Forfeiture of Shares, Meaning, Definition, Objectives, Procedure and Effects

Forfeiture of shares refers to the cancellation of shares by a company due to the non-payment of calls by a shareholder. When a shareholder fails to pay the allotment money or call money within the stipulated time, the company may take back the shares after following the prescribed legal procedure. Upon forfeiture, the shareholder loses all rights over the shares, and the amount already paid is not refunded.

Definition of Forfeiture of Shares

According to Company Law, forfeiture of shares is the act by which a company withdraws shares from a shareholder for default in payment of calls, in accordance with the Articles of Association. It is a penal action intended to enforce discipline among shareholders and ensure timely payment of share capital. Forfeiture is valid only if it complies strictly with statutory provisions and internal regulations of the company.

Legal Provisions Governing Forfeiture of Shares

The Companies Act, 2013 does not expressly define forfeiture, but it is recognized as a contractual right arising from the Articles of Association. A company can forfeit shares only if its Articles authorize it. Any forfeiture without such authority is invalid. The process must be carried out in good faith and strictly in compliance with the Articles, failing which it may be challenged in court.

Objectives of Forfeiture of Shares

• Ensuring Payment Discipline Among Shareholders

One of the primary objectives of forfeiture of shares is to ensure financial discipline among shareholders. By imposing the risk of forfeiture, the company encourages shareholders to pay allotment money and calls on shares on time. This mechanism discourages careless or speculative subscriptions and ensures that only serious and financially committed investors remain members of the company, thereby strengthening the reliability of the shareholder base.

• Protection of Company’s Financial Interests

Forfeiture protects the financial interests of the company by preventing capital loss due to defaulting shareholders. When calls remain unpaid, the company’s working capital is affected. Forfeiture allows the company to cancel such shares and later reissue them to reliable investors. This ensures that the company does not suffer due to non-payment and can maintain adequate funds for business operations and growth.

• Safeguarding Interests of Genuine Shareholders

Another important objective is to protect the interests of honest and punctual shareholders. Default by some shareholders places an unfair burden on others who fulfill their obligations. Forfeiture ensures fairness by penalizing defaulters and maintaining equity among shareholders. It promotes trust in the company’s governance system and assures compliant investors that their contributions are respected and protected.

• Maintaining Stability of Share Capital

Forfeiture helps in maintaining the stability and integrity of share capital. Unpaid calls create uncertainty in capital structure. By forfeiting shares of defaulters, the company ensures that only fully or partly paid shares form part of its capital. This leads to accurate representation of capital in financial statements and strengthens confidence among investors, creditors, and regulatory authorities.

• Deterrence Against Wilful Default

Forfeiture serves as a deterrent against wilful non-payment of calls. The fear of losing ownership rights and amounts already paid discourages shareholders from defaulting deliberately. This objective is crucial for companies raising large amounts of capital, where delayed payments can disrupt financial planning. Thus, forfeiture acts as a preventive measure ensuring timely inflow of funds.

• Enabling Reissue of Shares

A key objective of forfeiture is to enable the reissue of shares. Once forfeited, shares become the property of the company and may be reissued to new investors. This helps the company recover unpaid amounts and bring in fresh capital. Reissue also ensures optimal utilization of authorized capital and helps maintain shareholder diversity and financial strength.

• Strengthening Corporate Governance

Forfeiture supports effective corporate governance by enforcing compliance with contractual obligations. It reflects the company’s commitment to transparency, accountability, and fairness. By acting against defaulters, the Board demonstrates responsible management and adherence to the Articles of Association. This improves the company’s reputation and enhances confidence among investors and regulatory bodies.

• Legal Enforcement of Contractual Obligations

Shares represent a contract between the company and shareholders. Forfeiture enforces this contract by ensuring that shareholders fulfill their payment obligations. It upholds the principle that rights such as voting and dividends arise only after meeting financial commitments. This objective reinforces the legal sanctity of share subscription agreements and maintains order in corporate financial dealings.

Procedure for Forfeiture of Shares

Step 1. Authority in the Articles of Association

The first and most important step in the forfeiture procedure is that the Articles of Association must authorize forfeiture. A company cannot forfeit shares unless its Articles expressly provide for such power. Any forfeiture made without this authority is invalid and void. Therefore, before initiating forfeiture proceedings, the company must ensure that its Articles contain clear provisions relating to forfeiture of shares.

Step 2. Making a Valid Call on Shares

Forfeiture can occur only when a shareholder fails to pay a valid call. The company must first make a proper call on shares in accordance with the Companies Act and the Articles of Association. The call must specify the amount payable and the due date. If the call itself is invalid or irregular, subsequent forfeiture based on such a call will also be invalid.

