COMPANY OBJECTS AND CAPACITY NOTES

COMPANY OBJECTS AND CAPACITY

A company’s objects are its aims and purposes. If a company enters into a contract which is outside its objects, that contract is said to be ultra vires. However, the rights of third parties to the contract are protected. The objects

The objects are the ‘aims’ and ‘purposes’ of a company. Under previous company’s legislation they were held in a specific clause within the memorandum of association. This clause set out everything the company could do, including being a ‘general commercial company’ which meant it could pretty much do anything.

The 2015 Act changed matters. The objects can now be found in the articles but most articles will not mention any objects. This is because under the Act a company’s objects are completely unrestricted (i.e. it can carry out any lawful activity). Only where the company wishes to restrict its activities is there an inclusion of those restrictions in the articles.

Alteration of the objects

As a company’s objects are located in its articles, it may alter its objects by special resolution for any reason. The procedure is the same as for any other type of alteration.

Contractual capacity and ultra vires

Companies may only act in accordance with their objects. If the directors permit an act which is restricted by the company’s objects then the act is ultra vires. Ultra vires is where a company exceeds its objects and acts outside its capacity.

Ultra vires is where a company exceeds its objects and acts outside its capacity.

Companies which have unrestricted objects are highly unlikely to act ultra vires since their constitution permits them to do anything. Where a company has restrictions placed on its objects, and it breaches these restrictions, then it would be acting ultra vires.

Transactions with directors

The Companies Act 2015 also applies when the company enters into a contract with one of its directors, or its holding company or any person connected with such a director. Contracts made between the company and these parties are voidable by the company if the director acts outside their capacity.

Whether or not the contract is avoided, the party and any authorising director are liable to repay any profit they made or make good any losses that result from such a contract.

The constitution/Articles of association as a contract The articles constitute a contract between:

  • Company and members
  • Members and the company
  • Members and members

 

The articles do not constitute a contract between the company and third parties, or members in a capacity other than as members (the Eley case).

 Effect of the companies’ constitution A company’s constitution binds:

Members to company

Company to members

Members to members

The company’s constitution does not bind the company to third parties.

This principle applies only to rights and obligations which affect members in their capacity as members.

Hickman v Kent or Romney Marsh Sheep breeders Association 1915

The facts: The claimant (H) was in dispute with the company which had threatened to expel him from membership. The articles provided that disputes between the company and its members should be submitted to arbitration. H, in breach of that article, began an action in court against the company.

Decision: The proceedings would be stayed since the dispute (which related to matters affecting H as a member) must, in conformity with the articles, be submitted to arbitration.

 

The principle that only rights and obligations of members are covered applies when an outsider, who is also a member, seeks to rely on the articles in support of a claim made as an outsider.

Eley v Positive Government Security Life Assurance Co 

The facts: E, a solicitor, drafted the original articles and included a provision that the company must always employ him as its solicitor. E became a member of the company some months after its incorporation. He later sued the company for breach of contract in not employing him as its solicitor.

Decision: E could not rely on the article since it was a contract between the company and its members and he was not asserting any claim as a member.

Constitution as a contract between members

The Companies Act gives to the constitution contractual effect between

  • The company and
  • Its members individually. It can also impose a contract on the members in their dealings with each other.

Articles and resolutions are usually drafted so that each stage is dealing between the company and the members, so that:

  • A member who intends to transfer their shares must, if the articles so require, give notice of their intention to the company.
  • The company must then give notice to other members that they have an option to take up their shares.

Company name and registered office

Except in certain circumstances a company’s name must end with the words limited (Ltd), public limited company (plc).

A company’s name is its identity. There are a number of rules which restrict the choice of name that a company may adopt.

Statutory rules on the choice of company name

The choice of name of a limited company must conform to the following rules.

  • The name must end with the word(s):
    • Public limited company (abbreviated plc) if it is a public company
    • Limited (or Ltd) if it is a private limited company, unless permitted to omit ‘limited’ from its name
  • The name must not be the same as any other company name appearing in the Registrar’s Index of Company Names,

Where a company has a name which is the same or too similar to another, the Registrar may direct the company to change its name.

  • No company may have a name the use of which would be a criminal offence or which is considered offensive or ‘sensitive’ (as defined by the Registrar).
  • Official approval is required for a name which in the Registrar’s opinion suggests a connection with the government or a local authority or which is subject to control.
  • A name which suggests some professional expertise such as ‘optician’ will only be permitted if the appropriate representative association has been consulted and raises no objection. The general purpose of the rule is to prevent a company misleading the public Criteria for determining offensive or undesirable names (Sec 11 of the Company Rules)

The Registrar is required to apply the following criteria in determining whether a particular name is offensive or undesirable or contrary to the public interest.

  • The name includes “co-operative”, “society” or “trade union “or any variant or synonym of those words;
  • The name suggests an association with, or the patronage of, the State or any of its agencies, unless there are circumstances that justify its use;
  • The name suggests an association with, or the patronage of, a foreign government or an embassy, high commission or consulate representing such a government in Kenya;
  • The name suggests an association with, or the patronage of, a county government;
  • The name comprises an acronym that will render its use vague or uncertain;
  • The name includes the name of a registered trade mark unless a document signed by the owner of the trade mark and indicating consent to its use is provided;
  • The name is such that the Registrar believes on reasonable grounds that there is reasonable possibility that it could offend members of a particular community or ethnic or racial group.

