E LAW - MURDOCH UNIVERSITY ELECTRONIC JOURNAL OF LAW ISSN 1321-8247 Volume 6 Number 3 (September, 1999) Copyright E Law and/or authors File: mwenda63.txt ftp://cleo.murdoch.edu.au/pub/elaw/issues/v6n3/mwenda63.txt http://www.murdoch.edu.au/elaw/issues/v6n3/mwenda63.html ________________________________________________________________________ Shareholders And Their Obligation To Pay-Up For Shares - a Zambian Perspective Kenneth Mwenda World Bank Contents * Introduction * What Is The Justification For Asking Shareholders To Pay-Up For Their Shares? o Fraud Theory o Trust Fund Theory o Contract Theory o Legislative in-roads * Policy Issues Underpinning The Concept Of Par Value o Allotment Of Shares And The Par Value Concept In England o Arguments Countering The Par Value System o The No-Par Value Concept o Arguments In Support Of The No-Par Value System * Payment For Shares And Share Watering o A Definition Of A Share And Some Contractual Rights Relating To Shares o Allotment Of Shares For Cash o Allotment Of Shares For Consideration Other Than Cash o Non-cash Considerations - Public Companies And Private Companies o Allotment Of Shares At A Premium o Issuing Shares At A Discount - The Zambian Case o Allotment Of Shares At A Premium - The Zambian Case * Conclusion * Notes Link for this article: Zambian Companies Act 1994 http://zamlii.zamnet.zm/acts/1994/list94.htm Introduction 1. That subscribers to a company's share-capital must pay-up for the allotted shares is a well known feature of the common law. The policy objectives underpinning this precept must, however, be addressed so as to provide a fuller view of the efficacy of the legal framework governing payment for shares. This paper is divided into three parts. The first part looks at theoretical issues surrounding some of the justifications for shareholders to pay-up for the allotted shares. The second part of the paper deals with the relevance of the par value concept in today's modern world of commerce. Finally, the work turns to look at provisions of the law in Zambia and the United Kingdom on payment for shares. 2. In this paper, only aspects of the common law are examined. Due to lack of space, no attempt is made to look at parallel developments in civil law countries. In addition, the work does not cover legal aspects of financial assistance in acquisition of company shares since this aspect is covered elsewhere[1] and it generally falls outside the scope of the study. It must be stressed, however, that the paper will confine its arguments to questions of law and policy surrounding obligations of shareholders to pay-up for shares. Indeed, are there any legal justifications, at the verge of a company's insolvency, for the company's creditors to enforce such obligations?[2] What about the rule in the US Supreme Court case of Handley v. Stutz[3] which says that shareholders are exempt from the obligation to pay-up for the shares at a par value equal to that of newly-issued shares where the company is in financial distress and the market value of the shares at the time of issue is less than par?[4] 3. This work argues that the legal justifications for a creditor to enforce the share payment obligation of shareholders rests not only on one theoretical premise, but on a number of thematic reasons. One of the reasons is to protect investors against some of the consequences of a company going bust; that is, there is a need to ensure that at least the share-capital account of the debtor company is well maintained and the called-up share-capital has been paid-up in full. What Is The Justification For Asking Shareholders To Pay-Up For Their Shares? Fraud Theory 4. The fraud theory, often referred to as the 'holding out theory' of shareholder liability, was first postulated in the case of Hospes v. North-Western Manufacturing and Car Co.,[5] where it was held that the tort of misrepresentation provides the ground upon which the liability of shareholders to pay-up for the allotted shares is based. As Manning and Hanks observe: "The basic rationale of the Hospes court was that the creditor had somehow received a representation from the corporation to the effect that the shares had been fully paid for; if in fact the shares had not been paid for, and if the company later became insolvent the creditor could claim that he had been misled and could compel shareholders who had not paid in the par value of their shares to do so... The most immediate effects of this beautifully representative expression... were to make it absolutely clear that (i) the creditor had no cause of action against shareholders unless the company became insolvent (since no damage had been shown to the creditor) and that (ii) any creditor who extended credit to the corporation before the relevant stock (share) was issued was barred from complaining"[6] 5. A major shortcoming of the fraud theory is that it places liability for share payment on the shareholders when, in fact, it is the corporation that makes the representation about the paid-up share capital. Here, the law simply makes out a presumption of shareholder liability and does not even require the creditor to show that the shareholders made the representation which the creditor then relied upon. Despite these anomalies, it is clear that under the fraud theory, liability of the shareholders crystallises only when the company becomes insolvent and when a creditor who has extended value after the shares have been issued institutes proceedings.[7] Trust Fund Theory 6. "Justice Story in his landmark opinion in Wood v. Dummer[8] said that shareholders are not permitted to take their assets out of a corporation, thus rendering the company insolvent, because the shareholders' equity (the 'capital stock') is in the nature of a 'trust fund' for creditors."[9] 7. But, can the obligation of shareholders to pay-up for the shares be extended to subsequent transferees if, in fact, the shares that have now been transferred are 'watered' shares?[10] This issue pushes to the fore interesting juridical opinions. One view here is that 'the creditor's remedy, if he has one at all, must be against the initial share purchaser who underpaid - if the creditor can find him.'[11] 8. Laudable as this view may seem, it does not resolve the polemic. I have argued elsewhere that under the English Companies Act 1985, while a public company faces restrictions in the way it deals with non-cash considerations, a private company does not generally face such constraints.[12] 9. Thus, a private company may, by agreement, allot shares as fully or partly paid up otherwise than in cash in return for the transfer of property or the rendering of services to the company.