer's program.
Enabling the issuing company to broaden the market for its shares through a more
diversified exposure, which often can increase or stabilize the companys share price.
Enhancing the companys image and that of its products, services or securities in the
United States.
Facilitating acquisitions utilizing ADRs as part or all of the acquisition currency.
Benefits for Investors:
With continued globalization, increasingly American investors aim to diversify their
portfolios globally. There are many obstacles that preclude many institutional and individual
investors from purchasing foreign equities. These include undependable settlements,
unreliable custody services for foreign securities, costly currency conversions, poor
information flow, confusion tax issues, and unfamiliar market practices.
The core benefit for investors - individuals and institutions alike - is that ADRs make it easy
to purchase and hold a non-U.S. issuer's securities.
Benefits to US individual and institutional investors include:
As US securities, ADRs are quoted in US dollars.
ADRs trade easily and conveniently in U.S. dollars and settle through U.S. clearinghouses.
Publicly traded ADRs are registered with the U.S. Securities and Exchange
Commission (SEC).
For companies that typically pay dividends, ADRs mean those dividends are paid promptly
in U.S. dollars at competitive foreign exchange rates.
Many institutional investors are restricted from investing in securities that do not trade on
a U.S. exchange, so listed ADRs represent a way to add international exposure to a portfolio.
ADRs overcome many of the obstacles that institutional investors, including mutual funds,
pension funds have in purchasing and holding securities outside the United States.
Typical global custodian safekeeping charges for holding foreign securities are eliminated,
saving ADR investors money.
ADRs are as liquid as the underlying securities, as the two are interchangeable.

Procedures and mechanisms of issuing ADRs:
ADRs are issued by a US bank, such as J. P. Morgan or The Bank of New York, which
functions as a depositary, or stock transfer and issuing agent for the ADR program. The
foreign, or local shares, remain on deposit with the Depositarys custodian issuers home
market. Each ADR is backed by a specific number of an issuers local shares (e.g. one ADR
ratio, which is designed to set the price of each ADR in US dollars. Financial information,
including annual reports and proxies are delivered to US holders on a consistent basis by the
Depositary. The dividends are converted into dollars and paid to ADR holders by the
Depositary.












Global Depository Receipts
Introduction:
A global depositary receipt (GDR) is similar to an ADR, but is a depositary receipt
sold outside of the United States and outside of the home country of the issuing company.
Most GDRs are, regardless of the geographic market, denominated in United States dollars,
although some trade in Euros or British sterling. There are more than 900 GDRs listed on
exchanges worldwide, with more than 2,100 issuers from 80 countries. Although ADRs were
the most prevalent form of depositary receipts, the number of GDRs has recently surpassed
ADRs because of the lower expense and time savings in issuing GDRs, especially on the
London and Luxembourg stock exchanges.
The Global Depositary Receipt as a Financial Instrument:
A GDR is issued and administered by a depositary bank for the corporate issuer. The
depositary bank is usually located, or has branches, in the countries in which the GDR will be
traded. The largest depositary banks in the United States are JP Morgan, the Bank of New
York Mellon, and Citibank.
A GDR is based on a Deposit Agreement between the depositary bank and the corporate
issuer, and specifies the duties and rights of each party, both to the other party and to the
investors. Provisions include setting record dates, voting the issuers underlying shares,
depositing the issuers shares in the custodian bank, the sharing of fees, and the execution
and delivery or the transfer and the surrender of the GDR shares.
A separate custodian bank holds the company shares that underlie the GDR. The depositary
bank buys the company shares and deposits the shares in the custodian bank, then issues
the GDRs representing an ownership interest in the shares. The DR shares actually bought or
sold are called depositary shares.
The custodian bank is located in the home country of the issuer and holds the underlying
corporate shares of the GDR for safekeeping. The custodian bank is generally selected by
the depositary bank rather than the issuer, and collects and remits dividends and forwards
notices received from the issuer to the depositary bank, which then sends them to the GDR
holders. The custodian bank also increases or decreases the number of company shares held
per instructions from the depositary bank.
The voting provisions in most deposit agreements stipulate that the depositary bank will
vote the shares of a GDR holder according to his instructions; otherwise, without
instructions, the depositary bank will not vote the shares.
GDR Advantages and Disadvantages:
GDRs, like ADRs, allow investors to invest in foreign companies without worrying about
foreign trading practices, different laws, accounting rules, or cross-border transactions.
GDRs offer most of the same corporate rights, especially voting rights, to the holders of
GDRs that investors of the underlying securities enjoy.
Other benefits include easier trading, the payment of dividends in the GDR currency, which
is usually the United States dollar (USD), and corporate notifications, such as shareholders
meetings and rights offerings, are in English. Another major benefit to GDRs is that
institutional investors can buy them, even when they may be restricted by law or
investment objective from buying shares of foreign companies.
GDRs also overcome limits on restrictions on foreign ownership or the movement of capital
that may be imposed by the country of the corporate issuer, avoids risky settlement
procedures, and eliminates local or transfer taxes that would otherwise be due if the
companys shares were bought or sold directly. There are also no foreign custody fees,
which can range from 10 to 35 basis points per year for foreign stock bought directly. GDRs
are liquid because the supply and demand can be regulated by creating or cancelling GDR
shares. GDRs do, however, have foreign exchange risk if the currency of the issuer is
different from the currency of the GDR, which is usually USD.
The main benefit to GDR issuance to the company is increased visibility in the target
markets, which usually garners increased research coverage in the new markets; a larger
and more diverse shareholder base; and the ability to raise more capital in international
markets.
GDR Market:
As derivatives, depositary receipts can be created or canceled depending on supply and
demand. When shares are created, more corporate stock of the issuer is purchased and
placed in the custodian bank in the account of the depositary bank, which then issues new
GDRs based on the newly acquired shares. When shares are canceled, the investor turns in
the shares to the depositary bank, which then cancels the GDRs and instructs the custodian
bank to transfer the shares to the GDR investor. The ability to create or cancel depositary
shares keeps the depositary share price in line with the corporate stock price, since any
differences will be eliminated through arbitrage.
The price of a GDR primarily depends on its depositary ratio (aka DR ratio), which is the
number of GDRs to the underlying shares, which can range widely depending on how the
GDR is priced in relation to the underlying shares; 1 GDR may represent an ownership
interest in many shares of corporate stock or fractional shares, depending on whether the
GDR is priced higher or lower than corporate shares.
Most GDRs are priced so that they are competitive with shares of like companies trading on
the same exchanges as the GDRs. Typically, GDR prices range from $7 - $20. If the GDR price
moves too far from the optimum range, more GDRs will either be created or canceled to
bring the GDR price back within the optimum range determined by the depositary bank.
Hence, more GDRs will be created to meet increasing demand or more will be canceled if
demand is lacking or the price of the underlying company shares rises significantly
Most of the factors governing GDR prices are the same that affects stocks: company
fundamentals and track record, relative valuations and analysts recommendations, and
market conditions. The international status of the company is also a major factor.
On most exchanges, GDRs trade just like stocks, and also have a T+3 settlement time in most
jurisdictions, where a trade must be settled within 3 business days of the trading exchange.
The exchanges on which the GDR trades are chosen by the company. Currently, the stock
exchanges trading GDRs are the:
1.London Stock Exchange
2.Luxembourg Stock Exchange
3.NASDAQ Dubai
4.Singapore Stock Exchange
5.Hong Kong Stock Exchange
Companies choose a particular exchange because it feels the investors of the exchanges
country know the company better, because the country has a larger investor base for
international issues, or because the companys peers are represented on the exchange.
Most GDRs trade on the London or Luxembourg exchanges because they were the 1st to list
GDRs and because it is cheaper and faster to issue a GDR for those exchanges.
Many GDR issuers also issue privately placed ADRs to tap institutional investors in the
United States. The market for a GDR program is broadened by including a 144A private
placement offering to Qualified Institutional Investors in the United States. An offering
based on SEC Rule 144A eliminates the need to register the offering under United States
security laws, thus saving both time and expense. However, a 144A offering must, under
Rule 12g3-2(b), provide a home country disclosure in English to the SEC or the information
must be posted on the companys website.
The Details of a GDR Purchase by An Investor:
1.An investor calls her broker to buy GDRs for a particular company.
2.The broker fills the order by either buying the GDRs on any of the exchanges that it trades,
or by buying ordinary company shares in the home market of the company by using a broker
in the issuer's country. The foreign broker then delivers the shares to the custodian bank.
3.The investors broker notifies the depositary bank that ordinary shares have been
purchased in the issuer's market and will be delivered to the custodian bank and requests
depositary shares to be issued in the investors account.
4.The custodian notifies the depositary bank that the shares have been credited to the
depositary banks account.
5.The depositary bank notifies the investors broker that the GDRs have been delivered.
6.The broker then debits the account of the investor for the GDR issuance fee.
The Details of a GDR Sale by an Investor:
1.An investor instructs his broker to sell his GDRs. The investor must deliver the shares
within 3 business days if the shares are not in the street name of the broker.
2.The broker can either sell the shares on the exchanges where the GDR trades, or the GDRs
can be cancelled, and converted into the ordinary shares of the issuing company.
3.If the broker sells the shares on an exchange, then the broker uses the services of a broker
in the issuer's market.
4.If, instead, the shares are cancelled, then the broker will deliver the shares to the
depositary bank for cancellation and provide instructions for the delivery of the ordinary
shares of the company issuer. The investor pays the cancelation fees and any other
applicable fees.
5.The depositary bank instructs the custodian bank to deliver the ordinary shares to the
investors broker, who then credits the account of its customer.
Technical Notes:
GDRs issued by a United States depositary bank are issued pursuant to Regulation S (Reg S)
of the Securities Act of 1933.
A GDR certificate is not delivered to the GDR holder, but is based on a master certificate
held by a Common Depositary for clearing purposes.
Most depositary receipts (DRs) are held in the street name of a bank or broker in a
securities depositary institution, such as the Depositary Trust Company (DTC), Euroclear, or
Clearstream, which expedites the trading and settlement of DR trades for the beneficial
interest of the owners. The beneficial DR owners are the owners who receive the actual
benefits of holding a depositary receipt, such as the capital gains from trading shares,
dividends, and voting rights.
Most GDR programs require that the issuing company notify the relevant exchanges of any
information that may cause the underlying shares to greatly change in price.