Omission of the word ‘limited’

A private company which is a charity or a company limited by shares or guarantee may omit the word ‘limited’ from its name if the following conditions are satisfied.

  • The objects of the company must be the promotion of either commerce, art, science, education, religion, charity or any profession (or anything incidental or conducive to such objects).
  • The articles must require that the profits or other income of the company are to be applied to promoting its objects and no dividends or return of capital may be paid to its members.
  • Also, on liquidation the assets (otherwise distributable to members) are to be transferred to another body with similar objects. The articles must not then be altered so that the company’s status to omit ‘Limited’ is lost.

Change of name

A company may decide to change its name by:

  • Passing a special resolution
  • by resolution of the directors acting in accordance with a direction by the Registrar under section 60;
  • Any other means provided for in the articles (in other words the company can specify its own procedure for changing its name)

Where a special resolution has been passed, the Registrar should be notified and a copy of the resolution sent.

If the change was made by any other procedure covered by (c), the Registrar should be notified and a statement provided which states that the change has been made in accordance with the articles.

The change is effective from when a new incorporation certificate is issued, although the company is still treated as the same legal entity as before. The same limitations as above apply to adoption of a name by change of name as by incorporation of a new company.

Effects of change of name

  • A change of a company’s name has effect from the date on which the certificate of change of name is issued.
  • The change does not affect any rights or obligations of the company or invalidate any legal proceedings by or against it.
  • Any legal proceedings that might have been continued or commenced against it by its former name may be continued or started against it by its new name.

Passing-off action

This is making false representation likely to induce a person to believe that the goods or services are those of another

A person who considers that their rights have been infringed under passing off can apply for an injunction to restrain a company from using a name (even if the name has been duly registered). It can do this if the name suggests that the latter company is carrying on the business of the complainant or is otherwise connected with it.

A company can be prevented by an injunction issued by the court in a passing-off action from using its registered name, if in doing so it causes its goods to be confused with those of the claimant.

Ewing v Buttercup Margarine Co Ltd 1917

The facts: The claimant had since 1904 run a chain of 150 shops in Scotland and the north of England through which he sold margarine and tea. He traded as ‘The Buttercup Dairy Co’. The defendant was a registered company formed in 1916 with the name above. It sold margarine as a wholesaler in the London area. The defendant contended that there was unlikely to be confusion between the goods sold by the two concerns.

Decision: An injunction would be granted to restrain the defendants from the use of its name since the claimant had the established connection under the Buttercup name. He planned to open shops in the south of England and if the defendants sold margarine retail, there could be confusion between the two businesses.

If, however, the two companies’ businesses are different, confusion is unlikely to occur, and hence the courts will refuse to grant an injunction. The complaint will also not succeed if the claimant lays claim to the exclusive use of a word which has a general use.

Publication of the company’s name

The company’s name must appear legibly and conspicuously:

  • Outside the registered office and all places of business
  • On all business letters, order forms, notices and official publications
  • On all receipts and invoices issued on the company’s behalf
  • On all bills of exchange, letters of credit, promissory notes, cheques and orders for money or goods purporting to be signed by, or on behalf, of the company (e) On its website

Registered office

The Companies Act 2015 provides that a company must at all times have a registered office to which all communications and notices can be sent. Its location in Kenya determines its domicile.

A company may change its registered office (but not its domicile), but for a period of 14 days after notice is served any person may validly present documents to the previous address.

CONSTRUCTIVE NOTICE OF THE COMPANIES’ CONSTITUTION

A company’ articles of association become public documents on registration with the registrar of companies. These documents are available for public inspection in the Registrar’s office on payment of such fees as may be prescribed.

Every person who deals with the company is deemed to know the contents of these documents. This is known as the “Doctrine of Constructive Notice” or ‘Constructive Notice of the company’s constitution’. It is presumed that the individuals dealing with the company have read these documents and understood their proper meaning.

The articles of association are open and accessible to all. It is the duty of every person dealing with the company to inspect these documents and see that it is within the powers of the company to enter into proposed contract. Likewise, special resolutions when registered with the registrar become public document so that an outsider is in notice of their contents in the same way as he is of the memorandum and articles of association.

Presumption that outsider has read the articles of association was observed in Mahoney vs. East Holyfield Mining Co. as follows:

“But whether he actually read them or not it will be presumed that he has read them. Every joint stock company has its memorandum and articles…open to all who are minded to have any dealings whatever with the company and those who so deal with them must be effected with notice of all that is contained in these two documents”

The doctrine of Constructive notice of the articles of association however is not a positive doctrine but a negative one. It does not operate against the company.

It operates only against an outsider dealing with the company. It prevents him from alleging that he did not know that the articles rendered a particular act ultra vires the company.

Doctrine of indoor management

The doctrine of indoor management is an exception to the rule of constructive notice.  According to the rule of constructive notice, a person dealing with the company is deemed to have knowledge of the articles of the company.  If he enters into a transaction with the company which is ultra vires, he cannot treat the transaction as binding on the company.

The doctrine of indoor management on the other hand argues that outsiders dealing with the company are entitled to assume that everything had been regularly done so far as its internal proceedings are concerned.  The doctrine had its origin in a famous case, “Royal British Bank vs.