[13] 10. In the English case of Re Wragg Limited,[14] Wragg and Martin was a partnership managed by two persons. It was later registered as E. J. Wragg Limited, a private company, whereby the two partners and another person became directors. The company then bought the property of the partnership and an agreement was executed and registered. The company went into liquidation and the liquidator filed a misfeasance summons to obtain payment for the shares. It was held that 'since the agreement could not be impeached the adequacy of the consideration could not be gone into.' Similarly, in Brownlie and Others, Petitioners,[15] decided after Re Wragg, Darling L. J. ruled: "Where a company, in good faith, issues shares as fully paid-up in consideration of property transferred or services rendered, the court will not inquire into the value of that which was accepted by the company as an equivalent of money."[16] 11. In Zambia, the standard articles of association in schedule 1 to the Zambian Companies Act 1994 - these articles have been adopted by many companies in Zambia - include articles governing the payment for shares. However, these standard articles do not state that issued shares must be paid-up when the allotment is made. Regulation 15 of the standard articles simply permits company directors to accept partial or full payment from an allottee before a call is made on the unpaid amount. This indicates that when shares are allotted an allottee can decide to pay immediately or in future. However, when a call is made on the unpaid-up share-capital the allottee must pay up.[17] 12. If a member fails to pay up the amount called on his shares at the time and place mentioned in the notice he may be charged interest on the principal amount.[18] 13. There are other consequences of failing to pay up for the shares. Under regulation 17, the company directors will be required to give what could be considered as the final notice, calling on the allottee to pay up the shares and to add interest to that. Failure to take heed of the notice may result in the shares being forfeited to the company.[19] The company could then re-issue the shares to another person. In the standard articles it is also provided that during the period when the call for payment has not been made, the allotting company has a first and paramount lien on every share that has not been fully paid-up.[20] As long as part of the share-capital has not been paid-up the lien will extend to dividends payable in respect of the issued, but unpaid-up share-capital.[21] 14. It is interesting to note that the Zambian Companies Act 1994 does not prohibit the sale of shares at a discount. In fact, the statute makes no specific reference to the issue of shares at a discount. To illustrate, in the case of ZAMANGLO Industrial Corporation v. Zambia Privatisation Agency and The Attorney General,[22] the granting of a declaratory order for the acquisition of additional shares at a discount in a privatised company followed the disclosure by the plaintiff (the disclosure was not contested by the state, as defendant) that another shareholder, with similar standing as the plaintiff, had been issued additional shares at a discount. 15. What all this evidence shows is that the 'trust fund theory' can only be appreciated in a context which argues against depletion of assets that have already been paid-in, and not assets that have not yet been paid-in. Indeed, this view was the original construction of Justice Story in Wood v. Dummer,[23] although later cases took a departure which has since faced heavy criticism from proponents of the 'fraud theory'.[24] Contract Theory 16. When shareholders subscribe for shares and the company agrees to allot them the shares a contractual arrangement of mutual obligations is established. It is pursuant to such contractual obligations that the shareholder must pay-up for the allotted shares. Under the contract theory, shareholders must be held to the terms upon which they have acquired the shares and the creditor of the insolvent company must be permitted to enforce obligations of the shareholders. Legislative in-roads 17. It must be noted that there are cases where shareholders are under a general statutory obligation to pay-up for the allotted shares in cash. As I have argued elsewhere,[25] the position of public companies in the United Kingdom provides a helpful example here. It will be shown below, and in greater detail, how legislation in countries such as the United Kingdom permits exceptions to the general statutory obligation of shareholders to pay-up for shares in cash.[26] Policy Issues Underpinning The Concept Of Par Value 18. This part of the paper looks at the policy bases underpinning the concept of 'par value' in equity financing. A comparative approach to the law is undertaken and it is argued that the concept of par value has little relevance in the world of commerce today. Further, an argument is made that shares of no-par value often reflect the true value of the shares. 19. "Stock (shares) which was issued without a corresponding pay-in of assets valued at an amount equal to par was called 'watered stock' - stock issued not against assets but against water... It must be emphasised that concepts of watered stock..., and the doctrines that came to surround them, were and are limited in application to the issue of stock, that is, sales by the corporation of its own stock. The doctrines do not in any way inhibit the shareholder's freedom to sell his stock at any price he can get, or to give it away if he wishes. Similarly, a corporation holding shares of another corporation may, like any other shareholder, dispose of them at any price it wishes or can get. The reason why shareholders were held to pay in the par value of their shares is that that was the price exacted by the law for the corporate advantage of limited liability."[27] 20. The concept of par value of company shares denoted the minimum amount by which the shares could be purchased.[28] However, even if the law exacted a price for the advantage of limited liability to the shareholders, taking into account the net worth of the company, it was not easy to maintain a constant equilibrium between the nominal capitalisation of the company and the value of its assets. The value of the assets, with time, could depreciate or appreciate. Indeed, if this were to happen then the value of the assets of the company could cease to have a corresponding value to the original share-capital employed. To this extent, it could be argued that any monetary pricing introduced as a signal to the market of the value of a share in the equity of a company is almost always a fiction and may not only be meaningless but also misleading. Allotment Of Shares And The Par Value Concept In England 21. Under the Companies Act 1985 of the United Kingdom, a company limited by shares must state in its memorandum of association the division of the share-capital into shares of a fixed amount.[29] The nominal amount of each share is what is known as the par value.[30] 22. The English Companies Act 1985 permits a company to state its nominal capital and the value of its shares in any currency, provided that in the case of a public company the nominal capital with which it is registered must include 50,000.00 British Pounds Sterling.