Bhagwati Developers v. Peerless General Finance

Introduction : Bhagwati Developers v. Peerless General Finance and Investment Co. (2005) 69 CLA 288 (SC)

The Bhagwati developers case deals with the events to reach a decision about the issuance of bonus shares and whether such an issue can be made out of the Revaluation Reserve of the firm. During the proceedings of this case, Article 182(1) of the Articles of Association of the firm has been discussed to conclude the case in an appropriate manner.

Article 182(1) mentioned here specifies that “any sum standing in the credit of Shares Premium Account or Capital Redemption Account or any amount forming a part of the undivided profits of the company including profits forming part of realization account can be used for issue and distribution of fully paid up shares, stocks, debentures, and bonds, etc.”[1] It explicitly indicates that any sum which stands to the credit of Capital Redemption Reserve of a registered firm could be used towards issuing completely paid Bonus Shares to the existing shareholders of the firms as well as the other members.

Upset with the ruling of the Division Bench of the High Court of Calcutta, the petitioner appealed before the Honorable Supreme Court of India regarding the matter in question.

Facts

• In 1986, Bhagwati lend money to Mr. Tuhin Ghosh to enable him to acquire 3,530 equity shares of Peerless. In 1987, for the of settlement of the loan amount, Mr. Tuhin decided to allocate the shares of Peerless (taken over by him) to Bhagwati. But, as the transfer agreements were not effected in a proper manner, the transfer failed and the shares were not transferred to Bhagwati.
• Afterward, Peerless announced to issue two rounds of bonus shares. In accordance with the bonus issues, Tuhin turned into a shareholder of peerless with a total number of 14,120 shares. Tuhin failed to handover any of the shares to Bhagwati and as a result, Bhagwati filed a suit against Tuhin in the year 1991.
• In the year 1994, while the suit was still pending in the court, Tuhin and Bhagwati decided to enter into an agreement for settlement, in terms of which were as follows:

1. Tuhin decided to allocation of the 14,120 shares of Peerless to Bhagwati,
2. Bhagwati decided to pay a sum of Rs.10 lakh to Tuhin, while allowing him to hold the dividend that was payable on the shares of Peerless for the financial year of 1989-1990.
3. Moreover, a negotiation verdict was approved by the trial court uniting the terms and conditions of the agreement of Settlement. Subsequently, Bhagwati advanced Peerless regarding the transfer of shares. But, Peerless declined to make the transfer on the contentions that the initial transfer did not create a ‘spot delivery contract’. Distressed by this, Bhagwati again decided to approach the board of Company Law and the High Court of Calcutta. After both the institutions declined his plea, Bhagwati decided to file a petition before the Hon’ble Supreme Court of India.

Issues

• Whether the defendant firm is allowed by the law to issue Bonus Shares from the Revaluation Reserve.
• Whether the notice rolled out for issue of Bonus Share was valid and the Annual General Meeting held was in accordance with the laws of a company.
• Whether the decision given by the Division Bench of High Court of Calcutta was justified with a fitting set of reasons.

Summary of the Court Decision

The Hon’ble Supreme Court while deciding this case opined that the issue of Bonus Shares out of the revaluation reserve of the firm was not against the guidelines issued by SEBI. It was held so because the defendant company was not a listed company, so, it depends upon the discretion of its members whether to follow the guidelines issued by SEBI. The court also detected that the circular accepted by the Firm Affairs does not have a binding value; it is only of an advisory nature.

The Court decided to back upon Article 182(1) while delivering its final verdict in this case. The court interpreted from Article 182(1) that any sum that stands in the credit of the capital redemption reserve and securities premium reserve can be utilized by the firm to roll out fresh number of shares, debentures, bonds, stocks, Bonus shares, and the like. The court further cleared that the explanation of “dividend” includes within itself the entitlement to “Bonus”, so it points toward the sum that are “available for dividend” are similar to the funds “available for bonus”.

Article 182 also clearly mentions that if any piece of the legislation necessitates the imbursement of bonuses from the increased value, it should be done without any delay. Article 182 empowers the firms to issue Bonus shares from the reserves made from the reassessment of capital assets of the company. Consequently, even if the explanation agreed to by the High Court regarding Article 182 was not accurate, yet the decision that Article 182 does not forbid issuing of Bonus shares from the revaluation reserves of the company is justified and needs no intrusion.

