Forfeiture of Shares

Forfeiture of shares refers to the process by which a company cancels the ownership of shares held by a shareholder due to non-payment of calls or non-fulfilment of other conditions of issue. It is a corporate action that arises when shareholders fail to meet their financial obligations towards the company, such as paying the allotment or call money on their shares. Once forfeited, the shareholder loses all rights over the shares, including the right to dividends and voting, and the company may reissue these shares to new investors.

Concept and Meaning

When a company issues shares, it may not always require the full face value to be paid upfront. Instead, payment is made in stages—application money, allotment money, and subsequent calls. If a shareholder fails to pay the amount due on any call within the specified time, even after due notice, the company may decide to forfeit those shares under the provisions of its Articles of Association (AOA).
Thus, forfeiture is a penalty imposed on defaulting shareholders for failure to pay the due amount on shares. The amount already received on such shares is generally forfeited and retained by the company as compensation for the default.

Legal Framework and Conditions

The process of forfeiture of shares is governed by the Companies Act, 2013 (in India) and the Articles of Association of the company. Key legal conditions include:

1. Authorisation in the Articles of Association: A company can forfeit shares only if its AOA expressly provides for such power.
2. Proper Notice: The company must issue a written notice to the defaulting shareholder specifying:
   • The amount due and payable.
   • A period of not less than 14 days within which payment must be made.
   • A warning that the shares will be forfeited if payment is not made within the prescribed period.
3. Board Resolution: If payment is not received within the stipulated time, the Board of Directors must pass a formal resolution approving the forfeiture.
4. Fair Procedure: The company must ensure procedural fairness; otherwise, the forfeiture may be declared invalid by a court.
5. Recording and Notification: The name of the shareholder is removed from the Register of Members, and the company issues a notice confirming the forfeiture.

Once forfeiture is effected, the shareholder ceases to be a member of the company but remains liable to pay the outstanding amount if the Articles so provide.

Accounting Treatment of Forfeiture

The accounting entries for forfeiture depend on the amount paid by the shareholder before forfeiture.
Example: A share of ₹10 is issued at par, ₹8 called up, and ₹6 received before forfeiture. The shareholder fails to pay ₹2 on the final call.

• The accounting entry at forfeiture would be:Share Capital A/c (₹8 called up) — Dr. ₹8To Share Forfeiture A/c — ₹6To Calls in Arrear A/c — ₹2

The Share Forfeiture Account represents the amount received on forfeited shares and is treated as a capital reserve unless the shares are reissued.

Reissue of Forfeited Shares

Forfeited shares may be reissued by the company, usually at a price lower than their nominal value. However, the total discount allowed on reissue cannot exceed the amount forfeited on those shares.
Example: If a ₹10 share (₹8 paid before forfeiture) is reissued at ₹7, the discount of ₹3 is adjusted against the forfeited amount of ₹6, leaving a surplus of ₹3 transferred to Capital Reserve.
Accounting Entry for Reissue:

• Bank A/c — Dr. ₹7
• Share Forfeiture A/c — Dr. ₹3
• To Share Capital A/c — ₹10

Any remaining balance in the Share Forfeiture Account after reissue is transferred to the Capital Reserve, as it represents a profit of a capital nature.

Effects and Consequences of Forfeiture

The forfeiture of shares has several implications for both the company and the shareholder.
For the Company:

• The company retains the amount already received on the forfeited shares.
• The forfeited shares can be reissued to raise additional capital.
• The forfeiture strengthens the company’s equity position by converting unpaid capital into paid-up capital upon reissue.

For the Shareholder:

• The shareholder loses all ownership rights in the forfeited shares.
• The amount already paid is forfeited and cannot be reclaimed.
• The shareholder may still be liable for unpaid calls if the company’s Articles stipulate such liability.

Distinction Between Forfeiture and Surrender of Shares

Reinstatement of Forfeited Shares

In certain circumstances, a company may decide to reverse a forfeiture if the defaulting shareholder pays all outstanding dues along with interest before the forfeited shares are reissued. Such reinstatement requires a fresh resolution by the Board of Directors and entries in the company’s register.

Regulatory Provisions and Compliance

The Companies Act, 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 require listed companies to disclose details of forfeited and reissued shares in their financial statements and stock exchange filings. The forfeiture must be carried out in accordance with the company’s Articles of Association, ensuring transparency and fairness.

Significance of Forfeiture

Forfeiture of shares serves several important functions:

• Ensures Discipline: It discourages shareholders from defaulting on payment obligations.
• Protects Financial Integrity: The company can recover funds by reissuing forfeited shares.
• Maintains Capital Structure: Enables the company to preserve its equity base and liquidity.
• Acts as a Deterrent: The threat of forfeiture encourages compliance with payment schedules.

Limitations and Legal Challenges

Despite its utility, forfeiture must be exercised cautiously. Improper procedure or lack of fair notice can render the action invalid. Courts have held that forfeiture amounts to a penalty and must strictly comply with the Articles of Association and statutory provisions.
Key limitations include:

• Absence of Authority: Forfeiture without express authorisation in the AOA is void.
• Defective Notice: Failure to provide proper notice invalidates the forfeiture.
• Abuse of Power: Forfeiture for reasons other than non-payment or breach of conditions may be challenged in court.

Illustration

Suppose a company issues 10,000 shares of ₹10 each, ₹8 called up. A shareholder holding 500 shares fails to pay ₹3 (allotment ₹2 and call ₹1). After due notice, the company forfeits the shares. The accounting treatment would be:

• Share Capital A/c (₹8 × 500) — Dr. ₹4,000
• To Share Forfeiture A/c — ₹2,500
• To Calls in Arrear A/c — ₹1,500

If the forfeited shares are reissued at ₹9 per share, the following entries would be passed:

• Bank A/c — Dr. ₹4,500
• Share Forfeiture A/c — Dr. ₹500
• To Share Capital A/c — ₹5,000(Balance of ₹2,000 transferred to Capital Reserve.)