[31] 23. While the concept of par value might be relevant to primary issues of securities in both private and public companies (e.g. at incorporation), that is not necessarily true for secondary trading of securities. In the case of secondary trading, par value might only be useful to issues in private companies, but not to issues in public companies. One of the reasons supporting this view is that in many countries shares in a public company are traded on a stock exchange. Since for the most part of this stock market trade the public can purchase shares in such companies, it is the market itself that will be expected to set the price of the shares. BonBright argues that the purpose of the par value concept is not to reflect the market value of the enterprise, which is constantly shifting and which therefore cannot be set by the face value of the share certificate, but to indicate the capital that the shareholders have agreed to contribute.[32] This feature is alluded to by BonBright as being historical and therefore fixed.[33] 24. Another view supporting the policy basis of having the par value system is that in order for creditors of a company to be confident that the corporation will pay off its debts, when in financial distress, the par value is seen as a basis upon which the share-capital account of the debtor company can be based. Also, the par value prevents arbitrary valuation of shares in excess of their true value. Pennington adds that the nominal value of shares is useful in declaring dividends (usually expressed as a percentage of the nominal value), determining voting rights at meetings of shareholders and, in the case of preference shares which have priority for re-payment of capital, determining the amount which must be paid to the preference shareholder in winding up before the company's remaining assets are shared between the ordinary shareholders.[34] 25. The general rule under the English Companies Act 1985 is that when shares are allotted the allottee must pay-up for the shares.[35] Payment must be in money or money's worth, including goodwill and know how.[36] Shares are deemed to be paid-up in cash if the payment received by the company is in cash or is a cheque received in good faith and the directors have no reason for suspecting that it will not be paid.[37] Also, payment in cash could involve an undertaking to pay cash to the company at a future date.[38] 26. Another general rule applying to both private and public companies is that no share can be issued at a discount.[39] Section 100 of the English Companies Act 1985 provides: "(1) A company's shares shall not be allotted at a discount. (2) 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." In other words, shares cannot be issued as fully paid up at a consideration below their nominal value. Where shares are paid-up at a discount, the allottee will be liable to pay the allotting company an amount equal to the amount of the discount, with interest at an appropriate rate.[40] 27. Where the allottee has already sold the shares, the subsequent holder of the shares will be liable to pay the company an amount equal to the amount of the discount, with interest at an appropriate rate.[41] The subsequent holder is, however, allowed a defence if he can show that he is a bona fide purchaser for value and without actual notice.[42] Directors and any officer of the allotting company who are responsible for the allotment will be liable to a fine.[43] 28. The principle that shares must be paid-up in full must be seen as important not only in safeguarding efforts to raise company finance, but also in ensuring that fair trade in securities takes place. To hold otherwise would amount to condoning 'share watering' and thereby putting the existing shareholders and the creditors at a disadvantage. It is submitted that if a case of collusion between an allottee and the directors of the allotting company were to occur, for purposes of issuing shares at a discount (while the company is a going concern), the remedy must not only be in making the allottee pay an amount equal to the discount. The allottee must also be made to forfeit his right to hold shares - only with regard to those shares acquired under the transaction - since he has shown that he can undermine the company by entering into dubious transactions. This proposal is made in the light of the fact that the law in the United Kingdom is silent on the fate of an allottee who subsequently makes a payment equal to the discount on the share price. It is submitted further that although the English Companies Act 1985 provides for statutory provisions governing the law on payment for shares, the statute does not deal with situations relating to share price discounts on a single share. Section 100 of the English Companies Act 1985 covers only situations relating to the allotment of more than one share: 29. "A company's shares shall not be allotted at a discount..." What happens where only one share is allotted at a discount? It is argued that since an issued share is part of the share-capital, the directors of the company, as persons who manage or who are custodians of assets of the company, have unquestionable fiduciary duties towards the corporation they direct.[44] On that basis, the directors can be held liable for breach of fiduciary duties if they allot one share at a discount.[45] Arguments Countering The Par Value System 30. The concept of par value has received some criticism from a number of scholars.[46] Among these criticisms is the problem associated with issuing shares for consideration other than cash. What happens where shares are issued in return for services or in return for goods? How do we determine if the services or goods are at par with the nominal value of the shares? 31. Another difficulty facing the concept of par value is the attitude of the courts towards this concept.[47] In the American case of Commonwealth v. Leigh Av. Ry. Co.,[48] the court over-looked the applicable par value and adopted an arbitrary value based on the amount paid to the company. In that case, a company was 'capitalised' at US$1,000,000.00 altogether. The charter of the company provided that the company could not issue bonds in excess of 50% of the par value of the shares. A suit was brought to enjoin an issue of US$250,000.00 of bonds and an injunction was then granted. The court declined to recognise the fifty dollars 'par value' established by the charter, and instead held that the five dollars per share received by the company was the real par value while the other figure was merely a 'nominal' value. 32. The courts have also disregarded the par value in instances where recognising par value would prejudice interests of the company. In Handley v. Stutz,[49] a company that was on the verge of insolvency managed to get out of financial distress for a while by attracting new finance through the sale of debt instruments; to make the debt instruments saleable, the company gave a certain number of free shares of newly issued share-capital to each purchaser. In a creditor's bill to compel payment in cash to the corporation at the par value of the new shares, the court declared as to the shares delivered with the bonds that 'an active corporation may, for the purpose of paying its debts and obtaining money for the successful prosecution of its business, issue the stock (shares) and dispose of it for the best price that can be obtained.' 