KB3 BL Study Text

STUDY TEXT
MANUAL
CA SRI LANKA CURRICULUM 2015
KB3
Business Taxation and Law
(Part B : Business Law)
First edition 2015
ISBN 978-955-9118-77-0
National Library and Documentation Services Board – Cataloguing-In-Publication Data
Business Taxation and Law: Part B – Business Law – Colombo:

The Institute of Chartered Accountants of Sri Lanka, 2014
192p.
ISBN 978-955-9118-77-0
1. 336.2 DDC 23
2. Business Law
Published by
The Institute of Chartered Accountants of Sri Lanka

30A, Malalasekera Mawatha
Colombo 7.
https://casrilanka.com
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(CA Sri Lanka)
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reproduced, stored in a retrieval system or transmitted
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The contents of this book are intended as a guide and

not professional advice and every effort has been made
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the time of going to press by CA Sri Lanka, Moderator
and Author.
Every effort has been made to contact the copyright

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©
The Institute of Chartered Accountants of Sri Lanka
2015
ii KB3 Business Taxation and Law – Part B

Contents
Page
Introduction iv
Chapter Features vi
Learning Outcomes vii
Action verbs checklist xiv
KB3 Business Taxation and Law

Part B – Organisational Law
1 Features of a Company and Organisational Personality 3
2 Incorporation of a Company 21
3 Equity and Debt Capital 45
4 Directors, Company Secretary, Auditors 69
5 Meetings, Resolutions and Company Records 89
6 Winding Up 111
7 Securities Regime in Sri Lanka 133
8 Alternate Dispute Resolution 153
9 References 173
10 Index 176
Contents iii
Introduction
KB 3 Business Taxation and Law

Part A – Business Taxation: At the Business level a Financial Accountant has to
perform accounting and operational activities and ensure compliance with other
responsibilities independently in various undertakings. The syllabus content is aligned
to provide a thorough understanding in company taxation, and other taxes applicable
to various types of business.
Part B – Organisational Law: The syllabus for corporate Law has been aligned to gain
knowledge on affairs relating to companies, from incorporation to wind up, including
statutory provision relating to capital, meetings and resolution, directors, auditors,
secretaries and procedures to be adhered to by a company in the modern context. The
Syllabus content covers the role of regulatory authorities and dispute resolution as
well.
Syllabus Structure
Main Syllabus Area Weighting

Part B : Organisational Law
1. Features of a Company and Organisational Personality 5%
2. Incorporation of a Company 10%
3. Equity and Debt Capital 10%
4. Directors, Company Secretary, Auditors 5%
5. Meetings, Resolutions and Company Records 5%
6. Winding Up 5%
7. Securities Regime in Sri Lanka 5%
8. Alternate Dispute Resolution 5%
One of the key elements in examination success is practice. It is important that not only
you fully understand the topics by reading carefully the information contained in this
Study Text, but it is also vital that you practise the techniques and apply the principles
that you have learned.
In order to do this, you should:
 Work through all the examples provided within the chapters and review the
solutions, ensuring that you understand them;
 Complete the progress test for each chapter.
In addition to that, you should use the Practice and Revision Kit. These questions will
provide you with excellent examination practice when you are in the revision phase of
your studies.
iv KB3 Business Taxation and Law – Part B

Pillar Structure
The Curriculum 2015 is structured around three pillars, namely, Knowledge, Skills
and Personal.
The Pillars are subdivided into specific subject areas or sub pillars and content is
delivered to meet the requirements of three progressively ascending levels of
competency, namely, Executive, Business and Corporate.
The Business Level provides the fundamentals of accounting and harnesses the skills
and professional values needed to mould a Senior Business Accountant.
The Knowledge Pillar focuses on imparting sound technical knowledge required
from a competent CA, and comprises five sub pillars that focus on the following
subject areas:
Sub pillar 1: Financial Accounting and Reporting (FA&R)
Sub pillar 2: Management Accounting and Finance (MA&F)
Sub pillar 3: Taxation and Law (T&L)
Sub pillar 4: Assurance and Ethics (A&E)
Sub pillar 5: Management and Contemporary Issues (M&C)
Pillar structure v
Chapter Features
Each chapter contains a number of helpful features to guide you through each topic.
Topic List This tells you what you will be studying in the chapter. The topic items
form the numbered headings within the chapter.
Chapter The introduction puts the chapter topic into perspective and explains
Introduction why it is important, both within your studies and within your
practical working life.
Learning The learning outcomes issued for the module by CA Sri Lanka are
Outcomes listed at the beginning of the chapter, with reference to the chapter
section within which coverage will be found.
Key Terms These are definitions of important concepts that you really need to
know and understand before the exam.
Examples These are illustrations of particular techniques or concepts with a

worked solution or explanation provided immediately afterwards.
Case Study Often based on real world scenarios and contemporary issues, these
examples or illustrations are designed to enrich your understanding
of a topic and add practical emphasis.
Questions These are questions that enable you to practise a technique or test
your understanding. You will find the answer underneath the
question.
Formula to These are the formula that you are required to learn for the exam.
Learn
Section This summarises the key points to remember from each section.
Introduction
Chapter This provides a recap of the key areas covered in the chapter.
Roundup
Progress Progress tests at the end of each chapter are designed to test your
Test memory.
Case Law Law formulated through a legal case.
Bold Text Throughout the Study Text you will see that some of the text is in bold
type. This is to add emphasis and to help you to grasp the key
elements within a sentence or paragraph.
vi KB3 Business Taxation and Law – Part B

Learning Outcomes
CA Sri Lanka’s learning outcomes for the Module are set out on the following pages. They are cross-referenced to the chapter in the Study
Text where they are covered.
Part B: Organisational Law
1 Features of a Company and Organisational Personality

(Syllabus Weighting 5%)
Knowledge Knowledge Knowledge Chapter

Learning Outcome
Component Dimension Process
1.1 Law governing Factual/ Remember / 1.1.1 Identify the law governing companies in Sri Lanka. 1
companies in Conceptual Comprehension 1.1.2 Explain the general features of a company registered under 1
Sri Lanka the Companies Act, including new features.
1.2 Definition of a Factual/ Remember/ 1.2.1 Define the term company. 1
company, Conceptual Comprehension 1.2.2 Explain the characteristics of a company. 1
characteristics 1.2.3 Explain the advantages and disadvantages of incorporation. 1
of a company
1.3 The concept of Conceptual/ Comprehension/ 1.3.1 Explain the concept of “organisational personality” and its 1
organisational Procedural Application legal consequences.
personality 1.3.2 Demonstrate instances where the concept of organisational 1
personality is applied, with relevant cases.
1.3.3 Explain the concept of “veil of incorporation”. 1
1
1.3.4 Assess the situations where the “veil of incorporation” can be
lifted, with relevant cases.
vii
2 Incorporation of a Company

Learning Outcome
2.1 Types of conceptual Analysis 2.1.1 Compare and contrast between the different types of companies 2
companies recognised under the Companies Act (including foreign
companies doing business in Sri Lanka and listed companies).
2.2 Incorporation Factual/ Remember / 2.2.1 Explain the process involved for registration of a company. 2
of a company Procedural Comprehension 2.2.2 Explain the process and restriction in selecting a name. 2
2.2.3 State the types of Forms to be submitted to the ROC and their 2
contents.
2.2.4 Explain the documentation involved for registration of a 2
company (public and private).
2.3 Promoters Conceptual/ Comprehension 2.3.1 Analyse the rights and duties of “promoters” including liability 2
Procedural / Analysis for “pre-incorporation contracts” with relevant cases.
2.3.2 Explain remedies of breach of duties. 2
2.3.3 Discuss payments to promoters. 2
2.4 Articles of Conceptual/ Comprehension 2.4.1 Explain the contents, amendments to the AA. 2
Association Procedural / Analysis 2.4.2 Analyse the nature, purpose and legal consequences of the 2
(AA) Articles of Association, including relevant cases.
2.5 Company Conceptual/ Comprehension 2.5.1 Explain “pre-incorporation contracts, implied warrantees and 2
contracts Procedural ratification”.
2.5.2 Explain method of contracting and “authority of directors, 2
officers and agents”.
2.5.3 Explain the “indoor management” rule and the doctrine of 2
“constructive notice”.
viii KB3 Business Taxation and Law – Part B

3 Equity and Debt Capital
( Syllabus Weighting 10%)
Learning Outcome
3.1 Types of Conceptual Analysis 3.1.1 Analyse types of shares, with reference to stated capital regime, 3
shares, / classification, risk, variation of class rights, dividends, voting rights,
allotment Procedural priority in a winding up.
and issue of 3.1.2 Compare and contrast the procedures for the issue of shares 3
shares (including “issues at a premium or at a discount”).
3.2 Dividends Conceptual Comprehension 3.2.1 Explain the procedure for payment of dividends including that of a 3
/ listed company.
Procedural 3.2.2 Explain the importance of “solvency test” and capital maintenance 3
mechanisms
3.3 Major types Conceptual Analysis 3.3.1 Analyse the following principles in relation to capital maintenance 3
of share in a company (redemption, reduction of capital, financial
dealings in a assistance, share buy-back, minority buy-out)
company
3.4 Debt capital Conceptual Analysis 3.4.1 Analyse the following principles in relation to long-term debt 3
capital (classification, risk, interest payments, rights, priority in a
winding up).
3.5 Rights of Conceptual Analysis 3.5.1 Compare and contrast rights available for shareholders and 3
sharehol debenture holders.
ders and 3.5.2 Outline the principles relating to “majority rule” and “minority 3
debentur protection” (including “Oppression, Mismanagement and
e holders derivative action and Major Transactions) (S.185 of the Companies
Act )
Learning Outcomes ix
4 Directors, Company Secretary, Auditors
(Syllabus Weighting 5% )

Learning Outcome
4.1 Role of Conceptual/ Comprehension 4.1.1 Explain the following in relation to the directors of a company 4
Directors Procedural (appointment, retirement and removal, powers, duties and
liabilities, civil and criminal liabilities).
4.1.2 Explain the division of power between directors and members. 4
4.2 Role of Conceptual/ Remember 4.2.1 State the functions of a Company Secretary along with 4
Secretary Procedural “Panorama case”.
4.2.2 Identify the process of appointment of Secretary and relevant 4
qualifications.
4.3 Role of Conceptual/ Comprehension 4.3.1 Discuss the functions, rights and duties of an Auditor (including 4
Procedural provisions contained in the Sri Lanka Accounting and Auditing
Auditor Standards Act No. 15 of 1995).
x KB3 Business Taxation and Law – Part B

5 Meetings, Resolutions and Company Records
Learning Outcome
5.1 Different Conceptual Application/ 5.1.1 Compare and contrast the different types of meetings in a 5
types of Analysis company, and their purposes and notice periods.
meetings 5.1.2 Prepare a notice for an Annual General Meeting. 5
5.2 Different Conceptual Comprehension/ 5.2.1 Explain the different types of resolutions which could be 5
types of Application passed by the members of a company.
resolutions 5.2.2 Prepare resolutions for Reappointment of directors,
Reappointment of auditors, Declaration dividends.
5.3 Company Factual Remember/ 5.3.1 List company records, stipulated in the Company’s Act. 5
Records Comprehension 5.3.2 Identify returns to be filed with ROC. 5
5.3.3 Discuss the regulatory requirements with regard to accounts
(including provisions contained in the Sri Lanka Accounting and 5
Auditing Standards Act No. 15 of 1995).
Learning Outcomes xi
6 Winding Up
Learning Outcome
6.1 Compulsory Procedural Analysis 6.1.1 Differentiate “compulsory and voluntary winding up” and 6
and explain their consequences.
voluntary
winding up
6.2 Functions of Conceptual Analysis 6.2.1 Outline the functions of administrator/liquidator and 6
parties receivers/managers.
involved in
winding up
7 Securities Regime in Sri Lanka

Learning Outcome
7.1 Security Conceptual/ Comprehension 7.1.1 Explain the roles of the Securities and Exchange Commission, 7
trading Procedural the Colombo Stock Exchange and the Central Depository
process, System.
regulation 7.1.2 Explain transfer of listed securities via CSE. 7
and insider 7.1.3 Explain “off the floor transactions”. 7
dealing 7.1.4 Explain “insider dealing” and relevant information. 7
xii KB3 Business Taxation and Law – Part B

8 Alternate Dispute Resolution
Learning Outcome
8.1 Mediation Conceptual Comprehension 8.1.1 Explain the Process of mediation. 8
8.1.2 Explain the role of the Mediation Board. 8
8.1.3 Explain the role of Commercial Mediation Center. 8
8.2 Conciliation Conceptual Comprehension 8.2.1 Explain the process of conciliation. 8

8.2.2 Explain the role of the Debt Conciliation Board. 8
8.3 Arbitration Conceptual Remember/ 8.3.1 Identify “arbitrability” disputes. 8

Comprehension 8.3.2 Explain the process of arbitration. 8
8.3.3 Explain the role of the Arbitral Tribunal. 8
8.3.4 Explain enforcement of the Arbitral Award. 8
Learning Outcomes xiii

Action Verbs Checklist
Knowledge Process Verb List Verb Definitions
Tier-1 Remember Define Describe exactly the nature, scope

Recall important or meaning
information Draw Produce (a picture or diagram)
Identify Recognise, establish or select after
consideration
List Write the connected items one
below the other
Relate To establish logical or causal

connections
State Express something definitely or
clearly
Tier-2 Calculate/ Make a mathematical computation
Comprehension Compute
Explain important Discuss Examine in detail by argument
information showing different aspects, for the
purpose of arriving at a conclusion
Explain Make a clear description in detail
revealing relevant facts
Interpret Present in understandable terms or
to translate
Recognise To show validity or otherwise,
using knowledge or contextual
experience
Record Enter relevant entries in detail
Summarise Give a brief statement of the main
points (in facts or figures)
xiv KB3 Business Taxation and Law – Part B

Tier-3 Application Apply Put to practical use

Use knowledge in a
setting other than the Assess Determine the value, nature, ability
one in which it was or quality
learned/solve close- Demonstrate Prove, especially with examples
ended problems
Graph Represent by means of a graph
Prepare Make ready for a particular

purpose
Prioritise Arrange or do in order of
importance
Reconcile Make consistent with another
Solve To find a solution through

calculations and/or explanations
Tier-4 Analysis Analyse Examine in detail in order to
Draw relations among determine the solution or outcome
ideas and to compare Compare Examine for the purpose of
and contrast/solve discovering similarities
open-ended problems
Contrast Examine in order to show
unlikeness or differences
Differentiate Constitute a difference that
distinguishes something
Outline Make a summary of significant
features
Action Verbs Checklist

xv
Tier – 5 Evaluate Advise Offer suggestions about the best

Formation of course of action in a manner suited
judgments and to the recipient
decisions about the Convince To persuade others to believe
value of methods, something using evidence and/or
ideas, people or argument
products
Criticise Form and express a judgment
Evaluate To determine the significance by

careful appraisal
Recommend A suggestion or proposal as to the
best course of action
Resolve Settle or find a solution to a
problem or contentious matter
Validate Check or prove the accuracy
Tier – 6 Synthesis Compile Produce by assembling information

Solve unfamiliar collected from various sources
problems by Design Devise the form or structure
combining different according to a plan
aspects to form a
Develop To disclose, discover, perfect or
unique or novel
unfold a plan or idea
solution
Propose To form or declare a plan or
intention for consideration or
adoption
xvi KB3 Business Taxation and Law – Part B

Part B-
Business Law
KB3 | Part B: Business Law
2
CA Sri Lanka
01
CHAPTER
Features of a
Company and
Organisational
Personality
INTRODUCTION
In this chapter we will discuss the law governing companies in Sri
Lanka. We will further discuss the characteristics of a company and
its organisational personality.
Knowledge Component
Features of a Company and Organisational Personality
1.1 Law governing companies 1.1.1 Identify the law governing companies in Sri Lanka.
in Sri Lanka 1.1.2 Explain the general features of a company registered under the Companies
Act including new features.
1.2 Definition of a company, 1.2.1 Define the term company.
characteristics of a 1.2.2 Explain the characteristics of a company.
company 1.2.3 Explain the advantages and disadvantages of incorporation.
1.3 The concept of 1.3.1 Explain the concept of “organisational personality” and its legal
organisational personality consequences.
1.3.2 Demonstrate instances where the concept of organisational personality is
applied, with relevant cases.
1.3.3 Explain the concept of “veil of incorporation”.
1.3.4 Assess the situations where the “veil of incorporation” can be lifted, with
relevant cases.
3
KB3 | Chapter 1: Features of a Company and Organisational Personality
LEARNING
CHAPTER CONTENTS OUTCOME
1 The law governing companies in Sri Lanka 1.1.1,1.1.2
2 Characteristics of a company 1.2.1, 1.2.2
3 Advantageous and disadvantageous of incorporation 1.2.3
4 Organisational personality 1.3.1, 1.3.2
1.3.3,1.3.4
1 The Law Governing Companies in Sri Lanka

The law governing companies in Sri Lanka is laid down in the Companies Act No. 07
of 2007 which repealed the previous Companies Act.
1.1 The Companies Act No. 07 of 2007

Company law was introduced to Sri Lanka by the British in the colonial era, thus,
the English Law governed company matters in Sri Lanka until most recent times.
The Companies Act No. 07 of 2007 repealed the previous Companies Act of No 17
of 1982 and introduced significant changes to the law governing companies in Sri
Lanka. The new Act not only introduced new concepts but also shifted the legal
basis of company law from English Law to New Zealand and Canadian law.
The new Act repealed the following three previous Acts which were based on
English law.
 The Companies Act No. 17 of 1982, as amended by the Companies

(Amendment) Act No. 33 of 1991
 Companies (Special Provisions) Law No.19 of 1974
 Foreign Companies (Special Provision) Law No. 09 of 1975
The New Companies Act, No. 07 of 2007 has followed the New Zealand Companies
Act of 1993 and the Canadian Business Corporation Act 1985.
4
CA Sri Lanka
1.2 Features of the Companies Act No.07 of 2007
Incorporation of a company made convenient
The new Act provides that a company can be incorporated by merely filling an
application form thus the memorandum of association is no longer a requirement.
A company can adopt the entire model articles which are provided in the new
Companies Act or opt to expressly adopt certain parts of the said Model articles.
Single shareholder companies
Under the previous law, a public company was required to have a minimum of seven
shareholders and private company was required to have a minimum of two
shareholders. In terms of Section 4(2) of the new Companies Act, a company shall
have no less than two shareholders, provided that a company may have a single
shareholder where such single shareholder is the Secretary to the Treasury who is
holding shares on behalf of the Government of Sri Lanka or is an individual or a
body corporate.
Simplified internal operating procedures
The new Companies Act permits the incorporation of single shareholder companies
(vide Section 4(2) of the Companies Act) and permits companies to carry out its
affairs with a single director.
It also dispenses with certain administrative and reporting requirements for

private companies with the consent of its shareholders, thereby reducing the
expenses of the company.
Simplified formal procedures
The formal procedures on major matters of the company such as capital reductions
and amalgamations have been simplified by dispensing with the requirement of
court approval.
CA Sri Lanka 5
2 Characteristics of a Company
Section 2 of the Companies Act defines a company as a body corporate. The concept
of a company is the culmination of theories of organisational structures over a
number of years which have gained formal legal recognition. The aspects that set a
“company” apart from other organisational structures are important and merit
discussion.
2.1 Definition of a Company
A company can be generally defined as an independent legal entity established by

a group of people known as shareholders acting together to achieve common
objectives. Such an entity is empowered with legal rights which are usually only
reserved for individuals, such as the right to sue and be sued, the right to own
property, the right to hire employees or the right to loan and borrow money.
2.2 General Characteristics of a Company
Generally , a company also has a birth, life and death as a human being. However,
certain companies are still functioning and carrying out their affairs for several
centuries. Company law governs the affairs of a company from the date of its
incorporation to the date of its death (namely, when a company is wound up).
Year Company Current Field Sources