Turquand”.

Case Law:  Royal British Bank vs. Turquand 

The directors of the Bank issued a bond to Mr. Turquand.  The articles provided that the directors had the power to issue bond if authorized by proper resolution of the company.  No such resolution was passed.  It was held that Turquand could sue on the bond as he was entitled to assume that the resolution must have been passed.  It was observed that persons dealing with the company are bound to read the registered documents and to see that the proposed dealings are not inconsistent therewith, but are not bound to do more.  They need not inquire into the irregularity of internal proceedings.

Exceptions to The doctrine of indoor management

The doctrine is however, subject to the following exceptions:-

  • Knowledge of irregularity: – A person who deals with the company and who has knowledge of the irregularity in its internal management in connection with the subject matter of his dealings cannot claim the benefit of the rule in Turquand’s case. Thus where company A lends money to company B on a mortgage of its assets and the procedure laid down in the article for such a transaction was not complied with and the directors of the two companies were the same, the mortgage is not binding. It may be presumed that company A had notice of irregularities through its directors.

Similarly in Howard v. Patent Ivory Co. the directors were empowered to borrow up to 1000 pounds and such further sums as the company in general meeting might authorize. Without such consent, they issued to themselves debentures for sums in excess of 1,000 pounds. It was held that as they had knowledge of irregularities in the internal proceedings of the company, the company would be liable for the 1,000 pounds only. Sums borrowed in excess of this were held to be invalid.

  • Negligence: – A person cannot claim the benefit of the rule in Turquand in circumstances under which he would have discovered the irregularity if he had made proper inquiries. Further, where circumstances surrounding the transaction are suspicious, and therefore invite inquiry, the outsider cannot claim the benefit of this rule.
  • Forgery: – The rule in Turquand’s case will not apply where a document on which the person seeks to rely on is a forgery.

Case Law: Ruben vs. Great Fungall Consolidated Co. 

Ruben lent a company a sum of money on the security of a share certificate.  The secretary had forged the signatures of the two directors and had affixed the seal on the certificate without authority.  The company refused to register the share certificate.  Ruben claimed damages relying on the Turquand’s rule.

It was held that he could not do so because the rule did not apply where the document was forged.

  • Acts outside the apparent authority: – The rule in Turquand does not apply where a person acting on behalf of the company exceeds any actual or ostensible authority given to him. A person who enters into a transaction with a company official who has acted beyond official powers will not be protected by the rule in Turquand case. Case Law:  Anand Lal vs. Dinshaw & Co. (1942)

P accepted a transfer of company’s property from its accountant.  Since such transaction is apparently beyond the scope of the accountant’s authority it was void.

No knowledge of the contents of the articles of association: –

A person who has not actually read the articles and who was not at the time he entered into the contract, aware of their content cannot seek to rely on the doctrine of indoor management.

The doctrine of indoor management is based on the principle of estoppels and therefore cannot be invoked in favor of a person who has not consulted the company’s memorandum and articles.

No one can rely and act upon something of which he was in fact completely ignorant.

FLOATATION OF CAPITAL

This is a process by which companies avail securities to the public for subscription. It enables companies to raise capital from the public.

This is only done by public companies since private companies are prohibited by their articles from doing so.

A private company which intends to have its capital floated off to the public must:

  •  Alter its articles in such manner that they no longer: (i) Restrict the right to transfer shares
  • Restrict the maximum number of members and
  • Prohibit an invitation to the public to subscribe for any shares or debentures of the company
  •  Within fourteen days after altering its articles, deliver to the registrar for registration a prospectus relating to the company which complies with the Third Schedule

 

If a private company “floated off” its shares to the public without altering its articles, the company would cease to be entitled to privileges and exemptions which the Act confers on a private company and would henceforth be governed by the provisions of the Act as if it were not a private company.

If the company altered the articles but failed to deliver the statement in lieu of the prospectus the company and every officer of the company who is in default shall be liable t o a default fine.

The following methods are generally used in flotation or raising capital:

  • Direct offers/ issue by prospectus
  • Offers for sale
  • Placing
  • Offer by Tender
  • Bonus issue
  • Right issue

 

  • Direct offers /issue by prospectus: By this method the company issuing the securities prepares and issues a prospectus inviting subscriptions. The prospectus must be prepared in accordance with the provisions of the Companies Act and must be accompanied by an application form.

The company is responsible for the administrative tasks of the issue and bears the risk if the issue is unsuccessful.

To spread this risk, the company may arrange for the issue to be underwritten, whereby an underwriter undertakes to take up all or a specified number  of shares if they are not taken up in return for a commission which is payable whether or not they are taken up. The underwriter may also arrange for the securities to be sub-underwritten whereby the sub-underwriter undertakes to take up a specified number of shares in return for a commission.  

  • Offer for sale: Under this method, the company allows the securities of an offer to an issuing house which in return prepares and issues a prospectus inviting subscriptions.

Company……..sells shares to…….Issuing House…………Resells the shares ……….to Public        (Issues a document called “Offer for sale”) The securities are offered at a premium.

The issuing house bears the risk of the issue being unsuccessful and may arrange for the same to be underwritten.

On application, the issuing house may renounce the allotment in favour of the applicant.

This method has two advantages:

✓ It ensures that the amount due on securities is paid to the company in full. ✓ It relieves the company of the administrative tasks of the issue.