33. In essence, what the above two cases show is that American courts are slowly developing a common law which makes share-watering lawful. The cases also point to a critical weakness in the use of the par value concept as a yardstick to measure limited liability of shareholders. Generally, an investor could be attracted to subscribe for the shares on the basis of the represented value of the shares and it is often this represented value that bolsters the price of the shares above their real value.[50] 34. A great discrepancy between the value of the holdings of a corporation and the nominal value of capitalisation usually lends an opportunity to defraud inexperienced purchasers. Therefore, a shift inclined towards abandoning the par value system and adopting a non-par value system might be more efficient as it would put the investor on guard and thus avoid creating a false sense of investor protection. The No-Par Value Concept 35. Generally, the notion of issuing shares at no-par value can be traced to the joint stock companies of the Elizabeth period when shares were used in the natural sense, namely, as an appreciable part of the whole undertaking not as a multiple of units of the capital.[51] Harmen, however, observes that the concept of no-par value originates from American jurisprudence.[52] He argues that in the US company promoters often found themselves engaged in lawsuits to prove that some of the shares which had been allotted, although treated as fully paid-up, were in fact not fully paid-up. These lawsuits constrained functions of promoters and thus, to avoid such bottlenecks, companies were permitted to issue shares of no-par value.[53] In the Gedge Report on Shares of No-Par Value the following three instances were identified as typical cases where shares can be issued for no-par value under the American legal system:[54] o (a) where the law only requires the certificate of incorporation to state the number of shares of no-par value to be issued, leaving it to the corporation to determine how much of the proceeds of issue of such shares should be allocated to capital and how much to distributable surplus; o (b) where the law requires the certificate of incorporation to state the amount of the capital of the corporation which must include some minimum amount (for example US$1.00) in respect of every issued share of no-par value. In such cases, any excess of the proceeds of issue of such shares over the minimum amount may in general be treated as a distributable surplus; and o (c) where the law requires that the amount of capital stated must include the whole consideration received on the issue of shares of no-par value. In such cases there can be no distributable surplus. This system is permissible in New York and certain other states. But in Wisconsin, for example, an amount up to 25% of the proceeds of issue may be allocated to surplus. 36. In New Zealand[55] and Canada,[56] the issuing of shares of no-par value is also allowed. In Ghana, following the Gower Report in that country,[57] the issuing of shares of no-par value is no longer forbidden. The case of Ghana, like that of New Zealand, shows that company legislation now requires that all shares should be issued at no-par value.[58] In Ghana, the Gower Report noted: "...the main obstacle in rendering the true nature of a share in a company readily comprehensible to the man-in-the street is that fact that the present law insists that a nominal value should be attached to it... 37. At the commencement of a company's life par-value may be arbitrary and misleading, since shares may be issued at a premium or even (through an issue for a consideration other than cash) at a disguised discount. There after they become totally arbitrary; a so-called $G1 share may if the company has made losses be worth anything from $G1 to infinity. The retention of the misleading $G1 symbol is an endless source of complication and confusion both to the sophisticated and especially, to the unsophisticated investor who is apt to think that he is getting a bargain if he buys a $G1 share for 10 cents. And that he has been cheated if he is able to buy 30 cents. If Ghanaians are to be encouraged to invest in shares everything should be done to make it clear to them that a share is simply a share in the fluctuating value of a business and not a piece of paper worth the value endorsed upon it."[59] Arguments In Support Of The No-Par Value System 38. Generally, shares issued without par value afford a more realistic approach to appraisal of profits in relation to the assets employed in a business.[60] Such an approach avoids problems associated with determining profits and dividends by reference to a nominal value.[61] 39. Also, the issue of shares of no-par value affords flexibility. The issuing company is free from threats pointing to prohibitions on share watering. Indeed, in a troubled economy, such as where there is war, companies may wish to issue shares at lower prices. They should be able to do so without a cloud of juridical fear distilling on them. At the same time, it must be acknowledged that it is in furtherance of good business practice that companies must be permitted to raise finance by selling shares at a fair and true value. If such a view is over-looked, companies may begin to engage in over-leverage to raise finance. Over-leverage could then increase the risks and costs associated with insolvency on both ends of the debtor and the creditor. 40. Countering the school of thought that supports the no-par value system, Berle argues that the concept of no-par value could be open to abuse by some company directors.[62] This view assumes somewhat that no remedial measures will be taken by the company because the legal system is not transparent enough for the shareholders to access the relevant information on the abuses. Indeed, Berle observes that in dealing with corporations having non par-value shares, an investor must ascertain whether shares without a visible dollar mark on the share certificate are in fact true non-par value shares, or whether they are 'stated value' non-par value shares - in substance merely a par value share with a different name.[63] 41. Adding to the criticisms, BonBright argues that the removal of par value is likely to lead to a serious danger in corporate finance; that is, the danger that stated capital will be fixed far below the real capital.[64] He notes further that, as a result thereof, creditors would be stripped of their long-recognised rights to hold share-holders liable for partly paid-up shares and to hold directors of the issuing company liable for an impairment of capital.