Location
578 Kongō Gumi Japan Construction
717 Koman Japan Hotel
718 Hoshi Ryokan Japan Hotel
803 Stiftskeller St. Peter Austria Restaurant
862 Staffelter Hof Germany Wine
885 Tanaka-Iga Japan Religious goods
A list of some of the oldest companies of the world
6
CA Sri Lanka
Separate Legal Personality
Under company law, subsequent to incorporation a company becomes a separate

legal personality as compared to its members. In other words, the company is
distinct and different from its members in the eyes of the law. It has its own seal
and its own name, its assets and liabilities are separate and distinct from those of
its members. It is capable of owning property, incurring debt, and borrowing
money, employing people, having a bank account, entering into contracts and suing
and being sued separately. Sole proprietors and a partnerships are not separate
legal personalities, thus, cannot be sued or sue in its own name.
Limited Liability
Limited liability in effect means that the liability (namely the contribution a
member will have to make once the company is being wound up) of the members
of the company is limited to the contribution made to the assets of the company up
to the face value of shares held by him. A member is liable to pay only the uncalled
money due on shares held by him.
This is different to a partnership or a sole proprietorship which are not legal

personalities. If the assets of a partnership or a sole proprietorship are not sufficient
to pay the respective liabilities, the creditors can force the partners or the sole
proprietor to make good the deficit from their personal assets. Shareholders of
company however would not be liable once they have paid all their dues towards
the shares held by them in the company.
Perpetual Succession
A company does not cease to exist unless it is specifically wound up or the task for
which it was formed has been completed. Membership of a company may keep on
changing from time to time but that does not affect the life of the company.
Insolvency or death of a member does not affect the existence of the company.
CA Sri Lanka 7
Separate Property
A company is a distinct legal entity. The company's property is its own and such
ownership is independent of the members of the company. A member cannot claim
to be the owner of the company's property during the existence of the company.
When a company is wound-up, its assets would be sold to settle its creditors.
Transferability of Shares
Shares in a company are freely transferable, subject to certain conditions, such that
no share-holder is permanently or necessarily bound to a company. When a
member transfers his shares to another person, the transferee steps into the shoes
of the transferor and acquires all the rights of the transferor in respect of those
shares.
Common Seal
A company is an artificial person and does not have a physical presence. Thus, it
acts through its board of directors in order to carry out its activities and enter into
various agreements. Such contracts must be under the seal of the company. The
common seal is the official signature of the company. The name of the company
must be engraved on the common seal. Any document not bearing the seal of the
company may not on occasion be accepted as authentic and may not have any legal
force. Under the provisions of the new Company Act however, the mandatory
requirement of attaching the company seal to documents has been relaxed.
Capacity to Sue and to be Sued
A company can sue or be sued in its own name as distinct from its members. Thus,
members are not named as parties in a case when a company institutes action or is
sued by a third party.
8
CA Sri Lanka
Separate Management
A company is administered and managed by its managerial personnel i.e. the board
of directors. The shareholders are simply the holders of the shares in the company
and need not be necessarily the managers of the company. The shareholders own
the company but, unless a shareholder is part of the board, such shareholder cannot
be involved in the management affairs of the Company. The role of management of
a company is therefore exclusively the role of the directors.
3 Advantages and Disadvantages of Incorporation
There are many forms of businesses, but an incorporated body is considered to be

the most advantages form of business. However there are disadvantages in
incorporating a business.
3.1 Advantages of Incorporation
Independent Corporate Existence
As stated earlier, a central feature of a company is its independent corporate

existence. By registration under the Companies Act, a company becomes vested
with corporate personality, which is independent and distinct from its members. A
company is a legal person which can sue and be sued in its own corporate name.
Therefore a shareholder is safeguarded from bearing any liability upon a law suit
being filed on behalf of or against the company.
Ease of Raising Capital
An incorporated company can raise capital by selling its shares, which is a lucrative
method of increasing capital as compared to the likes of partnerships and sole
proprietorships. Also an incorporated company attracts more investors due to its
limited liability. In addition to that, incorporation is generally considered a more
stable form of business compared to mere partnerships or sole proprietorships.
Hence corporations are more attractive to some lending institutions.
CA Sri Lanka 9
Transfer of Ownership
Stemming from the principle of perpetual succession, the company continues to

exist irrespective of any changes in shareholders. In other words, an incorporated
company never dies. Ownership of the company can be transferred fairly easily by
simply selling the shares of the company. In such an instance the company assets
will remain unchanged and owned by the company itself. This ensures continuity of
a business as well as proving to be more attractive of an investment to investors.
Limited Liability
Unlike a partnership or sole proprietorship, the shareholders of an incorporated

company are not liable for the company’s debts beyond the value of their shares.
This is considered as the most important advantage of incorporation as a
shareholder’s personal assets are safeguarded and independent of the assets of the
company.
3.2 Disadvantages of Incorporation
Expense
Incorporating a business will take longer to set up compared to other types of

business structures. Incorporation also incurs higher start-up expenses. Compared
to a partnership or sole proprietorship, a corporation is a far more complex legal
structure, hence it is more costly and complicated to set up.
Double Taxation
Incorporating a business will also mean annually having two tax returns on file. This
is commonly referred to as double taxation. Double taxing involves corporation tax
and income tax. This means not only additional legal formalities and paperwork,
but also as opposed to a sole proprietorship business structure, an incorporated
business will not have the capacity to deduct its losses from the personal profit of
its owner. In addition to that, there are extra costs in the form of account fees, legal
fees and other charges. On the other hand, he income of a non-incorporated
business, is only taxed once.
10
CA Sri Lanka
Complex Procedure
An incorporated business will need to take care of detailed books, take notes at
meetings, as well as create and maintain reports, a share register, tax return files, a
transfer register, bank account records and audit books.
Lack of Control
Once the company is incorporated it has a separate existence from the shareholders
and it will be identified by its corporate name. The shareholders will become the
joint owners of the business but they will elect the board of directors who will be
actually controlling the business. But in a sole proprietorship of partnership, the
proprietor or the partners have direct physical control of the business.
4 Organisational Personality
In terms of section 2(1) of the Companies Act, a company incorporated is a body

corporated by the name by which it is registered. It is a juristic person and it has a
distinctive legal personality separate from its shareholders. This principal carries
many aspects with it which require attention.
4.1 Legal Status and Capacity of a Company
Section 2(2) of the Companies Act sets out the capacity and rights of a company. A
company has the capacity, both within and outside Sri Lanka to carry out and
undertake any business or activity and to undertake or engage in or enter into any
transaction, subject to the restrictions imposed by its articles of association. It also
has all the rights, powers and privileges necessary to carry out the aforesaid
functions.
CA Sri Lanka 11
Case Law: Properties of the company do not belong to the owner of the
company
Mr. Macaura owned a timber estate. He sold timber there to Irish Canadian
Sawmills Ltd., a company in which Mr. Macaura was the sole owner with
nominees. He took out insurance policies on the timber against fire with Northern
Assurance in his own name and not in the name of the company. Due to a fire,
Northern Assurance refused to pay because the timber was owned by the
company and not by Mr. Macaura. Therefore, because the company was a
separate legal entity, it was not bound to pay Mr. Macaura any money.
The House of Lords held that the insurers were not liable on the contract, since
the timber that perished in the fire did not belong to Mr. Macaura in who’s name
the insurance policy was held. Lord Sumner said,
“It was not his. It belonged to the Irish Canadian Sawmills Ltd, He stood in
no ‘legal or equitable relation to’ the timber at al. His relation was to the
company, not to its goods.”
Macaura v Northern Assurance (1925) A.C. 619
4.2 The Corporate Veil
The corporate veil (veil of incorporation) is a legal concept that separates the
personality of a company from the personalities of its shareholders, and protects
them from being personally liable for the company's debts and other obligations.
This was established in the landmark judgment of Salomon v. Salomon Co. Ltd.
(1897), which held that the legal personality of a company is a veil or mask which
covers the identity of its shareholders.
However, it must be noted that this protection is not ironclad or impenetrable.

Where a court determines that a company's business was not conducted in
accordance with the provisions of corporate legislation (or that it was just a façade
for illegal activities or fraud) it may hold the shareholders personally liable for the
company's obligations under the legal concept of lifting the corporate veil.
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Case Law: landmark judgment on the corporate veil
Mr. Salomon, a boot manufacturer, converted his business into a limited liability
company. His wife, children and he were shareholders. Salomon also took out
debentures in his own name. About a year later the company became insolvent.
The assets of the company were just sufficient to pay the debentures and nothing
was left to pay the unsecured creditors. The creditors sued against Salomon to
recover their amounts.
Held: That the company was a separate legal person distinct from Salomon and
as the company had been validly formed, there was no fraud on the creditors. The
unsecured creditors got nothing.
Salomon v. Salomon Co. Ltd (1897)
4.2.1 Exceptions to the Theory of Veil of Incorporation:
In some compelling situations, courts have lifted the veil of incorporation and have
held that shareholders may be liable for the acts of the company. Where a
fraudulent and dishonest use is made of the legal entity, the individuals concerned
will not be allowed to take shelter behind the corporate personality. In such
instances, the Court will disregard the corporate personality and look behind the
real persons who are in the control of the company. This principle is known as
“lifting or piercing through the corporate veil”.
However it must be noted that lifting the veil of incorporation is a rare exception to
the rule. Limited liability is a paramount principle in business law, and undue
interference of this rule may cause severe unpredictability. Hence, the courts will
not lift the veil of incorporation without extreme necessity.
Case Law: where corporation is considered as an association of persons
“A corporation will be looked upon as a legal entity as a general rule but when the
notion of legal entity is used to defeat public convenience, justify wrong, protect
fraud or defend crime, the law will regard the corporation as an association of
persons.”
United States V. Milwaukee Refrigerator Co. (1905)
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Case Law: Lifting the Corporate Veil
“The doctrine laid down in Salomon v. Salomon and Salomon Co. Ltd, has to be
watched very carefully. It has often been supposed to cast a veil over the
personality of a limited liability company through which the Courts cannot see.
But, that is not true. The Courts can and often do draw aside the veil. They can
and often do, pull off the mask. They look to see what really lies behind”.
Littlewoods Mail Order Stores Ltd V. Inland Revenue Commissioner [1963]
The following situations are examples where the courts have been known to lift the
veil of incorporation:
1. When the company has been used as a cover for deliberate wrong doing.
Ex: Gilford Motor Co Ltd V Horne
2. When the number of members falls below the statutory minimum
3. If the controlling shareholder uses the company as his agent, or if the corporate
body is abused for an unlawful or improper purpose
4. To prevent a fraud
5. To determine a company’s place of residence for the application of specific

statues such as tax laws
Ex: Sec 79 of the Inland Revenue Act No 10 of 2006
6. To prevent deliberate evasion of contractual obligations
7. To promote the interests of national security, or to ensure conformity with

public policy
8. Legislation sometimes lifts the veil in requiring holding and subsidiary

companies to prepare group accounts, in prohibiting a company from giving
financial assistance, subject to a certain exception, for anyone to purchase
shares of that company or its holding company.
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Case Law: where the corporate veil has been used as a cover for deliberate
wrong doing
“Although the independent personality of the company is distinctive from its
directors and shareholders, in appropriate circumstances courts have lifted the
veil of incorporation. In particular, courts have been vigilant not to allow the veil
of incorporation to be used for some illegal or improper purpose or as a devise to
defraud creditors.”
Hatton National Bank Ltd. v. Jayawardane & Others 2007 (1) SLR 181
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CHAPTER ROUNDUP
 The law governing companies in Sri Lanka is laid down in the Companies Act No. 07
of 2007 which repealed the Companies Act of No 17 of 1982 and introduced
significant changes to the law governing companies in Sri Lanka.
 Convenient incorporation of companies, simplified internal operating procedure,

simplified formal procedure, recognizing Single Shareholder Companies are some
of the significant features of the new Companies Act.
 A company can be generally defined as an independent legal entity established by a

group of people known as shareholders acting together to achieve common
objectives.
 A company is a juristic person which can sue and be sued in its own name and has
a distinct legal personality separate from its shareholders.
 However, under exceptional circumstances, the courts may lift the veil of
incorporation and hold the shareholders liable for the acts of the Company.
 The incorporation makes it easier for companies to raise capital by selling its
shares. Also the incorporated company attracts more investors due to its limited
liability. Moreover incorporated businesses are considered to be a more stable form
of business.
 The main disadvantages of incorporation are that it is more expensive than sole
proprietorships or partnerships, and also may result in double taxation.
Incorporation a lso results in complex procedures and lack of ownership.
 A company has the capacity, both within and outside Sri Lanka to carry out or
undertake any business or activity and to undertake or engage in or enter into any
transaction, subject to restrictions imposed by its articles of association.
 The veil of incorporation is a legal concept that separates the personality of a

company from the personalities of its shareholders, and protects the shareholders
from being personally liable for the company's debts and other obligations..
 In some compelling situations, courts have lifted the veil of incorporation and hold
the owners personally liable for the acts of the company. Where a fraudulent and
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dishonest use is made of the legal entity, the individuals concerned will not be
allowed to take shelter behind the corporate veil.
 The Courts have been vigilant not to allow the veil of incorporation to be used for
some illegal or improper purpose or as a devise to defraud creditors.
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1 Mr. Perera and Mr. Silva wish to commence a laundry business in Sri Lanka. They
are in discussions as to whether the business should be in the form of a partnership
PROGRESS TEST
or in the form of a company. Mr. Perera and Mr. Silva seek your advice on the
following:
a) Identify what are the features of a company that will distinguish it from other
business organisations such as partnerships.
b) Outline the main advantages and disadvantages of establishing the business

as a company.
2 Mr. Perera seeks additional advice from you regarding the legal personality of a
company. He seeks advice as to whether the identities of the shareholders will
remain separate from that of the company regardless of whatever business and
conduct that the company is involved in.
Explain to Mr. Perera the manner in which the “corporate veil” operates in an
incorporated body.
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1 Key aspects of a company

ANSWERS TO PROGRESS TEST
A company is an independent legal entity established by a group of people known

as shareholders acting together to achieve common objectives.
A company possesses “legal personality” which means that a company is

considered to be a juristic person which can sue and be sued in its own name
independent of its shareholders, own property in the company’s name, etc.
A company bears “limited liability” which ensures that the shareholders are only
liable for the capital that is to be invested by the respective shareholder in relation
to the number of shares owned by that that shareholder.
A company has “perpetual succession” and continues with its existence

independent of the existence shareholders of that company.
The ownership of a company can be transferred easily in the form of buying and
selling the shares of that company.
Advantages
- Incorporation makes it easier for companies to raise capital by selling its shares.
- Companies attract more investors due to its limited liability.
- Shareholders liability is not unlimited (as found in partnerships) and is limited
only to the unpaid share capital.
- Incorporated businesses are considered to be a more stable form of business.
- Ownership is easily transferable.
- An independent legal personality provides more security to the investment of a
shareholder.
Disadvantages
- More expensive to establish.
- Double taxation.
- Incorporation results in complex procedures and creates additional regulations
to conform to.
- An owner is not vested with operational control of the property.
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The “corporate veil” is a legal fiction that separates the personality of a company
from the personalities of its shareholders. Since a court of law is not allowed to
pierce the corporate veil (except under limited circumstances), the shareholders
are safeguarded from being personally liable for the company's debts and other
obligations.
The case of Salomon v Saloman must be considered.
The courts have however been known to lift/pierce the corporate veil in the
following situations:
i. When the company has been used as a cover for deliberate wrong doing.
ii. When the number of members falls below the statutory minimum.
iii. If the controlling shareholder uses the company as his agent, or if the corporate
body is abused for an unlawful or improper purpose.
iv. To prevent a fraud from being perpetuated.
v. To determine a company’s place of residence for the application of specific
statues such as tax laws.
vi. To prevent deliberate evasion of contractual obligations.
vii. To promote the interests of national security, or to ensure conformity with
public policy.
viii. Where legislation provides for it.
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02
CHAPTER
Incorporation of a
Company
INTRODUCTION
In this chapter we will discuss the types of companies recognized in Sri Lanka
and the procedure of incorporating a company.
Knowledge Component
Incorporation of a Company
2.1 Types of Companies 2.1.1 Compare and contrast between the different types of companies recognised
under the Companies Act (including foreign companies doing business in Sri
Lanka and listed companies).
2.2 Incorporation of a Company 2.2.1 Explain the process involved for registration of a company.
2.2.2 Explain the process and restriction in selecting a name.
2.2.3 State the types of Forms to be submitted to the ROC and their contents.
2.2.4 Explain the documentation involved for registration of a company (public
and private).
2.3 Promoters 2.3.1 Analyse the rights and duties of “promoters” including liability for “pre-
incorporation contracts” with relevant cases.
2.3.2 Explain remedies of breach of duties.
2.3.3 Discuss payments to promoters.
2.4 Articles of Association (AA) 2.4.1 Explain the contents, amendments to the AA.
2.4.2 Analyse the nature, purpose and legal consequences of the Articles of
Association, including relevant cases.
2.5 Company contracts 2.5.1 Explain “pre-incorporation contracts, implied warrantees and ratification”.
2.5.2 Explain method of contracting and “authority of directors, officers and
agents”.
2.5.3 Explain the “Indoor Management” rule and the doctrine of “constructive
notice”.
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KB3 | Chapter 2: Incorporation of a Company
LEARNING
1 Types of companies 2.1.1
2 Incorporation of a company 2.2.1, 2.2.2