PRODUCER COMPANY
Concept of the producer company: Co-operative societies exist in the Indian socio-
economic field for a significantly long period to aid the general population to become
economically self-reliant & self-sufficient, where they are endowed with abilities to create
or produce articles required in the society on a day to day basis but do not possess the
financial resources to do the same. The principle that was embedded in this context was co-
operation amongst individuals based on responsibility of mutual assistance & pooling
together individual skills/ capabilities & finance to carry on the activities of creation or
production for mutual benefit on a sustained basis. The co-operative societies that gradually
came up had only a limited scope of activity & market. They mostly operated at village or at
best sub-division or district level. Naturally, their market also remained mostly localised. To
overcome this limitation Multi-State Co-operative Societies Act was passed in 1942 & the
same was adapted to evolving conditions by amendments & amending Acts from time to
time.
On the other hand, the Companies Act, 1956 (the Act), recognised only three types of
companies, namely
I. companies limited by shares (sub-divided into public limited and private limited
companies), these companies are popularly known as limited liability companies. In such a
company, the liability of the members is limited to amount, if any unpaid on these shares
respectively held by then the liability can be enforced at any time during the existence and
also during the winding up of the company. Such as company must have share capital as the
extent of liability is determined by the face value of shares. Most of the companies are India
is of this type and most of the provisions of the Companies Act are concerned with
companies of this class.
II. companies limited by guarantees, Section 12(2)(b) of the Companies Act defines
company limited by guarantee as "a company having the liability of its member limited by
the memorandum to such amount as the members may respectively thereby undertake to
contribute to the assets of the company in the event of its being wound up".
The amount guaranteed by each member cannot be demanded up to the company is wound
up; hence it is in the nature of 'reserve capital'.
Such companies may or may not have share capital. Generally they are formed without the
share capital for non-trading purposes e.g. for the promotion of commerce, art, science,
culture, sports, etc.
III. Unlimited companies, a company having no limit on the liability of its member is an
unlimited company [Sec. 12(2) (c)]. Thus, in the case of an unlimited, liability, company, the
liability of each member extends to the whole amount of the company's debts and
liabilities. Like partnership every member is liable to contribute, in proportion to his interest
in the company, towards the amount required for payment in full of the total liabilities of
the company, and if one is unable to contribute anything then the additional deficiency is to
be shared among then the additional deficiency is to be shared among the remaining
members in proportion to their capital in the company. But unlimited liability company is
different form ordinary partnership in one important respect viz. creditors of such a
company cannot the members directly and they can only option to the winding up of the
company and default as being a registered company it has a separate legal personality in the
eyes of law. Also, the liability of the members is enforceable only at the time of winding up.
Such a company may or may not have share capital. The article of association of an
unlimited company must state the number of members with which the company is to be
registered and, if the company has share capital, the amount of share capital with which the
company is to be registered [Sec. 27(1)].
As the capital, if any, is stated in the articles of association and not in the memorandum, it
may be varied by passing a special resolution, without the sanction of the Court.
Again, an unlimited company is not subject to any restrictions regarding purchase of its own
shares [Sec. 7]. According, such a company may purchase its own shares or advance monies
to any person to purchase its shares.
Under Section 32, a company registered as an unlimited company may subsequently
convert itself into a limited liability company, subject to the provision that any debt,
liabilities, applicationsits in regard to entered into, by or on behalf of the unlimited liability
company before such conversion are not affected by such conversion.
But on February 6 of the Companies (Amendment) Act 2002, (1 of 2003), a fourth category,
`producer companies,' finds a place in the Act.
For this, a new Part IXA, divided into 12 chapters, has been included in the Act, comprising
46 sections, interestingly numbered as 581A to 581Z and 581ZA to 581ZT. However, the
section that defines the various types of companies that can be incorporated under the Act
remains unaltered.
The new concept of producer companies is based on the recommendations of an expert
committee led by noted economist, Y. K. Alagh. The committee was asked (a) to frame a
legislation that would enable incorporation of cooperatives as companies and conversion of
existing cooperatives into companies and (b) to ensure that the proposed legislation
accommodated the unique elements of cooperative business with a regulatory framework
similar to that of companies.
The new type is termed as `Producer Company', to indicate that only certain categories of
persons can participate in the ownership of such companies. The members have necessarily
to be `primary producers,' that is, persons engaged in an activity connected with, or related
to, primary produce.
What is primary produce? In terms of the Act in section 581A (J) it is a produce of farmers
arising from agriculture including animal husbandry, horticulture, floriculture, pisciculture,
viticulture, forestry, forest products, re-vegetation, bee raising and farming plantation
products: produce of persons engaged in handloom, handicraft and other cottage
industries: by products of such products; and products arising out of ancillary industries.
The 46 new sections respectively deal with incorporation of producer companies: their
management; general meetings; share capital and members rights; finance, accounts and
audit; loan to members and investments; penalties; amalgamation, merger or division;
resolution of disputes; and reconversion of producer company to inter State cooperative
society. A few salient features are now briefly described.
Formation
In section 581C discuss about formation of the producer company. It says that any ten or
more individuals, each of them being a producer, that is, any person engaged in any activity
connected with primary produce, any two or more producer institutions, that is, producer
companies or any other institution having only producers or producer companies as its
members or a combination of ten or more individuals and producer institutions, can get a
producer company incorporated under the Act.
In section 581(c) (3)the companies shall be termed as limited and the liability of the
members will be limited to the amount, if any, unpaid on the shares, a producer company
so formed shall have the liability of its members limited by the memorandum to the amount
if any, unpaid on the shares respectively held by them & be termed a company limited by
shares.On registration, the producer company shall become as if it is a private limited
company with the significant difference that a minimum of two persons cannot get them
registered, the provision relating to a minimum paid-up capital of Rs. 1 lakh will not apply
and the maximum number of members can also exceed 50.
Members' equity cannot be publicly traded but be only transferred. As such, "producer
companies would not be vulnerable to takeover by other companies or by MNCs.''
Objects
The objects of producer companies shall include one or more of the eleven items specified
in section 581B the Act, the more important being:
(i) Production, harvesting, procurement, grading, pooling, handling, marketing, selling,
export of primary produce of members or import of goods or services for their benefit;
(ii) Processing including preserving, drying, distilling, brewing, venting, canning and
packaging of produce of its members; and
(iii) Manufacture, sale or supply of machinery, equipment or consumables mainly to its
members.
The other objects include rendering technical or consultancy services, insurance, generation,
transmission and distribution of power and revitalisation of land and water resources;
promoting techniques of mutuality and mutual assistance; welfare measures and providing
education on mutual assistance principles.
It is to be noted that private limited or public limited companies are not confined by such
restrictions as to their objectives, provided they are legal.
Management
(a) In section 581(O) every producer company is to have at least five and not more than 15
directors. But if we look at to the Company Act,1956 in section 252 it prescribed minimum
directors for private limited is two and for public limited three.
The maximum will depend on the number mentioned in the respective Articles. Usually the
maximum is pegged at twelve.
(b) In section 581W discuss about chief executive & his function. A full time chief executive,
by whatever name called, is to be appointed by the board. He shall be an ex-officio director
and will not be liable to retire by rotation. He shall be entrusted with substantial powers of
management as the board may determine. This provision differs from that applicable to
limited companies a private limited need not have any chief executive. But when we go
through section 269(1) of companies Act, 1956 then we see that public limited companies,
only with paid-up capital exceeding Rs. 5 crores, have to have a managing director & it came
into picture by second Amendment Rules, 1990, i.e. 17-04-1990.
(c) In section 581X speaks on secretary of producer company, a stipulation that could
dismay company secretaries is that only producer companies having an average annual
turnover exceeding Rs. 5 crores in each of three consecutive years need have a whole-time
secretary.
It is not mentioned what would happen to the incumbent, if the turnover falls below this
minimum.
This is in contrast to the mandate that private and public limited companies having a paid-
up capital of Rs. 2 crores or more should have a whole-time secretary.
Members' benefits
In section 581E laid down benefits to members, members will initially receive only such
value for the produce or products pooled and supplied as the directors may determine. The
withheld amount may be disbursed later either in cash or in kind or by allotment of equity
shares.
Members will be eligible to receive bonus shares.
An interesting provision is for the distribution of patronage bonus (akin to dividend) after
the annual accounts are approved patronage bonus means payment out of surplus income
to members in proportion to their respective patronage (not shareholding). Patronage, in
turn, is defined as the use of services offered by producer companies to their members by
participation in their business activities. Incidentally, there is an error in drafting the powers
of the board include "determination of the dividend payable'' it should have been
"patronage bonus payable.''
Audit
An unnecessary stipulation is that "without prejudice to the concerned sections in the Act,''
the auditors of producer companies have to specially report on some additional items such
as debts due and bad debts, verification of cash balances and securities, details of assets
and liabilities, loans extended to directors and details of donations and subscriptions. These
are all integral parts of any audit, both statutory and internal and one fails to understand
the logic behind this stipulation.
Internal audit
Section 581ZF every producer company shall have internal audit of its accounts carried by a
chartered accountant as defined in clause (b) of sub-section (1) of section 2 of the Institute
of Chartered Accounts Act, 1949(38 of 1949).
It is mandated that every producer company should carry out internal audit of its accounts
by chartered accountants. The Act has not so far made it compulsory for limited companies
to carry out internal audit, although listed companies, by virtue of the clause in the listing
agreement relating to corporate governance, are to have a full-scale internal audit system.
Resolution of disputes
Section 581ZO deals with resolution of disputes under the Act. Any dispute relating to the
formation, management or business of producers companies is to be settled by conciliation
or by arbitration under the Arbitration and Conciliation Act, 1996 as if the parties to the
dispute have consented in writing to such procedure. The arbitrator's decision shall be final.
This seems to be inequitable since usually an arbitration award can be appealed against in
high courts.
Inter-State cooperative societies
With objects not confined to one State may make an application to the Registrar for
recognition as producer companies. The statute also provides for reconversion of such
producer companies to their former status as inter-State cooperative societies subject to
the approval of High Court.
In conclusion, it is to be noted that "all the limitations, restrictions and provision of the Act,
other than those specified in Part IXA, applicable to a private limited company, shall, as far
as may be, apply to a producer company, as if it is a private limited company under the Act
in so far as they are not in conflict with the provisions of this Part.'' In other words, a
producer company is a hybrid between a private limited company and a cooperative society.