  • Placing: By this method the securities on offer are purchased by an issuing house or taken up without a purchase. The issuing house then places them with its clients privately; there is no direct or indirect invitation to the public. The securities are offered to specific persons and institutions. ……………………………………Broker …………………..sells the shares to…………..Public (acts as the company’s agent)If the issuing house has not purchased the securities, it acts as broker in the transaction and is entitled to brokerage for the services rendered.
  • Offer by Tender: The Company or issuing house may invite tenders from persons who desire to take up the company’s shares and sells them to the highest bidder. This is done with a view to obtaining the best price possible for the shares. Under this method, the company fixes the minimum number of securities (shares) as well as price in much the same way as an auctioneer who sells goods subject to a reverse price. The company or issuing reserves the right to accept tenders in parts  This approach has 2 advantages:
  • It makes available to the company or issuing house any excess above the issue price.
  • It discourages stags who submit tenders for speculative purposes.

In addition to these 4 approaches, a company may further raise capital from existing members and debentures holders by way of bonus, rights, script or conversion issue.

  • Bonus issue: This is a capitalization issue where a company issues extra shares to existing members in proportion to their current holding at no direct consideration. The shares are financed by retained earnings for the company.

In this method instead of the company paying a cash dividend to its members, it retains the cash but issues new shares to the members. The total nominal value of shares issued equals the retained cash.

For a bonus issue to be effected the following conditions are necessary:

  • It must be authorized by the Articles of the company. The nominal capital of a company must be sufficient.
  • The shares must be issued in the proportions prescribed by the Articles.
  • The issue must be recommended by the board at a board meeting.
  • It must be authorized by an ordinary resolution of members in the general meeting.
  • It must be sanctioned by CMA
  • A return must be made to the Registrar of companies within 60 days.

Advantages of bonus issue

Advantages to existing shareholders

  • It will increase the existing shareholders security for loans in case he needs further finance.
  • It will increase the existing shareholders stake in the business and possible increase in dividends in the future
  • Existing shareholders get more shares in the company without any dilution of control since bonus issue is issued in proportion to existing shareholding.
  • Existing shareholders will realise tax free profits for this capital gain
  • In case of future sales of these shares, the existing shareholders will make a capital gain.
  • Right issue: This occurs if a company which has been trading for some time makes an offer to the existing members to buy shares of a new issue in proportion to the number of shares they hold. The existing members, rather than the public, are thereby given a “right” to buy new shares.

The advantages of this method is that the company avoids the substantial expenditure that is incidental to an offer  to the public and as far as the member is concerned, it enables him to buy shares at a price that is usually below their market price. For a rights issue to be effected:

  • It must be authorized by Articles of the company.
  • It must be sanctioned by CMA
  • It must be recommended by the board at the board meeting.
  • It must be authorized by an ordinary reduction of members in the general meeting.
  • A return must be made to the Registrar.

Advantages of rights issue to existing shareholders

  • This issue will increase the shareholders voting rights over and above their previous levels thus boosting their influence in the company’s decision making process.
  • The issue increases the shareholder’s shares in the company and this will boost his future dividends from the company
  • In case the shareholders sell their rights shares, they will earn a profit on this shares thus boosting their income
  • The right issue will increase the amount of shares he owns in the company and this will boost his securities for loans using his shares as security
  • The right issue will reserve the company’s control on existing shareholders in case some of them do not sell their shares this avoiding dilution of control.

 

Disadvantages of rights issue to existing shareholders

  • The shareholders EPS (Earnings Per Share) will decline due to increase in shareholding without a corresponding increase in profits
  • The existing shareholders are issued with short notice to buy the shares which tempts many of them to sell the right issue against wishes. This leads to apathy among shareholders
  • The company’s equity growth may decline because the company will be pre occupied with paying increased dividend due to increased number of shares and as a result of the rights issue thus reducing retained earnings
  • If all or some of the shareholders elect to sell their shares, the supply of shares (in the securities market) of such a company will exceed its demand, thereby lowering the prices of shares which shall lead to capital losses to the shareholders
  • The finance raised through a rights issue is invested at the discretion of the Board of Directors in areas of their interest and this will prejudice the interests of shareholders.

Similarities between bonus issues and rights issue

  • Both are issued at the discretion of directors
  • Both are only issued by limited companies
  • Both issues are reserved to existing shareholders of the company
  • In both cases, shareholders can sell their shares to earn a capital gain
  • Both may be invested without the consent of the existing shareholders
  • Both are issued to ordinary shareholders in proportion to their existing shareholders. Differences between bonus and rights issue
Bonus issue Rights issue
• It is issued to existing shareholder free of charge • Existing shareholders have to pay for

this issue

• It has no effect on the company’s net worth and the capital employed • It increases the company’s capital employed
• It depletes the company’s reserves • It does not affect the company’s reserves
• It is an internal source of finance • It is an external source of finance
• The issue does not earn the company a share premium • This issue enables a company to realize the share capital

 

Under writing commission

A public company which invites the public to subscribe to its shares or debentures must ensure that the issue is subscribed by the public. As such, it is willing to pay anyone a certain commission on all shares or debentures offered to the public if he guarantees that if any of these shares are not taken up by the public he will take them up. The commission so paid, is known as the “underwriting commission”.