2.2.3, 2.2.4
3 Promoters 2.3.1, 2.3.2
2.3.3
4 Articles of Association 2.4.1, 2.4.2
5 Company Contracts 2.5.1, 2.5.2
2.5.3
1 Types of Companies
In terms of the Companies Act, the companies are categorized in to three types. i.e.
limited companies, unlimited companies and companies limited by
guarantee. Among these, limited companies are the most common type and it is
further divided in to Private Limited and Public Limited companies.
1.1 Introduction
Section 3 of the Companies Act No 7 of 2007 reads as follows
A company incorporated under this Act may be either ;
(a) a company that issues shares, the holders of which have the liability to
contribute to the assets of the company, if any, specified in the company's
articles as attaching to those shares (in this Act referred to as a "limited
company") ; or
(b) a company that issues shares, the holders of which have an unlimited liability to
contribute to the assets of the company under its articles (in this Act referred
as an "unlimited company") ; or
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(c) a company that does not issue shares, the members of which undertake to
contribute to the assets of the company in the event of its being put into
liquidation, in an amount specified in the company's articles (in this Act referred
to as a "company limited by guarantee").
1.2 Limited Companies
This is the most commonly used method of business incorporation. A limited

company is a business that is owned by its shareholders, run by directors and most
importantly whose liability is limited.
Limited liability (as discussed in the previous chapter) means that the investors can
only lose the money they have invested and no more. This encourages people to
finance the company, and/or set up such a business, knowing that they can only lose
what they put in, if the company fails. In terms of Section 89 of the Companies Act
once the shareholders have paid for their shares, the company cannot increase their
liability to the company or compel them to take further shares in the company
without their consent.
For people or businesses who have a claim against the company, “limited liability”
means that they can only recover money from the existing assets of the business.
They cannot claim the personal assets of the shareholders to recover amounts owed
by the company.
There are two types of limited companies.
i. Public Limited Companies
ii. Private Limited Companies
1.3 Public Limited Companies
Limited liability companies which are listed in the Stock Exchange are known as
Public Limited Companies. The Colombo Stock Exchange (CSE) has 295
companies representing 20 business sectors as at 30th July 2014, with a market
capitalization of Rs. 2,851.79 Bn.
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Companies incorporated under the Companies Act No.7 of 2007 or any other
statutory corporation, incorporated or established under the laws of Sri Lanka or
established under the laws of any other state (subject to Exchange Control
approval) are eligible to seek a listing on the Colombo Stock Exchange to raise debt
or equity. Companies desiring to be admitted to the official list of the Exchange and
to secure a listing of their securities will be required to comply with the relevant
provisions of the above act and the provisions of the Securities & Exchange
Commission Act No.36 of 1987 (as amended) and the Listing Rules of the Exchange.
Shares of a Public Limited Company (also refered to as a “Public quoted Company”)

can be purchased by any member of the general public through a licensed
stockbroker. Share trading in Sri Lanka dates back to 1896 when the Colombo
Brokers Association commenced the share trading in limited liability companies
which were involved in opening plantations in Sri Lanka.
The establishment of a formal stock exchange took place in 1985 with the
incorporation of the Colombo Stock Exchange (CSE), which took over the Stock
Market from the Colombo Share Brokers Association. currently it has a membership
of 15 institutions, all of which are licensed to operate as stockbrokers.
Public Limited Companies are carefully scrutinised and monitored by the Securities &
Exchange Commission and CSE, as the shareholding of these types of companies are
held by the general public.
Code of Best Practice on Corporate Governance
Public Limited Companies unlike Private Limited Companies are expected to adhere
and comply with the “Code of Best Practice on Corporate Governance”. This is not a
mandatory Code, however, a corporate entity following and adhering to the Code is
generally regarded as a good corporate citizen.
Good corporate governance is globally accepted as being fundamental to an

organisation’s competitiveness, growth and sustainability. There is great attention
given by boards of directors to discharge their duties with high ethical values and
accountability in their commitment to good governance practices. Strong business
ethics, sound policies and procedures, effective and efficient monitoring systems
are considered as ingredients of a good corporate governance system.
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The Securities and Exchange Commission of Sri Lanka as the apex regulator of the
Sri Lankan capital market is committed to maintain a higher standard of corporate
governance in order to maintain market integrity. In view of this broader objective,
the Securities and Exchange Commission of Sri Lanka together with the Institute of
Chartered Accountants of Sri Lanka published the first “Code of Best Practices on
Corporate Governance” in the year 2008 in order to establish good corporate
governance practices in the Sri Lankan capital market. The current Code of Best
Practices on Corporate Governance in operation is the version released in the year
2013.
1.4 Private Limited Companies
Private Limited Companies are the companies which have a limited number of
shareholders which are closely held by members of a family or group. The
fundamental rule in a Private Company is that its shares should not be offered to
the public and its shareholders should be limited to a maximum of fifty
shareholders.
The new Companies Act has granted private companies a considerable degree of
informality, by recognizing the unanimous agreement of shareholders under
Section 31 of the Act to dispense with formalities in major transactions of the
company such as the issue of shares or making distributions.
Private Limited Companies are generally used as start-up companies which hope to
evolve into Public Limited Companies at a later date by calling for investment from
the general public. Private Limited Companies are also ideal for business models
which require power to be centralised in a smaller group of individuals.
1.5 Unlimited Companies
In terms of Section 3(1)(b) of the Act, Unlimited Companies are companies where
shareholders are unlimitedly liable to contribute to the company, i.e. in case of
company failing to pay its debts, the shareholders’ personal estates maybe used to
satisfy the company’s debts. These forms of companies are rarely incorporated, as
it lacks the fundamental advantage of incorporation which is limited liability.
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1.6 Companies ,limited by Guarantee
These types of companies do not issue shares but the members are bound by the
Articles of the company to contribute in an amount specified therein, if the company
is liquidated. These companies are suitable for charities and non-profit
organizations. It is significant to note that where a company limited by guarantee is
formed for the purpose of promoting commerce, arts, charity, sports etc. as
specified in section 34 of the Act, such a company is given the opportunity of
dispensing the word “Limited” from its name.
Whereas (as morefully set out in the following chapter) with Public Limited
Companies and Private Limited Companies, the names of these respective
companies must necessarily contain the word “Limited” within the corporate name.
2 Incorporation of a Company
Unlike sole proprietorships and to a lesser extent partnerships, the establishment

of a company is a complicated process closely monitored by regulation. The
necessary methodology and procedure to be followed in creating a company merits
closer attention.
2.1 Methodology of Incorporating a Company
Section 4 of the Act sets out the required documents to incorporate a company
(other than a company limited by guarantee). The prescribed form for
incorporation of a company is set out in Form 1 of the Gazette Extraordinary
No.1493/20 dated 20.04.2007. Form 5 of the same Gazette shall be used for
incorporation of a Company Limited by Guarantee.
The prescribed form consists of the proposed name of the company, registered
address, initial directors, shareholders and secretary/secretaries. It also includes a
declaration to the effect that, to the best of the applicants’ knowledge the proposed
name of the company is not identical or similar to that of any existing company.
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Section 4 of the Companies Act reads as follows:
(1) Subject to the provisions of subsection (2), any person or persons may apply to
incorporate a company, other than a company limited by guarantee, by making an
application for the same to the Registrar in the prescribed form signed by each of
the initial shareholders, together with the following documents :
(a) a declaration stating that to the best of such person or persons knowledge, the
name of the company is not identical or similar to that of an existing company ;
(b) the articles of association of the company, if different from the articles set out in
the First Schedule hereto, and signed by each of the initial shareholders;
(c) consent from each of the initial directors under section 203, to act as a director
of the company ; and
(d) consent from the initial secretary under subsection (2) of section 221, to act as
secretary of the company.
(2) A company shall have not less than two shareholders, provided that a company
may have a single shareholder where such single shareholder is the Secretary to the
Treasury who is holding shares on behalf of the Government of Sri Lanka or is an
individual or a body corporate.
In terms of Section 5(1) of the Act, upon receipt of a properly completed application
for incorporation, the Registrar shall enter the particulars of the company on the
register and assign a unique number as its company number. Pursuant thereto the
Registrar shall issue the Certificate of Incorporation to the company.
Section 5(2) of the Act sets out the necessary ingredients of the Certificate of
Incorporation, namely:
(a) the name and number of the company ;
(b) the date on which the company was incorporated ;
(c) whether the company is a limited company, an unlimited company or a

company ,limited by guarantee ;
(d) whether the company is a private company ;
(e) whether the company is an off-shore company ;
CA Sri Lanka 27
A Certificate of Incorporation shall be conclusive evidence of the fact that all the
requirements under the Companies Act relating to the incorporation of a company
have been complied with and the company has been incorporated under the Act on
the date specified in such Certificate of Incorporation.
2.3 Selecting the Company Name
Section 6 of the Act provides as follows:
The name of every company;
(a) limited company other than a listed company, shall end in the word "Limited"
or by the abbreviation "Ltd" ;
(b) private company, shall end in the words "(Private) Limited" or by the
abbreviation "(Pvt) Ltd" ;
(c) limited company which is a listed company, shall end in the words "Public
Limited Company" or by the abbreviation "PLC".
Section 7 of the Companies Act provides that;
(a) A company shall not be registered by a name which is identical with the
name of any other company or of any registered overseas company ;
(b) A company shall not be registered by a name which contains the words
"Chamber of Commerce", unless the company is a company which is to be
registered under a licence granted under section 34 without the addition
of the word "Limited" to its name ; or
(c) A company shall not be registered by a name which is in the opinion of
the registrar.
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A Company has a right to prevent its name being used by another Company. Where
the name of a company is identical or can be calculated to deceive third parties the
Registrar has the discretion to prohibit registration of such names. Moreover, even
Courts can intervene in these instances as in the cases of Ouvah Ceylon Estates v. Uva
Rubber Estates, Ceylon Insurance Co Ltd. v. United Ceylon Insurance Co Ltd and British
Diabetic Association v. Diabetic Society Ltd.
3 Promoters
Promoters have a specific role in relation to the establishment and development of

a company and the company’s affairs. This chapter addresses some key aspects of a
“promoter” in relation to the Companies Act.
3.1 Who is a Promoter?
Case Law: Definition of a Promoter
A promoter was defined as ‘one who undertakes to form a company with

reference to a given project, and set it going, and who undertakes the necessary
steps to accomplish that purpose’.
Twycross v Grant (1877)
Section 41 (6) of the Companies Act which deals with the provisions relating to the
civil liability borne by persons responsible for untrue statements contained in a
company prospectus, states that for the purposes of the said section “A "promoter"
means a promoter who was a party to the preparation of the prospectus or of the
portion thereof containing the untrue statement, but does not include any person by
reason of his acting in a professional capacity for persons engaged in procuring the
formation of the company.”
Hence A promoter typically is responsible for raising capital, targeting initial leads
and chasing initial business opportunities, entering into the initial contracts for the
formation of the business and incorporating the company.
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3.2 Duties of a Promoter
 A promoter must not make any secret profit out of the promotion of the
company. A secret profit is made by entering into a transaction on a promoter’s
own behalf and then selling the concerned property to the company at a profit,
without making disclosure of the profit to the company or its members. The
promoter can make profits in his dealings with the company, provided the
promoter discloses these profits to the company and its members.
What is not permitted is making secret profits i.e. making profits, without
disclosing them to the company and its members.
 A promoter must make full disclosure to the company of all relevant facts,
including any profit made by the promoter in transactions with the company.
In case the promoter fails to disclose the profits, made by him in the course of
promotion or he knowingly makes a false statement in the prospectus, whereby the
person relying on that statement, makes a loss, he will be liable to make good the
loss, suffered by that other person.
The promoter is also liable for untrue statements, made in the prospectus. A person,
who subscribes for any shares or debenture in the company on the faith of the
untrue statement contained in the prospectus, can sue the promoter for the loss or
damages, sustained by him as the result of such untrue statement.
3.3 Payment of Promotion Costs and for Services
In general, a promoter is not entitled to be reimbursed for the costs the promoter
has incurred in forming the company or to recover a payment for the services
rendered in forming that company in the absence of an express agreement to the
contrary.
Therefore the following methods are being used to reimburse a promoter for the
costs incurred by him and for the services rendered.
a) Payments clause is included in the Articles of the company permitting the

payments to a promoter for costs and services rendered by him. However, the
promoters have no right to compel the company to effect such payment.
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b) The promoters are given the option to buy a specified number of shares from
the company at the nominal value within an agreed period of time. If after the
formation of the company, the share prices of the company increases, the
promoter can exercise his option and purchase such number of shares at the
nominal value, thereby making a profit which will set off his expenses relating
to the promotion of the company.
c) The promoters may be allowed to make a profit by entering in to transactions

with the Company and thereby cover the promotional cost incurred by such
promoter, but in such event a proper disclosure of the profits is an essential
requirement.
4 Articles of Association
In terms of the new Companies Act, the sole constitutional document of a company
is its Articles, as the requirement for a Memorandum of Association is dispensed
with by the Act. Under the previous Act, the companies were required to have a
Memorandum of Association and Articles of Association.
4.1 Content of the Articles of Association
The Articles of Association of a company refer to a document that specifies the

regulations for a company's operations. The Articles of Association often constitute
the constitution of a company and defines the company's purpose and lays out how
tasks are to be accomplished within the organization, including for example the
process for appointing directors and how financial records will be handled.
CA Sri Lanka 31
Section 13 of the Companies Act sets out the following:
The Articles of Association of a company may provide for any matter not
inconsistent with the provisions of this Act other than the First Schedule hereto,
and in particular may provide for:
(a) the objects of the company ;
(b) the rights and obligations of shareholders of the company ; and
(c) the management and administration of the company.
Section 14 of the Companies Act states that:
The Articles of Association set out in the First Schedule hereto (hereinafter referred to
as "model articles") shall apply in respect of any company other than a company
limited by guarantee, except to the extent that the company adopts Articles which
exclude, modify or are inconsistent with the model articles.
Thereby, the new Companies Act has made easier the formation of a company by
allowing it to adopt model Articles of Association as set out in the First Schedule to
the Act. However, promoters generally prefer to incorporate specific rights and
duties in the Articles of Association.
4.2 The ultra vires Doctrine
The new Act dispenses with the ultra vires rule. The ultra vires rule prevented
companies from entering in to contracts outside the objects or exceed the powers
which were specified in the memorandum.
In terms of the doctrine of ultra vires, a company was prohibited to engage in any
business which was not of those as set out as the business that the company was
formed for. The objectives of the company were set out in the Memorandum and
any act which was outside such objectives was held to be ultra vires, hence void.
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Case Law: directors acting beyond their powers was considered ultra vires
The Plaintiff company was formed with the objective ‘to make and sell, or lend on
hire, railway-carriages…’. The company entered into a contract with Riche who
would construct the railway. The contract was ratified by all the company’s
members. The company later terminated the contract and Riche sued the
company for its breach. The House of Lords held that the directors have acted
beyond their powers in the companies’ Articles and was therefore ultra vires. It
was decided that a company cannot act outside the objects in its Memorandum of
association even if all its members had subsequently ratified such action.
Ashbury Railway Carriage and Iron Co. Ltd v Riche (1875)
This position was detrimental to the investors, because if any contract entered into
by the company was found to be outside its scope of objectives, the innocent parties
had no remedy under the law.
Section 2(2) of the Companies Act states that,
A company shall have, both within and outside Sri Lanka,
(a) subject to the provisions of section 13 of the Act, the capacity to carry on or
undertake any business or activity, do any act or enter into any transaction ; and
(b) subject to the provisions of any written law of Sri Lanka or of any other country,
all the rights, powers and privileges necessary for the purposes of paragraph (a)
In terms of Section 13, the new Companies Act has granted the freedom to
companies to carry out any business activity without being restricted to its object
clause. The new Companies Act has in fact dispensed with the requirement of the
objects clause altogether, but a company may set out its objects in the Articles at its
discretion. However Section 17(2) specifically states that capacity and powers of
the company shall not be affected by such a restriction.
CA Sri Lanka 33
Section 17 of the Companies Act provides that,
(1) Where the Articles of a company sets-out the objects of the company, there shall
be deemed to be a restriction placed by the Articles in carrying on any business
or activity that is not within those objects, unless the articles expressly provide
otherwise.
(2) Where the Articles of a company provide for any restriction on the business or
activities in which the company may engage:
(a) the capacity and powers of the company shall not be affected by such
restriction ; and
(b) no act of the company, no contract or other obligation entered into by the
company and no transfer of property by or to the company, shall be invalid
by reason only of the fact that it was done in contravention of such
restriction.
(3) Nothing in subsection (2) shall affect:
(a) the ability of a shareholder or director of the company to make an

application to court under section 233 to restrain the company from acting
in a manner inconsistent with a restriction placed by the Articles, unless the
company has entered into a contract or other binding obligation to do so; or
(b) the liability of a director of the company for acting in breach of the
provisions of section 188.
4.3 The Legal Effect of Articles
As discussed previously, section 16 of the Companies Act mentioned as follows:
Subject to the provisions of section 89 the Articles of a company shall bind the
company and its shareholders as if there were a contract between the company and
its shareholders. In particular, all money payable by any shareholder to the
company under the Articles, shall be a debt due from that shareholder to the
company.
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5 Company Contracts
A company is a juristic person, hence may enter in to contracts which will bind the
company. There are two main categories of company contracts.
(a) Pre-Incorporation Contract (Before incorporation)
(b) Company Contract (After incorporation)
5.1 Pre-Incorporation Contracts
A pre- incorporation contract is a contract entered into for and on behalf of the
company before it is formally incorporated. These types of contracts are used
where the promoters have to obtain properties or secure other rights and
obligations as a pre requisite to the incorporation of the company.
Examples of Pre incorporation Contracts:
 Agreements to acquire property
 Franchising or distributorship agreements
Under the law as it existed prior to the new Companies Act, pre incorporation
contracts were not recognised and hence had no legal effect.
Case Law: company cannot ratify a pre-incorporation contract

The promoters of a hotel company entered into a contract on its behalf for the
purchase of wine. When the company formally came into existence it ratified the
contract. The wine was consumed but before payment was made the company
went into liquidation. The promoters, as agents, were sued on the contract. They
argued that liability under the contract had passed, by ratification, to the
company. It was held, however, that as the company did not exist at the time of
the agreement the contract would be wholly inoperative unless it was binding on
the promoters personally and a stranger cannot by subsequent ratification
relieve them from that responsibility.
Kelner v Baxter [1866] L.R.2 CP 174
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The new Companies act however not only to recognizes pre incorporation
contracts, but it regulates the process by making it a legal requirement to ratify a
pre incorporation contract within a reasonable time after the incorporation of the
company.
In terms of Section 24 of the Act, where a person enters into a pre incorporation
contract for and on behalf of a company, that person is deemed to give an implied
warranty that,
(a) the company will be incorporated within such period as may be specified in the
contract, or if no period is specified, within a reasonable time after the making of
the contract; and
(b) that the company will ratify the contract within such period as may be specified
in the contract or if no period is specified, within a reasonable time after the
incorporation of such company.
5.2 Company Contracts
Section 19 of the Companies Act sets out the formalities that a company must
observe when entering in to a contract. In terms of Section 19(1), the legal
requirements applicable for contracts that are entered in to by natural persons are
applicable to company contracts with the necessary modifications. Accordingly, an
obligation which, if entered into by a natural person is required by law to be in
writing signed by that person and be notarially attested, such an obligation may be
entered into on behalf of the company in writing signed under the name of the
company by two directors of the company, or where there is only one director, by
that director, or if the articles of the company so provide, by any other person or
class of persons or one or more attorneys appointed by the company, and be
notarially executed. Where an obligation is required by law to be in writing and
signed by the person entering in to it, a person acting under the company's express
or implied authority may sign on behalf of the company and enter in to such
obligation.
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5.3 Authority of Directors, Officers and Agents to Enter into

Contracts
In terms of Section 21 of the Companies Act, a company or a guarantor of an

obligation of the company or any person claiming under the company, cannot assert
that the Articles of the company have not been complied with against any person
who has dealt with it or acquired rights from it. They also cannot assert that the
persons named in the most recent notice filed under section 223 or the annual
return delivered under section 131 are not the directors or the secretary of the
company. Further, where a company holds out a person as a director, officer or
agent of the company, it cannot assert that such person has not been duly appointed
or does not have authority to exercise the powers and perform the duties that are
customary in the business of the company or are normal for a director, officer or
agent of a company carrying on business of the kind carried on by that company. A
company also cannot assert that a document issued by any director, the secretary
of the company or by any officer or agent, with actual or normal authority to issue
such document, is not valid or genuine.
However it must be noted that these protections are not available to a person who
had knowledge or, should have had knowledge to the contrary by virtue of their
position with or in relation to the company,
Indoor Management Rule
Under the common law, a person acting in good faith and without knowledge of any
irregularity who is dealing with a corporation need not inquire about the formality
of the internal proceedings of the corporation, but is entitled to assume that there
has been compliance with the Articles and bylaws.
This principle, known as the 'Indoor Management Rule', was authoritatively laid
down in the 19th century case of Royal British Bank v Turquand where it was held
that,
"a person dealing with a corporation has no obligation to ensure that a corporation
has gone through any procedures required by its articles, by-laws, resolutions,
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contracts, or policies to authorize a transaction or to give authority to a person

purporting to act on behalf of the corporation."
Constructive notice is a legal concept that signifies that a person or entity should
have known, or as a reasonable person would have known that fact, even if they
have no actual knowledge of it.
The Companies Act has specifically dispensed the concept of constructive notice in
terms of section 22 where it states that a person will not be affected by or deemed
to have notice or acknowledge of the contents of the Articles or the company’s
documents merely because it is delivered to the Registrar for filing or that it is
available at the company office for the inspection.
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 There are three main types of companies recognized under the Companies Act. i.e.,
CHAPTER ROUNDUP
limited companies, unlimited companies and companies limited by guarantee.
 Limited liability companies are the most commonly used method of business
incorporation. A limited company is a business that is owned by its shareholders,
run by directors and most importantly whose liability is limited.
 When a limited company opts to list on the stock exchange, it is referred to as Public
Limited Company (PLC).
 Private Limited Companies are the companies which have a limited number of
shareholders or are closely held by members of a family or group.
 Unlimited companies are the companies where shareholders are unlimitedly liable
to contribute to the company where the company failing to pay its debts.
 Companies limited by guarantee do not issue shares but the members are bound by
the articles of the company to contribute in an amount specified in therein, if the
company was put into liquidation.
 Any person or persons may apply to incorporate a company, other than a company
limited by guarantee, by making an application to the Registrar in the prescribed
form signed by each of the initial shareholders, together with the specified
documents in terms of Section 4 of the Companies Act.
 A Company has a right to prevent its name being used by another company. Where
the name of a company is identical or can be misunderstood by a 3 rd Party, the
courts may intervene.
 A "promoter" means a person who undertakes to form a company and who

undertakes the necessary steps to accomplish that purpose.
 In terms of the new Companies Act the sole constitutional document of a company
is its Articles of Association.
 There are two main categories of Company Contracts – Pre-Incorporation Contract

and Company Contracts.
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 A pre incorporation contract is a contract entered into for and on behalf of the
company before it is formally incorporated.
 The indoor management rule provides that a person acting in good faith and
without knowledge of any irregularity who is dealing with a corporation need not
inquire about the formality of the internal proceedings of the corporation, but is
entitled to assume that there has been compliance with the Articles and bylaws.
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PROGRESS TEST
1 Mrs. Cooray is seeking to formalise her catering business which currently functions
as a sole proprietorship. She seeks to convert the business into a company which
will have only her close family members as the only shareholders so as to ensure
that the control of the company does not pass down to unknown persons. She also
requires that the investments made by the shareholders will be safeguarded as
much as possible. She seeks your advice with regard to the following ;
a) Identify as to what are the types of companies that can be incorporated and
explain as to what are the key features of each type of company.
b) Differentiate as to what type of company would be most suited to Mrs.

