Disputes Over Unpaid Share Capital and Capital Contributions

The Problem of Unpaid Capital in Malaysian SMEs

It is common for founders of a Malaysian private company to agree that each will subscribe for shares and contribute capital to get the business running. Problems arise when one party fails to honour that commitment. The shares may have been allotted on the understanding that payment would follow, or a shareholders' agreement may require capital injections at certain milestones.

When a co-founder does not pay up, the consequences can include formal calls on shares, forfeiture of those shares, dilution of the defaulting shareholder's stake, and potential legal claims by the company or other shareholders.

Share Capital Under the Companies Act 2016

Under the Companies Act 2016, a company limited by shares must have share capital, but there is no minimum capital requirement for private companies. Shares may be issued as fully paid or partly paid. If shares are issued partly paid, the shareholder owes the company the unpaid portion and the company can demand payment in accordance with its constitution.

Section 74 of the Companies Act 2016 provides that shares are movable property and are transferable in the manner set out in the constitution. Importantly, section 76 states that a share is taken to be issued when the name of the shareholder is entered in the register of members. At that point, the shareholder becomes liable for any unpaid amount on those shares.

Partly Paid Shares

Where shares are issued partly paid, the company retains a right to call for the balance. This is particularly relevant where founders agree to pay for their shares in instalments or where capital is to be contributed as the business grows. The terms governing when and how calls may be made are usually found in the company's constitution.

Calls on Shares

A call on shares is a formal demand by the company for a shareholder to pay some or all of the unpaid amount on their shares. The power to make calls is typically vested in the board of directors, subject to the constitution.

The Third Schedule to the Companies Act 2016 sets out model articles that apply if a company has not adopted its own constitution. Regulation 18 of those model articles provides that directors may make calls on members in respect of money unpaid on their shares, subject to the terms of allotment. Calls must be made by board resolution and the shareholder must be given notice specifying the amount and the time and place for payment.

If a shareholder fails to pay a call by the due date, interest may be payable on the outstanding amount. The rate and terms are governed by the constitution or the terms of issue.

Forfeiture of Shares

Forfeiture is the process by which a company cancels shares held by a shareholder who has failed to pay a call. It is a serious step because it extinguishes the shareholder's ownership of those shares.

The model articles in the Third Schedule provide a procedure for forfeiture. If a call remains unpaid after notice, the directors may resolve to forfeit the shares. The former shareholder loses their shares and their rights as a member, but remains liable for any amount that was unpaid at the time of forfeiture until the company receives payment.

Forfeited shares may be sold, re-allotted or otherwise disposed of by the company. Any surplus after satisfying the unpaid amount belongs to the former shareholder.

Procedural Requirements

Forfeiture must be carried out strictly in accordance with the constitution. Failure to follow the correct procedure may render the forfeiture invalid. Directors should ensure that proper notice is given, that board resolutions are correctly passed, and that the register of members is updated.

Dilution of Shareholding

Even without forfeiture, a defaulting shareholder may see their proportionate stake in the company reduced. If the company issues new shares to raise capital and the defaulting shareholder cannot or does not participate, their percentage holding will be diluted.

Shareholders' agreements often contain provisions dealing with this scenario. For example, an agreement may provide that if a shareholder fails to meet a capital call, the other shareholders may subscribe for additional shares on favourable terms, resulting in dilution of the defaulting party's stake. Such provisions are enforceable as contractual terms, subject to the Contracts Act 1950.

Claims Between Co-Founders

Disputes over unpaid capital frequently arise between co-founders who feel that one party is not pulling their weight financially. The available remedies depend on the legal structure of the business and the agreements in place.

Contractual Claims

If a shareholders' agreement requires a shareholder to contribute capital by a certain date or upon a certain trigger, failure to do so is a breach of contract. The company or, in some cases, the other shareholders may have a right to claim damages or specific performance under the Contracts Act 1950.

Where there is no written agreement, it may be more difficult to establish what was promised and what remedies are available. Oral agreements can be enforceable, but proving their terms is often challenging.

Company's Claim for Unpaid Shares

The company itself has a statutory right to recover any unpaid amount on shares. This is a debt owed by the shareholder to the company. If necessary, the company can commence legal proceedings to recover the amount owing.

Partnership Disputes

If the business is structured as a partnership rather than a company, the Partnership Act 1961 applies. Section 27 of that Act provides that partners are bound to contribute equally to losses, and the partnership agreement usually sets out capital contribution obligations. A partner who fails to contribute as agreed may be liable to the other partners for breach of the partnership agreement.

Limitation Periods

Claims for unpaid capital are subject to limitation periods under the Limitation Act 1953. Generally, an action to recover a debt must be commenced within six years from the date on which the cause of action accrued. Directors and shareholders should act promptly when a default occurs.

Practical Steps for Directors and Shareholders

When a shareholder fails to pay for shares or contribute agreed capital, consider the following steps:

• Review the company's constitution and any shareholders' agreement to understand the rights and procedures available.
• Confirm whether the shares were issued fully paid or partly paid, and on what terms.
• If a call is to be made, ensure the board follows the procedure in the constitution, including giving proper notice.
• Before forfeiting shares, take legal advice to ensure the procedure is correctly followed and the forfeiture will be valid.
• Consider whether a negotiated solution, such as a buyback of shares or restructuring of ownership, may be preferable to litigation.
• Document all communications and resolutions carefully.

Conclusion

Disputes over unpaid share capital can be disruptive to a business and damaging to relationships between co-founders. The Companies Act 2016 provides mechanisms for companies to enforce payment and, if necessary, forfeit shares. Shareholders' agreements can provide additional protections and remedies. Early legal advice can help directors and shareholders understand their options and take appropriate action.

Common questions

Can a company force a shareholder to pay for shares they agreed to buy?

Yes. The company can make a formal call on unpaid shares and, if the shareholder still does not pay, pursue the debt through legal proceedings. The company may also forfeit the shares.

What is forfeiture of shares?

Forfeiture is when a company cancels shares because the shareholder has not paid a call. The shareholder loses ownership but may still owe money to the company for the unpaid amount.

How long do I have to make a claim for unpaid capital?

Under the Limitation Act 1953, claims to recover a debt generally must be brought within six years from when the payment was due.

Does a shareholders' agreement help prevent these disputes?

A well-drafted shareholders' agreement sets out capital contribution obligations, consequences for default, and dispute resolution procedures. This provides clarity and can reduce the risk of disputes.

What if there is no written agreement about capital contributions?

Oral agreements can be enforceable but are harder to prove. Without clear documentation, disputes may become more difficult and costly to resolve.