Step 3. Default in Payment by Shareholder

After the call is made, the shareholder is expected to pay the amount within the stipulated time. Forfeiture can be initiated only if the shareholder defaults in payment of call money or allotment money. Non-payment must be genuine and not due to any mistake or fault of the company. The default forms the legal ground for initiating forfeiture proceedings.

Step 4. Issue of Notice of Forfeiture

Upon default, the company must issue a notice of forfeiture to the defaulting shareholder. The notice must clearly mention:

• The amount due

• The last date for payment

• A warning that shares will be forfeited if payment is not made

The notice must be served properly and allow reasonable time for compliance.

Step 5. Expiry of Notice Period

If the shareholder fails to pay within the notice period, the company becomes entitled to forfeit the shares. The notice period is crucial as it provides a final opportunity to the shareholder to avoid forfeiture. Forfeiture without waiting for the expiry of the notice period would be invalid and contrary to principles of natural justice.

Step 6. Resolution by the Board of Directors

After the notice period expires, the Board of Directors must pass a formal resolution to forfeit the shares. Forfeiture cannot be automatic. The resolution should specify the name of the shareholder, number of shares forfeited, and the amount unpaid. The Board must act in good faith and without discrimination while passing the resolution.

Step 7. Entry in Register of Members

Once forfeiture is approved, the company must record the forfeiture in the Register of Members. The name of the defaulting shareholder is removed, and the shares are marked as forfeited. This step legally terminates the shareholder’s membership. Proper documentation ensures transparency and serves as evidence in case of disputes or regulatory scrutiny.

Step 8. Intimation to the Shareholder

After forfeiture, the company should inform the shareholder about the forfeiture of shares. Although not mandatory in all cases, intimation is considered a good corporate practice. It ensures transparency and helps avoid misunderstandings or legal conflicts. The communication may include details regarding forfeiture and the consequences thereof.

Step 9. Treatment of Forfeited Shares

Forfeited shares become the property of the company. The company may reissue these shares on terms decided by the Board, subject to the condition that any discount on reissue does not exceed the amount forfeited. Reissue helps the company recover unpaid capital and strengthens its financial position.

Step 10. Compliance with Legal Formalities

The company must ensure compliance with all statutory and procedural requirements after forfeiture. Proper entries in books of accounts, registers, and adherence to the Articles of Association are essential. Non-compliance may render forfeiture invalid and expose the company to legal action.

Effects and Consequences of Forfeiture of Shares

• Termination of Membership

One of the most significant effects of forfeiture of shares is the termination of the shareholder’s membership. Once shares are forfeited, the defaulting shareholder ceases to be a member of the company. His or her name is removed from the Register of Members, and all rights arising from membership come to an end. This includes the loss of ownership status and the inability to participate in corporate affairs.

• Loss of Shareholder Rights

Upon forfeiture, the shareholder loses all rights associated with the shares, such as voting rights, rights to dividends, and rights to attend general meetings. The forfeited shareholder also loses the right to inspect company records or influence management decisions. This consequence acts as a strong deterrent against non-payment of calls and ensures that only compliant shareholders enjoy corporate privileges.

• Forfeiture of Amount Already Paid

Another important consequence is that the amount already paid by the shareholder is forfeited and is not refunded. The paid-up amount becomes the property of the company and is transferred to a forfeiture account. This serves as a penalty for default and compensates the company for inconvenience and financial loss caused due to non-payment of calls.

• Continuing Liability for Unpaid Amounts

Although membership ends, the forfeited shareholder may remain liable for unpaid amounts at the time of forfeiture. This liability continues until the forfeited shares are reissued or the company’s liability on those shares is discharged. This ensures that shareholders cannot escape their financial obligations merely by losing their shares.

• Company Gains Ownership of Forfeited Shares

Once forfeiture is complete, the forfeited shares become the property of the company. The company is free to dispose of these shares in any manner permitted by law and the Articles of Association. This provides the company with flexibility to recover unpaid capital and manage its share capital efficiently.

• Right to Reissue Forfeited Shares

The company may reissue forfeited shares at par, at a premium, or at a discount. However, the discount on reissue cannot exceed the amount forfeited earlier. Reissue allows the company to recover the unpaid call money and bring in new shareholders. Upon reissue, the new holder acquires full legal rights over the shares.

• Impact on Share Capital Structure

Forfeiture affects the share capital structure of the company. The forfeited shares reduce the paid-up share capital temporarily. Upon reissue, the capital is restored. Proper accounting treatment ensures accurate disclosure in financial statements. This effect highlights the importance of forfeiture in maintaining a realistic and reliable capital base.

• Legal and Accounting Consequences

Forfeiture has important legal and accounting implications. The company must record the forfeiture in its books, update statutory registers, and comply with accounting standards. Improper handling may lead to legal disputes or regulatory penalties. Accurate recording ensures transparency, accountability, and compliance with corporate law requirements.