Cooray’s requirements.
2 “The Articles of Association forms the sole constitutional document of a company

under the new Companies Act. Therefore it must be ensured that the business of a
specific company must be conducted strictly for the objects as set out in the Articles of
Association.”
Do you agree with this statement?
Discuss reasons for conclusion.
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1 a) The main categories of companies are as follows ;

i) Limited companies
ii) Unlimited companies
iii) Companies limited by guarantee
Limited companies
Companies in which the shareholders liability is limited to the value of the

shares owned by the relevant shareholder. This type of company provides
the most safeguards to potential investors.
There are two types of limited companies, namely Private Limited Liability
Companies; and Public Limited Liability Companies.
Private Limited Liability Companies
Limited companies where the number of shareholders is limited to a

maximum of fifty and where the company shares cannot be traded on the
stock exchange. A company of this nature must carry with the words
“Pvt/Private” and “Ltd/Limited” within its title.
Public Limited Liability Companies
Limited companies which are listed on the stock exchange, the shares of
which can be traded by the public. Considerable regulation is in place in
relation to these types of companies. A company of this nature must carry
with it the words “Public Limited/PLC” within its title.
Unlimited companies
Companies in which the shareholders have unlimited liability in relation to

the debt of the company.
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Companies limited by guarantee
Companies which do not issue shares but wherein members are bound by the
Articles of the company to contribute in an amount specified therein if the
company is liquidated.
b) Given Mrs. Cooray’s requirements for safeguarded investments and limited

shareholders, the most suited model for Mrs. Cooray will be a Private Limited
Liability Company.
The limited liability borne by shareholders in a Private Limited Liability Company

will safeguard the investments made by the shareholders.
In addition to that the limited number of shareholders capable of being included in
a Private Limited Liability Company will ensure that the ownership can be
confined to a family or a close group of individuals.
Furthermore, Private Limited Liability Companies have less regulatory

requirements and therefore suit start-up companies such as Mrs. Cooray’s
business better than the other models.
2 The new Companies Act established that it is only the Articles of Association that
are required to be filed by a company. Under the previous legal regime a
Memorandum of Association was also required, but this requirement has been
dispensed with. Therefore it can be agreed that the Articles of Association
constitute the only constitutional document of a company under the new
Companies Act.
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However the doctrine of ultra vires is no longer recognised under the new
Companies Act and therefore companies under the new regime will not be bound
by the objects clause of the Articles of Association as it would have been under the
previous regime. Therefore a company will no longer be strictly restricted to the
objectives contained in the constitutional documents of the company.
(Note: the doctrine of ultra vires will be required to be discussed)
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03
CHAPTER
Equity and Debt
Capital
INTRODUCTION
In this Chapter we will discuss the ways in which companies raise their
capital, inxc volvement of shares and granting of dividends.
Knowledge Component
Equity and Debt Capital
3.1 Types of shares, allotment 3.1.1 Analyse types of shares, with reference to stated capital regime,
and issue of shares classification, risk, variation of class rights, dividends, voting rights,
priority in a winding up.
3.1.2 Compare and contrast the procedures for the issue of shares (including
“issues at a premium or at a discount”).
3.2 Dividends 3.2.1 Explain the procedure for payment of dividends including that of a listed
company.
3.2.2 Explain the importance of “solvency test” and capital maintenance
mechanisms.
3.3 Major types of share 3.3.1 Analyse the following principles in relation to capital maintenance in a
dealings in a company company (redemption, reduction of capital, financial assistance, share buy-
back, minority buy-out).
3.4 Debt capital 3.4.1 Analyse the following principles in relation to long-term debt capital
(classification, risk, interest payments, rights, priority in a winding up).
3.5 Rights of shareholders and 3.5.1 Compare and contrast rights available for shareholders and debenture
debenture holders holders.
3.5.2 Outline the principles relating to “majority rule” and “minority protection”
(including “Oppression, Mismanagement and derivative action and Major
Transactions”) (s.185 of the Companies Act).
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KB3 | Chapter 3: Equity and Debt Capital
LEARNING
1 Shares 3.1.1,3.1.2
2 Dividends 3.2.1,3.2.2
3 Major types of share dealings in a company 3.3.1
4 Corporate capital 3.4.1
5 Rights of shareholders and debenture holders 3.5.1,3.5.2
1 Shares
A company divides its ownership into shares, which are offered for sale to raise
capital, termed as issuing shares. Thus, a share is an indivisible unit of capital,
expressing the ownership relationship between the company and the shareholder.
1.1 Nature of Shares
Shares are noted to possess the following characteristics by section 49 of the

Companies Act which reads as follows:
(1) A share in a company shall be movable property.
(2) Subject to the company's articles, a share in a company shall confer on the
holder:
(a) the right to one vote on a poll at a meeting of the company on any resolution;
(b) the right to an equal share in dividends paid by the company;
(c) the right to an equal share in the distribution of the surplus assets of the
company on liquidation.
(3) A company may issue different classes of shares, and in particular it may
issue shares which are:
(a) redeemable;
(b) confer preferential rights to distributions; or
(c) confer special, limited or conditional voting rights or confer no voting rights.
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A share in a company is transferable in the manner provided for by the Articles of

that company and such Articles may limit or restrict the extent to which a share is
transferable.
A company may alter its Articles to empower itself to issue preference shares since
there is no implied condition that all shares should be equal. When the terms of
issue specify particular rights that will apply as special conditions, they are prima
facie a definition of the whole of the rights in that respect and they negate any
further or other right.
1.2 Types of Shares
There can be different classes of shares in a company.
1.2.1 Ordinary Shares
The basic form of shares is ordinary shares. Most companies have just ordinary
shares. Ordinary shares vest the owner with one vote per share; entitlement to
participate equally in dividends; and if the company is wound up, share in the
proceeds of the company's assets after all the debts have been paid. Holders of
ordinary shares have a right to unrestricted participation in the dividends of the
company and to the distribution of its remaining property. The risk is that holders
of ordinary shares will be entitled to dividends only if the company makes profits.
1.2.2 Preference Shares
In terms of Section 49(3)(b) of the Companies Act, a Company can issue shares
having a ranking above ordinary shares in specified aspects. Preference
shareholders have a priority to a fixed dividend and to a return of capital in a
winding up. These usually confer rights to preferential dividends which may be
cumulative or non-cumulative. The general rule is that shares rank equally, the
terms relating to preference shares have to be clearly stated at the time of issue.
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1.2.3 Deferred Shares
These shares are issued with limited rights. In a modern world company the
tendency is not to issue deferred shares. The fact that the deferred shares have no
rights to dividends during a particular period does not mean they are not ordinary
share capital. Deferred shares are often created for commercial reasons, to enable
private investors to take capital growth instead of dividend income. They are
generally issued to founders or directors of the company. These shares receive no
rights to a company's remaining assets in the event of bankruptcy until all common
and preferred shareholders have been paid.
1.2.4 Non-voting Shares
In terms of Section 49(3)(c), companies may issues shares which do not carry
voting rights at all or which carry limited rights of voting in specified situations as
set out in the Articles of Association. These shares are only issued by a public listed
company. Such shares are usually issued for the purposes of retaining control with
the promoters. For example, there could be situations where the law prohibits
foreign control of certain types of companies.
1.2.5 Redeemable Shares
Redeemable shares are created on the understanding that they will be bought back
by the company. They redemption may be at the option of the company or the
shareholder, or on a fixed date or upon the occurrence of an event. The price at
which the shares must be redeemed may also be specified either on the basis of a
predetermined price or a formula.
1.3 Issue of Shares
A company may raise capital through the issue of securities, i.e. shares and
debentures. Debentures are considered as loans obtained by a company while the
shares constitute the capital of the company. Where an invitation is made to the
public, the law requires that the persons to whom such invitations are directed
should be given all material information relating to the company, in order to make
informed investment decisions.
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Therefore, a document containing all information is given to interested parties.

Such a document is called a “prospectus”. A prospectus is taken to mean any
prospectus, notice, circular, advertisement, or other invitation, offering to the
public for subscription to or purchase of any shares or debentures of a company,
and includes any such notice, circular, advertisement, or other invitation,
notwithstanding that it may contain on the face thereof, that it is not a prospectus
or offer of shares to the public.
In terms of Section 37(3), it is illegal to issue applications for subscriptions without

a prospectus, and every prospectus should be delivered to the Registrar for
registration. However a prospectus is not required where an application is issued
with the bona fide invitation to underwrite an issue or the offer is not made to the
public or where it is made in relation to a commercial paper by a company listed in
the stock exchange or where it is issued to existing shareholders.
The prospectus must contain information and reports specified in Parts I and II of
Schedule 4 of the Companies Act subject to the Part III of the same Schedule. These
provisions ensure that a prospectus contains all the required information and is
delivered to the investors before making a decision.
After the prospectus is issued, a company may place a “tombstone notice” that the
prospectus has been registered and that it is available on application. The
tombstone notice shall not carry any invitations for subscriptions.
In addition to these requirements, Public Limited Companies shall comply with the
listing rules of the Colombo Stock Exchange.
If a prospectus contains untrue statements, it may result in the company and the
officers who were responsible for the issue of such prospectus incurring Civil
liabilities, and Criminal liabilities in terms of section 41 and 42 of the Companies
Act.
A company cannot make an allotment of shares in any initial public offering unless
the minimum amount of funds, which is in the opinion of the directors is required
for achieving the objects of the offer and the expenses of the offer have been
subscribed for and the sums are received by the company.
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It is noted that section 50 of the Companies Act provides that,
(1) Immediately following the incorporation of a company under section 5, the

company shall issue to each shareholder named in the application for
incorporation, the shares to which that person is entitled.
(2) Immediately following the issue of a certificate of amalgamation under section,

244, the amalgamated company shall issue to each person who is entitled to shares
under the amalgamation proposal, the shares to which that person is entitled.
Furthermore, section 51 of the Companies Act states:
(1) Subject to the provisions of section 52 and 53 and the company’s Articles, the
board of a company may issue such shares to such person as it considers
appropriate.
(2) If the shares issued confer rights other than those set out in subsection (2) of
section 49 or impose any obligation on the holder, the board shall approve the term
of issue which will set out the rights and obligations attached to those shares.
(3) Terms of issue approved by the board under subsection (2)
(a) shall be consistent with the articles of the company, and to the extent that
they are not so consistent, are invalid and of no effect;
(b) are deemed to form part of the articles, and may be amended in accordance
with section 15.
(4) Within twenty (20)working days of the issue of any shares under this section,
(a) the company shall give notice to the Registrar in the prescribed form of
(i) the number of shares issued
(ii) the amount of the consideration for which the shares have been
issued or its value as determined by the board under subsection (2) of
section 58; and
(iii) the amount of the company’s stated capital following the issue of the
shares;
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(b) the company shall deliver to the Registrar a copy of any terms of issue
approved under subsection (2).
It is noted that section 54 of the Companies Act states that,
(i) A share is deemed to be issued when the name of the holder is entered on the
share register, and such entry shall be made prior to compliance with subsection
(4) of section 51.
(ii) The issue by a company of a share which imposes a liability to the company on
the holder shall be invalid and of no effect, until such time as the person to whom it
is issued has consented in writing to become the holder of the share.
1.4 Pre-emptive Rights to New Issues
Section 53 of the Companies Act states that,
(1) Subject to the company's articles, where a company issues shares which rank
equally with or above existing shares in relation to voting or distribution rights,
those shares shall be offered to the holders of existing shares in a manner which
would, if the offer was accepted, maintain the relative voting and distribution rights
of those shareholders.
(2) An offer which a company is required to make under subsection (1), shall
remain open for acceptance for a reasonable period of time.
This amounts to a privilege extended to select shareholders of a corporation that

will give them the right to purchase additional shares in the company before the
general public has the opportunity in the event if there is a seasoned offering. A
pre-emptive right is written in the contract between the purchaser and the
company, but does not function like a put option. It is also known as "pre-emptive
rights".
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2 Dividends
A benefit that a shareholder derives from owning shares in a company is that the
shareholder is entitled to a benefit from the profits that are derived from that
company. This benefit is commonly allocated in the form of a dividend and therefore
amounts to being an important component of the operation of a company.
2.1 What is a Dividend?
Section 60(1) states that a dividend is a distribution out of profits of the company,
other than an acquisition by the company of its own shares or a redemption of
shares by the company.
A dividend is the benefit that the shareholders get in return for their investment in
the company. Any distribution made by the company may be termed as a 'dividend'
if it fits the description of a dividend as specified in Section 60(1). The board has
discretion in issuing dividends. But where dividends have been unreasonably
restricted, the court may intervene. The shareholders of a same class are entitled to
equal treatment.
It is noted that a company is only allowed to declare a dividend in favour of its

shareholders if the company meets the “solvency test”.
2.2 Solvency Test
Section 57 of the Companies Act provides that a company shall be deemed to have
satisfied the solvency test, if:
(1) (a) it is able to pay its debts as they become due in the normal course of
business; and
(b) the value of the company's assets is greater than ,
(i) the value of its liabilities
(ii) the company's stated capital.
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(2) In determining whether a company satisfies the solvency test, the board:
(a) shall take into account the most recent financial statements of the company
prepared in accordance with the section 151 of the Act .
(b) shall take into account circumstances the directors know or ought to know
which affect the value of the company's assets and liabilities ,
(c) may take into account a fair valuation or other method of assessing the value
of assets and liabilities.
The solvency test as applied under New Zealand and Canada from where the new
Companies Act adopted most of its principles, requires that the company should be
able pay its debts as they became due in the ordinary course of business (known as
the liquidity test) and that the assets of the company are greater than its liabilities.
But in terms of Section 57(1)(b)(ii), the assets of the company’s assets must be
greater than the stated capital. This is a unique provision which has integrated the
principle known as the “Capital Maintenance Rule” in the solvency test. Hence to
issue a dividend under the Companies Act, a company requires not only an earning
surplus, but also assets in excess of its stated capital.
3 Major Types of Share Dealings in a Company
Dealings in relation to the shareholding in a company are closely monitored and

regulated by the Companies Act as the shareholding essentially constitutes the
ownership of a company. These transactions therefore merit attention.
3.1 Redemption of Shares
The Companies Act permits companies to redeem their shares. There are three
types of redemptions recognized under the Act.
 Redemption by the company at its own option
The redemption by the company at its own option is considered as different

to the other two forms of redemptions. It is because the directors may misuse
the option for their own benefit. Hence before such redemption is made, the
board must resolve that the redemption is in the best interest of the company.
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A redemption of a share at the option of the company is deemed to be an

acquisition by the company of the share, for the purposes of subsection (3) of
section 64 and a distribution for the purposes of section 56.
 Redemption at the option of the holder of the shares
Where a share is redeemable at the option of the holder of the share and the
holder gives proper notice to the company requiring the company to redeem
the share, such redemption will take place on the date specified in the notice
or if no date is specified, on the date of receipt of the notice.
 Redemption on a date fixed in the Articles
In terms of Section 69 of the Companies Act, where a share is redeemable on

a specified date as set out in the Articles, the company shall redeem the share
on that date.
Under redemption at the option of the holder of the shares and redemption on
a date fixed in the Articles, the share is deemed to be cancelled on that date.
From that date, the former shareholder ranks as an unsecured creditor of the
company for the sum payable on redemption. It must be noted that their rights
are not equal to the other creditors of the company.
3.2 Reduction of Capital
A company may by special resolution, reduce its stated capital to an amount it

thinks appropriate in compliance with the provisions of the Act. In order to assure
that persons dealing with the company are aware of such a decision, the companies
are required under Section 59 to give public notice of such reduction of stated
capital at least sixty days prior to such a resolution being passed. However, where
a company has agreed to obtain its creditors’ consent or fulfil some specific
condition, a resolution passed without such consent or fulfilling such condition shall
be invalid and of no effect.
Where a company is obliged to redeem shares on a fixed date or upon the exercise
of an option by the shareholders, or it is compelled to purchase its own share under
the minority buy out provisions, sometimes it may not have adequate profits or
reserves out of which the redemption or buy back may be affected. In such
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situations the Act empowers the board to obtain a certificate of solvency from the
auditors and to resolve to reduce the stated capital of the company by the amount
by which the company would fail to satisfy the solvency test. Such resolution shall
have the effect notwithstanding other provisions relating to the reduction of stated
capital specified in Section 59. A reduction of stated capital with the amount of
reduction and the amount of reduced stated capital must be communicated to the
Registrar within ten days of such reduction.
3.3 Financial Assistance for Purchase of Own Shares
In general, law has prohibited granting financial assistance to purchase its own
shares, unless lending money is an ordinary business of the company. This rule is
based on two main reasons. One is that if the company failed and its money has been
spent on funding purchase of its own shares, the company will be severely affected.
Secondly, financial assistance to purchase its own shares could be abused by the
directors of the company for their own benefit.
However, the Companies Act has permitted a company to fund purchase of its own
shares where,
i. giving such assistance is in the interest of the company;
ii. the terms and conditions on which the assistance is given are fair and
reasonable to the company and to any shareholders not receiving that
assistance; and
iii. immediately after giving the assistance, the company will satisfy the
solvency test.
Furthermore funding has been recognised under a distribution to a shareholder