Even if the company is sure that all shares or debentures will be taken up by the public it is advisable for it to get the shares or debentures underwritten to avoid the risk arising from certain unforeseen contingencies which may endanger the success of the issue.

In simple words the term underwriting means that a person agrees to take shares or debentures specified in the underwriting agreement, if the public fail to subscribe for them. Consideration for this contract takes the form of a commission whether or not the underwriters are called upon to take up any shares or debentures.

The following conditions however, have to be fulfilled for the payment of underwriting commission:

  • The payment of commission should be authorized by the Articles of the company
  • The commission paid or agreed to be paid must not exceed 10% by the price at which the shares are issued or such lower rates as may be fixed by the articles
  • The amount and rate of the commission and the number of shares which underwriters have agreed to subscribe must be disclosed as:
    • In the case of shares offered to the public for subscription, the disclosure must be made in the prospectus
    • In the case of shares not offered to the public for subscription, the same disclosure must be made in the statement in the prescribed form delivered to the registrar before payment of the commission

Brokerage

This is a payment made to issuing houses and brokers in return for their placing the company’s shares or securities but without undertaking to subscribe for them. It differs from underwriting commission in that it is payment made to an agent who is selling the company’s shares on its behalf without undertaking to buy the shares which he fails to sell.

In Andreae V Zinc Mines of Great Britain Ltd, the court explained that a payment is brokerage only if it is made to “stockbrokers, bankers and the like that who exhibit prospectuses and send them to their customers and through whose mediation the customers are induced to subscribe” as. Consequently, a payment which was made to a lady of a percentage on the amount of capital which she induced third parties to subscribe for shares in the defendant company was held not to be brokerage. The lady could not be regarded as a “broker” on the basis of such an isolated transaction. The person to whom the payment is made must be one who carries on the business of a broker, either exclusively or as part of his general business, as in the case of a banker.

 

Therefore, though the payment of brokerage results in the company receiving less money for the shares, the payment is nevertheless not prohibited by the Act. Differences between the position of underwriters and brokers 

 

UNDERWRITES

They give an undertaking to take up shares or debentures if the issue is under subscribed

  • They give no such undertaking to take up shares or debentures if the issue is under-subscribed
  • They get underwriting commission on 2. They get brokerage only on those the entire issue which is underwritten shares or debentures for which they

by them procure subscription

 

  • They are entitled to underwriting They are entitled  to get such commission at a rate not exceeding ten brokerages as has been recognised or percent of the issue price of shares usual for the companies to pay such  brokerage.
  • Underwriting commission is payable
  • 4. Brokerage is payable on the shares or only on those shares or debentures debentures for which subscription is which are offered to the public procured even where the shares are debentures are not offered to the public
  • Underwriters are entitled to get
  • 5. The brokers are entitled to brokerage underwriting commission only if the even if the articles are silent articles authorise its payment.

 

  • The name, address and occupation of 6. There is no such requirement in case of each has to be disclosed in the brokers prospectus

 

Allotment SharesDefinition of Allotment

Allotment is the company’s acceptance of an applicant’s offer to take up the shares. It concludes a legally binding agreement between the applicant and the company.

 

However it doesn’t constitute the applicant as a member of the company as held in Re: Nicols case where Wilkinson applied for 100 shares of a company and was allotted the same. The company required him to pay £8 for every share held, his name was not entered in the register of members and he did not pay the amount demanded. Three years later, the BOD cancelled the allotment and issued the shares to third parties. Upon liquidation, Wilkinson’s name was put on the list of contributories. It was held that he was not liable as a contributory as he was not a member of the company.

An allotment, legally, is the company’s acceptance of an offer to buy its shares. It is governed by the following common law rules relating to contract:

  • Where a company issues a prospectus, the issue is an invitation to treat but not an offer.
  • The company’s acceptance must be unconditional. If, therefore, the application was for 10 shares and only 5 were allotted, the allotment would be a counter-offer which the allottee could reject. But this might be the only reasonable or just thing for the company to do if the issue was over-subscribed.
  • The acceptance must be communicated to the applicant. This means that the allottee must actually receive the letter of allotment so that he is aware of the allotment. If the letter of allotment is lost in transit there would be no binding contract. However, it was explained in Household Fire Insurance Co. Ltd v Grant that, if the applicant expressly or impliedly authorized the company to communicate the acceptance by post, there would be a binding contract the moment the letter of acceptance is posted. It is irrelevant that the letter was delayed or, as in that case, was lost in transit.
  • The allotment must be made within a reasonable time

 

Rules for the allotment of shares in a public company

The following are rules provided in section 354 of the Companies Act in the allotment of shares by a public company.

  • The issue must be subscribed for in full;
  • The offer is made on terms that the shares subscribed for may be allotted for in any event; or if specified conditions are made and those conditions are satisfied.
  • A company shall not allot its shares at a discount.
  • A public company shall not allot share unless at least one-quarter of its nominal value is paid up.
  • A public company shall not allot shares as fully or partly paid up otherwise than in cash. Consideration to a company in the allotment of shares must therefore be cash.