1. MUTUAL FUND
Definition: A mutual fund is nothing more than a collection of stocks and/or bonds. You can
think of a mutual fund as a company that brings together a group of people and invests their
money in stocks, bonds, and other securities. Each investor owns shares, which represent a
portion of the holdings of the fund.
You can make money from a mutual fund in three ways:
1) Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly
all of the income it receives over the year to fund owners in the form of a distribution.
2) If the fund sells securities that have increased in price, the fund has a capital gain. Most
funds also pass on these gains to investors in a distribution.
3) If fund holdings increase in price but are not sold by the fund manager, the fund's shares
increase in price. You can then sell your mutual fund shares for a profit.
Funds will also usually give you a choice either to receive a check for distributions or to
reinvest the earnings and get more shares.
Advantages of Mutual Funds
Professional Management - The primary advantage of funds is the professional
management of your money. Investors purchase funds because they do not have the time
or the expertise to manage their own portfolios. A mutual fund is a relatively inexpensive
way for a small investor to get a full-time manager to make and monitor investments.
Diversification - By owning shares in a mutual fund instead of owning individual stocks or
bonds, your risk is spread out. The idea behind diversification is to invest in a large number
of assets so that a loss in any particular investment is minimized by gains in others. In other
words, the more stocks and bonds you own, the less any one of them can hurt you. Large
mutual funds typically own hundreds of different stocks in many different industries. It
wouldn't be possible for an investor to build this kind of a portfolio with a small amount of
money.
Economies of Scale - Because a mutual fund buys and sells large amounts of securities at a
time, its transaction costs are lower than what an individual would pay for securities
transactions.
Liquidity - Just like an individual stock, a mutual fund allows you to request that your
shares be converted into cash at any time.
Simplicity - Buying a mutual fund is easy! Pretty well any bank has its own line of mutual
funds, and the minimum investment is small. Most companies also have automatic purchase
plans whereby as little as $100 can be invested on a monthly basis.
Disadvantages of Mutual Funds
Professional Management - Many investors debate whether or not the professionals are
any better than you or I at picking stocks. Management is by no means infallible, and, even if
the fund loses money, the manager still gets paid.

Costs - Creating, distributing, and running a mutual fund is an expensive proposition.
Everything from the managers salary to the investors statements cost money. Those
expenses are passed on to the investors. Since fees vary widely from fund to fund, failing to
pay attention to the fees can have negative long-term consequences.
Dilution - It's possible to have too much diversification. Because funds have small holdings
in so many different companies, high returns from a few investments often don't make
much difference on the overall return. Dilution is also the result of a successful fund getting
too big. When money pours into funds that have had strong success, the manager often has
trouble finding a good investment for all the new money.
Taxes - When a fund manager sells a security, a capital-gains tax is triggered. Investors
who are concerned about the impact of taxes need to keep those concerns in mind when
investing in mutual funds. Taxes can be mitigated by investing in tax-sensitive funds or by
holding non-tax sensitive mutual fund in a tax-deferred account, such as a 401(k) or IRA
2. HEDGE FUNDS
Meaning: An aggressively managed portfolio of investments that uses advanced investment
strategies such as leveraged, long, short and derivative positions in both domestic and
international markets with the goal of generating high returns (either in an absolute sense
or over a specified market benchmark).