approved under section 56; the issue of shares by the company; a repurchase or
redemption of shares by the company; anything done in terms of a compromise
reached under the provisions of Part IX or a compromise or arrangement approved
under the provisions of Part X; the lending of money by a company in the ordinary
course of business, where the ordinary business of the company includes the
lending of money; the provision by a company in good faith in the interest of the
company, of financial assistance for the purposes of an employees' share scheme;
CA Sri Lanka 55
the granting of loans by a company to its employees other than directors in good
faith in the interest of the company, with a view to enabling those persons to acquire
beneficial ownership of shares in the company.
3.4 Minority Buy-Out
The decisions of a company are taken by a majority of the shareholders. Where a

shareholder votes against a major transaction or amalgamation or altering the
Articles of the company to impose or remove restrictions on the business, but the
company approves the decision by majority, such shareholder is given the right to
require the company to purchase his shares. Where a shareholder wishes to
exercise this right, he shall give prior written notice to the company within ten days
of the passing the resolution. However, the company may make an application to
court for an exemption of this obligation to buy-out shares. The court has the power
to make order as it thinks fit, including exempting the company from purchasing
shares, setting aside the resolution passed by the company, granting compensation
to affected shareholders or even winding up of the company.
4 Corporate Capital
As already discussed, equity capital constitutes a major component of a company’s

financial asset. However debt capital is also vested with a pivotal role in the
financial stability of a company.
4.1 Debt Capital
Debt capital is money raised for a company that must be repaid over a period of
time with interest. Debt financing can be either short-term or long-term. Unsecured
debt is rare and lenders typically secure debt with the assets of the company. This
also means that service, technology, and other asset-light companies have a hard
time raising debt capital.
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Common debt financers include banks, credit unions, finance companies, and credit
card companies.
4.1.1 Advantages of Debt Capital
(a) Raising debt capital, for profitable asset intensive companies, can be faster
than raising equity capital.
(b) Debt capital is typically cheaper than equity capital because the financing
companies pick only the lowest credit risk companies and further secure their
loan with assets.
(c) The lender does not gain an ownership interest in the business and this allows
the business owner to remain in the driver’s seat of the company without
being answerable to investors.
4.1.2 Disadvantages of debt capital
(a) The loan amount and the interest payments can saddle the balance sheet and
income statement of the company.
(b) Any downturn in the business or unexpected capital needs can make it difficult
to make the interest payments and send the company into a debt induced
downward spiral.
(c) For some debt instruments, the terms can be complex and may onerously
burden the business.
(d) If the debt is personally guaranteed, liability will extend to non-business assets.
(e) If the company gets into trouble, the debt financier could become adversarial.
4.2 Equity Capital
Equity capital is money raised by a business in exchange for a share of ownership

in the company. Equity financing allows a business to obtain funds without
incurring debt and without having the burden of associated interest/principal
payments.
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For a growing company with cash needs and for companies with an erratic earnings
stream, it can be a big advantage to not have to repay a specific amount of money at
a particular time.
4.2.1 Advantage of Equity Capital
(a) Lack of recurring principle/interest payments makes the business better able
to cope with the ebb and flow of the business and increases the margin of safety.
(b) Corporation’s risk is shared with investors.
(c) The correct investors can add significant value.
(d) Smooth transition option for business owners looking to ease out of the
business.
(e) May be the only possible type of capital for rapidly growing and asset-light
companies.
(f) Equity investor is committed to the company until exit. If the company gets into
trouble, the equity investor is likely to help with the turn around.
4.2.2 Disadvantages of Equity Capital
(a) Owners are answerable to investors and some loss of control.
(b) Can be more expensive than debt capital (albeit at a lower risk).
(c) It typically takes longer to raise equity capital than debt capital.
(d) Deal terms can be complex. Without good counseling, the company may
unknowingly allow the investor to undervalue the company and take a
disproportionately higher percentage of the company compared to the value of
the investment made.
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5 Rights of Shareholders and Debenture Holders
Shareholders and debenture holders possess pivotal roles in relation to the

ownership and continuity of a corporate body. However the rights associated with
each party constitute equal importance in maintaining the continued relationship
between those parties and the company.
5.1 Shareholders vs. Debenture-holders
Shareholders are those who are subscribed to the shares of the company. Shares
are the parts which form the equity capital and in turn, the shareholders are the
owners of the company. Shareholders are invited to attend the annual general
meeting of the company and they have the right to vote. Shareholders are paid
dividends on their holdings, when there are sufficient profits made by the company.
The dividend rates are not fixed, and it is uncertain. Further, the shares are not
secured investments. In case of the winding up of the company, shareholders’ funds
are refunded after every claim is settled. Share capital is not returned except in case
of redeemable preference shares.
On the other hand, debenture-holders are the subscribers to debentures.

Debentures are essentially part of a loan. Debenture-holders are the creditors of the
company, hence they are paid interest on debentures held by them. The interest on
debentures is paid on pre-determined fixed rates. Debenture-holders are not
invited for annual general meetings, unless any decision affecting their interest is
taken, and have no right to vote. Debentures are however normally secured and will
be repaid by the company. Debenture-holders have a priority of the refund of their
loan prior to shareholders.
5.2 Shareholder Remedies
Generally, the companies take decisions by majority rule. The shareholders are free
to vote for their own interest while directors have a duty to act in the best interest
of the company. As a result, minority shareholders are often left helpless. The
Companies Act has strengthened the minority shareholder rights by introducing
new safeguards.
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5.2.1 Oppression and Mismanagement
In terms of the section 224 of the Companies Act, subject to section 226, any
shareholder or shareholders of a company who has a complaint against the
company that the affairs of such company are being conducted in a manner
oppressive may make an application to the court for relief.
Section 225 describes that subject to the provision of section 226 any shareholder
or shareholders of the company who have complains that the affairs of the company
are being conducted in a manner prejudicial to the interests of the company or that
a material change has taken place in the management or control of the company,
may make an application to the court under the provisions of Section 225. If the
court is of the opinion that the affairs of the company are being conducted in a
manner oppressive to any shareholder or shareholders as previously set out, the
court may, with a view to remedying the matters complained of, make such order
as it thinks fit. Pending the making of a final order, the court may on the application
of a party to the proceedings make an interim order which it thinks fit if necessary.
According to Section 226 An application under section 224 and section 225 may
only be made by a shareholder or shareholders who at any time during the six
months prior to the making of the application constituted not less than 5% of the
total number of shareholders or held shares which together carried not less than
5% of the voting rights at a general meeting of the company.
5.2.2 Derivative Actions
The right to a derivative action is originally developed as an exception to the rule

laid down in Foss v. Harbottle, in which it was held that proper party to bring actions
for wrongs committed against a company was no one but the company itself. This
rule was severely detrimental to the rights of the minority shareholders as where
the majority shareholders who are in control of the company fail or ignore to act in
the best interest of the company, the minority shareholders became helpless.
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The principle underling the derivative action is that since a company has a duty to
act in the best interest of its shareholders, a shareholder has a right to file suit acting
on behalf of the company when the directors and management are failing to act for
the benefit of the company and all of its shareholders. A derivative action often
arises in cases of fraud, mismanagement, self-dealing and/or dishonesty which are
being ignored by officers and the board of directors of a corporation.
The Companies Act recognizes derivative actions under section 234. Accordingly,
the court may, on the application of a shareholder or director of a company, grant
leave to that shareholder or director to:
(a) bring proceedings in the name and on behalf of the company or any subsidiary
of that company; or
(b) intervene in proceedings to which the company or any subsidiary is a party, for
the purpose of continuing, defending, or discontinuing the proceedings on behalf of
the company or subsidiary, as the case may be.
However, when granting leave as aforementioned, the court will consider the
following,
(a) the likelihood of the success of proceedings;
(b) the costs of the proceedings in relation to the relief likely to be obtained;
(c) any action already taken by the company or subsidiary to obtain relief;
(d) the interests of the company or subsidiary in the proceedings being commenced,
continued, defended or discontinued, as the case may be.
Leave to bring proceedings or intervene in proceedings may be granted only if the

court is satisfied that either,
(a) the company or subsidiary does not intend to bring, diligently continue, defend
or discontinue the proceedings, as the case may be; or
(b) it is in the interests of the company or subsidiary, that the conduct of the
proceedings should not be left to the directors or to the determination of the
shareholders as a whole.
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5.3 Major transactions
As set out in section 185 of the Companies Act a major transaction is taken to
mean,
(a) the acquisition of or an agreement to acquire whether contingent or not, assets

of a value which are greater than half the value of the assets of the company
before the acquisition;
(b) the disposition of an agreement to dispose of, whether contingent or not, the
whole or more than half by value of the assets of the company;
(c) a transaction which has or is likely to have the effect of the company acquiring
rights or interests or incurring obligations or liabilities of a value which is
greater than half the value of the assets before the acquisition; or
(d) a transaction or series of related transactions which have the purpose or effect
of substantially altering the nature of the business carried on by the company.
In terms of the Section 185(1), A company shall not enter into any major
transaction, unless such transaction is:
(a) approved by special resolution;
(b) contingent on approval by special resolution;
(c) consented to in writing by all the shareholders of the company; or
(d) a transaction which the company is expressly authorised to enter into by a

provision in its articles, which was included in it at the time the company was
incorporated.
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However it must be noted that the Companies Act recognises certain exceptional
circumstances as detailed below.
(a) A transaction under which a company gives or agrees to give a floating charge
over all or any part of the property of the company;
(b) A transaction entered into by a receiver appointed pursuant to an instrument

creating a floating charge over all or any part of the property of a company;
(c) A transaction entered into by an administrator or liquidator of a company.
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CHAPTER ROUNDUP
 A company may raise capital through issue of securities. i.e. shares and debentures.
The debentures are considered as loans obtained by the company while the shares
constitute the ownership of the company.
 The basic form of shares is ordinary shares which carry one vote per share, are
entitled to participate equally in dividends and, if the company is wound up, share
in the proceeds of the company's assets after all the debts have been paid.
 A Company can issue shares having a ranking above ordinary shares in specified
aspects, known as Preferred Shares. Preference shareholders have a priority to a
fixed dividend and to return of capital in a winding up.
 Where a company issues shares which rank equally with or above existing shares
in relation to voting or distribution rights, those shares shall be offered to the
holders of existing shares in a manner which would, if the offer was accepted,
maintain the relative voting and distribution rights of those shareholders.
 A dividend is a distribution out of the profits of the company, other than an

acquisition by the company of its own shares or a redemption of shares by the
company.
 The solvency test in terms of the Companies Act is used to establish whether a
company shall be able to pay its debts as they become due in the normal course of
business and the value of the company's assets is greater than the value of its
liabilities and the company's stated capital.
 The Companies Act permits companies to redeem their shares. There are three
types of redemptions recognized under the Act.
 Where a shareholder vote against a major transaction or amalgamation or altering

articles of the company to impose or remove restriction on its business, but the
company approve the decision by majority, such shareholder is given the right to
require the company to purchase his shares, known as minority buy-out.
 In terms of Section 224 and 225 of the Act a shareholder is able to institute judicial
proceedings to prevent oppression and mismanagement of the company.
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 The derivative action under Section 234 recognizes that any shareholder has a right
to file suit acting on behalf of the corporation when the directors and management
are failing to act for the benefit of the company and all of its shareholders.
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1 List out the types of capital in a company and outline the significant features of
those methods.
PROGRESS TEST
2 Sarath is shareholder of 123 (Pvt.) Ltd. a company registered under the company
law of Sri Lanka. Recently Sarath has noted that the business affairs of 123 (Pvt.)
Ltd. are being conducted in a manner which Sarath considers to be questionable.
Specifically he feels that his rights as a shareholder are being severely prejudiced
by this conduct.
Sarath seeks your advice.
Explain to him in detail as to what rights he possesses against the company and
the board of directors of the company in this regard.
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1 Capital in a corporate body can be divided into equity capital and debt capital.
Equity capital
- Amounts to the capital raised through the sale of shares in the company.
- These funds amount to the ownership of the company.
- The types of shares generally issued by a company are as follows -
i) Ordinary shares – basic form of shares with standard rights relating to voting and
general administration.
ii) Preference shares – ranked above ordinary shares and derive preferential rights,
including preferential dividends and compulsory return on investment, etc.
iii) Deferred shares – shares with limited rights in relation to ownership and return on
investment.
iv) Non-voting shares – related only to Public Limited Liability Companies, these
shares do not carry with them voting rights except in limited, specified situations.
v) Redeemable shares – shares that will be bought back by the company.
Debt capital
Amounts to capital raised primarily in the form of money which must be paid back by
the company over a period of time together with interest at an agreed rate.
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2 Oppression
- Action can be instituted under section 224 of the Companies Act on the basis that
the affairs of the company are being conducted in a manner that is oppressive to
the rights of the shareholder.
- The shareholder/shareholders making the application should during the six
months prior to the making of the application constitute not less than 5% of the
total number of shareholders or hold shares which together carry not less than
Mismanagement
- Action can be instituted under section 225 of the Companies Act on the basis that
the affairs of the company are being mismanaged by the relevant parties in a
manner that is prejudicial to the well-being of the company.
- The shareholder/shareholders making the application should during the six
months prior to the making of the application constitute not less than 5% of the
total number of shareholders or hold shares which together carry not less than
Derivative action
Under the provisions of under section 234, the court may, on the application of a
shareholder or director of a company, grant leave to that shareholder or director to
(a) bring proceedings in the name and on behalf of the company or any subsidiary
of that company; or (b) intervene in proceedings to which the company or any
subsidiary is a party, for the purpose of continuing, defending, or discontinuing the
proceedings on behalf of the company or subsidiary, as the case may be.
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04
CHAPTER
Directors,
Company Secretary
and Auditors
INTRODUCTION
In this Chapter we will discuss the powers, functions, duties and responsibilities
of Directors, Company Secretary and Auditors of a Company.
Knowledge Component
Features of a Company and Organisational Personality
4.1 Role of Directors 4.1.1 Explain the following in relation to the directors of a company
(appointment, retirement and removal, powers, duties and liabilities,
civil and criminal liabilities).
4.1.2 Explain the division of power between directors and members.
4.2 Role of Secretary 4.2.1 State the functions of a Company Secretary along with “Panoramacase”.
4.2.2 Identify the process of appointment of Secretary and relevant
qualifications.
4.3 Role of Auditor 4.3.1 Discuss the functions, rights and duties of an Auditor (including
provisions contained in the Sri Lanka Accounting and Auditing
Standards Act No. 15 of 1995).
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LEARNING
1 Directors 4.1.1,4.1.2
2 Company Secretary 4.2.1,4.2.2
3 Company Auditors 4.3.1
1 Directors
As described in Ferguson V. Wilson [(1866) 2 Ch App 77], although companies are
legal persons, they are legal fictions, and have neither a body nor a soul. The
companies act through its board of directors and shareholders. The Companies Act
requires every company to have at least one director and for Public Companies at
least two directors.
1.1 Who is a director?

A director is considered to be an individual who is elected as, or elected to act as,
a representative of the stockholders to establish corporate management related
policies and to make decisions on major company issues.
A director is interpreted in the Companies Act focusing on the functions performed

by the person and irrespective of mere designation. It also includes ‘shadow
directors’, under whose instructions the company operates, although they are not
designated as directors of the company.
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"Director" includes:
(a) a person occupying the position of director of the company, by whatever name
called;
(b) for the purposes of sections 187, 188, 189, 190, 197, 374 and 377 ,
(i) a person in accordance with whose directions or instructions a person
referred to in paragraph (a) may be required or is accustomed to act;
(ii) a person in accordance with whose directions or instructions the board of
the company may be required or is accustomed to act; and
(iii) a person who exercises or who is entitled to exercise or who controls or
who is entitled to control the exercise of powers which, apart from the articles
of the company, would be required to be exercised by the board ; and
(c) for the purposes of sections 187 to 195 (both inclusive), 197, 374 and 377, a
person to whom a power or duty of the board has been directly delegated by the
board with that person's consent or acquiescence, or who exercises the power
or duty with the consent or acquiescence of the board.
It is noted that the provisions of paragraphs (b) and (c) do not apply to a person to
the extent that the person acts only in a professional capacity
1.2 Types of Directors
Executive and Non-Executive Directors
An “Executive Director” is a director who has separate responsibilities within the

company as an employee of the company in addition to the responsibilities of a
director. A “Non-Executive Director” is a member of a company's board of
directors who is not part of the executive team. They usually do not engage in the
day-to-day management of the organization, but they are involved in policy making
and planning exercises. In addition, non-executive directors' responsibilities
include the monitoring of the executive directors, and to act in the interest of any
stakeholders.
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It is important to note that both Executive and Non-Executive Directors have the
same responsibilities in law, and can be held liable to the standard. The Companies
Act doesn’t impose any mandatory requirement that a board should consist of Non-
Executive directors but the Listing Rules of the Colombo Stock Exchange require
Public Limited Companies to have a minimum of two non-executive directors.
Executive and Managing Directors
The Managing Director is an Executive Director appointed by the board as the

