Legal and Procedural Framework for Share Issues in Sri Lanka: An Academic Overview
This article examines the legal, procedural, and compliance framework governing the issuance of shares in Sri Lanka, with particular emphasis on statutory provisions, regulatory oversight, and the pivotal role of the Company Secretary.
The issuance of shares is a fundamental mechanism through which companies raise capital, reorganize ownership structures, and implement strategic financial objectives. In the context of corporate law and governance, the process of issuing shares is governed by a framework of statutory provisions, regulatory guidelines, and procedural safeguards that ensure transparency, fairness, and legal compliance. In Sri Lanka, the principal legislation governing share issues is the Companies Act No. 7 of 2007, supported by directives from regulatory bodies such as the Registrar of Companies (ROC), the Securities and Exchange Commission of Sri Lanka (SEC), and, where applicable, the Colombo Stock Exchange (CSE).
This article explores the legal, procedural, and compliance framework surrounding the issue of shares by companies in Sri Lanka. It provides a comprehensive overview of the reasons that may prompt a company to issue shares, the various types of share issues, and the step-by-step process involved. In doing so, it emphasizes the pivotal role played by the Company Secretary, whose responsibilities span legal advisory, documentation, regulatory filings, and corporate governance compliance. The article further examines the relevant statutory provisions, highlights the requirements applicable to both private and listed companies, and offers practical guidance for ensuring adherence to best practices and regulatory standards.
1. Reasons for a Share Issue
Companies may issue shares for a range of commercial and strategic reasons, including:
Capital Raising
One of the most common reasons companies issue shares is to raise capital. This capital may be required to finance new business ventures, expand existing operations, purchase assets, improve infrastructure, or simply to bolster the company’s working capital. Additionally, share issues are often used as a means of repaying existing debt, thereby improving the company's gearing ratio and reducing interest costs. By opting for equity financing over borrowing, companies may avoid the burden of fixed repayment obligations, making this route attractive for long-term growth initiatives.
Equity Structuring
Companies often issue shares to restructure their equity base. This can include bringing in new shareholders such as strategic partners who can add value through expertise, networks, or access to new markets. Institutional investors may also be brought in through share issues to enhance the credibility of the company and provide a stable source of capital. Such equity restructuring can diversify ownership, strengthen governance structures, and improve the overall financial profile of the company, making it more attractive to future investors.
Regulatory Compliance
In some cases, companies are required to issue shares to meet regulatory obligations. For example, publicly listed companies may need to ensure a minimum level of public shareholding or satisfy capital adequacy norms mandated by regulatory authorities. Failure to comply with these requirements can lead to penalties or even delisting from stock exchanges. Issuing shares helps companies stay in compliance with such rules, maintain their listing status, and reinforce investor confidence in their regulatory adherence.
Debt-to-Equity Conversion
During times of financial distress or as part of negotiated restructuring agreements, companies may issue shares to creditors in lieu of debt repayment. This process, known as a debt-to-equity conversion, reduces the company’s debt burden and improves its balance sheet by converting liabilities into equity. It is particularly useful for companies looking to avoid insolvency, as it enhances financial flexibility while aligning the interests of creditors with the company’s future performance by making them shareholders.
Employee Incentivization
Companies may also issue shares as a form of employee compensation or incentive, typically through Employee Share Ownership Plans (ESOPs) or share option schemes. These plans aim to attract and retain talented employees by giving them an ownership stake in the company. By aligning employee interests with shareholder value, such schemes can drive productivity, loyalty, and long-term performance. This non-cash benefit can also be advantageous for start-ups and growth companies that may not have the liquidity to offer high salaries.
Bonus or Rights Issues
Companies may undertake bonus issues or rights issues as part of their shareholder reward and capital-raising strategies. Bonus issues involve issuing additional shares free of charge to existing shareholders, usually in proportion to their current holdings, thereby enhancing shareholder value. Rights issues, on the other hand, offer existing shareholders the right to purchase additional shares at a discounted price before they are offered to the public. These mechanisms not only reward shareholder loyalty but also provide the company with an efficient method to raise capital while maintaining control within the current shareholder base.
2. Types of Share Issues
Ordinary Shares: Ordinary shares, also known as common shares, represent the most basic form of equity ownership in a company. Holders of ordinary shares typically have voting rights at shareholders' meetings and the right to receive dividends, although these are not guaranteed and are paid at the discretion of the company. Issuing ordinary shares is a common method for companies to raise capital, and it often reflects long-term ownership and participation in the company's profits and risks. Ordinary shareholders are last in line to receive any proceeds in the event of liquidation, making this a higher-risk, higher-reward investment.