Legally, hedge funds are most often set up as private investment partnerships that are open
to a limited number of investors and require a very large initial minimum investment.
Investments in hedge funds are illiquid as they often require investors keep their money in
the fund for at least one year.
For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to
sophisticated investors. In the U.S., laws require that the majority of investors in the fund be
accredited. That is, they must earn a minimum amount of money annually and have a net
worth of more than $1 million, along with a significant amount of investment knowledge.
You can think of hedge funds as mutual funds for the super-rich. They are similar to mutual
funds in that investments are pooled and professionally managed, but differ in that the fund
has far more flexibility in its investment strategies.
It is important to note that hedging is actually the practice of attempting to reduce risk, but
the goal of most hedge funds is to maximize return on investment. The name is mostly
historical, as the first hedge funds tried to hedge against the downside risk of a bear market
by shorting the market (mutual funds generally can't enter into short positions as one of
their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't
accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers
make speculative investments, these funds can carry more risk than the overall market.
Similarities:
Both mutual funds and hedge funds are managed portfolios. This means that a manager (or
a group of managers) picks securities that he or she feels will perform well and groups them
into a single portfolio. Portions of the fund are then sold to investors who can participate in
the gains/losses of the holdings. The main advantage to investors is that they get instant
diversification and professional management of their money.
Differences:
Hedge funds are managed much more aggressively than their mutual fund counterparts.
They are able to take speculative positions in derivative securities such as options and have
the ability to short sell stocks. This will typically increase the leverage - and thus the risk - of
the fund. This also means that it's possible for hedge funds to make money when the
market is falling. Mutual funds, on the other hand, are not permitted to take these highly
leveraged positions and are typically safer as a result.
3. PRIVATE EQUITY
Private equity is a source of investment capital from high net worth individuals and
institutions for the purpose of investing and acquiring equity ownership in companies.
Partners at private equity firms raise funds and manage these monies for the purpose of
yielding favourable returns for their shareholder clients, typically with an investment
horizon between four and seven years.
These funds can be used in the purchase of shares of private companies, or in public
companies that eventually become delisted from public stock exchanges under go-private
deals. The minimum amount of capital required for investors can vary depending on the
firm and fund raised. Some funds have a $250,000 minimum investment requirement;
others can require millions of dollars. Let's delve a little deeper into private equity firms.
Smaller investors have found ways to get closer to the private equity action
Another key difference between these two types of funds is their availability. Hedge funds
are only available to a specific group of sophisticated investors with high net worth. The U.S.
government deems them as "accredited investors", and the criteria for becoming one are
lengthy and restrictive. This isn't the case for mutual funds, which are very easy to purchase
with minimal amounts of money.
Differences between Hedge Funds and Private Equity:
The last few years have brought an explosion in the number and size of hedge funds.
Additionally, recent deals by private equity funds are much larger than in the past and
include taking publicly traded companies private. And private equity funds are now doing
larger "club" deals. Both types of funds have more money under management than ever
before. More cash is chasing deals, causing overlap where both types of funds vie over the
same company.
Although these funds do not represent long-term threats to each other, secured lenders
must recognize that private equity and hedge funds have markedly different characteristics,
goals and behaviours. The differences are most starkly illustrated when a hedge fund invests
in the debt of a private-equity portfolio company. Knowing these differences will assist
secured lenders in evaluating alternatives when the different types of funds end up in the
same deal. The most fundamental difference: private equity funds seek to buy all of the
equity of companies; hedge funds are not constrained to controlling equity investments.
Highlighted below are other major differences between the two types of funds.
Time to hold: Whether investing in debt or equity, hedge funds typically demand a much
more rapid exit strategy than private equity funds. Hedge funds generally seek a quick flip of
their investments, often in as few as six months and most likely in no more than 18 months.
However, some hedge fund investments are "loan to own;" that is, they buy debt at a deep
discount with an eye towards converting that debt to equity, then monetizing that equity
(through a recapitalization, refinancing, sale, merger or other disposition) in a short time
period. This is a function of, among other things, the liquidity and leverage differences
between the two types of funds. Investments by private equity firms often are held for five
to seven years, sometimes longer. The time-hold differences directly affect the exit strategy,
risk tolerance and desired rate of return of the two types of funds. What does all this mean
to secured lenders? Simply this: if hedge funds buy debt held by your bank group, be
prepared for a transaction that results in distributions of both debt and equity to the
secured lenders.
Liquidity and leverage: The different hold periods are driven in large part by the different
use of leverage and liquidity demands for the types of funds. Put simply, hedge fund
investors generally are able to withdraw their investments more frequently than private
equity fund investors. For hedge funds, volatile withdrawal demands force a focus on short-
term returns and may lead to shorter hold periods.
Strategic direction: Private equity funds, having longer hold periods, are very interested in
the strategic direction of the companies and industries in which they invest. For that reason,
prior to making an investment, private equity firms engage in a significant amount of
research regarding both the targeted company and the industry in which it operates. Once
an investment is made, private equity firms devote substantial "hands-on" time to further
develop strategies, assess and evaluate results, and make changes on account thereof. This
generally translates into active participation on a board of directors. Hedge funds assess
target companies' strategies with a different focus, one tied to hold periods, returns and
company and industry hedging strategies. However, hedge funds are increasingly seeking
board seats and seeking to influence management decisions made by companies in which
they have invested.
Due diligence methodology: The degree of due diligence performed is another distinction.
Although both investors have well-developed methodologies for performing due diligence,
typically hedge funds rapidly execute due diligence because their exit strategy may be vastly
different. Due diligence performed by private equity funds typically takes longer and may be
more detailed. A high-level of financial sophistication exists with both types of funds;
consequently, each takes a customized approach to due diligence.
Risk tolerance: Whether prospectively investing in a healthy or distressed company, the risk
tolerance level of the private equity fund is measured carefully to include both short- and
long-term risk evaluations. The private equity firm is able to adjust its tolerance for risk as
market conditions change. With the longer period of time to maturity of the investment, a
more risk-averse investment style and resources dedicated to the operations of the
company, private equity firms have a lower tolerance for risk than hedge funds.
Mark to market: The hedge fund frequently marks its investment to market and utilizes this
valuation methodology in its decision making regarding exit strategies. Private equity funds
tend to use long-term valuation methodologies when valuing their investments.
Desired return on investments: Hedge funds strive for higher levels of return than private
equity funds. However, there may be significant differences in how private equity and hedge
funds define "return." Hedge funds typically rely upon a fairly straightforward methodology
pursuant to which return is based on the difference between invested value and sales
proceeds. The private equity firm's desired return on an investment may be adjusted based
on several factors, including market share, profitability, revenues and valuation metrics.
Hedge Funds v. Private Equity
Private Equity Fund a private equity fund, like a hedge fund, is an unregistered investment
vehicle in which investors pool money to invest. Private equity funds concentrate their
investments in unregistered (and typically illiquid) securities. Both private equity funds and
U.S based hedge funds are typically organized as limited partnerships (LLP). Like hedge
funds, private equity funds also rely on the exemption from registration of the offer and sale
of their securities. In both private equity and hedge funds the investors in private equity
Funds and hedge funds typically include high net worth individuals and families, pension
funds, endowments, banks and insurance companies. Private equity funds, however, differ
from hedge funds in terms of the manner in which contribution to the investment pool is
made by the investors. Private equity investors typically commit to invest a certain amount
of money with the fund over the life of the fund, and make their contributions in response
to capital calls from the funds general partner. Private equity funds are long term
investments, provide for liquidation at the end of the term specified in the funds governing
documents and offer little, if any, opportunities for investors to redeem their investments. A
private equity fund may distribute cash to its investors when it sells its portfolio investment,
or it may distribute the securities of a portfolio company.
Mostly Hedge funds are contributed by wealthy individuals through private placements. It is
also true for private equity also. Both private equity and Hedge Fund are in alternative
investment classes. So identifying the relation between hedge fund and private equity is
necessary. Both hedge funds and private equity funds are two types of investment funds
that are managed by a team of skilled investment professionals that solicit investors
directly, rather than through general advertising, a registered broker-dealer, or a public
offering.
The funds are generally organized as limited partnerships (LP) or limited liability Companies
(LLC) or general partnership. A management company, which acts as an investment adviser,
usually holds the general partnership interest of a LP or acts as a managing member of a
LLC. Investors usually consist of high net-worth individuals and families, pension funds,
endowments, banks, and insurance companies.
Because of these and other general similarities, hedge fund advisers and private equity fund
advisers have a long history of being treated similarly by the Securities and Exchange
Commission (SEC) in the United States. Specifically, the funds that they manage have
generally been able to avoid regulation by using the same exemptions under However,
notwithstanding the recent trend of financial convergence, these two types of funds have
traditionally differed with respect to their Investment philosophies and key partnership
terms. Although there is no standard or statutory definition of a hedge fund, the term is
generally used to describe a wide range of investment vehicles with different strategies,
structures, and fee arrangements. Hedge funds employ various trading strategies and invest
in multiple securities, including debt and equity securities, futures, options, and foreign
currencies. However, certain characteristics are common among hedge funds and can be
used to distinguish them from other types of investment funds.
A common feature of hedge funds is that they typically seek absolute returns. In addition,
the informal firm cultures promote flexibility in the way that hedge fund advisers manage
their funds. Advisers have the authority to take both long and short positions in securities,
providing the opportunity to exploit temporary market inefficiencies in both bull and bear
markets. In general, they enter in to and out of positions rapidly and on a short term basis,
using leverage as an additional tool to increase gains. Because hedge funds invest in liquid
securities with readily attainable market values, the overall value of a fund can be
determined on a regular basis. Fund assets are marked to- market, allowing advisers to
take both asset management fees as well as an additional incentive amount, based on the
fund's performance, at certain intervals. Fees are calculated based on the net asset value of
the fund. Since assets can be reduced to cash or invested quickly, funds usually permit
investors to withdraw and subscribe at regular intervals. Hedge funds offer their investors
liquidity access following an initial 'lock-up' period, which is typically for less than two
years.
Although these funds do not represent long-term threats to each other, secured lenders
must recognize that private equity and hedge funds have markedly different characteristics,
goals and behaviours. Unlike hedge fund advisers, private equity advisers concentrate fund
assets in illiquid Securities that do not actively trade in public markets. Many private equity
advisers Specialize in providing expansion capital for stable businesses, making leveraged
buyouts, management buyouts, or turnarounds of under-performing companies.

Hedge Funds v. Venture Capital Funds
Venture Capital Fund Venture capital pools are similar to hedge funds or private equity; they
attract the same class of investors. Venture capital funds, however, invest in the start-up or
early stages of a company. Unlike hedge fund advisors, general partners of venture capital
funds often play an active role in the companies in which the funds invest. In contrast to a
hedge fund, which may hold an investment in a portfolio security for an indefinite period
based on market events and conditions, a venture capital fund typically seeks to liquidate its
investment once the value of the company increases above the value of the investments.
The venture capital market, broadly speaking, provides funding to enterprises in their early
stages before they have the track record or the need to issue stock publicly. Since the
funding is provided when the possibilities of failure and bankruptcy are much greater, the
risks are much larger than investing in well-established public companies. Accordingly,
venture capitalists require a high rate of return on each deal to compensate for the risk,
usually in the range of 35% to 50% per year.
Contrary to popular belief, hedge funds are not an asset class like stocks, bonds, and real
estate; they are a rather heterogeneous group of funds that employs a range of trading and
investment strategies to generate returns. Many, but not all, of the strategies are intended
to generate positive returns even in a bear market hence the designation hedge. Funds
vary so widely in strategies, however, that it is no longer accurate to say that all hedge funds
actually hedge against market downturns.
Hedge Funds v. Mutual Funds
Like mutual funds, hedge funds also collect proceeds from the investors and deploy them in
profitable avenues. Both hedge funds and mutual funds are institutional investors. However,
this is where the similarity comes to an end. Some of the key differences between mutual
funds and hedge funds are:
Hedge funds are private, unregistered investment pools open only to a limited
number of accredited high net worth investors. On the other hand, mutual funds are
investment vehicles for small and retail investors and are heavily regulated investment
pools registered with regulatory authorities like the SEC.
Unlike the typical broadly diversified mutual fund, hedge funds generally have highly
concentrated large positions in just a few securities.
Mutual fund operations are characterized by high degree of transparency in the
sense that they submit a lot of information, inter alia, to the market regulator whereas
access to hedge fund information is available only to its investors.
Mutual funds generally reward their managers on the basis of 'assets under
management' and the fee is not linked to performance while hedge fund managers are
given performance-related incentive and a fixed fee. Fees typically may range from 1 to 20
% p.a.
Unlike mutual funds where fund managers may have limited personal financial stake,
hedge fund managers have substantial financial stake in the fund they manage, since they
are also supposed to put in their own money in the fund.
The mutual fund managers normally are able to generate positive returns only if the
market goes up while hedge funds are expected to give positive returns both in falling and
rising markets. In fact, Absolute Return Hedge Funds will often seek a fixed annual return
irrespective of how the market is moving.
Some critics, including the most noted hedge fund manager, George Soros, argue that this
fee structure creates incentives to take inordinate risks because managers share the upside
if the risks payoff but not the downside, should the strategies fail. However, the fact that
many hedge fund managers put their own capital into their funds may mitigate this risk.
Both Hedge Funds and Mutual Funds are investment products but they have similarities as
well as differences. They are both managed portfolios wherein the manager picks up the
securities that he or she feels will do well and then subsequently clubs them into a single
portfolio. The fund is then divided into parts whereby some portions are sold to investors
who can participate in the gains/losses of the holdings. The main advantage to investors is
that they get instant diversification and professional management of their money.
But on the other hand Hedge funds are managed more aggressively than mutual funds. They
are able to take speculative positions in derivative securities such as options and have the
ability to short sell stocks. This typically increases the leverage and thus the risk of the fund.
Therefore there is a possibility for hedge funds to make money when the market is falling
whereas Mutual funds are not permitted to take these highly leveraged positions and are
typically safer as a result.
Also Hedge funds are only available to a specific group of sophisticated investors with high
net worth. For e.g. they are deemed as accredited investors by the US Government, and
the criteria for becoming one are lengthy and restrictive. This is not the case for mutual
funds, they are very easy to purchase with minimal amount of money.
While hedge funds tend to invest in mediums such as options and futures that offer higher
risk and higher returns and often involve more sophisticated investment strategies, mutual
funds invest solely in stocks. The contents of a hedge fund are determined by the hedge
fund manager and the investment guidelines set out by the financial institution whereas the
contents of a mutual fund are determined by the fund manager and the investment
company offering the fund.