Managing Director of the company. Subject to the provisions provided by the
Articles of the company, a Managing Director, as with any other Executive Director
usually has a contract of employment with the company and acts in dual capacities
as director and employee.
1.3 Appointment of Directors
1.3.1 Qualification
In terms of Section 202 of the Companies Act, any person who doesn’t have the
following disqualifications can be appointed as a director.
(a) A person who is under eighteen years of age;
(b) A person who is an undischarged insolvent;
(c) A person who is or would be prohibited from being a director of or being

concerned or taking part in the promotion, formation or management of a
company, under the Companies Act No. 17 of 1982, but for the repeal of that Act;
(d) A person who is prohibited from being a director or promoter of or being

concerned or taking part in the management of a company under section 213 or
section 214 of this Act;
(e) A person who has been adjudged to be of unsound mind;
(f) A person that is not a natural person;
(g) In relation to any particular company, a person who does not comply with any
qualifications for directors contained in the Articles of that company.
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In addition, certain types of companies which are governed by specific statutes may
impose further qualifications to be a director in such companies.
Section 42 of the Banking Act No.30 of 1988
A person who is appointed, nominated or elected as a director of a licensed

commercial bank needs to be fit and proper to hold such office. The section lays
down the following criteria for determining whether a person is capable and
proper, namely:
(a) that such person possesses academic or professional qualifications or effective

experience in banking, finance, business or administration or of any other
relevant discipline;
(b) that there is no finding of any regulatory or supervisory authority, professional

association, any Commission of Inquiry, tribunal or other body established by
law in Sri Lanka or abroad, to the effect that such person has committed or has
been connected with the commission of, any act which involves fraud, deceit,
dishonesty or any other improper conduct;
(c) that person is not subject to an investigation or inquiry consequent upon being
served with notice of a charge involving fraud, deceit, dishonesty or other
similar criminal activity, by any regulatory authority, supervisory authority,
professional association, Commission of Inquiry, tribunal or other body
established by law, in Sri Lanka or abroad ;
(d) that person has not been convicted by any court in Sri Lanka or abroad in
respect of a crime committed in connection with financial management or of any
offence involving moral turpitude;
(e) that person is not an undischarged insolvent nor has he been declared a
bankrupt in Sri Lanka or abroad;
(f) that person has not failed, to satisfy any judgement or order of any court whether
in Sri Lanka or abroad, or to repay a debt;
(g) that person has not been declared by a court of competent jurisdiction in Sri
Lanka or abroad, to be of unsound mind;
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(h) that person has not been removed or suspended by an order of a regulatory or
supervisory authority from serving as a director, Chief Executive Officer or other
officer in any bank or financial institution or corporate body, in Sri Lanka or
abroad;
(i) that person has not been a director, Chief Executive Officer or held any other
position of authority in any bank or financial institution –
(i) whose license has been suspended or cancelled; or
(ii) which has been wound up or is being wound up, or which is being
compulsorily liquidated.
1.3.2 Procedure
The procedure of appointing directors is laid down in sections 203 to 206 of the
companies act. Accordingly, any person appointed as director must consent to the
appointment in a prescribed form and certify that he is not disqualified from being
appointed.
The directors mentioned in an application for incorporation or an amalgamation

proposal shall hold office form date of the incorporation or the amalgamation until
ceasing to hold the office. All other directors must be appointed by an ordinary
resolution unless the Articles provide otherwise.
1.4 Removal of Directors
In terms of section 206, subject to the Articles, a director may be removed by

ordinary resolution at a meeting, where prior notice of such removal has been given
or not. Reasons for removal need not to be disclosed. When the notice is given, the
concerned director has the right to make representation within 14days of such
notice, and the company is required to circulate the same to its shareholders or read
it at the meeting, unless the company obtain permission from court not to do so.
Removal of a director is a power vested with the shareholders, hence the court
usually does not interfere.
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Directors may also vacate office in the following manners as set out in section 207
of the Companies Act:
(a) resigning from his office in accordance with subsection (2);
(b) being removed from office in accordance with the provisions of this Act or the
articles of the company;
(c) becoming disqualified from being a director in terms of the provisions of section
202;
(d) death;
(e) vacating office pursuant to subsection (2) of section 210; or
(f) otherwise vacating office in accordance with the Articles of the company.
Any person shall not be appointed as a director of a company after he has reached
the age of seventy. In terms of section 210, where a director reaches the age of
seventy he shall vacate office at the conclusion of the annual general meeting
immediately following the attainment of that age.
1.5 Powers of Directors
Subject to the provisions contained in the Articles and the control that is vested with
the shareholders, the business affairs of the company will be conducted by the
board of directors. Section 184 of the Companies Act grants to the board, all the
powers necessary for managing, directing and supervising the management of the
business and affairs of the company.
However certain transactions which are classified as major transactions require to

be approved by special resolution; contingent on approval by special resolution;
consented to in writing by all the shareholders or expressly authorized by the
articles. As discussed under the previous chapter,
whether it is contingent or not ,major transactions of a company will include;
(a) the acquisition or an agreement to acquire the assets of a value which is greater
than half of the value of the company’s assets before the acquisition;
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(b) the disposition of, or an agreement to dispose of, the whole or more than half
by value of the assets of the company;
(c) a transaction which has or is likely to have the effect of the company acquiring
rights or interests or incurring obligations or liabilities of a value which is
greater than half the value of the assets before the acquisition; or
(d) a transaction or series of related transactions which have the purpose or effect
of substantially altering the nature of the business carried on by the company.
1.6 Directors Duties
The Companies Act has codified the fundamental principles that govern the duties
of directors.
 A director has a duty to act in good faith, in what he believes to be in the interest
of the company. Although shareholders are permitted to act in their own
interest, the directors are bound to act in the interests of the company even
though it might be against their own interest – vide section 187.
However, a director of a wholly owned subsidiary may act in the interests of the
holding company even though it may not be in the interests of the subsidiary.
 A director of a company shall not act or agree to the company acting, in a manner
that contravenes any provisions of the Act, or the provisions contained in the
Articles of the company – vide section 188.
 A director shall not act in a manner which is reckless or grossly negligent and
shall exercise the degree of skill and care that may reasonably be expected of a
person of his knowledge and experience – vide section 189
 The directors are permitted to rely on information provided to them by

employees, professional advisors and experts within their areas of competence,
or by other directors. However in doing so, they should act in good faith, make
proper inquiries when there is reason to do so and not have reason to believe
that such reliance was unwarranted.
 A director shall enter in the company’s interests register, when he has an

interest in a transaction or proposed transaction with the company. Such
disclosure must set out the nature and extent of such interest – vide section 192.
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 A director shall not disclose or use any information received by him in the
course of his functions, except for the purposes of the company or as required
by law.
 If a director believes the company is unable to pay its debts as they fall due, the
director must immediately call a board meeting to consider whether the board
should apply to court to wind up the company. If a director failed to do so and
the company is subsequently placed in liquidation a court may hold directors
liable for any loss suffered by the creditors as a result of the company continuing
its business.
 Where a company’s net assets are less than half of its stated capital, the board
must call an Extraordinary General Meeting within twenty working days of the
directors becoming aware of the fact. Such notice of the meeting shall be
accompanied by a report from the board advising the shareholders of the nature
and the extent of the loss suffered.
1.6.1 Corporate Governance
Corporate governance in essence is the system by which companies are directed

and controlled in the proper manner. The board of directors of a company are
particularly responsible for the governance of that company and it is noted that the
rules, codes and directives all indicate that it is “proper governance” that is required
and not “mere governance”.
As discussed in chapter 2 the Code of Best Practice in this regard has been
established in this regard by the Institute of Chartered Accountants of Sri Lanka
which relate to Financial Aspects of Corporate Governance (1997), the Code of Best
Practice on Audit Committees (2002) and the Code of Best Practice on Corporate
Governance (2003). The Code of Best Practice on Corporate Governance states that
“Directors are accountable to the shareholders and shareholder participation is
necessary to make that accountability effective. This should be done in a structured
manner so as to be progressive, effective and fair and not to in any way hamper the
overall business objectives of the company.”
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In this regard the responsibilities of the board include setting the company’s aims,
providing the correct leadership to put them into effect, supervising the
management of the business and reporting to the shareholders on their upright
stewardship.
It is particularly noted that while the Voluntary Code of Best Practice on Corporate
Governance is as the name suggests – voluntary, in relation to listed companies, the
Mandatory Code of Corporate Governance has also been adopted in 2008 which
provides minimal regulation with regard to corporate governance. Particularly this
Code deals with the inclusion of non-executive directors and independent directors;
the requirement of disclosures relating to directors; setting out a criteria to define
“independence”; and setting up a remuneration committee and an audit committee
in listed companies.
2 Company Secretary
Every company must have a secretary and the position forms an integral part of the
administration of a company. The role of the company secretary therefore has to be
considered in any discussion on the administration of a corporate body.
In terms of section 221 of the Companies Act, the qualifications required of a

secretary may be prescribed by the Registrar, depending on the turnover and stated
capital of a company and having regard to the nature of the duties that the secretary
will be called upon to discharge.
Before the secretary is appointed the company must obtain such person’s consent
and a certification that such person possesses the required qualifications in a
prescribed form. The board has the power to appoint or remove a secretary unless
the Articles provides otherwise.
The company secretary was treated as a mere servant previously. But in the present
context, the company secretary is considered as an officer of the company having
full capacity to enter in to a contract which will bind the company.
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Case law: the company secretary can enter into contracts binding the
Company
The company secretary of Fidelis, Mr. Bayne, hired cars from Panorama
Development's business, Belgravia Executive Car Rental. Bayne used the paper of
Fidelis and represented that he wished to hire a number of Rolls-Royces and
Jaguars for the business while his managing director was away. He was lying and
he used them himself. Bayne was prosecuted and imprisoned, but Belgravia had
outstanding £570 12s 6d for the hired cars. Fidelis claimed that it was not bound to
the hire contracts, because Bayne never had the authority to enter in to them.
Lord Denning MR held that Fidelis was nevertheless bound on the contract to
Panorama. Mr Bayne, as company secretary had ostensible, or apparent, authority
to enter such agreements.
“A company secretary is a much more important person nowadays than he was in
1887. He is an officer of the company with extensive duties and responsibilities.
This appears not only in the modern Companies Acts, but also by the role which he
plays in the day-to-day business of companies. He is no longer a mere clerk. He
regularly makes representations on behalf of the company and enters into
contracts on its behalf which come within the day-to-day running of the company's
business so that he may be regarded as held out as having authority to do such
things on behalf of the company. He is certainly entitled to sign contracts connected
with the administrative side of a company's affairs, such as employing staff, and
ordering cars, and so forth. All such matters now come within the ostensible
authority of the secretary of a company.”
Panorama Developments Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB
711
CA Sri Lanka 79
3 Company Auditor
Every company must have an auditor. In terms of section 154 of the Companies Act,
every company is required to appoint an auditor at its annual general meeting until
the conclusion of the succeeding annual general meeting.
3.1 Functions of Auditors
If the company failed to appoint an auditor at the annual general meeting or fill a
vacancy within one month of its occurring, the Registrar must be notified and then
the Registrar will appoint an auditor. According to section 157, the auditors are
required to be members of the Charted Accountants of Sri Lanka, although the
private companies and companies limited by guarantee are exempted from this
requirement.
The main function of the auditor is to audit the company’s financial statements and
the group financial statements where applicable for the accounting period next
after the balance sheet date for which financial statements were audited.
3.2 Rights and Duties of Auditors
 The auditors are specifically required to be independent and shall not have
conflicts of interest. It is to ensure that their judgment is not biased by any
interest they have in the company. In terms of section 161, the auditor is
required to deliver a statement with the audit report on the existence of any
other relationship or any interest in the company or its subsidiaries.
 Section 163 requires the auditor to make a report to shareholders on the

financial statements audited by him. Such report shall include the basis of
opinion, Scope and limitation of the audit, whether all required information and
explanations were obtained, whether proper accounting records have been
kept, whether the financial statements give a true and fair view of the matters
and whether the financial statements comply with legal requirements.
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 Section 164 of the Companies Act provides that, an auditor of a company is

entitled to access to the accounting books and other records of the company at
all times, and may require from a director or employee of the company, any
information and explanations as he thinks necessary for the performance of his
duties as auditor.
 In terms of Section 165 of the Companies Act, the auditor of the company has a
right to attend every meeting of shareholders of the company. The auditor is
entitled to receive the notices and communications that a shareholder is entitled
to receive relating to a meeting of shareholders and the auditor may be heard at
a meeting of shareholders which the auditor attends on any part of the business
of the meeting which concerns him as auditor.
 An auditor shall exercise reasonable skill and care of a degree and standard
expected of a reasonable professionally qualified accountant. An auditor shall
only certify to shareholders what he believes to be true. The auditor is entitled
to rely on a certification by a manager or a responsible manager if there is no
suspicion, but if any suspicion arises, he is required to make an exhaustive
investigation.
3.3 Sri Lanka Accounting and Auditing Standards Act

(No. 15 of 1995)
The Act was enacted with the objective of providing for the establishment of the Sri
Lanka Accounting Standards and Sri Lanka Auditing Standards. It also provides for
the establishment of the Sri Lanka Accounting Standards Monitoring Board.
Section 2 and 3 of the Sri Lanka Accounting and Auditing Standards Act provides
that The Institute of Chartered Accountants of Sri Lanka shall, from time to time,
 adopt such accounting standards (the "Sri Lanka Accounting standards") as may
be necessary for the purpose of maintaining uniform and high standard in the
preparation and presentation of accounts of business enterprises;
 adopt appropriate auditing standards (the "Sri Lanka Auditing Standards") as

may be necessary to govern the conduct of the audit of accounts of business
enterprises.
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The Sri Lanka Accounting Standards and the Sri Lanka Auditing Standards adopted
as aforesaid shall be published in the Gazette and shall become effective from and
after the date of such publication or such later date as may be specified therein.
In terms of section 7, the accounts of every specified business enterprise shall be

audited by professionally qualified auditors who shall be members of the Institute
holding a certificate to practice, issued by the Institute, and it shall be the duty of
such auditors to certify in their audit report that the audit has been conducted in
accordance with the Sri Lanka Auditing Standards and that accounts have been
prepared and presented accordance with the Sri Lanka Accounting Standards.
The provisions of the Act are applicable to specific business enterprises, which are
listed in the schedule to the Act.
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CHAPTER ROUNDUP
 Although companies are legal persons, they are legal fictions, and have neither a
body nor a soul. Companies therefore are administered through its board of
directors.
 A director is interpreted in the Companies Act focusing on the functions performed

by the person and irrespective of mere designation.
 An “Executive Director” is a director who has separate responsibilities within the

company as an employee of the company. A “Non-Executive Director” is a member
of a company's board of directors who is not part of the executive team. The
Managing Director is an Executive Director appointed by the Board as the Managing
Director of the Company.
 A director may be removed by ordinary resolution at a meeting, where prior notice

of such removal has been given. Reasons for removal need not to be disclosed.
 The business affairs of the company will be conducted by the board of directors.
Section 184 of the Companies Act grants to the board, all the powers necessary for
managing, directing and supervising the management of the business and affairs of
the company.
 Every company must have a Secretary. In terms of Section 221, the qualifications
required of a secretary may be prescribed by the Registrar, depending on the
turnover and stated capital of a company and having regard to the nature of the
duties that the secretary will be called upon to discharge.
 Every company must have an auditor. The auditor is appointed at the AGM until the
conclusion of next AGM, and any subsequent vacancy shall be filled within one
month. If the company failed to appoint an auditor or fill the vacancy, the Registrar
must be informed and thereupon the Registrar will appoint an Auditor.
 The main function of the auditor is to audit the company’s financial statements and
the group financial statements where applicable for the accounting period next
after the balance sheet date for which financial statements were audited.
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 The Institute of Chartered Accountants of Sri Lanka will adopt Sri Lanka Accounting
Standards and Sri Lanka Auditing Standards, and publish in the Gazette under the
Sri Lanka Accounting and Auditing Standards Act.
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PROGRESS TEST
1 Ms. Fernando has been invited to become an executive director in XYZ Ltd., a leading
Car Assembling company in Sri Lanka, which uses spare parts and other material,
purchased locally.
i) Ms. Fernando has no previous experience in functioning as a director and

therefore seeks advice on the role of an executive director and the duties of a
director under the Companies Act No.07 of 2007.
Summarise to Ms. Fernando the duties of a director and the role of an executive
director.
ii) Ms. Fernando is also a majority shareholder in Y2K Ltd., a leading tyre
manufacturer in Sri Lanka. Ms. Fernando however does not wish to disclose that
fact to XYZ Ltd.
Explain to Ms. Fernando the consequences of her decision.
2 Explain the significance of the Sri Lanka Accounting and Auditing Standards Act No.
15 of 1995.
CA Sri Lanka 85
1 i) Duties of a director
 A director has a duty to act in good faith.
 A director is bound to act in the interests of the company even though it might
be against the director’s own interest.
 A director shall not act or agree to the company acting, in a manner that
contravenes any provisions of the Act, or the provisions contained in the
Articles of the company.
 A director shall not act in a manner which is reckless or grossly negligent and
shall exercise the degree of skill and care that may reasonably be expected of
a person of his knowledge and experience.
 The directors are permitted to rely on information provided to them by

employees, professional advisors and experts within their areas of
competence, or by other directors but should do so in good faith, make proper
inquiries when there is reason to do so and not have reason to believe that
such reliance was unwarranted.
 A director shall enter in the company’s interests register, when he has an

interest in a transaction or proposed transaction with the company.
 A director shall not disclose or use any information received by the director in
the course of her functions, except for the purposes of the company or as
required by law.
 If a director believes the company is unable to pay its debts as they fall due,
she must immediately call a board meeting to consider whether the board
should apply to court to wind up the company.
 Where a company’s net assets are less than half of its stated capital, the board
must call an extra ordinary general meeting within twenty working days of the
directors becoming aware of the fact accompanied by a report from the board
advising the shareholders of the nature and the extent of the loss suffered.
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Role of an executive director
An executive director is a director who has separate responsibilities within the

company as an employee. Such directors will generally engage in the day-to-day
management of the organization, in addition to being involved in policy making
and planning exercises.
The board will, depending on the structure of the company and they appoint an
executive director as a Managing Director.
ii) A director is required to enter in the company’s “interests register”, any interest
in a transaction or proposed transaction with the company. Such disclosure
must set out the nature and extent of such interest.
The failure to disclose such interests will result in the director having
conducted herself in manner prejudicial towards the interests of the company
and can be subject to regulatory action.
2
 The Act provides for the establishment of the Sri Lanka Accounting
Standards and Sri Lanka Auditing Standards. It also provides for the
establishment of the Sri Lanka Accounting Standards Monitoring Board.
 The Act provides that The Institute of Chartered Accountants of Sri Lanka
shall, from time to time, adopt such accounting standards as may be
necessary for the purpose of maintaining uniform and high standards in the
preparation and presentation of accounts of business enterprises which will
be known as the "Sri Lanka Accounting standards".
 The Act provides that The Institute of Chartered Accountants of Sri Lanka
shall, from time to time, adopt appropriate auditing standards as may be
necessary to govern the conduct of the audit of accounts of business
enterprises which shall be known as the "Sri Lanka Auditing Standards".
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 The provisions of the Act are applicable to specific business enterprises,

which are listed in the schedule to the Act.
 The accounts of every specified business enterprise shall be audited by

professionally qualified auditors who shall be members of the Institute
holding a certificate to practice issued by the Institute, and it shall be the
duty of such auditors to certify the audit reports.
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05
CHAPTER
Meetings,
Resolutions and
Company
Records
INTRODUCTION
In this Chapter we will discuss different types of meetings held by
companies, purposes and resolutions passed at those meetings and
keeping record of the company’s business.
Knowledge Component
Meetings, Resolutions and Company Records
5.1 Different types of meetings 5.1.1 Compare and contrast the different types of meetings in a company, and
their purposes and notice periods.
5.1.2 Prepare a notice for an Annual General Meeting.
5.2 Different types of 5.2.1 Explain the different types of resolutions which could be passed by the
resolutions members of a company.
5.2.2 Prepare resolutions for Reappointment of directors, Reappointment of
auditors, Declaration dividends.
5.3 Company Records 5.3.1 List company records, stipulated in the Company’s Act.
5.3.2 Identify returns to be filed with ROC.
5.3.3 Discuss the regulatory requirements with regard to accounts (including
provisions contained in the Sri Lanka Accounting and Auditing Standards
Act No. 15 of 1995).
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KE3 | Chapter 5: Meetings, Resolutions and Company Records
LEARNING
1 Meetings of a company 5.1.1, 5.1.2
2 Resolutions 5.2.1, 5.2.2
3 Company records 5.3.1, 5.3.2
5.3.3
1 Meetings of a company
1.1 General Meetings
Although the Board of Directors of a Company manage the day to day business of
the company, the shareholders of the company – essentially the owners of the
company, have an oversight and control over the company affairs. General Meetings
provide the mechanism for such processes.
Under the previous Companies Act No.17 of 1982, there were three types of general
meetings recognised. However, under the new Act only two types of meetings are
recognized.
a. Annual General Meeting
b. Extraordinary general Meeting
It is noted that certain specified processes within a company cannot be
administered unless such a process is authorised by the shareholders at a general
meeting.
1.1.1 Annual General Meeting
An Annual General Meeting (commonly referred to as an AGM) is a mandatory