[65] 42. However, this view has its own limitations. Indeed, as was held in the US case of American Co. v. Staples,[66] 'it has been said that while non par value stock corporations have no nominal value - no dollar mark - stated in the face of their stock certificates, yet the general rules regarding the liability of the subscribers for non-payment of the full amount of their subscription, and the general rules regarding the declaration of dividends, apply as in the case of the par value corporation, the liability of the shareholders depending upon whether he has paid or delivered, the amount in money, or its equivalent for the stock that was sold while the capital stock of a non par-value corporation cannot be lawfully invaded by the declaration of dividends any more than the capital stock of a par value stock corporation.' Payment For Shares And Share Watering 43. This part of the paper examines the legal aspects of paying-up for shares purchased from an incorporated company; more so, in the case of primary issues. In this section, we examine the efficacy of the law on payment for shares in the United Kingdom and Zambia. The United Kingdom has been chosen as a case study because corporate law in that country has had significant influence on the development of corporate law in many common law jurisdictions. A Definition Of A Share And Some Contractual Rights Relating To Shares 44. "A share 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 into by all the shareholders inter se..."[67] 45. From the above definition, it is clear that whereas a share, as an interest, entitles a shareholder to a number of rights, such as the right to vote at meetings and to participate in the profits of the company by way of dividends, a share also attracts liability on the unpaid-up share-capital of the company in the event that the company goes into liquidation.[68] These rights and liabilities represent some of the contractual relationships between the shareholders inter se[69] and between the shareholders and the company.[70] 46. As Astbury J. observes in the Hickman case: "An outsider to whom rights purport to be given by the articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles, treating them as contracts between himself and the company, to enforce those rights."[71] 47. The relationships between the shareholders inter se, and the shareholders and the company, are regulated mainly by the articles of association. The articles are contractual rules and can thus be amended.[72] However, in a strict commercial sense equity interests held by shareholders in the company are commodities. Like any other commodity, the allotted shares must be paid for.[73] A share, as a commodity, has both economic and investment value.[74] Indeed, shares can yield dividends.[75] 48. In Zambia, the bulk of the law governing payment for shares is found in the Companies Act 1994. However, the Zambian Companies Act 1994, unlike the English Companies Act 1985, has fewer rules governing the law on payment for shares. Whereas the rendering of financial assistance in acquisition of company shares is regulated both under the Zambian and the English Companies Acts,[76] the allotment of shares at a discount, or 'share watering', as it is commonly known, is not covered under the Zambian Companies Act 1994. The English Companies Act 1985, by contrast, has provisions governing the allotment of shares at a discount.[77] Thus, in Zambia, as long as the common law or the articles of association do not provide that 'share watering'[78] is prohibited, companies have the liberty to engage in share watering. 49. It has already been noted above that share watering relates to shares which are issued without a corresponding pay-in of assets valued at an amount equal to par.[79] In Zambia, the standard articles of association found in schedule 1 to the Zambian Companies Act 1994 do provide for rules governing the issue of shares at a discount. We have already looked at these rules.[80] Here, suffice it to say that when a company has adopted the standard articles in schedule 1 to the Zambian Companies Act 1994, the company can alter the articles in the same manner as if it had formulated its own articles.[81] Besides, not all companies will adopt the standard articles since there is no obligation whatsoever to adopt these rules. 50. In discussing the legal aspects of share watering, we will focus on: o (i) allotment of shares for cash; o (ii) allotment of shares for consideration other than cash; o (iii) allotment of shares at a discount; and, o (iv) issuing shares at a premium. 51. It is important to observe that some of the restrictions, exceptions and risks that are associated with payments for shares are also discussed. We now turn to look at the legal aspects of allotting shares for cash. Allotment Of Shares For Cash 52. As noted above, under the Companies Act 1985 of the United Kingdom, a company limited by shares must state in its memorandum of association the division of the share-capital into shares of a fixed amount.[82] 53. Indeed, as discussed earlier, the general rule is that when shares are allotted they have to be paid-up in full.[83] In this section, however, we shall not regurgitate that discussion, as presented in the section dealing with par value and no-par value shares. It was noted in that discussion, too, that shares must be paid-up in cash. As we shall see now, the statutory requirement that shares must be paid-up in cash has some exceptions. Allotment Of Shares For Consideration Other Than Cash 54. While we consider the payment for shares by cash to be a preferred mode of payment, the exception to this rule in the United Kingdom is that a private company can allot shares for non-cash consideration.[84] The shortcoming here is that such a mode of payment is open to abuse. In the case of public companies, the English Companies Act 1985 provides as follows:[85] "(1) A public company shall not allot shares as fully or partly paid up (as to their nominal value or any premium on them) otherwise than in cash unless - (a) the consideration for the allotment has been independently valued... (b) a report with respect to its value has been made to the company by a person appointed by the company (in accordance with that section) during the 6 months immediately preceding the allotment of the shares; and (c) a copy of the report has been sent to the proposed allottee." 55. Indeed, to protect existing shareholders and creditors from possible share watering, whenever pubic companies are making non-cash considerations, the law has in place the above statutory rule. This rule is now examined in detail. Non-cash Considerations - Public Companies And Private Companies 56. It has already been explained above that under the English Companies Act 1985 the two mandatory provisions which prohibit public companies from allotting shares for non-cash consideration relate to situations where shareholders undertake to do work or perform services in return for shares,[86] and where the allotment of shares, as fully or partly paid-up, is for a consideration to transfer property to the company after five years from the date of allotment.