Each one of them steps on the other's shoes. The lines between venture capital and private
equity (and hedge funds) investments have been blurred by increased competition in the
capital markets, which has forced each type of firm to expand their respective horizons in
order to continue capturing new opportunities.


Securities Transaction Tax
INTRODUCTION
The Union Budget 2004-2005 proposed a paradigm shift in the taxation of capital gains on
financial securities by introducing the Securities Transaction Tax (hereinafter refer to it as
STT). Transactions in stock and index options and futures would also be subject to
transaction tax .Whereas transactions carried out on the Negotiated Dealing System (a
screen-based system for trading in government securities and bonds) operated by the
central bank, Reserve Bank of India, have been kept out of the purview of this tax. Only the
buyers of securities would pay the proposed tax. After collecting this tax from the buyer, the
broker would pay it to the stock Exchange, which would then pay it to the exchequer.
For years together, the profit on sale of securities like shares, debentures, bonds, units of
Mutual Funds, et al, was calculated in different ways and was also subject to income-tax at
different rates depending upon the period of holding. However, the Finance (No 2) Bill, 2004
introduced by the honourable Finance Minister, Mr P Chidambaram, while presenting his
much awaited Union Budget 2004-2005, had ushered a paradigm shift in the taxation of
profits on financial securities which came into effect from the assessment year 2005-2006
(financial year from April 1, 2004 to March 31, 2005).

The Finance Ministry have supported the introduction of the STT in order to simplify the tax
regime on financial market transactions. The authorities believe that the STT is a clean and
efficient way of collecting taxes from financial markets. That is why, the introduction of STT
has been linked with the dismantling of existing tax structure on capital gains. While
introducing the STT, the Finance Minister proposed to abolish the tax on long term capital
gains altogether and reduced the short-term capital gains tax from 33 per cent to10 per
cent.

There is no denying that STT could act as an efficient instrument to collect the taxes, as
many market players fudge transactions to evade capital gains taxes but it would be
erroneous to consider STT (indirect tax) as a substitute to capital gains tax (direct tax). If
there are problems in collecting capital gains taxes, these should be sorted out rather than
reducing and abolishing it altogether. Further, to justify the introduction of STT only in terms
of smooth collection of taxes would be a serious mistake.

ELUCIDATING SECURITIES TRANSACTION TAX
The Budget 2004-05 proposed to introduce a securities transaction tax (STT). In the words
of Mr P Chidambaram, STT is a neat, efficient and easy-to-administer tax and it has the great
advantage of virtually eliminating tax avoidance.
The STT is applicable at different rates on the value of the taxable securities transaction,
which again is defined to mean a transaction of purchase and sale of securities entered into
in a recognised stock exchange in India on or after the date on which Chapter VII of the
Finance (No 2) Bill, 2004 comes into force (i.e. the specified date) and is payable by the
buyer and the seller of the securities.
Definition of Securities
The term "Securities" is not defined in the Income tax Act,1961 but at several places, the
meaning of this term is stated to be the same as defined in section 2 (h) of the Securities
Contracts (Regulation) Act,1956. According to this section, "Securities" include:
i) shares, scrips, stocks, bonds, debentures, debenture stock or other
marketable securities of a like nature in or of any incorporated company or other
body corporate;
ii) derivative;
iii) units or any other instrument issued by any collective investment scheme to
the investors in such schemes;
iv) security receipt as defined in section 2(zg) of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002;
v) Government securities;
vi) such other instruments as declared by the Central Government; and
vii) rights or interest in securities
After the presentation of the Budget on July 8, 2004, Mr P Chidambaram had also
announced that securities would be defined to include equity-oriented mutual funds (not
debt-oriented mutual funds) but exclude debt instruments. Further, under Section 2(f) of
the SCRA, a recognised stock exchange means a stock exchange, which is for the time
being recognised by the Central Government under Section 4 thereof.
Moreover, the value of taxable securities transaction is to be determined as under:
Option in securities: The aggregate value of the strike price and option premium.
Futures: The price at which such futures are traded.
Other Securities: The purchase price for a purchaser and the selling price for a seller.
Therefore, when one buys securities on or after the specified date, STT is to be paid
irrespective of the future holding period giving rise to long-term or short-term capital gains
or business profits; and the investor or trader earning a profit or suffering a loss. But, in the
case of day-traders, arbitrageurs and derivative traders, who are paying income-tax on
business profits, for non-delivery-based and delivery-based transactions, credit for STT will
be available against the income-tax payable on business income there on.
CHANGE IN THE TAXATION OF LONG-TERM AND SHORT-TERM CAPITAL GAINS
In respect of securities, as has been already defined in chapter 1, sold on or after the
specified date on a recognised stock exchange in India, long-term capital gains will be
exempt under the proposed Section 10 (38) of the Income-tax Act, 1961 (the Act). Similarly,
under the proposed section 111A of the Act, short-term capital gains on securities, sold on
or after the specified date on a recognised stock exchange in India, will be taxed at a rate of
10 per cent before levy of surcharge (for an individual and a Hindu undivided family having
taxable income not exceeding and exceeding Rs 850,000 at nil and 10 per cent respectively
and for others at the rate of 2.50 per cent) and education cess of 2 per cent on the
aggregate of income-tax and surcharge taken together for all other taxpayers. However, in
respect of securities sold before the specified date or after the specified date, which does
not meet the conditions stipulated above, would be taxable before the levy of surcharge
and education cess at the following rates: Long-term capital gains: 10 per cent without
indexation benefit or 20 per cent with indexation benefit, whichever is lower.
59

SHORT-TERM CAPITAL GAINS: AT THE REGULAR RATE OF INCOME TAX
There is no change in the taxation of business income, which is taxed at the regular rate of
income-tax except that credit would be available for STT from the income-tax payable i.e.
income-tax on business profits would be reduced by the amount of STT.
RATIONALE OF STT IN INDIAN FINANCIAL MARKET
There are several justifications for the adoption of STT in the Indian financial markets. Some
of them are as follows:
Firstly, the underlying logic of securities transaction tax is to slow down the flow of
speculative money, as it would be taxed each time a transaction takes place. The STT is
expected to curb purely short-term speculation by day traders, noise traders, arbitrageurs
and big operators without significantly affecting the long-term investors. The tax on equities
held for a long period would be marginal while the tax on short-term trading would be
higher.
60
The STT would be a significant deterrent to speculators and day traders trying to
make a quick profit on a huge sum by just trading, without taking any deliveries of stocks.
The proposed tax would keep such players away, as they would have to factor in the tax
cost. The STT is expected to reduce the speculation in Indian financial markets, which are
amongst the most speculative markets in the world. Compared with several leading
international financial markets, the sheer volume of speculative trading in Indian markets is
extremely high.