yearly gathering of an incorporated body's executives, directors and shareholders.
Shareholders with voting rights vote on current issues, such as appointments to the
company's board of directors, executive compensation, dividend payments and
auditors.
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There is a statutory duty cast upon the board of directors to call an annual general
meeting once every calendar year. In terms of Section 133 of the Companies Act, the
annual general meeting must be held within six months of the balance sheet date
and not later than fifteen months after the previous annual general meeting. But the
initial annual general meeting need not be held in the calendar year of
incorporation but should be held within eighteen months of the incorporation of
the company.
If a company defaults in calling the annual general meeting, any shareholder of the
company may make an application to the Registrar of Companies. The Registrar is
vested with powers to call or direct a general meeting with conditions which he
thinks expedient, including modifying articles of the company with respect of the
meeting procedure.
However, there is an exception recognised under section 144(3), which states that
it shall not be necessary for a company to hold an annual general meeting, if
everything required to be done at an Annual General Meeting is done by a resolution
in writing signed by eighty-five per centum of the shareholders who would be
entitled to vote on that resolution at a meeting of shareholders.
Case Law: Failure to hold Annual General Meeting
The directors of a company were charged under section 108 (4) read with section
46 of the Companies Ordinance with having failed to forward to the -Registrar of
Companies the annual return for a certain year as required by section 108 (1).The
accused pleaded that no general meeting was held during the relevant year and
that it was, therefore, impossible to furnish the return. They did not, however,
establish that the failure to hold the general meeting was not due to any default
on their part.
Held, that the failure to hold the general meeting was due to the default of
the accused themselves and that they were not entitled, therefore, to rely
on their own default as an answer to the charge.
M. M. R. De Silva V. The Registrar Of Companies (1955) 56 NLR 519
CA Sri Lanka 91
In the event of a default in holding an annual general meeting as provided for in the
Companies Act, both the company as well as the officers of the company who are in
default shall be found guilty of an offence and shall be liable to fines as specified in
the Companies Act.
1.1.2 Extraordinary General Meeting
The annual general meeting is typically the only time during the year when
shareholders and executives interact. If a company needs to resolve a problem in
between annual general meetings, it may call an Extraordinary General Meeting
(commonly referred as an EGM). An Extraordinary General Meeting is usually called
on short notice and deals with an urgent matter.
In terms of Section 134 of the Companies Act, Shareholders holding not less than
10% of the shares with voting rights can make a request to call for an extraordinary
general meeting to discuss any issue. Upon receipt of such request, there is a
statutory duty cast upon directors to call an extraordinary general meeting within
fifteen working days after the date of such requisition. Section 134(1) requires that
the meeting must be held within thirty working days after the deposit of the
requisition. This is a significant improvement with regard to the shareholders’
rights, as under the previous companies act there was no provision as to a time
period in which the meeting had to be held, which granted opportunity for abuse of
process.
The request to hold the meeting must contain the issues to be considered at the
meeting and the notice of the meeting must specify the issues in order to enable the
shareholders to decide whether it is in their interest to attend. If the directors do
not call a meeting within fifteen days of the deposit of the requisition, the
requisitionists or those representing more than half of the voting rights of all of the
requisitionists may call a meeting (provided that any meeting so convened shall not
be held after the expiration of three months). In such event all reasonable expenses
incurred in convening such a meeting must be repaid by the company.
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1.1.3 Meetings by Order of Court
The Court is vested with the power to order a meeting to be called, held and
conducted in a manner that Court seems appropriate. Such order maybe granted
where it is impractical to call a meeting in a manner in which meetings are to be
normally called or to conduct a meeting in a manner specified by the Articles of the
company or the Companies Act. The Court may order a meeting to be called on its
own motion or upon an application made by a director or a shareholder who has
the right to vote at such a meeting.
1.2 Notice Periods
Given the importance vested in general meetings, the legal provisions relating to a
notice of such a meeting is applied very strictly.
Section 135 of the Companies Act specifies minimum periods of notice for calling
meetings. In terms of Section 135(1), any provisions in the Articles of a company
which prescribes a shorter notice period than that stipulated in the Act shall be void.
A meeting of the company (other than an adjourned meeting) may be called;
(a) in the case of the Annual General Meeting, by fifteen working days' notice in
writing ; and
(b) in the case of a meeting, other than an annual general meeting or a meeting for
the passing of a special resolution, by ten days notice in writing in the case of a
company other than a private or unlimited company, and by five working days
notice in writing in the case of a private or an unlimited company.
However, an exception to the above provision is recognized under Section 135(3),

which states that company may call a meeting with shorter notices than prescribed
in the Act, where it is agreed -
(a) in the case of the meeting called as the Annual General Meeting, by all the
shareholders entitled to attend and vote at such meeting; and
(b) in the case of any other meeting, by shareholders having not less than ninety five
percent of voting rights to attend and vote at the meeting,
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Resolutions Requiring Special Notice
Where a resolution which requires special notice under the Act is to be moved,
Section 145 requires that at least twenty eight working days notice must be given
to the Company before the meeting. It is important to note here that notice has to
be given to the company of the intention to move such a resolution. Thereupon the
company must give the notice of such intention to the shareholders not less than
fifteen days before the meeting. If after such notice is given the company calls the
meeting for a date that is twenty eight days or less from the notice, it will be deemed
that proper notice has been given.
1.2.1 Example: Notice of an AGM
A draft notice of the Annual General Meeting of “ABCD Limited” is set out as follows.
The following points are to be noted :
 Notice is sent by the company secretary of ABCD Limited on behalf of the board
of directors.
 The date of the notice is in excess of the statutory minimum notice period. The
law allows notices is excess of the statutory minimum but will not entertain
notices below the statutory minimum unless expressly permitted.
 Provision has been made for a member to vote by proxy.
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Notice of Meeting
NOTICE IS HEREBY GIVEN that the Annual General Meeting of ABCD Limited
will be held on Friday, 21st November 2014 at 4.30 p.m. at the Office of M/s.
Perera & Perera Co. Ltd., No. 123, Ward Place, Colombo 7.
AGENDA
1. Notice of Meeting.
2. To adopt Audited Accounts for the Financial Year ended 31st March 2014
together with the reports attached thereto.
3. To re-elect Directors retiring by rotation.
4. To re-appoint Auditors.
By order of the Board

Secretaries
Colombo
21st October 2014
Notes
A member entitled to attend and vote at the Meeting is entitled to appoint a

Proxy to attend and vote instead of him/her. A Proxy need not be a member of
the Company. A Form of Proxy accompanies this Notice. Any Proxy should be sent
to the registered address of the Company 456, Barnes Place, Colombo 7, 48 hours
prior to the meeting.
2 Resolutions
2.1 Types of Resolutions
At meetings shareholders may pass several types of resolutions which are

necessary for the operation and continuance of the Company. The Companies Act
prescribes certain formalities which apply to different types of resolutions
depending on the importance and effect of those resolutions.
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2.1.1 Special Resolutions
A Special Resolution is a one which is passed by a majority of seventy five percent

of those shareholders who are entitled to vote and voting on the question.
In terms of Section 143 of the Companies Act, such special resolution can be passed
only at a general meeting where at least fifteen working days notice has been given
that such special resolution will be proposed at the meeting.
According to the Regulations of the Companies (Prescribed Returns Notice and

Documents) Regulations 2007, every company should notify the Registrar of
Companies within ten working days of each special resolution passed by it in the
prescribed Form.
2.1.2 Shareholders’ Resolution in Writing
Section 144 of the Companies Act provides for passing a Shareholders’ Resolution
without convening a general meeting. This is also known as a Circular Resolution,
and it was new feature introduced by the new Companies Act. However this
provision is not available if the Articles expressly prohibit it.
Accordingly, a resolution in writing signed by not less than eighty five percent of
the shareholders who would be entitled to vote on that resolution at a meeting of
shareholders, who together hold not less than eighty five percent of the votes
entitled to be cast on that resolution, is as valid as if had been passed at a meeting
of those shareholders. If the Secretary to the Treasury is the holder of a share in the
company, his consent in favour of such resolution is mandatory.
Section 144(2) mentioned that where a matter that is required by the Act or by the
articles to be decided at a meeting of the shareholders of a company is made by way
of a circular resolution, such matter is deemed to have been made in accordance
with the provisions of the Act or the articles of the company. Further, Section 144(3)
sets out that it will not be necessary for a company to hold an annual general
meeting, if everything required to be done at that meeting is done by resolution in
accordance with section 144.
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It is required that within five working days of a resolution being passed under
section 144, the company should send a copy of the resolution to every shareholder
who did not sign the resolution. If a company fails to comply with those provisions
the company and every officer of that company will be guilty of an offence.
2.1.3 Resolutions Passed at Adjourned Meetings
Where after the appointed date, a resolution is passed at an adjourned meeting of:
(a) a company;
(b) the holders of any class of shares in a company; or
(c) the directors of a company,
the resolution will for all purposes be treated as having been passed on the date on
which it was in fact passed. Such a resolution will not be deemed to have been
passed on an earlier date.
2.1.4 Example: Resolution
Draft minutes of “ABCD Limited” are set out as follows. The following points are to
be noted –
 A resolution has been passed the re-election of a director retiring by rotation.
 A resolution has been passed for the re-appointment of the auditors of the
company till such time as the next annual general meeting.
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ABCD LIMITED
Minutes of the Annual General Meeting of ABCD Limited held on Friday 21 st

November 2014 at 4.30 p.m. at the Office of M/s. Perera & Perera Co. Ltd., No.
123, Ward Place, Colombo 7.
Present : Mr. Sarath Perera (Chairman), Mr. Kusal De Silva, Ms. Shanthi Fernando
In attendance: Ms. Priyani Silva (Representing - Company Secretary)
Minute No. 1 – Notice of Meeting

The Notice of meeting was taken as read.
Minute No. 2 – Audited Accounts for the Financial Year ended 31st March
2013 together with the reports attached thereto
The Audited Financial Statements for the year ended 31st March 2013 together
with Reports were tabled and adopted on the proposal of Ms. Shanthi Fernando
seconded by Mr. Kusal De Silva.
Minute No. 3 – Re-election of Directors retiring by rotation

On the proposal of Mr. Sarath Perera, seconded by Mr. Kusal De Silva, Ms. Shanthi
Fernando was re-elected as Director.
Minute No. 4. Re-appointment of Auditors.

Proposed by Mr. Sarath Perera and seconded by Mr. Kusal De Silva, Messrs. Peiris
and Peiris, Chartered Accountants were re-appointed auditors to hold office until
the next Annual General Meeting and the Directors were authorized to determine
their remuneration.
No further items were presented for resolution. The meeting was adjourned at
7.30pm.
CONFIRMED AS CORRECT
CHAIRMAN
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3 Company Records
3.1 Registered Office of the Company
As set out in section 113 of the Companies Act, every company should have a
registered office in Sri Lanka to which all communications and notices may be
addressed. Unlike under the previous Act, the new Act allows the registered office
to be situated in any part of Sri Lanka.
It is to be noted that if the registered office of a company is at the offices of a

Chartered Accountant, Attorney-at-Law, or any other person, the description of the
registered office shall state ,
i) That the registered office of the company is at the offices of the Chartered
Accountant, Attorney-at-Law, or any other person; and
ii) The particulars of the location of those offices.
3.2 Duty to Maintain Records
Every company is bound by law to maintain proper records, to produce those

records to the relevant authorities and to grant access as applicable to the public. A
company’s records shall be kept at its registered office.
Under the provisions of section 116 of the Companies Act, a company is

required to keep the following documents at its registered office.
(a) The certificate of incorporation and the articles of the company;
(b) Minutes of all meetings and resolutions of shareholders passed within the
preceding ten years;
(c) An interests register, unless it is a private company which is dispensed with the
need to maintain such a register;
(d) Minutes of all meetings held and resolutions passed by the board of directors
and directors’ committees held within the preceding ten years;
(e) Certificates required to be given by the directors under the Act within the
preceding ten years;
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(f) The register of directors and secretaries as specified in section 223;
(g) Copies of all written communications to all shareholders or all holders of the
same class of shares during the preceding ten years, including annual reports
prepared under section 166;
(h) Copies of all financial statements and group financial statements required to be
completed under the Act for the preceding ten completed accounting periods
of the company;
(i) The copies of instruments creating or evidencing charges and the register of
charges required to be kept under section 109 and 110;
(j) The share register required to be maintained under section 123; and
(k) The accounting records required to be maintained under section 148 for the
current accounting period and for the preceding ten completed accounting
periods of the company.
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Section 116 further provides that, notice must be given to the Registrar if the
aforementioned records are to be kept at any place other than the registered office
or if the place in which such records are kept is changed.
In terms of Section 117, all company records must be in written form or in a form
which can be easily accessed and converted to written form. A company is required
to take measures to prevent falsification of company records and detect falsification
of records. Failure to comply with this requirement is an offence on the part of the
company and on the part of the officers of the company.
3.2.1 Right to Inspect Records
A Director of a company is entitled to inspect the company records upon reasonable

notice being provided to the company. However a court has the right to limit rights
as it deems fit in the event that it would not be in the company’s best interest for a
director to inspect the records; or in the event the proposed inspection is not
properly connected with the director’s duties.
All shareholders and anyone authorised by a shareholder is entitled to inspect the

following documents;
(a) Minutes of all meetings and resolutions of shareholders;
(b) Copies of written communications to all shareholders or to all holders of a class

of shares during the preceding ten years, including annual reports, financial
statements, and group financial statements;
(c) Certificates issued by directors under this Act; and
(d) The interests register of the company.
In terms of Section 120, the following documents shall be made available for
public inspection
(a) The certificate of incorporation of the company;
(b) The articles of the company, if they are not the model articles;
(c) The share register;
(d) The register of directors and secretaries;
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(e) Particulars of the registered office of the company;
(f) Copies of the instruments creating or evidencing charges and the register of
charges kept under sections 109 and 110.
The failure to comply with the right of a legitimate party right to inspect the records
is an offence on the part of the company and on the part of the officers of the
company.
3.2 Annual Return
All companies are required to deliver an annual return containing details specified
in the fifth Schedule to the Act. In terms of section 131, such report shall be
completed within thirty working days of the annual general meeting. The annual
return must be signed by a director and the company secretary. The failure to
comply with these requirements is an offence on the part of the company and on
the part of the officers of the company.
Every private company should send to the Registrar with its annual return a
declaration signed by the directors of the company that to the best of their
knowledge and belief the directors have done all things required of them under the
Act;
3.3 Accounting Records
It is the duty of every company to keep accounting records. The accounting records
explain the transactions of the company and it helps to determine the company’s
financial position. In terms of section 148, every company shall keep accounting
records which correctly record and explain the company's transactions, and will:
(a) at any time enable the financial positions of the company to be determined with
reasonable accuracy;
(b) enable the directors to prepare financial statements in accordance with the Act;
and
(c) enable the financial statements of the company to be readily and properly
audited.
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Accounting records shall contain:
(a) entries of money received and expended each day by the company and the
matters in respect of which such money was spent;
(b) a record of the assets and liabilities of the company
(c) if the company's business involves dealing in goods;
(i) a record of goods bought and sold, except goods sold for cash in the ordinary
course of carrying on a retail business that identifies both the goods and
buyers and sellers and the relevant invoices;
(ii) a record of stock held at the end of the financial year together with records
of any stock takings during the year;
(d) if the company's business involves providing services, a record of services

provided and relevant invoices.
Maintaining the company’s financial statements is the duty of its directors. The
board must ensure that within specified time period (section 150) financial
statements that comply with the requirements as set out in section 151 are
completed, certified that it is in compliance with the Companies Act by the person
responsible for preparation of the statements and signed by two directors, or if the
company has only one director, by that director.
Where a company has subsidiaries, and it is not wholly owned by that company, in
addition to complying with the requirements as set out above, the board of directors
must ensure that a group financial statement in relation to that group is completed.
Where a company is in default of these responsibilities, every director who is in

default is guilty of an offence.
3.3.1 Sri Lanka Accounting and Auditing Standards Act
The law which relates to the content of accounting records is primarily set out in
the Sri Lanka Accounting and Auditing Standards Act No 15 of 1995. Section 2 and
3 of this Act empowers the Institute of Charted Accountants of Sri Lanka to adopt
such accounting and auditing standards as may be necessary for the purpose of
maintaining uniform and high standards in business enterprises in Sri Lanka.
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As such, authority is granted for the adoption of the “Sri Lanka Accounting
Standards” and “Sri Lanka Auditing Standards” which may be revised, altered and
amended from time to time. The schedule to the Act also specifies the businesses
which are bound by it as “specified business enterprises”.
Under section 6 of the Sri Lanka Accounting and Auditing Standards Act it shall be
the duty of every specified business enterprise to prepare its accounts in
compliance with the Sri Lanka Accounting Standards. It must be required that all
necessary measures are taken to ensure that its accounts are audited in accordance
with the Sri Lanka Auditing Standards with the object of presenting a true and fair
view of the financial performance and financial condition of such enterprise.
Section 7 of the Sri Lanka Accounting and Auditing Standards Act provides that such
audits may only be conducted by professionally qualified auditors licensed to
practice by the Institute. The auditor is required to certify every audit that it has
been conducted in compliance with the auditing standards.
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 Shareholders of a company have a control and oversight over the company affairs
CHAPTER ROUNDUP
through General Meetings.
 There is a statutory duty cast upon the Board of Directors to call an annual general
meeting once in every calendar year.
 Shareholders holding not less than 10% of the shares with voting rights can make
a request to call for extraordinary general meeting to discuss any issue.
 The Court is vested with power to order a meeting to be called and held and conduct
in a manner that Court seems appropriate.
 Section 135 of the Companies Act specifies minimum periods of notice for calling
meetings.
 A Special Resolution is one which is passed by majority of 75% of those

shareholders who are entitled to vote and voting on the question.
 Section 144 of the Companies Act provides for passing a Shareholders’ Resolution
without convening a general meeting.
 At meetings shareholders may pass several types of resolutions which are

necessary for the continuance of the Company.
 Every company is bound by law to maintain proper records.
 Records of a company shall be kept at its registered office.
 All companies are required to deliver an annual report containing details specified
in the 5th Schedule to the Act.
 The accounting records explain the transactions of the company and it helps to
determine the company’s financial position.
 Financial statements of a company are a duty of directors.
 The law which relates to content of accounting record is primarily set out in Sri
Lanka Accounting and Auditing Standards Act No 15 of 1995.
 It shall be the duty of every “specified business enterprise” to prepare its accounts
in compliance with the Sri Lanka Accounting Standards.
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 Audits may only be conducted by professionally qualified auditors licensed to

practice by the institute.
 Failure to comply with the provisions set out herein is an offence on the part of the
company and on the part of the officers of the company.
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1 a) List the types of General Meetings found in Company.

PROGRESS TEST
b) Outline the key features of the types of General Meetings listed under
the previous question.
2 Prepare a Board Resolution for the purposes of declaring a dividend of Rs.