PROSPECTUS

After obtaining the certificate of incorporation, the promoters will take steps to raise the necessary capital for the company.  A public company may invite the general public to subscribe to the capital of the company and for this purpose a prospectus has to be issued. The basic objective of issuing a prospectus is to arouse public interest in the proposed company and induce the general public to buy its shares and debentures. However, it is not essential for a public company to issue a prospectus. If the promoters are confident of raising the required capital privately from their relatives and friends, they need not issue a prospectus. In such a case, a statement in lieu of prospectus must be filed with the Registrar of companies.

A private company, by its articles, prohibits any invitation to the public to subscribe for any shares in, or debentures of the company. Definition of Prospectus  The term prospectus means:

“Any prospectus, notice, circular, advertisement or other invitation offering to the public for subscription or purchase any shares of debentures of a company”.

Any invitation intended to avail company securities for subscription for the public qualifies as a prospectus. Its distinguishing characteristics are the contents and intentions of the issuer.

In Re: South of England Natural Gas Co Ltd, a newly formed company issued 3000 copies of a document stamped “for private circulation only”. The document invited subscription for the company shares and the copies were distributed to members of several gas companies. Question was whether the document was a prospectus. It was held to be.

The term “offering” used in the definition is used in a non-technical sense as a prospectus invites offers.

Meaning of public

The term public in the definition isn’t restricted to the public at large as it includes a section thereof.

In Re: South of England Natural Gas Co. Ltd it was held that a document inviting applications for shares in certain gas companies was an offer to the public even though it was marked “for private circulation only.” However, a “circular” by which a company offered to acquire the shares of another company in exchange for its own shares was held not to be a “prospectus” within the statutory definition:

Government Stock and other Securities Investment Co. Ltd v Christopher

Circumstances in which a company may issue a prospectus

  • A newly formed company may issue a prospectus inviting prospectus investors to subscribe for securities.
  • An existing public company wishing to raise additional capital from the public may issue a prospectus in relation to the issue.
  • If a private company passes a special resolution converting itself into a public company, it ceases to be a private company from the resolution date and must within 14 days thereof deliver to the Registrar for registration either a prospectus or a statement in lieu of prospectus.

Rules applying to prospects

  • A prospectus must be in writing
  • A prospectus must also be in the English language.
  • An oral invitation to subscribe shares in, or debentures of, a company, or deposit is not a prospectus.
  • Likewise, an advertisement in television or a film is not treated to be a prospectus.

 

Subscription The word “subscription” in the definition of a prospectus means “taking” or agreeing to take shares for cash. It means that the person agreeing to take the shares puts himself under a liability to pay the nominal amount thereof in cash.

Why regulate prospectus?

A company’s shares are legally regarded as goods. Consequently, the common law rule known as “caveat emptor” applied to their sale. In particular, the company as a seller was not bound to say anything to potential buyers which would enable them to assess the risks involved. Buyers were therefore left without a legal remedy if they bought shares which they would not have bought if the relevant material facts had been disclosed by the company’s agents. In an attempt to remedy this situation the Companies Act incorporated a number of statutory provisions which must be complied with.

 

Persons Responsible for preparing the Prospectus

  • The issuer of the securities;
  • Each person who is a director at the time of publishing the prospectus
  • Each person who has given his consent to be named as a director or as having agreed to become a director immediately or at a future time;
  • Each person who accepts, and is stated in the prospectus as accepting, responsibility for, or for any part contained in the prospectus; and
  • Each person not falling within any of the foregoing paragraphs who has authorized the publication of the prospectus

 

Contents of a prospectus

Every prospectus issued by or on behalf of a company or by or on behalf of any person who has been engaged or interested in the formation of the company must contain the particulars as provided under the Companies Act.

  • Identity of directors, senior management and advisers i.e. persons responsible for the information disclosed;
  • Offer statistics and expected timetable;
  • Information on the Issuer;
  • Operating and financial review and prospectus (the recent development and Prospects of the group);
  • Directors and senior management;
  • Major shareholders and related party transactions;
  • Financial information;
  • The offer and listing;
  • Vendors
  • The contents of the Prospectus with the particulars of signatories and number of shares subscribed by them
  • The number and value of shares
  • Description of business to be undertaken and its prospects
  • Any provision in the articles relating to remuneration of Directors and Chief Executive
  • Particulars of the present and proposed directors, chief Executive and Company Secretary

The amount of minimum subscription;

  • The date and time of the opening and closing of the
  • Subscription list;
  • The amount payable on application for each share;
  • The number, description and amount of share capital issued within the two preceding years along with the amount of premium or discount, if any;
  • Name of the underwriters, if any along with opinion of Directors as to financial soundness of the company;
  • The name and address of Auditors and Legal
  • Advisors;
  • The amount of preliminary expenses;
  • The right of voting at meetings of the company;
  • Particulars of capitalization of any reserves or profits if any;
  • Particulars of surplus on revaluation of the assets and the manner, in which such surplus has been applied, adjusted or treated.

 

Annexures to the Prospectus

With respect to initial offers to the public, the shall include-

  • An Accountant’s report confirming compliance by the Issuer of the financial disclosures prescribed under Regulation10 (1); and
  • The scope of the engagement is governed by the Intentional Standards on Related Services- Engagements to Compile Financial Statements
  • A legal opinion which shall include but not be limited to the following-
  • Whether all licences and consents required to perform the business or proposed business of the issuer have been duly obtained;
  • The validity of evidence of ownership of land, plant and equipment and other important and relevant assets of the issuer;
  • Any agreements or contracts with respect to the proposed issue of securities
  • Any material litigation, prosecution or other civil or criminal legal action in which the issuer or any of its directors is involved
  • Whether the existing capital of the issuer and any proposed changes thereto is in conformity with applicable laws and has received all necessary authorizations; and
  • Any other material items with regard to the legal status of the Issuer and the proposed issue

 

Other contents of a prospectus:

A prospectus issued by or on behalf of a company or in relation to an intended company must be dated and unless otherwise provided, this is taken to be the date of publication.