Despite a sharp increase in the daily turnover in the Indian financial markets, actual
deliveries are less than 20 per cent of trading. Due to excessive speculation, much of trading

59
http://economictimes.indiatimes.com/News/Economy/Policy/IDRs_to_attract_securities
transaction_tax/articleshow/3374596.cms

60
The Case for a Securities Transaction Tax in India, ASED-PIRC Briefing Paper, 2001 available online at
www.ased.org


in the Indian markets is concentrated in a handful of stocks. The top 10 stocks account for
over 80 per cent of the turnover of the Indian financial markets. The top 100 stocks account
for almost 99 per cent of the turnover. While there are several thousand stocks listed in the
markets that are not traded at all. The speculative nature of Indian financial markets can
also be gauged from the fact that the volume of secondary market trading has increased
several times while new capital raised through primary market has significantly declined
over the years. Over the years, we have witnessed that excessive speculative trading by big
players more often than not degenerates into market manipulation. There is an entire
history of frauds in the financial markets starting from the securities scam of 1992.
61
The
financial frauds recurring at regular intervals reveal that our financial markets are prone to
abuse, manipulation and excessive speculation.
India has also the distinction of having extreme price volatility at the individual stock level.
Short-term trading is one of the major factors responsible for increased market volatility. By
raising the cost of speculative trading, STT would contribute towards restraining short-term
trading, thereby making Indian financial markets less volatile and more efficient.
Secondly, the revenue potential of a 0.15 per cent of STT provides another justification. On
an average, the daily trading in the Indian stock markets is about Rs 100000 million. By
imposing a 0.15 per cent STT on this volume, the Indian tax authorities can collect Rs 150
million every day. As Indian financial markets operate on an average 250 days a year, STT
could generate revenue of Rs 37500 million every year. This is a substantial amount in the
present times when country is finding it difficult to raise revenues through taxation. Indias
tax-GDP ratio is among the lowest in the world and has fallen particularly in the 1990s the
decade of economic liberalization and globalization.
Further, the need of the hour is to tax the financial economy that has remained under taxed
despite tremendous growth in the recent years. To a large extent, this has happened due to
several loopholes in the present tax system, which have been consistently exploited by the
big operators in the financial markets. For instance, the foreign institutional investors (FIIs)
avoid paying taxes in India by routing their investments through Mauritius, which has signed
double tax avoidance treaty with India. Under this treaty, corporate bodies registered in
Mauritius would be taxed under the Mauritian law rather than Indian law. Since Mauritius
does not tax capital gains and dividend, it is no surprise that bulk of portfolio investment as
well as foreign direct investment into India is routed through Mauritius. But once the STT is
implemented in India, evasion of taxes by the FIIs and other international fund managers
through such tax treaties would be effectively curbed.
62


61
See, for instance, B. G. Shirsat, Indian Bourses Second-most Speculative after Nasdaq, Business
Standard, April 5, 2001; and Rishi Chopra, Excessive Speculation Plagues Capital Markets, The Economic
Times, May 8, 2001.
62
Supra 3
Thirdly, an additional advantage of STT is that it could discourage hot money flows, which
are known for their volatile and destabilizing behavior. As recent international experience
shows that developing countries are more vulnerable to hot money flows, STT could
ensure some degree of insulation to the Indian financial markets from the deleterious
effects of such volatile financial flows.
Fourthly, by cutting back financial resources in unproductive speculation, STT could
encourage long-term financial flows. The speculative activity in the financial markets diverts
large amounts of resources away from productive purposes. As a result, fewer financial
resources are available to fund long-term economic development. In the long run, STT has
the potential to benefit the real economy.
63

Fifthly, the securities tax is much easier to implement. It is a clean and efficient instrument
of collecting taxes from financial markets as collections will be centralized through the stock
exchanges. Further, STT does not require any international consensus or agreement to levy
it. India, like any other country, is free to levy STT.









CONCLUSION
While favouring the implementation of STT, the researcher is not arguing that all problems
related to speculation and volatility in the Indian financial markets would be resolved by it.
In the present times, no single instrument by itself can solve all problems plaguing the
Indian financial markets. However, if used in conjunction with other policy mechanisms
(e.g., banning short selling and insider trading), STT does offer a potent mechanism to deal
with the multiple problems. Therefore, any attempt to dilute the provisions of the proposed
tax should be strongly opposed by all those who are concerned about stability in the Indian
financial markets.

Shares transactions are now being effected by a very wide spectrum of people in the
country. The various provisions of tax laws must therefore be understood by them and by
their tax advisors properly so that the best use of provisions granting various incentives and
relief can be made.



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http://www.macroscan.com/cur/jul04/pdf/equitable_equity.pdf
STOCK EXCHANGE SCAMS IN INDIA
Harshad Mehta Scam
Having figured out his scheme, Mehta needed banks which issued fake BRs, or BRs
not backed by any government securities. Two small and little known banks - the Bank of
Karad (BOK) and the Metropolitan Co-operative Bank (MCB) - came in handy for this
purpose. These banks were willing to issue BRs as and when required, for a fee, the authors
point out. Once these fake BRs were issued, they were passed on to other banks and the
banks in turn gave money to Mehta, assuming that they were lending against government
securities when this was not really the case This money was used to drive up the prices of
stocks in the stock market. When time came to return the money, the shares were sold for a
profit and the BR was retired. The money due to the bank was returned. The game went on
as long as the stock prices kept going up, and no one had a clue about Mehtas modus
operandi. Once the scam was exposed, though, a lot of banks were left holding BRs which
did not have any value the banking system had been swindled of a whopping Rs 4,000
crore. When the scam was revealed, the Chairman of the Vijaya Bank committed suicide by
jumping from the office roof. He knew that he would be accused if people came to know
about his involvement in issuing cheques to Mehta. Mehta made a brief comeback as a
stock market guru, giving tips on his own website as well as a weekly newspaper column.
This time around, he was working with owners of a few companies and recommended only
the shares of those companies. This game, too, did not last long By the time he died,
Mehta had been convicted in only one of the many cases filed against him. The Mehta
scandal was portrayed in a recent Hindi movie, 'Gafla.
Ketan Parekh
Ketan Parekh is a former stock broker from Mumbai, India, who was convicted in
2008, for involvement in the Indian stock market manipulation scam in late 1999-2001.
Currently he has been debarred from trading in the Indian stock exchanges till 2017.
On 9th Dec 2010, NDTV India (a news channel of india) claims that Ketan Parekh has relation
with Ravi inder (arrested by Delhi police in November 2010). / According to the news
channel he still has a vital role in indian share market. A chartered accountant by training,
Parekh came from a family of brokers, which helped him create a trading ring of his own.
Between 1999 and 2000, as the technology bubble was engulfing the rest of the world, the
stock market in India sprang to life too. Be it investment firms, mostly controlled by
promoters of listed companies, overseas corporate bodies or cooperative banks, all were
ready to hand the money to Parekh, which he used to rig up stock prices by making his
interest apparent. In no time, scrips like Visualsoft rose from Rs 625 to Rs 8,448 per share
and Sonata Software from Rs 90 to Rs 2,150. But the vicious cycle of fraud did not end with
price rigging. The inflated stocks had to be dumped onto someone in the end, for which
Parekh used financial institutions like the UTI. But the party ended rather abruptly a day
after the Union Budget was presented in February 2001. A bear cartel started disrupting
Parekh's party by hammering prices of the K-10 stocks, precipitating a payment crisis in
Kolkata. As SEBI investigated, it was evident that bank and promoter funds were used to rig
the markets. Parekh was arrested in March that year and was in custody for 53 days. In the
aftermath of the scam, many gaping loopholes in the market were plugged. The trading
cycle was now reduced from one week to one day. Badla was banned and operators could
not carry forward trade in its primitive form. Forward trading was formally introduced in the
form of exchange-traded derivatives to ensure a well-regulated futures market. Broker
control over stock exchanges was demolished. It's perhaps thanks to the Pentafour Bull that
India's stock markets are today considered safe. And to his credit, Parekh forced lethargic
policy-makers to institute reforms in the financial system. He is, however, now suspected to
be operating in the markets through conduits. Parekh will remain a work-in-progress for
regulators






Byrraju Ramalinga Raju

Ramalinga Raju founded Satyam Computers in 1987 and was its Chairman until
January 7, 2009 when he resigned from the Satyam board after admitting to cheating six
million shareholders.After being held in Hyderabad's Chanchalguda jail on charges including
cheating, embezzlement and insider trading, Raju was granted bail on 18 August 2010. A
botched acquisition attempt involving Maytas in December 2008 led to a plunge in the share
price of Satyam. In January 2009, Raju indicated that Satyam's accounts had been falsified
over a number of years.He admitted to an accounting dupery to the tune of 7000 crore
rupees or 1.5 Billion US Dollars and resigned from the Satyam board on January 7, 2009. In
his letter of resignation, Raju described how an initial cover-up for a poor quarterly
performance escalated: "It was like riding a tiger, not knowing how to get off without being
eaten." Raju and his brother, B Rama Raju, were then arrested by the Andhra Pradesh
police on charges of breach of trust, conspiracy, cheating, falsification of records. Raju
may face life imprisonment if convicted of misleading investors. Raju had also used dummy
accounts to trade in Satyam's shares, violating the insider trading norm. It has now been
alleged that these accounts may have been the means of siphoning off the missing
funds.[10] Raju has admitted to overstating the company's cash reserves by USD$ 1.5
billion. Raju was hospitalized in September 2009 following a minor heart attack and
underwent angioplasty. Raju was granted bail on condition that he should report to the local
police station once a day and that he shouldn't attempt to tamper with the current
evidence. This bail was revoked on 26 October 2010 by the Supreme Court of India and he
has been ordered to surrender by 8 November 2010] The people of his native village,
Garagaparru, hail the development works undertaken by the Byrraju Foundation, the
charitable arm of Satyam.Ramalinga Raju may head Indias first BPO from prison.