Preference Shares: Preference shares are a special class of shares that provide shareholders with preferential rights over ordinary shareholders, particularly in relation to dividend payments and capital repayment. Types of preference shares include cumulative preference shares, where unpaid dividends accumulate and must be paid before any dividends to ordinary shareholders, and redeemable preference shares, which can be bought back by the company after a specified period. Preference shareholders generally do not have voting rights, but they enjoy a more secure income stream, making these instruments attractive to investors seeking steady returns.
Rights Issues: A rights issue is a method of raising additional capital by offering existing shareholders the right to purchase new shares in proportion to their current holdings, often at a discounted price. This method enables companies to raise funds while giving current shareholders the opportunity to maintain their percentage ownership. Rights issues require careful planning and regulatory compliance, including providing shareholders with an offer document outlining the terms and purpose of the issue. It is a cost-effective way for companies to raise capital while respecting shareholder pre-emption rights.
Private Placements: Private placements involve the sale of shares directly to a select group of investors, such as institutional investors, high-net-worth individuals, or strategic partners, rather than to the general public. This method is typically faster and less costly than public offerings, as it involves fewer regulatory formalities. Private placements are often used when companies seek to raise funds confidentially or when bringing in investors who can contribute more than just capital, such as expertise, networks, or strategic alignment. However, restrictions on transferability and resale of the shares may apply.
Bonus Issues: Bonus issues, also known as scrip issues or capitalizations, involve the issuance of additional shares to existing shareholders free of charge, based on the number of shares they already hold. This is usually done by capitalizing part of the company's reserves and does not result in any fresh inflow of funds. Bonus issues increase the number of outstanding shares, which can enhance liquidity in the market and may be perceived positively by shareholders as a sign of the company’s financial strength. It also improves the affordability of shares for small investors by reducing the share price.
Initial Public Offerings (IPOs) and Secondary Offerings: An Initial Public Offering (IPO) is the first sale of a company’s shares to the public, typically through a stock exchange. This process transforms a private company into a publicly listed entity and provides access to substantial capital from a broad base of investors. IPOs involve extensive regulatory scrutiny, disclosure requirements, and due diligence. Secondary offerings, by contrast, involve the sale of additional shares by a company that is already publicly listed. These can be used to raise further capital or facilitate the exit of existing investors, and they require compliance with continuing disclosure obligations and stock exchange rules.
3. Legal and Procedural Steps in Share Issues
Preliminary Checks
Before proceeding with a share issue, the company must first review its Articles of Association to confirm that it has the authority to issue shares. The Articles may contain specific provisions that govern the types of shares that can be issued, the process for doing so, or any limitations on the issuance of further shares. If the Articles do not grant the necessary powers or if they restrict certain actions, the company may need to amend the Articles by passing a special resolution at a shareholders' meeting. In some cases, shareholder approval may also be required even if the Articles are silent, depending on the nature and impact of the share issue.
Determination of Issue Terms
Once the company has confirmed its authority to issue shares, the next step is to determine the terms of the issue. This involves deciding on the number of shares to be issued, their class (e.g., ordinary or preference), the issue price, and the method of issuance—such as through a rights issue, private placement, or public offering. If shares are being issued at a premium or discount, or to related parties, an independent valuation may be necessary to support the fairness of the pricing and to satisfy legal or regulatory standards. The company must also consider how the issue will affect existing shareholders and the company's capital structure.
Board Approval
The proposed share issue must be formally approved by the company’s Board of Directors. Under Section 50 of the Companies Act No. 07 of 2007 (Sri Lanka), a board resolution must be passed authorizing the issue of shares. This resolution should detail the terms of the issue and confirm the directors’ belief that the consideration for the shares is fair and reasonable to the company and all existing shareholders. The resolution must be properly recorded in the minutes of the meeting and retained as part of the company's statutory records.
Offer and Acceptance
The company must then offer the shares in accordance with applicable legal requirements. If pre-emption rights apply—typically in the case of existing shareholders— those shareholders must be given the first opportunity to subscribe for the new shares in proportion to their existing holdings. In the case of private placements, the company will negotiate the terms directly with selected investors and execute written agreements to document the acceptance and subscription details. These agreements should clearly outline the subscription amount, payment terms, and any conditions precedent to completion.
Allotment and Issuance
Once payment or other consideration for the shares has been received, the company proceeds with the allotment of shares. A resolution should be passed by the board recording the allotment, including details of the allottees and the number of shares issued to each. Following the allotment, the company is required under Section 53(2) of the Companies Act to issue share certificates to the allottees within 20 working days. The certificates must be signed in accordance with the company's Articles and properly dated to reflect the date of allotment.