  • A prospectus must state on its face, any documents annexed thereto or endorsed there on.
  • Under Capital Markets (Public Offer Listing and Disclosure), Regulations of 2002, the prospectus of a company quoted on the main segment must state:
    • The particulars of directors and service managers.
    • The bankers and legal advisors of the company.
    • The date of incorporation.
    • The country of incorporation.
    • Whether or not listing has been approved by the CMA
    • The cautionary statement from the CMA The summary of the memorandum and Articles.
    • The principal objects of the company.

 

Approval Process

 

  • In case of a listed company approval of the CMA must be obtained within sixty days before the date of issue of the Prospectus
  • A copy of the Prospectus must be sent to the Registrar of companies for registration before the issue of the Prospectus
  • The copy delivered must be signed by every person who is named or proposed as a director either in person or by an agent authorized in writing.
  • The Registrar of companies shall not register the Prospectus Unless the above requirements have been complied with
  • The Registrar may reject the prospectus if:
  1. i) It is undated ii) If it is not signed as required by the Act.

If it does not have the necessary annexures or endorsements

 

Liability in respect of the prospectus

Criminal liability

These are crimes created by the provisions of the Companies Act to compel companies to observe the provisions relating to prospectus namely the preparation, the contents and the registration.

 

  • It is a criminal offence to issue any form of application for shares or debentures unaccompanied by a prospectus of the company. The person in default is liable to a fine not.

However an application form need not be accompanied by a prospectus if it is issued:

  • In relation to shares or debentures not offered to the public;
  • In relation to shares or debentures similar to those previously issued by the company; or
  • In relation to a bonafide invitation to a person to enter into an underwriting agreement on the issue
  • It is a criminal offence to issue a prospectus containing a statement purported to have been made by an expert without his written consent.

The company and every person who was knowingly party to the issue is liable to a fine.

  • It is a criminal offence to Issue a prospectus before a copy thereof is delivered to the Registrar for registration.
  • Deliver to the Registrar for registration a copy of a prospectus without the necessary annexure or endorsements.
  • It is a criminal offence to authorize the issue of a prospectus containing any untrue statement. The person in default is liable to imprisonment for a term not exceeding 2 years or a fine or both.

 

However the accused escapes liability by proving either that:

  • The statement was immaterial; or
  • He had reasonable ground to believe and did believe up to the date of issue that the statement was true.

 

In R.V Kylsant , the accused, who was a chairman of the BOD of the company, was being prosecuted under the provision of the Larceny Act of 1861 for having authorized the issue of a prospectus containing untrue statements. The prospectus had stated between 1911 and 1927, the company had paid an annual dividend of between 5% and 8% except in 1914 where no dividend was paid and 1926, when a dividend of 4% was paid. In actual fact, the company had been paying dividend out of capital and between 1921 and 1926 it had made losses. The accused was found guilty and was sentenced to imprisonment for 12 months.

 

Civil liability

 

Statutory liability

 

A third party who has suffered loss or damage by reason of subscribing for the shares or debentures of a company on the faith of a prospectus containing an untrue statement is entitled to compensation for the loss or damage by:

  • Every person who was a director of the company at the time of issue.
  • Every person who was a promoter of the company.
  • Every person who had authorized him to be named in the prospectus as a director and was so named.
  • Every person who had agreed to become a director of the company either immediately or after an interval of time.
  • Every person who authorized the issue of the prospectus.

Defences:

A director sued for compensation may escape liability by relying on the defenses prescribed by the sub section that:

  • He withdrew his consent to act as a director before the issue of the prospectus.
  • The prospectus was issued without his knowledge or consent and on becoming aware of the issue, he gave reasonable public notice that it was so issued.
  • On becoming aware of the untrue statement, after the issue of the prospectus, but before the allotment of the securities, he withdrew his consent and gave reasonable public notice of the withdrawal and the reasons thereof.

 

An expert sued for compensation may escape liability by relying on the defenses prescribed by the sub section that:

  • Withdrawal of consent: He withdrew his consent in writing before the prospectus was delivered to the register for registration.
  • On becoming aware of the untrue statement, after the prospectus was delivered to the register for registration, but before allotment of the securities, he withdrew his consent in writing and gave reasonable public notice of the withdrawal and the reasons therefore.
  • True Statement: He was competent to make the statement and had reasonable grounds to believe and did believe up to the date of allotment that it was true.

 

  • Common law liability (Mainly deals with misrepresentation)

 

A person who has suffered loss or damage by reason of subscribing for shares or debentures on the faith of a prospectus containing any untrue statements has a common law action in damages for misrepresentation.