Stock exchange/ capital market scams of USA and UK



1. Enron scandal (USA)

The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron
Corporation, an American energy company based in Houston, Texas, and the dissolution
of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in
the world. In addition to being the largest bankruptcy reorganization in American history at
that time, Enron was attributed as the biggest audit failure.
Enron was formed in 1985 by Kenneth Lay after merging Houston Natural
Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff
of executives that, through the use of accounting loopholes, special purpose entities, and
poor financial reporting, were able to hide billions in debt from failed deals and projects.
Chief Financial Officer Andrew Fastow and other executives not only misled Enron's board of
directors and audit committee on high-risk accounting practices, but also pressured
Andersen to ignore the issues.
Shareholders lost nearly $11 billion when Enron's stock price, which hit a high of US$90 per
share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S.
Securities and Exchange Commission (SEC) began an investigation, and rival Houston
competitor Dynegy offered to purchase the company at a fire sale price. The deal fell
through, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of
the United States Bankruptcy Code. Enron's $63.4 billion in assets made it the largest
corporate bankruptcy in U.S. history until WorldCom's bankruptcy the following year.
Many executives at Enron were indicted for a variety of charges and were later sentenced to
prison. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court,
but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the
majority of its customers and had shut down. Employees and shareholders received limited
returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of
the scandal, new regulations and legislation were enacted to expand the accuracy of
financial reporting for public companies. One piece of legislation, theSarbanes-Oxley Act,
expanded repercussions for destroying, altering, or fabricating records in federal
investigations or for attempting to defraud shareholders. The act also increased the
accountability of auditing firms to remain unbiased and independent of their clients

2. Financial fraud by Michael Milken (USA)

Michael R. Milken, who created the ''junk bond'' market that financed many big corporate
takeovers in the 1980's, agreed yesterday to plead guilty to six criminal charges related to
securities transactions and pay $600 million in fines, people who have been briefed about
the decision said.
A final settlement between Mr. Milken, the former head of the junk bond department at the
defunct Drexel Burnham Lambert Inc., and the Government would end the largest criminal
case in Wall Street history. Some details of the settlement must still be worked out and the
final pact will be subject to Federal District Court approval.
Mr. Milken has been at the center of the inquiry that began in 1986, when Ivan F. Boesky,
the former stock speculator, agreed to settle insider trading charges, pay a fine of $100
million and provide evidence about other wrongdoing on Wall Street. For more than three
years, Mr. Milken vigorously maintained his innocence.
Mr. Milken, 43 years old, has been one of the best-known figures on Wall Street over the
last decade. He was the most highly paid financier in history, personally collecting more
than $1.1 billion between 1983 and 1987 from Drexel, while earning income from other
investments as well.

3. Fraud by Anthony Elgindy and the corrupt FBI agent (USA)
Here is a guy who built up a large following in the late 90's by exposing overvalued
stocks and then subsequently short-selling them for profit. He had a corrupt FBI agent
on his payroll, Jeffrey Royer, who would log into government databases using his
credentials and try to dig up confidential information that they could use to
manipulate the stock market. For instance, if the CEO of a company had a criminal
investigation against him ongoing, they would short the stock (bet that it would fall)
and then disseminate the confidential information in order to create weakness in the
stock. Elgindy would also inform the companies that he possessed this information,
and then try to extort funds from them in exchange for not releasing the info.
Eventually the FBI caught on to their scheme and Elgindy ended up receiving 11 years
in jail, where he still is today.


4. ZZZZ Best Inc. scam (USA)
In 1983 fifteen year old Barry Minkow began a carpet cleaning business in his parent's
garage which he named ZZZZ Best (pronounced zee best). His fraudulent
activities began almost immediately. He over and double-billed clients, kited checks,
stole checks and deposited them into his account. When that wasn't enough to cover
his deficits, he obtained his first bank loan using unaudited financial statements and
phoney tax returns. Subsequent loans followed, each one larger than the last and
granted with increasing ease since, on paper, it appeared that ZZZZ Best had plenty
of cash.
In 1986 Barry Minkow and his partners changed their business operations to insurance
restoration and took their company public. They compiled false financial data consisting
of billings to made-up companies, phoney billings to existing customers, classifying
expenses as capital expenditures (see: Worldcom), and drawing up phoney
contracts. Forbes and The Wall Street Journal touted ZZZZ Best as one of the hottest
stocks to buy and investors lined up. At it's height ZZZZ Best was valued at around $300
million. Minkow threw lavish parties, bought boats, cars, houses and was known on
Wall Street as a wonder boy. It was all based on fiction.
The mountain of phoney documentation was dutifully audited by the accounting firm
of Ernst and Young. Minkow had a close scrape when the auditors asked to see the buildings
that ZZZZ Best were restoring. To hide the fact that no such work was going on, Minkow
bribed his way into buildings that were under construction, hired "workers", put ZZZZ Best
signs around the site and took his auditor on a tour. Due diligence was satisfied.
Unfortunately, the auditors later asked to see the finished buildings and the scam started to
unravel. It was at this same time that ZZZZ Best was attempting to merge with a much larger
company and a damaging newspaper article was published citing complaints from former
disgruntled clients for the rampant overbilling practices. The merger was canceled and
the SEC launched an investigation.
Barry Minkow succeeded in selling thousands of people something that never existed. He
bilked them out of over $200 million and for that he served 7 years of a 25 year jail sentence
and was fined $26 million.


5. Guinness share-trading fraud(UK)
The Guinness share-trading fraud was a famous British business scandal of the 1980s. It
involved an attempt to manipulate the stock market on a massive scale to inflate the price
of Guinness shares and thereby assist a 2.7 billion take-over bid for the Scottish drinks
companyDistillers. The European Court of Human Rights in Strasbourg later found the trial
violated the defendants' human rights by making use of statements obtained under duress.
The scandal was discovered after testimony as part of a plea bargain by the US stock
trader Ivan Boesky. Ernest Saunders, Gerald Ronson, Jack Lyons and Anthony Parnes, the so-
called "Guinness four", were charged, paid heavy fines and, with the exception of Lyons,
who was suffering from ill-health, served prison sentences later reduced on appeal.
Crime
Essentially, the defendants were to buy shares in Guinness plc, and by supporting the share
price Guinness would be able to take over Distillers, a much larger company. The Distillers
board favoured Guinness as partners and were facing a hostile bid by Argyll. In guaranteeing
without limit the defendants' losses if the value of their Guinness shares dropped, the
defendants were seen to have an unfair advantage in what should be a fair market. The
prosecution relied on a new law; the defendants claimed that supporting a share price with
a guarantee was an unusual but longstanding market practice

6. Barings Bank Fraud (UK)
The bank focused its activities in the investment sector, so its successes in trading
determined its future. In February 1995 the bank discovered that a massive fraud scheme,
perpetrated by one of its traders in Singapore, had wiped out the banks capital and
destroyed the 220-year-old institution. By 1989, Barings had established trading operations
at most of the worlds exchanges, operating primarily in British Commonwealth countries
and former British colonies. In that year, Nick Leeson, a young commodities trader, joined
the bank. He had graduated from college and spent two years at Morgan Stanley as a
settlements clerk, clearing the huge futures and options deals the traders were making.

When he joined Barings, it was in this same role, clearing settlements and learning the back
office operations of the bank. Bored with the limited opportunities for advancement,
Leeson quickly applied for a transfer, taking a position in the Banks trading operation in
Jakarta, Indonesia. He had applied for the position based on the image of an exotic locale
and the flashy marketing materials the bank used to promote its Far East experience. But he
soon found the reality to be vastly different, with the operations actually just a hotel room
with several computers in it. In his autobiographical account of the scheme, Leeson claims
to have learned just how lax the banks controls were and how much tolerance the bank
extended to superstar traders. He claims that significant losses were essentially ignored,
because they were typically not found until subsequent profits were booked to cover them.
With this experience under his belt, Leeson was returned to London, where he spent the
next year or so traveling around the Far East, meeting the various people and learning about
Barings various operations in the region. During that time period, Barings acquired a seat
on the Singapore International Monetary Exchange (SIMEX) but had not yet begun utilizing
it. In 1992 Leeson was selected to open, run, and manage the new operation in Singapore,
managing all aspects of trading on SIMEX. He had been with the bank approximately three
years and had a total of five years of experience in banking.

In his early stages, Leeson concentrated on arbitraging currency transactions. This is a fast-
paced practice in which speed and timing can enable a slow and steady profit. But for its
relatively low risk, it is a stressful and high-energy way to make relatively small profit
margins. Leeson soon became disenchanted. With his background in settlements, Leeson
was quick to catch any slight errors in the trading slips. Typically small errors would be
booked against an errors account in London, with the positives and negatives generally
netting out over time. In order to take advantage of the time differential, Leeson asked to
be allowed to create a local error account, named the 88888 account. This would later prove
vital to his orchestration of the scheme.
In his early stages, Leeson concentrated on arbitraging currency transactions. This is a fast-
paced practice in which speed and timing can enable a slow and steady profit. But for its
relatively low risk, it is a stressful and high-energy way to make relatively small profit
margins. Leeson soon became disenchanted. With his background in settlements, Leeson
was quick to catch any slight errors in the trading slips. Typically small errors would be
booked against an errors account in London, with the positives and negatives generally
netting out over time. In order to take advantage of the time differential, Leeson asked to
be allowed to create a local error account, named the 88888 account. This would later prove
vital to his orchestration of the scheme.