Post-Issue Filings
After the shares have been allotted, the company must complete and file Form 6 (Return of Allotment) with the Registrar of Companies within 10 working days, as required by the Companies Act. This form provides details of the new shares issued, the allottees, and the consideration received. If there has been a change in the company's stated capital, Form 15 may also be filed to reflect the updated capital structure, although this is optional unless specifically required. Additionally, the company must update its internal records, including the register of shareholders and the share ledger, to accurately reflect the new shareholding structure. These records must be maintained in accordance with statutory requirements and be made available for inspection as mandated by law.
4. Regulatory and Compliance Framework
Companies Act No. 7 of 2007
The Companies Act No. 7 of 2007 of Sri Lanka provides the primary legal framework governing share issues. Section 50 of the Act empowers the Board of Directors to issue shares, provided they are satisfied that the consideration is fair and reasonable to the company and its existing shareholders. Section 51 outlines the pre-emption rights of existing shareholders, ensuring they are given the first opportunity to subscribe for new shares unless these rights are waived or disapplied in accordance with the Articles or a shareholders’ resolution. Section 53 mandates that share certificates must be issued within 20 working days of allotment, confirming the shareholder’s legal title to the shares. Section 123 requires the company to maintain an up-to-date register of shareholders, reflecting the current shareholding structure at all times. Compliance with these provisions is essential to ensure the legal validity of a share issue.
SEC and CSE Requirements
Companies that are listed on the Colombo Stock Exchange (CSE) must adhere to the Listing Rules and the broader regulatory framework enforced by the Securities and Exchange Commission (SEC) of Sri Lanka. These rules include requirements for obtaining shareholder approval for certain types of share issues, making timely and transparent disclosures, and securing prior clearance from the SEC for specific transactions, particularly those involving related parties or large volumes. Public share issues must be accompanied by detailed circulars, public announcements, and regulatory filings that provide full information to investors, thereby ensuring market integrity and investor protection. Failure to comply with these rules can result in penalties or reputational damage, and may even affect the company’s continued listing on the exchange.
Other Statutory and Sector-Specific Regulations
In addition to the Companies Act and securities regulations, companies may be subject to other legal requirements depending on their industry or ownership structure. For instance, companies operating under Board of Investment (BOI) agreements may need prior BOI approval for certain share transactions, especially if foreign shareholders are involved. The Inland Revenue Act may impose tax implications on share issues, including stamp duty and capital gains considerations. Further, under the Foreign Exchange Act, share transfers or issuances involving non-residents must comply with the rules governing foreign investment in Sri Lanka, including obtaining approval from the Central Bank or authorised dealers, where applicable. Companies must be mindful of these overlapping requirements to ensure full regulatory compliance.
5. The Role of the Company Secretary
Legal Advisory
The Company Secretary serves as a key legal advisor to the Board of Directors, offering expert guidance on the legal framework governing share issues. This includes interpreting the provisions of the Companies Act No. 7 of 2007, the company’s Articles of Association, and any shareholder agreements that may influence the structure or permissibility of the proposed share issue. The Company Secretary also advises on procedural requirements, such as whether pre-emption rights apply, if special resolutions are needed, and how to address any limitations under statutory or regulatory regimes. Their legal input ensures that decisions made by the Board are not only commercially sound but also legally compliant.
Documentation
One of the core responsibilities of the Company Secretary during a share issue is the preparation of all essential documentation. This includes drafting and finalizing board resolutions authorizing the issue, shareholder resolutions if required, subscription agreements for private placements, offer letters for rights issues, and any supporting documentation to be submitted to regulators. The accuracy, completeness, and timely execution of these documents are critical, as they form the legal basis of the share issue and must withstand scrutiny by auditors, shareholders, and regulators alike.
Regulatory Compliance
The Company Secretary is the primary officer responsible for ensuring full compliance with statutory and regulatory obligations arising from the share issue. This includes the preparation and timely filing of prescribed forms such as Form 6 (Return of Allotment) with the Registrar of Companies, and where relevant, coordinating filings with the Securities and Exchange Commission (SEC) and the Colombo Stock Exchange (CSE). The Company Secretary also ensures compliance with disclosure obligations, especially for listed entities, and acts as the liaison with regulators to obtain necessary approvals and respond to any queries or concerns.
Corporate Governance
Acting as a guardian of corporate governance, the Company Secretary plays a crucial role in ensuring that the share issue is carried out in a transparent and equitable manner. This includes upholding the rights of existing shareholders by ensuring proper observance of pre-emption rights where applicable, advising on the timing and disclosure of the offer, and ensuring that the process is not used to favour any particular party unjustly. By embedding governance principles into the share issue process, the Company Secretary helps build shareholder trust and supports the integrity of the company’s management practices.