[87] 57. It was noted, too, that while a public company under the UK law faces restrictions in the way it deals with non-cash considerations, a private company does not generally face such constraints.[88] Indeed, the case of Re Wragg Limited[89] was examined, together with the Brownlie and Others, Petitioners[90] case. What, then, are the lessons to be learnt from the two cases? Under the law of contract, freedom to contract is guaranteed. Once the parties have agreed on the property or services to be exchanged for fully paid-up shares, the courts will not look into the adequacy of the consideration. As a consequence, it will not be possible to determine if the shares have been issued at a discount or at a premium. The result is that the company will operate without knowing whether or not its shares have been watered down. Also, the company will not know whether or not its shares have been issued at a premium and, of course, a premium account will not have been created and set aside.[91] Such is the position for a private company. 58. Generally, a private company, as the name suggests, does not distribute its securities to the public. In many common law jurisdictions, private companies are perceived as small companies whose shareholding is composed of close friends or relations who know each other very well. This means that when shares are allotted the allottees will usually be close friends or family relations.[92] 59. Such a closely-nit 'family of shareholders', whose relationship is anchored upon mutual trust and confidence, will not be too willing to accept people from outside the family circle to buy shares in the company. By contrast, the position is different for many public companies. The relationships between shareholders inter se within a public company are often based on a broad range of grounds which include personal and impersonal grounds. For example, if a public company is listed on a stock exchange it means that members of the public could bid for shares in the company. In order to protect the public, as well as the creditors, it is a matter of public policy that such companies must be protected by legislation from 'share watering' which could arise from unvalued non-cash-considerations.[93] 60. In Zambia, the standard articles of association, contained in schedule 1 to the Companies Act 1994 do not provide for the payment of shares through non-cash consideration. Also, the Zambian Companies Act 1994 itself is silent on the matter. Thus, a company that is properly advised might opt not to adopt these standard articles. Instead, to attract more investment, particularly in the case of public companies, these companies might consider adopting certain aspects of the United Kingdom law on non-cash considerations in their articles of association. Allotment Of Shares At A Premium 61. In the United Kingdom, before the enactment of the Companies Act 1948, share premiums were not treated as part of the share-capital.[94] As Harman J. observes in the case of Henry Head & Co. Ltd. v. Ropner Holdings Ltd:[95] "The question which I have to determine is whether the defendants were obliged to keep their accounts in that way. That depends purely on s.56 of the Companies Act 1948 [CA 1985, s.130], which is a new departure in legislation and was, it is said, intended to make compulsory that which had long seemed to be desirable, namely, the practice of putting aside as a reserve and treating in the ordinary way as capital cash premiums received on the issue of shares at a premium." 62. The reasoning behind the old view that share premiums were not part of the share-capital was based on the argument that since par value was the nominal value of each share any value of the issued shares above the par value was not considered to be part of the share-capital. The excess amount was considered to be part of distributable profits which the company could return to the shareholders as dividends.[96] 63. After 1948, the position changed. A company could issue shares at a premium (normally during boom periods when the company is said to be enjoying good business) at a consideration in cash or in kind which exceeded the nominal value of a share.[97] Indeed, today, once shares are issued at a premium, a sum equal to the aggregate amount or value of the shares must be transferred to a premium account.[98] Issuing Shares At A Discount - The Zambian Case 64. It was pointed out at the start that the standard articles of association found in schedule 1 to the Zambian Companies Act 1994 include articles governing the payment for shares. However, the standard articles do not state that the shares issued to the allottee must be paid-up when the allotment is made. Thus, as noted already, regulation 15 of the standard articles simply permits company directors to accept partial or full payment from an allottee before a call is made on the unpaid amount. Indeed, it has been argued above that this indicates that when shares are allotted an allottee can decide to pay immediately or in future. In addition, the case of ZAMANGLO Industrial Corporation v. Zambia Privatisation Agency and The Attorney General[99] showed that the Companies Act 1994 of Zambia does not prohibit the sale of shares at a discount.[100] Allotment Of Shares At A Premium - The Zambian Case 65. The Zambian Companies Act 1994, like the English Companies Act 1985, has provisions permitting the allotment of shares at a premium.[101] Section 61(1) of the Zambian Companies Act 1994 provides as follows: "Where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount of value of the premiums on these shares shall be transferred to an account, to be called 'the share premium account'..." 66. Thus, under the Zambian Companies Act 1994, like in the case of the English Companies Act 1985,[102] shares issued at a premium may be paid-up in cash or otherwise.[103] We shall examine below what constitutes 'otherwise'. Here, suffice it to say that the allotting company must set aside a share premium account to which the aggregate amount or value of the premiums must be transferred.[104] 67. Indeed, both the Zambian Companies Act 1994 and the English Companies Act 1985 do not define what constitutes the term 'otherwise' as it applies to the share premium provision: 'if a company issues shares at a premium, whether for cash or otherwise'.[105] 68. Here, only one logical meaning could be discerned; that is, the term 'otherwise' refers to non-cash considerations since these are something else other than cash.