The Hindu Business Line : Divided over dividends

HISTORY is an account, mostly false, of events, mostly unimportant, which are brought about by rulers, mostly knaves, and soldiers, mostly fools. That's a quote that's `mostly' attributed to Ambrose Bierce, though I'm sure historians may like to retort that accounts are a story, mostly false, and so on. Quite probably, auditors may nod in agreement hurriedly, hassled as they are by the follies in the books and records produced by their clients. Fun ends here, let me caution, because I'm going to take you through a case that's heavy-duty on company law...

It was about a week ago that the apex court delivered its judgment in Bhagwati Developers vs Peerless General Finance and Investment Co, and the case discussed, among other things, aspects relating to accounting. The text of the ruling traces a story that's more than a dozen years old — about how Peerless, an investment company, had challenged the directions issued by the RBI (Reserve Bank of India), and how the apex court had then upheld the RBI's authority and power to issue directions so as to provide a stable, identifiable and monitorable method of operation.

The directions were just, fair and reasonable not only to the depositors but, in the long run, to the very existence of Peerless and its continued business, the court had opined.

You may pinch yourself in disbelief if told that one of the directions that Peerless had opposed was that the depositors' monies must be shown, in their balance-sheets, as a `liability' instead of `income'! It was necessary for the Supreme Court to state that the company should transfer Rs 217.34 crore to the Depositors' A/c by debiting the Profit & Loss A/c with a like amount.

Though the RBI had reminded Peerless, through a letter dated March 11, 1992, to prepare the balance-sheet in conformity with its earlier directions, the company did not immediately comply with this direction but instead took a long period to show the depositors' money as liability, reads the text.

Meanwhile, Peerless issued a notice calling for an AGM to consider increasing the share capital of the company from Rs 3 crore divided into 3,00,000 equity shares of Rs 100 each to Rs 35 crore divided into 35,00,000 equity shares of Rs 100 each.

An excerpt of the notice, as reproduced in the judgment, indicated the company's intention to capitalise Rs 31 crore of the Rs 73 crore "standing to the credit of Revaluation Reserve as per the Audited Accounts for the financial year ending on March 31, 1994", as per Article 182 of the company's Articles of Association.

The sum of Rs 31 crore was to be applied in paying up in full the un-issued equity shares of the company of Rs 100 each at par; and such shares (`Bonus Shares') were to be allotted, distributed and credited as fully paid-up to and amongst such members in proportion of 15 bonus shares for every existing equity share. The bonus shares so distributed were to be treated as an increase in the nominal amount of the capital of the company held by each such member and not as income, the company had proposed.

Here's where Bhagwati comes in, as a shareholder challenging the authority of the company to issue bonus shares out of Revaluation Reserve.

However, the meeting came to be held, and the resolution passed by a majority. The case shuttled back and forth to the courtroom and ultimately, in 1995, the Calcutta High Court held that Peerless was entitled to issue bonus shares out of Revaluation Reserve.

That brought Bhagwati to the apex court for justice, on three grounds viz. "(a) that the bonus shares had been issued contrary to SEBI guidelines, (b) their issue is contrary to the Circular of the Department of Company Affairs dated September 6, 1994, and (c) that the issue could not have been made as it is contrary to Article 182 of the Articles of Association of the Company."

Justices S. N. Variava and A. R. Lakshmanan of the apex court heard the case and disposed of the first two objections in as many paragraphs. "The SEBI guidelines, which have been relied upon, were clarified on August 13, 1992, wherein it has been stated that these guidelines do not apply to issue of securities by existing private/closely held and other unlisted companies. In view of this clarification, we see no infirmity in the impugned Judgment wherein it has been held that the SEBI guidelines were not applicable to the Respondent Company."

As for the DCA circular, the court said that the Department's communiqué was advisory in nature, without any mandatory effect.