Administrative Coordination
Beyond legal and regulatory functions, the Company Secretary is responsible for the administrative execution of the share issue. This includes updating the register of shareholders to reflect the new allotments, ensuring that share certificates are prepared and delivered to shareholders within the legally mandated timeframe, and maintaining comprehensive records of all documentation, resolutions, and filings. These records are essential for future audits, legal due diligence, and shareholder reference, and their meticulous upkeep ensures that the company remains in good standing with regulatory authorities.
6. Special Considerations: Preference Shares
Defining Rights Attached to Preference Shares
When issuing preference shares, it is essential for the company to clearly define the rights and privileges attached to those shares. These rights typically include the rate and priority of dividend payments, rights upon liquidation, redemption rights, convertibility into ordinary shares, and voting rights (if any). The terms must be explicitly set out either in the Articles of Association or in the resolution authorizing the issue. Clear articulation of these rights is necessary not only to avoid future disputes but also to ensure potential investors fully understand the nature of the investment they are making.
Compliance with Section 49 and Sections 69–70
Under the Companies Act No. 7 of 2007, companies must comply with Section 49 when issuing preference shares. This provision requires that the terms of issue, including the rights, obligations, and conditions attached to the shares, be approved by the Board and recorded in writing. If the shares are redeemable, Sections 69 and 70 of the Act come into play. These sections specify the manner in which redeemable shares can be repurchased by the company, including the source of funds (such as profits or proceeds from a fresh issue of shares), the need for solvency certificates, and compliance with redemption timelines. Failure to follow these provisions could render the issue invalid or expose the company to regulatory sanctions.
Disclosure of Dividend Structures and Approvals
Companies issuing preference shares must fully disclose the proposed dividend structure, including whether the dividend is fixed or variable. For instance, if the dividend is calculated based on a benchmark such as the Average Weighted Prime Lending Rate (AWPLR) plus a fixed margin (e.g., AWPLR + 3%), this must be specified in the issue documentation. Transparent disclosure of how and when dividends will be paid is vital for investor confidence. Furthermore, the proposed terms must receive the necessary approvals from the Board of Directors, and in some cases, shareholder approval may also be required, particularly if the Articles demand it or the issue alters the rights of existing shareholders. This ensures that the issuance is both procedurally correct and legally valid.
Conclusion
The issuance of shares is a powerful strategic instrument that enables companies to raise capital, attract new investors, restructure equity, meet regulatory requirements, and incentivize employees. However, this process must be executed with precision, ensuring strict adherence to legal, procedural, and governance standards. In Sri Lanka, the Companies Act No. 7 of 2007 provides a comprehensive statutory framework that governs all aspects of share issuance, including the powers of the Board (Section 50), protection of shareholder rights through pre emption (Section 51), timelines for share certificate issuance (Section 53), and maintenance of accurate shareholder records (Section 123).
For listed entities, compliance with the additional regulatory requirements of the Securities and Exchange Commission (SEC) and the Colombo Stock Exchange (CSE) is mandatory. These include disclosure obligations, shareholder approvals, and timely regulatory filings that uphold market transparency and investor protection. Other statutory regimes, such as the Inland Revenue Act, BOI agreements, and the Foreign Exchange Act, may impose sector-specific or transaction-specific conditions, particularly in cross-border or tax-sensitive contexts.
The issuance process involves a series of structured steps, beginning with preliminary legal checks, followed by the determination of share terms, board and shareholder approvals, offer and acceptance, allotment, and post-issue compliance filings. Each phase demands careful planning, sound legal reasoning, and diligent documentation. Special attention must be paid when issuing instruments like preference shares, which require clear articulation of rights, redemption terms under Sections 69 and 70, and disclosure of dividend structures, such as those linked to market benchmarks like the AWPLR.
Throughout this process, the Company Secretary plays a central and indispensable role. As the custodian of corporate compliance, the Company Secretary advises the Board on legal requirements, prepares essential documentation, ensures regulatory filings are made in a timely manner, coordinates administrative tasks such as updating statutory registers and issuing share certificates, and upholds the principles of corporate governance and fairness in shareholder dealings.
As corporate financing structures become more innovative and capital markets evolve, a sound understanding of the legal and regulatory aspects of share issues is crucial. For legal practitioners, company directors, investors, and corporate advisors, mastering this process is not just about compliance, it is about safeguarding stakeholder interests, maintaining corporate integrity, and enabling sustainable growth in an increasingly competitive and regulated business environment.
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