Misrepresentation renders a contract voidable at the option of the innocent party. However for misrepresentation to give rise to liability it must be proved that:

 

  • The statement was false in a material particular.
  • The statement was more than mere sales talk, whether a statement amounts to misrepresentation or mere sales talk depends on what a reasonable person will deem it to be.
  • The statement was one of fact and not opinion. As a general rule opinion does not amount to misrepresentation unless:
    • The maker does not honestly hold such opinion.
    • The opinion purports to be based on certain facts within the maker’s knowledge whose truthfulness he does not verify.

 

  • The statement was intended to be acted upon by the person or persons to whom it was made.
  • The statement was in fact made by the other party. As a general rule, silence, non-disclosure or does not amount to misrepresentation unless it renders the prospectus misleading.

However silence may amount to misrepresentation:

  • In contracts of utmost good faith.
  • In confidential relationships.
  • Where the statement made is half true ❖ Where disclosure is a statutory requirement.
  • Where the statement was true when made, but turns false due to a change in circumstances before the contract was concluded but the maker fails to disclose it falsity.

 

  • The false statement influenced the party’s decision to contract. The statement must have been made before or when the contract was being concluded. At common law, the ordinary purpose of a prospectus is to invite persons to subscribe to a company’s shares or debentures. Once the purpose is accomplished, the prospectus becomes exhausted and cannot be relied upon by persons who purchased the securities at the stock exchange.

 

It was so held in Peek V Gurney where the company’s shares were allotted between July and October and the plaintiff purchased the shares at the stock exchange in December and purported to rescind the contract as well as sue in damages for fraudulent misrepresentation of the prospectus. It was held that he could not base his action in the prospectus as it had become exhausted by the time he purchased the shares.

N.B: This case is authority for the proposition that directors are not liable for misrepresentation in a prospectus, after all the shares have been allotted, in respect of transaction concerning them thereafter.

 

However if it evidenced that the prospectus was intended to influence original and other subscribers, it is not deemed to have been exhausted.

 

This was the case in Andrews V Mockford where the plaintiff sued the defendant in damages for conspiracy to defraud him. The defendant had formed a company ostensibly to mine gold in Transvaal South Africa. However, very few persons applied for the company shares. The plaintiff, who had a copy of the prospectus, did not subscribe to them. After 8 months, the defendant sent a telegram to the UK that the company had struck gold and the information was printed in the financial news. The plaintiff applied and was allotted 50 shares. The company collapsed thereafter. It was held that the defendant were liable in damages for fraudulent misrepresentation as the prospectus had not become exhausted.

vii) The statement was innocently, fraudulently or negligently made.

 

  • Innocent misrepresentation: It arises where the make honestly believes in the truth of the statement and has no capacity to ascertain its falsity. The innocent party may apply for rescission of the contract or sue for indemnity for any financial loss occasioned by the statement.
  • Fraudulent misrepresentation: This is a situation where the maker of the statement has knowledge that it is false, makes it carelessly and recklessly and without belief in its truth.

This test for fraud was formulated in

Derry V Peek: In a company prospectus the defendant stated the company had the right to use steam powered trams as opposed to horse powered trams. However, at the time the right to use steam powered trams was subject to approval of the Board of Trade, which was later refused. The claimant purchased shares in the company in reliance of the statement made and brought a claim based on the alleged fraudulent representation of the defendant. Held: The statement was not fraudulent but made in the honest belief that approval was forthcoming.

 

Remedies

The innocent party may either:

  • Apply for rescission of contract; or
  • Sue in damages for the tort of deceit as was the case in Andrews V Mockford.

 

  • Negligent misrepresentation: It exists where the maker of the statement has both the means and capacity of ascertaining its falsity but fails to do so and is thus negligent.

For a party to rely on negligent misrepresentation it must be proved that:

  • The maker of the statement owed the recipient a legal duty of care. When a company issues a prospectus asking the public to subscribe for shares it owes a duty of care to the public to tell them the whole truth about itself and its operations.
  • That there was a breach of the duty of care. This is established when the prospectus contains false and misleading statement.
  • There must have a special relationship between the parties as held in Hedley Byrne Co Ltd v Heller and Partners Co Ltd.

The plaintiff an advertising agent inquired as to the credit worthiness of their client’s bank. The bank replied that without accepting any responsibility on its part the client was good

For business up to 100,000 pounds. This was not the case the plaintiff invested in the client and suffered financial loss.

Held: the bank was liable to the plaintiff for negligent misstatement which was a breach of its duty of care. However the plaintiff would not be entitled to any damages because of the disclaimer that the bank had included in the letter.

  • The loss suffered was of a financial nature. He would not have invested in the company had he known the truth.

Remedies

The innocent party may either:

  • Apply for rescission of the contract. In recession the allotee gives back his shares and receives the money he paid on application.
  • Sue for damages for the tort of negligence.

 

STATEMENT IN LIEU OF PROSPECTUS

In lieu means instead of / in place of

The Companies Act does not define the words statement in lieu of prospectus. However this is document prepared and issued by public companies in certain circumstances either in place of or in addition to an ordinary prospectus inviting for the public to subscribe for the shares or debentures of the company.

Its contents are prescribed by the provisions of the Companies Act.

Contents of a statement in lieu of prospectus

  • Nominal share capital
  • Any preference share capital (redeemable)
  • Names and particulars of directors
  • Voting rights of different share classes
  • Debentures issued
  • Names and particulars of vendors/sellers of property
  • Date and particulars of material contracts
  • The accountant’s report on profit & losses and assets.
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