To dissect the third objection, the court studied Article 182 of Peerless's Articles of Association. "Any General Meeting may resolve that any amounts standing to the credit of the shares premium account or the Capital Redemption Reserve Account or any monies, investments or other assets forming part of the undivided profits including profits or surplus monies arising from the realisation and (where permitted by law from the appreciation in value of any capital assets of the Company) standing to the credit of the General Reserve, Reserve or any Reserve Fund or any other Fund of the Company or in the hands of the Company and available for dividend be capitalised," it read and then listed the uses: "(i) by the issue and distribution as fully paid up of shares, debentures, debenture stock, bonds or other obligations of the Company, or (ii) by crediting shares of the Company which may have been issued and not fully paid up, with the whole or any part of the sum remaining unpaid thereon." A proviso to the Article was that any amounts standing to the credit of the share premium account or the Capital Redemption Reserve Account should be applied only in crediting the payment of capital on shares of the Company to be issued to members (as herein provided) as fully paid bonus shares.

From Bhagwati's side the following points, culled from the company's Articles of Association, were placed before the court: Article 2 defines `dividend' as including `bonus'; Article 182 permits capitalisation of profits only where the `funds are available for dividends' and the words `available for dividends' cover all the categories of funds which could be capitalised for the purpose of issue of fully paid up shares; any fund which was not available for dividend could not be used for purposes of issue of fully paid up shares; Article 175 taboos dividend except out of profits arising from the business of the company; reading the Articles together, it is clear that dividends or issue of fully paid up shares could only be made out of profits and not from the revaluation of capital assets; and the High Court had erred in holding that the words `available for dividends' only applied to words `other funds of the company or in the hands of the company', and not the other categories laid down under Article 182.

To clear the maze of interpretations, the court did a break-up of Article 182 as follows: "Any General Meeting may resolve that any amounts standing to the credit of (a) Share Premium Account, (b) Capital Redemption Reserve Account and (c) any monies... available for dividends."

If read in this manner it is clear that the words `available for dividends' would be applicable to all categories, said the court, and ruled that the High Court was wrong in concluding that these words only applied to the last category, that is, funds of the company or in the hands of the company.

But here comes an unexpected turn in the judgment. "However, it must be seen that the word `Dividend' wherever it appears in the Articles also includes `Bonus'. Thus the words `available for dividends' would necessarily mean `available for dividend/bonus'," reasoned the court. The court pointed out that Article 182 provided that where the law permits issuing of bonus from appreciation of value in the capital assets the same could be done. So, if one read in the manner suggested by Bhagwati, "this portion of Article 182, i.e., issuing of bonus out of Revaluation Reserves would be rendered otiose," said the court. Similar extra-cautious phrasing that serves no useful purpose in Article 182 could be the provision regarding issuing of bonus out of Share Premium Account and Capital Redemption Reserve Account.

The court drew inputs from Section 205 of the Companies Act, which provides that dividend could only be paid out of profits.

"The proviso to Sub-section 3 of Section 205 permits capitalisation of profits or reserve of a company for the purpose of issuing fully paid up bonus shares or paying up any amount for the time being unpaid on any shares held by the members of the company," cited the court, and said that the Companies Act specifically permits utilisation of reserve arising out of revaluation of assets for purpose of issuing fully paid up bonus shares.

"When the law so permits, Article 182 authorises the company to issue Bonus shares out of reserves arising from revaluation of capital assets. Thus, even though the interpretation given by the High Court on Article 182 is not correct, still the final conclusion that Article 182 does not prohibit issuance of Bonus shares is correct and requires no interference," said the apex court.

But Bhagwati had another objection: that Peerless did not comply with the RBI's directions and so the company's balance-sheet did not reflect the true picture.

When the bonus shares were sought to be issued, the company was in a loss, averred Bhagwati. In response, though, the company submitted that it had complied with the directions and was granted seven years' time to regularise its accounts.

"In our view it is not necessary for us to go into this controversy as it will always be open to the Reserve Bank of India to take such action as is available to it in law, if it feels that its directions were not complied with," the court opined, wrapping up the case and dismissing the appeal.

"Events will take their course, it is no good of being angry at them; he is happiest who wisely turns them to the best account," said Euripides, and that perhaps lifts your spirits.

AccountSpeak@TheHindu.co.in

D. Murali

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