The Supreme Court of India clarified that the decision made by the High Court of Calcutta was correct; but, the justification behind the decision was not justified. The Court also referred to the Section 205(3) which permits the capitalization of a firm’s incomes or reserves with the objective of issue of fresh Bonus Shares.

Analysis : Bhagwati Developers v. Peerless General Finance and Investment Co. 

The judgement delivered by the Supreme Court in Bhagwati Developers case was only a bit different from the one which was delivered by the Calcutta High Court. The difference lies in the reasoning given by the Supreme Court against the reason given by the High Court to justify its verdict. It must be noticed that the meaning of the word “Dividend”, wherever it has been used in the Articles of the company, also includes “Bonus”. Therefore, the words “available for dividends” would directly imply “available for dividend as well as bonus”.

Article 182 is itself a guarantee that where the law allows the issuance of bonus from the revaluation reserves, the same could be done without any confusion. If read in the way as has been recommended by the Plaintiffs, this specific part of Article 182 would turn out to be futile and impractical. Likewise, certain other parts of Article 182 viz. the provision that deals with issuing of bonus out of Share Premium Account and Capital Redemption Reserve Account would be rendered otiose.

Section 205 of the Companies Act provides for the fact that the dividend for shares could only be allowed out of the profits earned by the company. The proviso to sub-section 3 of Section 205 allows for capitalization of such profits or reserves of a firm merely for the objective of issue of fresh bonus shares. Therefore, the Companies Act precisely authorizes the companies to utilize their reserves for the purpose in question. When the law itself allows, Article 182 permits the firmst to issue Bonus shares out of the revaluation reserves made from revaluation of capital assets of the company.

It was further given in on the behalf of the Plaintiff that as per the facts of the case, the guidelines issued by the Reserve Bank of India had not been followed by the company. The balance sheet of the firm did not clearly reflect the true financial picture. When the bonus shares were to be issued, the Company was already in a weak financial position and suffering from losses. On the other hand, it was also submitted on the behalf of the Defendants that the Company followed all the guidelines in the issue of the bonus shares. They also contended that the company had been allowed for a period of 7 years to legalize its financial accounts.

In our view it is not compulsory to go into this argument as it will always be open to the discretion of the Reserve Bank of India to take such action, even if its directions were not followed by the companies. The court trusted on the suggestion that has been made before it specifying that  Article 182 allows the capitalization of the surplus by issuing fully paid-up shares, bonds, debentures, and bonus shares out of the Revaluation of the Capital Assets specifically when the “funds are available for dividends”. There a special mention was made in the regard that funds available for dividend include all categories of funds which could be capitalized whereas funds not available for this purpose cannot be used.

Further, importance was also given to Article 175 which states that “no dividend is paid out of the profits which do not arise from the business of the firm”. It is important to consider that both the Articles 175 and 182 have to be read altogether to make a clear interpretation regarding the issue of fully paid-up shares and making such an issue from the revaluation reserves of the company. The judgement delivered by the court was in accordance with Section 205(3) of the Companies Act, 2013, and the provisions of Memorandum and Articles of Association of the firm.

Conclusion

The case discusses the provisions related to issue of Bonus Shares in a firm. The issue of such shares must depend entirely upon the provisions specified in the Memorandum and Articles of Association of the company. As per the provisions laid down by the Companies Act, A company is authorized by law to issue fully paid-up bonus shares to its members out of Free Reserves, Securities Premium Account or Capital Redemption Reserve Account.

In the Bhagwati Developers case, the court ruled that if the articles of the association allow; a firm could issue bonus shares by capitalizing revaluation reserves. Articles provides that, in order to resolve this Bhagwati decision, no issue of Bonus Shares shall be made by capitalizing reserves generated by the revaluation of assets. The Supreme Court in Bhagwati Developers case was of the opinion that the judgment delivered by the Division Bench of the High court of Calcutta was valid but the reasoning provided by them was not justified. The funds which are available for dividend include all sorts of categories and monies available instead of a specific category i.e. the funds which are only in the hands of the company.

References:

[1] As per the provisions of the Companies Act, 2013.