[106] However, it might also be that whilst in the United Kingdom non-cash considerations for shares in a public company require valuation of the consideration,[107] in Zambia valuation is not necessary since the Zambian Companies Act 1994 says nothing on valuation of non-cash considerations. An amendment to the Zambian Companies Act 1994 on this matter would improve the law. Conclusion 69. This paper has examined the efficacy of the law on payment for shares in common law jurisdictions such as Zambia and the United Kingdom. It was argued that the legal justifications for a creditor to enforce the share payment obligation of shareholders rests not only on one theoretical premise, but on a number of thematic reasons which include the need to protect investors against the presence of a called-up share-capital which has not been paid-up. Theories supporting the argument that shareholders must pay-up for their shares were examined. These theories included the fraud theory, the trust fund theory and the contract theory. 70. In the second part of the paper it was argued that the concept of par value has little relevance in the world of commerce today and that shares of no-par value often reflect the true value of the shares. It was noted also that whereas English company law still recognises the concept of par value, as applicable to allotment of shares, the position in the US, Ghana, New Zealand and Canada show that the concept of par value is now obsolete and redundant. 71. Finally, the third part of the paper established that matters such as share watering and non-cash considerations must not be left to be dealt with by standard articles of association. Indeed, as shown in this study, not all companies in Zambia have adopted the standard articles. Problems which often arise with what is commonly known as 'legal technical assistance' explain some of the shortcomings of the law in a developing country such as Zambia. Legal technical assistance, a concept which is mainly propagated by Western international financing institutions,[108] has often entailed the donors themselves sending over some 'experts' to developing countries to draft the laws of these countries. No doubt, many a time this form of technical support has brought along with it unsuitable legislative models, because in the commercially sophisticated world in which developing countries increasingly find themselves, their financial legislation often demonstrates weaknesses which result mainly from a limited number of indigenous professional specialists, in particular lawyers.[109] Notes [1] See K.K. Mwenda, "Legal Problems Of Financial Assistance: A Comparative Legal Study," The African Journal Of International And Comparative Law, Vol. 9, Pt. 4, (1997), pp. 919-933. See also K.K. Mwenda, Legal Aspects of Corporate Capital and Finance, (Washington DC: Penn Press 1999), pp. 70-94; K. K. Mwenda and D. Ailola, "Legal Aspects Of Corporate Finance: A Comparative Study Of The Law On Financial Assistance," Southern Africa Journal of Comparative and International Law, Vol. XXXI, No. 2, July 1998. [2] Here, creditors could fall under various categories. For example, the ordinary depositor, who holds a client's account at the Bank, will be treated as an unsecured creditor. On the other hand, it is possible that the Bank will have obtained some further finance from secured creditors. Such secured creditors are often holders of floating and/or fixed charges. It must be noted that in regard to all creditors the ranking of priorities and claims can be altered through debt subordination agreements. I have examined this aspect of the law elsewhere: see K.K. Mwenda and A. Laszczynska, "Legal Problems Of Debt Subordination: A Comparative Study," African Journal of Comparative and International Law, (The African Society of International and Comparative Law, UK, Vol.10, Pt. 4, December 1998). On the ranking of priorities and claims, see also generally R.M. Goode, Legal Problems of Credit and Security, (London: Sweet and Maxwell, 1988); R.M. Goode, Principles of Corporate Insolvency Law, (London: Sweet and Maxwell, 1997) 2nd edition; P.R. Wood, Project Finance, Subordinated Debt and State Loans, (London: Sweet and Maxwell, 1995); R.M. Goode, Commercial Law, (London: Penguin Books, 1995) 2nd edition; F. Oditah, Legal Aspects of Receivables Financing, (London: Sweet and Maxwell, 1991); and W.J. Gough, Company Charges, (London: Butterworths, 1996) 2nd edition. [3] 139 U.S. 417, 11 S.Ct. 530 (1891). [4] R.W. Hamilton, Corporation Finance: Cases and Materials, (St. Paul, Minn: West Publishing, 1989), pp. 73-75: The reason for giving shares a par value is mainly historical. At a time when it was envisaged that the nominal value of shares would be so large that a substantial proportion would be left uncalled, the introduction of the par value concept was a convenient yardstick to measure the extent of liability of shareholders. [5] 48 Minn.174, 50 N.W. 1117 (1892). [6] B. Manning and J.J. Hanks, Legal Capital, (Westbury NY: Foundation Press, 1990), p. 50. [7] See Ibid., pp.51-52. [8] 30 F. Cas 435 (No. 17, 944) (C.C.D. Me. 1824). [9] See B. Manning and J.J. Hanks, Legal Capital, supra. (n. 6), p. 50. [10] For a definition of share watering, see R.W. Hamilton, Corporation Finance: Cases and Materials, supra. (n. 4), p. 75. See also the second paragraph of Part II of this work. [11] See B. Manning and J.J. Hanks, Legal Capital, supra. (n. 6), p. 49. [12] K.K. Mwenda, Legal Aspects of Corporate Capital and Finance, supra. (n. 1), p. 60. [13] See Ibid., p. 60. [14] (1897) 1 Ch. 796. [15] (1898) 6 S.L.T. [16] (1898) 6 S.L.T. at p. 251. [17] Regulation 9 of Schedule 1 to the Zambian Companies Act 1994. Schedule 1 contains the standard articles of association. There is no mandatory obligation to adopt the standard articles. These articles can be modified or replaced altogether by other contractual rules. [18] Schedule 1 to the Companies Act 1994 of Zambia, reg. 12. [19] See Ibid., regs. 16 and 17. [20] Ibid., reg. 16. [21] Ibid., reg. 16. [22] 1996/HP/706, unreported Zambia High Court case. [23] 30 F. Cas 435 (No. 17, 944) (C.C.D. Me. 1824). [24] See for example B. Manning and J.J. Hanks, Legal Capital, supra. (n. 6), p. 51. [25] See K.K. Mwenda, Legal Aspects of Corporate Capital and Finance, supra. (n. 1), pp. 48-68. [26] See also Ibid., pp. 48-68. [27] R.W. Hamilton, Corporation Finance: Cases and Materials, (St. Paul, Minn: West Publishing, 1989), p. 75. See also Final Report Of The Committee Of Inquiry Into The Working And Administration Of The Present Company Law Of Ghana, "Gower's Report", (Accra: Government Printers, 1961) p. 53. [28] See Ooregum Gold Mining Co. Of India v. Roper [1892] AC 125. [29] English Companies Act 1985, sec. 2(5)(a). [30] See Ooregum Gold Mining Co of India Ltd. v. Roper [1892] AC 125. [31] English Companies Act 1985, secs. 117 and 118. [32] J.C. BonBright, "The Dangers Of Shares Without Par Value," Columbia Law Review, 24 (1924), p. 449. [33] Ibid., pp. 448-450. [34] R. Pennington, Pennington's Company Law, (London: Butterworths, 1990), p. 21. [35] See English Companies Act 1985, sec. 99(1). However, the English Companies Act 1985 spells out some exceptions to the general rule that requires shareholders to pay-up for their shares. For example, section 101 of the Act reads as follows: "(1) A public company shall not allot a share except as paid up at least as to one-quarter of its nominal value and the whole of any premium on it. (2) subsection (1) does not apply to shares allotted in pursuance of an employees' share scheme." [36] English Companies Act 1985, sec. 99(1). [37] Ibid., sec. 738(2). [38] Ibid., sec. 738. [39] Ibid., sec. 100. [40] English Companies Act 1985, sec. 100 (2). [41] Ibid., sec. 112. [42] Ibid., sec. 112(1) and (3). [43] Ibid., sec. 114. [44] See J.C. Shepperd, Law of Fiduciaries, (Toronto: Carswell Co., 1981), p. 362. See also Regal (Hastings) Ltd v. Gulliver [1942] 1 All E.R. 378 and cf. Phipps v. Boardman [1966] 3 All E.R. 721. [45] See generally cases cited in supra. (n. 44). See also generally P. Loose, J. Yelland and D. Impey, The Company Director: Powers and Duties, (Bristol: Jordans, 1993). [46] For example, J.C BonBright, op. cit., p. 3. [47] See D. Frederick, "The Par Value Of Stock," Yale Law Journal, 16, (1906-1907), p. 249. [48] 129 Pennsylvania St. 405. [49] 139 US. 417, 11 Sup. Ct. 530 (1891). [50] See C. Allen, "Non Par Value Stock," 90 (1920), Central Law Journal, p. 170. [51] See generally C. Allen, Ibid. See also generally, V. Morawetz, "Shares Without Nominal Or Par Value," Harvard Law Review, 26 (1913); and J.E. Goodbar, "No Par Value Stock - Its Nature And Use," Miami Law Quarterly, Vol. 3, No. 1, (1948). [52] M.C. Harmen, Memorandum To Gedge Committee, in the Board of Trade, Report Of The Committee On Shares Of No Par Value, Cmd 9112 of 1954 (The Gedge Report). [53] See generally Ibid. See also A.A. Berle, "Problems Of Non Par Stock," Columbia Law Review, 25 (1925), p. 44 where he observes that the first authorisation for the issuance of shares of no-par value was made under Chapter 351 of the Laws of the Sate of New York in 1912. Since then other American states have enacted legislation to permit issuance of no-par value shares. [54] See the Gedge Report, op. cit., p. 11. [55] See the New Zealand Companies Act 1990, sec. 28. [56] See the Canadian Companies Act 1934, sec. 12(7). [57] See generally Final Report Of Commission Of Enquiry Into Working And Administration Of Company Law Of Ghana, supra., (n.27). [58] See Ghana's Companies Code 1963, sec. 40(1), which provides explicitly that: "All shares created or issued after the commencement of this Code shall be shares of no-par value." See also New Zealand Companies Act 1990, sec. 28, which provides expressly that: "No share shall have a nominal or par value." [59] See Final Report Of Commission Of Enquiry Into Working And Administration Of Company Law Of Ghana, supra., (n.27), p. 53. [60] See Memorandum from The Council Of The Chartered Institute Of Secretaries Of Joint Stock Companies And Other Public Bodies To Gedge Committee, op. cit., p. 7. [61] See R. Pennington, op. cit., p. 21. [62] See generally A.A. Berle, op. cit. [63] See generally, Ibid. [64] J.C. BonBright, op. cit., p. 449 [65] See Ibid., p. 449. [66] 1924 Tex. Civ. App. 260. S.W. 614. [67] Borland Trustees v Steel Brothers and Co. (1901) 1 Ch. 279; See also Re Paulin [1935] 1 KB 26; IRC v Crossman [1937] AC 26. [68] See Sutton's Hospital (1612) 10 Co Rep. 1; Tillard v Brown (1668) 1 Lev 237; Salmon v Hamborough Company (1671) 1 Ch Cas 204, HL. [69] London Sack & Bag Co v Dixon & Lugton [1943] 2 All ER 763, CA. [70] See below. [71] [1915] 1 Ch 881 at 897. [72] In most common law legal systems, such a procedure is found in the Companies Act. [73] See Ooregum Gold Mining Co of India Ltd. v Roper [1892] AC 125; Re White Star Line [1938] Ch 458; Tintin Exploration Syndicate v Sandys (1947) 177 LT 412; Re Bradford Investments plc (No.2) [1991] BCLC 688; Pro-Image Studios v Commonwealth Bank of Australia (1990-1991) 4 ACSR 586; System Controls plc v Munro Corporation plc [1990] BCC 386. [74] See infra. (n. 75). [75] On dividend yields, see generally R.A. Brealey and S.C Myers, Principles of Corporate Finance, (New York: McGraw-Hill, 1991); E.W. Davis and J. Pointon, Finance and the Firm: An Introduction To Corporate Finance, (Oxford: Oxford University Press, 1994). [76] Elsewhere, I have examined this aspect in great detail, see K.K. Mwenda, "Legal Problems Of Financial Assistance: A Comparative Legal Study," The African Journal Of International And Comparative Law, Vol. 9, Pt. 4, (1997), pp. 919-933; see also K.K. Mwenda, Legal Aspects of Corporate Capital and Finance, (Washington DC: Penn Press 1999), pp. 70-94. [77] See below. [78] For a discussion on 'share watering', see above. [79] See above. See also R.W. Hamilton, Corporation Finance: Cases and Materials, (St. Paul, Minn: West Publishing, 1989), p. 75. [80] See Part II of this work, dealing with the par value concept. [81] See for example Andrews v. Gas Meter Co. [1897] 1 Ch 361 (Court of Appeal); Peter's American Delicacy Co. Ltd. v. Heath (1939) 61 CLR 457 (High Court of Australia). [82] English Companies Act 1985, sec. 2(5)(a). [83] Ibid., sec. 99(1). [84] Ibid., sec. 103 [85] Ibid., sec. 103(1) [86] English Companies Act 1985, sec. 99(2). See also Pro-Image Studios v. Commonwealth Bank (1991) 4 ACSR 586; Re White Star Line [1938] Ch 458. [87] English Companies Act 1985, sec. 102 (1). [88] See above. [89] (1897) 1 Ch. 796. [90] (1898) 6 S.L.T. [91] See below. [92] Particularly on incorporation of a partnership. See for example, Re Wragg (1897) 1 Ch. 796. [93] See Re Keith Bray pty Ltd. (1991) 5 ACSR 450-452; Flitcroft's Case (1882 21 Ch D. 519; Hong Kong Gas Co. v. Glen [1914] 1 Ch. 527; Famatima Development Corp. Ltd v. Bury [1910] A.C. 439. [94] See P. Davies, Gower's Principles of Modern Company Law, 6th ed., (London: Sweet and Maxwell Ltd., 1997), pp. 282-294. See also below. [95] [1952] Ch. 124, [1951] 2 All E.R. 994 (Chancery Division) [96] See generally Ibid. [97] See the repealed English Companies Act 1948, sec. 56. Cf. English Companies Act 1985, sec. 130. See also Shearer (Inspector of Taxes) v. Bercain Ltd [1980] 3 All E.R. 295; Drown v. Gaumont British Corp. [1937] Ch. 402; Re Ratners Group plc. [1989] BCLC 612; Re Ossory Estates plc [1988] BCLC 213. [98] English Companies Act 1985, sec. 130. [99] 1996/HP/706, unreported Zambia High Court case. See above for a fuller discussion. [100] See above. [101] Zambian Companies Act 1994, sec. 61. Cf. the position in the United Kingdom as discussed above. [102] English Companies Act 1985, sec. 130(1) provides in part: "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 shall be transferred to an account called 'the share premium account'." [103] Zambian Companies Act 1994, sec. 61. [104] Ibid., sec. 61. [105] See Ibid., sec. 61(1). [106] On what constitutes cash, see Clealand's Case (1872) LR 14 Eq 387; Kent's Case (1888) 39 Ch D 259; Re Hiram Maxim Lamp [1903] 1 Ch A 70; Re Jones, Llyod & Co. Ltd. (1889) 41 Ch. D 159. Cf. English Companies Act 1985, sec 739(1). [107] See above. [108] See generally J. Faundez, "Legal technical assistance," in J. Faundez (ed), Good Government and Law: Legal and Institutional Reform in Developing Countries, ( London: MacMillan, 1996), pp. 1-24. [109] See K.K. Mwenda, "Zambia's Securities Act 1993 On Trial: The Case of Insider Dealing," Statute Law Review, (UK), Vol. 18, No. 2, p. 159.