One of the keys to making money in this type of trading is the fast-paced nature of the
transactions. Deals are done and cleared the same day, reducing the risk but also minimizing
the opportunity for profits. As Leesons group grew on the relatively small SIMEX exchange,
their percentage of the total number of deals grew dramatically, making clearing all of the
settlements on the same day difficult. As such, Barings was occasionally allowed to hold
deals overnight and settle the next day. This would also later prove to become a key
element of the scheme.Soon after these two keys were in place, Leeson discovered a major
error. One of his traders had improperly sold a position instead of buying the position,
creating a 20,000 loss in the process. Leeson took the matter to his boss, who told him to
fire the trader and go on. Leeson instead attempted to hide the loss in the error account,
holding the closing not only overnight but over a weekend to attempt to lose the
transaction in the flurry on Mondays work, hoping that a profit then would cover his loss
from Friday. But the markets began moving against this hidden transaction, so that, a few
days later, the same still unreconciled trade would create a 60,000 loss. Leeson decided
that, rather than admit the situation to his superiors, he would actively manipulate the
books to conceal the loss. This was his first foray into the fraud that would eventually
destroy Barings Bank

Over the next two years Leeson expanded upon an increasingly risky trading strategy,
making larger and larger bets on the movements of the currency markets. He had discarded
the safe but low-margin arbitrage approach in favor of a much more risky but potentially
much more profitable series of direct currency gambles. He explained to his superiors that
his change in strategy would entail holding positions longer, but he began booking
significant profits from his trading activities. But these paper profits only concealed the
roller coaster of up and down wins and losses on the trading floor. To cover his losses
Leeson had to transfer cash at closing, so, despite the large paper profits being booked, he
was continually asking for additional cash from London. By July 1994 Leeson had created
and concealed losses totaling over 50 million. With his strategy failing, Leeson took ever
increasingly wilder risks. He expanded the size of his positions, making and losing in a single
day first millions and then tens of millions. When the scheme collapsed, Barings had to
transfer over 7.7 billion yen ($600 million) to the exchange to cover Leesons margin losses
Leesons audacious scheme succeeded for two primary reasons: management failed to look
beyond the paper profits to understand how he was generating these tremendous returns,
and nobody in London questioned his continual and increasing needs for cash. Barings
failure was in not recognizing that Leesons activities were essentially a Ponzi scheme, albeit
one that relied on a single internal investor to continually cover the snowballing losses
caused by the scheme. Its controls failed because of an inability of management to see the
impact of the ever-increasing demand for cash into an ostensibly profitable trading division.

7. The Stock Exchange Fraud of 1814 (UK)

Shortly after midnight on Monday the 21st February 1814 a man purporting to be a
Lieutenant-Colonel R. du Bourg, aide-de-camp to Lord Cathcart, the ambassador to the
Court of Russia, appeared at the Ship Inn in Dover on the south coast of England. He
claimed that he had just arrived from France and bore the important news that the
allied forces had gained a great victory, had now entered Paris, and that Napoleon
Bonaparte had been cut to pieces by a detachment of Cossacks. The Lieutenant-Colonel
called for pen, ink and paper and sat down to compose a message to the commander of
the naval garrisson atDeal before setting off in a post-chaise for London. On his way du
Bourg took great care to repeat his story at every available point on his journey before
his arrival in London at about 9 a.m. when he disappeared in the direction of Grosvenor
Square.
News of the end of the war soon spread and was widely believed. Any doubts that
might have arisen appeared to be dispelled when at around noon three French officers
appeared wearing white cockades, and drove around the City of London distributing
leaflets inscribed with the slogans "Vive le Roi! Vivent les Bourbons!"
Of course Napoleon Bonaparte was alive and well and continued to make trouble for
the next year or so. The whole affair had been nothing more than an elaborate if
somewhat puzzling hoax.
The Fraud Revealed
When the London Stock Exchange opened at 10 a.m. that morning, prices soon rose on
the strength of the exciting news from Dover, fell back, and then rose once more on the
news of the appearance of the three French officers. However, once a messenger had
returned from the government that afternoon with the official word that the whole
affair was a hoax, prices soon sank back to their previous level.
Trading on the exchange that day had been heavy, although not excessively so;
nevertheless the Committee of the Stock Exchange decided to launch an enquiry into
the day's trading. They soon established that just three men were responsible for the
sale of over 1.1 million of Consols and Omnium stocks, most of which had been
acquired during the previous week. These three men were Thomas Cochrane, known at
the time as the Lord Cochrane, a naval hero and Radical MP for Westminster, his uncle
and fellow MP Andrew Cochrane-Johnstone and Richard Gathorn Butt, a well known
speculator and financial advisor to the Lord Cochrane.
Further enquiries revealed that Lieutenant-Colonel du Bourg was in fact a Captain Random
de Berenger who, on his arrival in London, had called at Lord Cochrane's home at 13 Green
Street, Grosvenor Square, where he had changed into civilian clothes before making himself
scarce, whilst the three French officers were identified as Ralph Sandom, Alexander M'Rae,
and Henry Lyte all of whom were jobbers in the aforementioned funds. It seemed therefore
that the whole affair was simply a conspiracy to artificially boost the price of government
securities in order to enable the conspirators to offload their holdings at a profit.
The creation and manipulation of rumours in order to move stock prices was nothing new,
but such a blatant and theatrical attempt to profit at the expense of others was all too much
for the Stock Exchange who decided to prosecute. The accused were therefore brought
before the Court of the King's Bench at theGuildhall, on the 8th June 1814, and charged with
conspiracy to defraud the Stock Exchange "by circulating false news of Bonaparte's defeat,
of his being killed by the Cossacks, etc, in order to raise the funds to a higher price than they
would otherwise have borne, to the injury of the public, and the benefit of the
conspirators."
The Trial of the Lord Cochrane
The trial attracted a great deal of interest since it involved the celebrated and well-known
naval hero Thomas Cochrane who assembled a particularly capable defence team
featuring Henry Brougham (a future Lord Chancellor), William Best (a future Chief Justice of
Common Pleas and James Scarlett (a future attorney-general). But despite this array of legal
talent, in the end the question of Thomas Cochrane's guilt turned on the seemingly trivial
point as to whether Berenger had turned up Grosvenor Square that day wearing a red or a
green uniform. Thomas came up with a reasonably plausible explanation as to why Captain
Berenger had turned up at his home and changed into civilian clothes, but this relied
entirely on his assertion that Berenger was wearing the green uniform of the Duke of
Cumberland's Regiment of Sharpshooters to which Berenger belonged, as opposed to the
red uniform which he wore when playing the part of Lieutenant-Colonel du Bourg. Thomas
Cochrane swore that it was the former, but there were witnesses who tesitified to the latter
and thus as Chief Justice Lord Ellenborough pointed out in his summing up the Lord
Cochrane had lied, and the fact that he lied was a clear indication that he had something to
hide.
After deliberating the matter for two and a half hours the jury returned with verdicts of
guily against all the accused. Ellenborough duly passed sentence and ruled,
That the defendants, Lord Cochrane and Butt, should each pay a fine of 1,000; the
defendant, Holloway, a fine of 500; all the defendants to be imprisoned for one
year in the custody of the Marshal of the Marshalsea; and that the defendants - Lord
Cochrane, Butt, and De Berenger - should once, during that period, stand in and
upon the pillory for one hour, between the hours of twelve and two at noon, in the
open space facing the Royal Exchange, in the city of London.
Later that same month Thomas Cochrane appeared before the House of Commons to face a
motion for his expulsion. There he asserted his innocence, blaming his conviction on the
bias of Lord Ellenborough, the incompetence of his lawyers, the perjury of witnesses etc, in
a speech that was so abusive that the official record is peppered with deleted expletives.
But despite the passion of Cochrane's speech, the House voted by a majority of 140 to 44 to
expel him, although they also resolved to remit that part of the sentence which condemned
him to stand in the pillory. Neither did this quite end Cochrane's humiliation as he was also
struck off the navy list, and formally ejected from the Order of the Bath.
The Rehabilitation of the Lord Cochrane
Despite his conviction Thomas Cochrane coninued to maintain that the verdict against him
was politically motivated, and conducted a long-running campaign to have his sentence
quashed. Eventually with the accession of William IV and the election of an
unequivocally Whig government, he was eventually granted a pardon in 1832, by which
time he had succeeded his father as the Earl of Dundonald. He was also restored to the navy
list, reinstated to his former rank of rear admiral and placed on half pay. In 1847 he was
restored to the Order of the Bath and later returned to active service and served as
commander of the North American and West Indian station between 1848 and 1851.
Despite all this he continued to campaign for the repayment of the 1,000 fine he'd been
forced to pay and the payment of the naval back pay that he'd missed out on between 1814
and 1832. Even after his death in 1860 his heirs were still pursuing this claim years later,
until his grandson received an ex-gratia payment of 5,000 in 1878.
Thomas Cochrane has thus often been characterised as the victim of a miscarriage of justice.
Thanks largely to his own efforts at rewriting his life to suit his own purposes, it afterwards
became common to state that he was "falsely accused" and that he was "wrongly jailed for
fraud". Many later accounts of his life have tended to uncritically accept Thomas's own
account of events and it is only in more recent times that historians have re-examined the
case and concluded that the "evidence of Cochrane's intimate knowledge of the 'hoax' was
overwhelming" and that the jury got it right first time round. Therefore whilst the 1911
Encyclopedia Britannica refers to the affair as "a notorious fraud ... perpetrated on the Stock
Exchange by an uncle of his and by other persons with whom he habitually acted in his
speculations", clearly implying his innocence, the modern version simply states that he was
"involved in a plot to make money on the stock exchange by spreading false rumours".