4000/- for “XYZ Limited”.
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1 a) Annual General Meeting & Extraordinary General Meeting

b) Annual General Meeting
 A mandatory yearly gathering of an incorporated body.
 Shareholders with voting rights vote on current issues.
 Statutory duty upon the board of directors to call an annual general

meeting once every calendar year.
 The annual general meeting must be held within six months of the balance
sheet date and not later than fifteen months after the previous annual
general meeting.
 If a company defaults in calling the annual general meeting, any

shareholder of the company may make an application to the Registrar of
Companies.
 Exception – it shall not be necessary for a company to hold an annual

general meeting, if everything required to be done at an Annual General
Meeting is done by a resolution in writing signed by eighty-five per centum
of the shareholders who would be entitled to vote on that resolution at a
meeting of shareholders.
Extraordinary General Meeting
 Called on short notice and deals with an urgent matter.
 Shareholders holding not less than 10% of the shares with voting rights
can make a request to call for an extraordinary general meeting.
 Upon receipt of such request, there is a statutory duty cast upon directors
to call an extraordinary general meeting within fifteen working days after
the date of such requisition. Section 134(1) requires that the meeting must
be held within thirty working days after the deposit of the requisition.
 The request to hold the meeting must contain the issues to be considered
at the meeting and the notice of the meeting must specify the issues in
order to enable the shareholders to decide whether it is in their interest to
attend.
 If the directors do not call a meeting within fifteen days of the deposit of
the requisition, the requisitionists or those representing more than half of
the voting rights of all of the requisitionists may call a meeting
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XYZ Limited
Minutes of the Meeting of the Board of Directors of XYZ Limited held on 27th
November 2014 at No. 45, Park Road, Colombo at 5.00 p.m.
PRESENT : Mr. E A Perera (Chairman), Mrs. R L Stephan (Director)
IN ATTENDANCE: Mr. Gihan De Alwis (on behalf of the Company Secretary)
Represented by Ms. Helen de Silva
1. Notice of Meeting
Notice of Meeting was taken as read.
2. Declaration of Dividend
Proposed by the Chairman and seconded by Mrs. R L Stephan a First and

Final Dividend of Rs. 4000/- per share was declared.
Chairman
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06
CHAPTER
Winding Up
INTRODUCTION
In this chapter we will discuss the processes available to wind up a
company. We will consider the different methods available for such a
purpose and identify the duties and functions of the parties involved
such processes.
Knowledge Component
Winding Up
6.1 Compulsory and 6.1.1 Differentiate “compulsory and voluntary winding up” and explain their
voluntary winding up consequences.
6.2 Functions of parties 6.2.1 Outline the functions of administrator/liquidator and
involved in winding up receivers/managers.
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LEARNING
1 What is a winding up?
2 Winding up by court 6.1.1
3 Voluntary winding up 6.1.1
4 Winding up subject to the supervision of court 6.1.1
5 Parties to a winding up 6.2.1
1 What is a Winding up?
As discussed in previous chapters, although a company in theory possesses a

perpetual existence, a company can be brought to a closure. The process adopted
by the law to oversee the process of ceasing the affairs of a company is known as
“winding up” or “liquidation”.
The winding up of a company is therefore the process upon which the operations
of a company are ceased. It is important that such a process balances out the
interests of the several stakeholders of the company; disposes the assets of the
company; settles the debts of the company; and distributes any remaining surplus
between shareholders.
1.1 Types of Winding up

As set out in section 267 of the Companies Act, the winding up of a company can be
either ;
(a) A winding up by court

(b) A voluntary winding up; or
(c) A winding up subject to the supervision of court.
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The specific provisions of the Companies Act will apply to every winding up of a
company (unless the contrary appears). It is noted however that certain special
provisions are made for the liquidation of certain sector specific companies – for
example, companies involved in banking and insurance.
The relevant procedure to be adopted sets out whether the winding up of a

company can be commenced voluntarily by the stakeholders of the company, or as
to whether the winding up is imposed compulsorily by the law. However the
essential difference between compulsory winding up and voluntary winding up is
that the former does not necessarily involve action taken by an organ of the
company itself, whereas voluntary winding up does.
2 Winding up by Court
The winding up of a company can be ordered by court on any one of the grounds as
set out in section 270 of the Companies Act.
According to section 270, a company may be wound up by court if
(a) The company has by special resolution resolved that the company be wound up
by the court;
(b) The company does not commence its business within a year from its
incorporation, or suspends its business for one year;
(c) If the number of the members falls below the minimum number required under
sub-section (2) of section 4 of the Act;
(d) The company has no directors;
(e) The company is unable to pay its debts; or
(f) The court is of the opinion that it is just and equitable that the company should
be wound up.
If the grounds as set out under any of the aforementioned heads are found to be
present within a company, it shall be compulsory for the said company to be wound
up.
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2.1 Inability to Pay Debts
Section 271 of the Companies Act sets out that a company is deemed unable to pay
its debts in the following situations –
(a) Where the company has failed to pay, secure or compound an admitted debt
exceeding fifty thousand rupees which is payable to a creditor, within three
weeks of the creditor serving a demand (known as a “statutory demand”) on the
company to pay back the relevant sum owed.
(b) Where any execution or other process issued on a judgement, decree or order
of any court in favour of a creditor of the company is returned unsatisfied, in
whole or in part.
(c) Where it is proven to the satisfaction of the court that the company is unable to
pay its debts, and in determining whether a company is unable to pay its debts,
the courts shall take into account the contingent and prospective liabilities of
the company.
2.2 Just and Equitable to Wind up a Company
A winding up application may be presented by shareholders of the company as

contributories (“contributory” meaning every shareholder of the company and
every other person liable to contribute to the assets of a company in the event of it
being wound up, including those who are deemed or alleged to be contributories in
proceedings for determining contributories) on the ground that it is just and
equitable that the company should be wound up. In such circumstances the court
shall, where it is of the opinion that –
(a) the party who has made the application (the Petitioner) is entitled to relief
either by winding up the company or by some other means; and
(b) in the absence of any other remedy it would be just and equitable that the
company should be wound up,
make a winding up order. If however the court is of the opinion that some other
remedy is available to the Petitioner and that the Petitioner has acted unreasonably
in seeking to have the company wound up instead of pursuing that remedy, a
winding up order will not be made.
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2.3 Winding Up Rules
The Companies Winding Up Rules 1939 which were made under previous
legislation continue to operate at present. An application to court for winding up of
a company should be made and proceedings thereafter should be conducted in
terms of the Winding Up Rules.
In terms of the Winding Up Rules every application for the winding up of a company
by court, or subject to the supervision of court should be made in the prescribed
form. Thereafter upon the Petitioner satisfying court that the Rules have been
complied with, steps should be taken to serve and advertise the application to wind
up the company. Thereafter all interested parties who intend to appear at the
hearing of the application should give notice of such intention (in the prescribed
form) to the Petitioner, of which the Petitioner should make a list. If a party seeks
to oppose the winding up of the company, such party should do so by tendering the
requisite documents to Court within the stipulated time period. After hearing all
relevant parties, the court may order the company to be wound up or dismiss the
application (or make such other order as it deems fit).
2.4 Powers of Court

As set out in section 273 of the Companies Act, on hearing a winding up application,
the court may:
(a) Dismiss it; or
(b) Adjourn the hearing conditionally or unconditionally; or
(c) Make any interim order or any other order as it thinks fit.
However the court cannot refuse to make a winding up order on the ground that
the assets of the company have been mortgaged to an amount equal to, or in excess
of those assets; or that the company has no assets.
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2.4.1 Power of Court to Stay Proceedings
After an application is presented to court and before the winding up order is made,
the company, any creditor, or a contributory may apply for a stay of or restraint
against any actions or proceedings pending against the company in any court. Such
an application may be made either to the court where the action or proceeding is
pending, or to the court hearing the winding up application.
When however a winding up order has been made or a provisional liquidator

appointed, no action or proceeding can be proceeded with or commenced against
the company, except by leave of the court.
2.4.2 Avoidance of Distribution of Property
In a winding up by the court, any disposition of the property of the company,

including things in action, and any transfer of shares, or alteration in the status of
the members in the company made after the commencement of the winding up will
unless the court otherwise orders be void.
2.5 Appointment of a Provisional Liquidator
Subsequent to the filing of an application to wind up a company and until such time
as the application is heard by court, a risk may exist in allowing the assets of the
company to remain in the hands of the directors or shareholders. In such
circumstances, the court has the authority under section 286 to appoint a
provisional liquidator. Such an appointment places the provisional liquidator in
control of the business and displaces the directors.
2.6 Appointment of the Liquidator
In the event that a winding up order is issued by court, one or more liquidators may
be appointed by court for purpose of conducting the winding up proceedings and
for performing other duties in reference to it. The duties and responsibilities of a
liquidator are set out in a following section.
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2.7 Dissolution of a Company
Once the liquidator makes such an application to court that the affairs of the
company are completely wound up, the court shall make an order dissolving the
said company. Subsequent to such an order of dissolution by court, the company
shall effectively be brought to a close.
3 Voluntary Winding up
The law allows companies to be wound up voluntarily without the intervention of

court. Such procedures permit creditors and contributories to manage the process
of bringing the affairs of a company to an end on their own accord, without having
to involve a court of law.
3.1 Types of Voluntary Winding up
There are two types of voluntary winding up, namely:
(i) A shareholder’s (or a member's) voluntary winding up – available where

the company is solvent and will proceed on the certification by the directors
that the company is solvent and able to pay its debts; and
(ii) A creditor’s voluntary winding up – available where the company is, or

will be, insolvent and unable to pay its debts in full.
3.2 Grounds for a Voluntary Winding up
Section 319 of the Companies Act provides that a company may be wound up
voluntarily:
(a) when the period (if any) fixed for the duration of the company expires or on the
occurrence of the event upon which the company is to be dissolved (if any), and
the company at a general meeting has passed an ordinary resolution requiring
the company to be wound up voluntarily;
(b) where the company resolves by special resolution that the company be wound
up voluntarily;
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(c) where the company resolves by special resolution to the effect that it cannot by
reason of its liabilities continue its business and that it is advisable to wind up.
3.3 Declaration of Solvency
A company must be solvent to qualify for a shareholders’ winding up in order to

protect the rights of the creditors. The directors must therefore make a declaration
of solvency by a majority decision at a meeting of the board of directors. A full
inquiry has to have been conducted into the affairs of the company and the directors
must declare that the company is able to pay its debts in full within twelve months
from the commencement date of the winding up.
A winding up where a declaration of solvency is not made and delivered will qualify
as a creditors’ voluntary winding up.
3.4 Consequences of a Voluntary Winding up
In the case of a voluntary winding up, the company shall from the date of
commencement of the winding up, cease to carry on its business except to the
extent as may be required for the beneficial winding up of the company. The
corporate status and corporate powers of the company shall however continue
until the company is dissolved.
A company that is being wound up voluntarily must, at a general meeting (for a

shareholders’ voluntary winding up) or on the nomination of the company and the
creditors at their respective meeting (for a creditors’ voluntary winding up),
appoint one or more liquidators to wind up the affairs of the company and
distribute the assets of the company. The directors powers will cease once the
appointment of a liquidator is made, except to the extent sanctioned by an
authorised party as set out in the Act.
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4 Winding up Subject to the Supervision of Court
As set out in section 351 of the Companies Act, when a company has passed a
resolution for voluntary winding up, a petition may be made to court for an order
that the winding up be continued as a voluntary winding up, but subject to the
supervision of court. Liberty is given to creditors, contributories or others to apply
to court for relevant applications to be made. A winding up subject to the
supervision of court will for the purposes of sections 275 and 276 of the Companies
Act be deemed to be a winding up by the court.
4.1 Power of Court to Appoint or to Remove a Liquidator
Where an order is made by court for a winding up subject to the supervision of

court, the court may, by that or any subsequent order, appoint an additional
liquidator to the proceedings. A liquidator so appointed shall have the same powers,
be subject to the same obligations, and in all respects have the same position, as if
he had been duly appointed in accordance with the provisions of the Companies Act
with respect to the appointment of liquidators in a voluntary winding up.
The court may remove any liquidator appointed under the aforementioned
provisions, or any liquidator in a winding up continuing under the supervision of
court, and fill any vacancy occasioned by such removal, or by death or resignation
of any liquidator.
4.2 Effect of Supervision Order
When an order is made for a winding up subject to the supervision of court, the
liquidator may subject to any restrictions imposed by the court, exercise all his
powers without the sanction or intervention of the court, in the same manner as if
the company were being wound up voluntarily. However, as set out in section 355,
certain powers that are vested in the liquidator must only be exercised with the
express sanction of court.
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5 Parties to a Winding up
As discussed in the previous sections, a number of parties are involved in winding

up a company. These parties have designated roles and tasks which are set out by
the law in order to ensure the smooth functioning of a winding up as well as to safe
guard the interests of the stakeholders of the company being wound up.
5.1 Official Receiver
For the purpose of the Companies Act, the expression “official receiver” in the
context of a winding up of a company by the court, means the official receiver
attached to the court for insolvency purposes, or if there is no such official receiver
so attached, such person as the Minister may appoint as official receiver to that
court. An official receiver therefore is an individual appointed to monitor a
company for a short period of time in a manner that will ensure as much debt is
paid back to creditors.
The official receiver is tasked with the duty of compiling statements and reports as
may be ordered by court from time to time as set out in detail in sections 283 and
284 of the Companies Act.
5.2 Liquidator
A liquidator refers to an officer that is specially appointed to wind up the affairs of

a company. The liquidator is legally empowered to act on behalf of the company in
various capacities including the power to institute and defend lawsuits on behalf of
the company being wound up; collecting outstanding receivables; disposing of
company assets; paying off debts and finishing other corporate termination
procedures.
As set out in more detail in section 2.5, a court may appoint a liquidator
provisionally and either the official receiver or any other suitable person may be so
appointed. Where a provisional liquidator is appointed by the court, the court may
limit and restrict his powers by the order appointing him.
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5.2.1 Qualifications of a Liquidator
Section 383 of the Companies Act provides that none of the following persons may
be appointed or act as a liquidator of a company:
(a) A person below eighteen years of age;
(b) A creditor of the company in liquidation;
(c) A person who has within the two years immediately preceding the
commencement of the winding up, been a shareholder, director, auditor, or
receiver of the company or of a related company;
(d) An undischarged bankruptcy;
(e) A person who has been adjudged to be of unsound mind under the provision of
the Mental Diseases Ordinance;
(f) A person in respect of whom an order has been made under section 468 of the
Companies Act prohibiting such person from acting as a liquidator;
(g) A person who is prohibited from being a director or promoter of, or being
concerned or taking part in the management of a company under section 186 of
the Companies Act, No. 17 of 1982 (persons restrained from managing
companies due to the fact of having been found guilty of specified offences), or
who would be so prohibited, but for the repeal of that Act;
(h) A person who is prohibited from being a director or promoter of, or being
concerned or taking part in the management of a company under section 213
(persons prohibited from managing companies) or section 214 (directors
disqualified by court); or a corporate body.
5.2.1 Appointment Style of Liquidator
Section 287 of the Companies Act sets out that the following provisions with respect
to liquidators shall have effect on a winding up order being made –
(a) The official receiver shall by virtue of his office become the provisional
liquidator and shall continue to act as such until he or another person becomes
liquidator and is capable of acting as such;
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(b) The official receiver shall summon separate meetings of the creditors and
contributories of the company, for the purposes of determining whether or not
an application is to be made to the court for appointing a liquidator in place of
the official receiver;
(c) The court may make any appointment and make any order required to give
effect to any such determination, and if there is a difference between the
determinations of the meetings of the creditors and contributories in respect of
the matter set out above, the court shall decide the difference and make such
order thereon as the court may think fit;
(d) In a case where the liquidator is not appointed by the court, the official receiver
shall be the liquidator of the company;
(e) The official receiver shall by virtue of his office be the liquidator during any
vacancy in the office of liquidator.
Where in the winding up of a company by the court, a person other than the official
receiver is appointed as the liquidator, section 288 of the Companies Act provides
that such person ,
(a) shall not be capable of acting as liquidator until he has been notified of such
appointment and given security in the prescribed manner to the Registrar;
(b) shall give the official receiver such information and such access to and facilities
for inspecting the books and documents of the company, and generally such aid
as may be required for enabling that officer to perform his duties under this Act.
5.2.3 Company Property
Where a winding up order has been made or where a provisional liquidator has
been appointed, the liquidator or the provisional liquidator, as the case may be,
shall take into his custody or under his control all the property and things in action
to which the company is or appears to be entitled. The liquidator is also entitled to
make an application to court and obtain an order that all or any part of the property
of whatever description belonging to the company or held by trustees on its behalf,
shall vest in the liquidator by his official name.
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5.2.4 Powers of the Liquidator
As set out in section 292 of the Companies Act, the liquidator in a winding up by the
court shall have power, with the sanction either of the court or of the committee of
inspection .
(a) to bring or defend any action or other legal proceeding in the name and on
behalf of the company;
(b) to carry on the business of the company so far as may be necessary for the
beneficial winding up of such company;
(c) to appoint an attorney-at-law to assist him in the performance of his duties;
(d) to pay any classes of creditors in full;
(e) to make any compromise or arrangement (within limitations) with creditors or

persons claiming to be creditors or having or alleging themselves to have any
claim;
(f) to compromise ;
i) all calls, liabilities to calls, debts, and liabilities capable of resulting in debts
and all claims between the company and a contributory (or alleged
contributory or other debtor or person apprehending liability to the
company) and
ii) any way all questions in relating to /affecting the assets or the winding up of
the company
on such terms as may be agreed and take any security for the discharge of any
such call, debt, liability or claim and give a complete discharge in respect thereof.
The liquidator in a winding up by the court shall have power;
(a) to sell the movable and immovable property and things in action of the company
by public auction or private contract, with power to transfer the same to any
person or company or to sell the same in parcels;
(b) to do all acts and to execute in the name and on behalf of the company, all deeds,
receipts, and other documents and for that purpose to use when necessary, the
seal of the company, if any;
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(c) to prove, rank and claim in the bankruptcy, insolvency or sequestration of any
contributory for any balance against his estate, and to receive dividends in
respect thereof;
(d) to draw, accept, make and endorse any bills of exchange or promissory note or
like instruments in the name and on behalf of the company;
(e) to raise on the security of the assets of the company any money required ;
(f) to take out in his official name (with limitation) letters of administration to any
deceased contributory, and to do in his official name any other act necessary for
obtaining payment of any money due from a contributory or his estate which
cannot be conveniently done in the name of the company;
(g) to appoint an agent to do any business on behalf of such liquidator;
(h) to do all such other things as may be necessary for winding up the affairs of the
company and distributing its assets.
5.3 Committee of Inspection
When a winding up order has been made by the court, separate meetings of
creditors and contributories will be called to determine whether or not an
application should be made to the court for appointing a liquidator in place of the
official receiver. At such meetings it should also be determined, whether or not
there should be appointed a committee of inspection to act with the liquidator.
Where in the case of a winding up there is no committee of inspection, the court

may on the application of the liquidator, do any act or give any direction or
permission which such a committee is authorised or required to be do or give under
the Companies Act.
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5.4 Administrator
Although not directly connected with the winding up of a company, the role of an
administrator is relevant to the lead up to, or to avoid liquidation proceedings and
therefore merits attention. The provisions relating to the appointment of an
administrator is set out in Part XIII of the Companies Act.
When a board considers that the company is or is likely to become unable to pay its
debts as they fall due, and that the appointment of an administrator is likely to
enable the survival of the company and the whole or any part of its undertaking as
a viable concern; or the preparation and approval of a compromise or arrangement
under the Companies Act; or a more advantageous realization of the company’s
assets than would be likely in a winding up, it may resolve to appoint an
administrator.
An administrator may not however be appointed in the following situations
i) Where an order has been made to wind up the company in question.
ii) A receiver has been appointed for the whole of the property and the
undertaking of the company (unless the person by whom or on whose behalf
the receiver was appointed has consented to the making of the order).
iii) An administrator has been appointed by the court previously (unless court
grants prior leave for a further appointment).
Subsequent to the appointment of an administrator however, and until the end of

the period specified in the Act,
a) no resolution may be passed or order made for the liquidation of the company;
b) subject to the exceptions provided in the Act, no steps may be taken to enforce
any security over any property of the company or to repossess any goods in the
company's use or possession under any hire-purchase agreement, excet with
the consent of the administrator or with the leave of the Court and subject to
such terms as the Court may impose ;
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c) no other proceedings and no execution or other legal process may be

commenced or continued and no distress may be levied against the company or
its property, except with the consent of the Administrator or with the leave of
the Court and subject to such terms as the Court may impose.
5.4.1 Powers and Duties of an Administrator
An administrator
a) shall manage the affairs, business and property of the company;
b) may do all such things as may be necessary or desirable for the management of
the affairs, business and property of the company;
c) without limiting the powers specified in paragraphs (a) and (b), shall have all
the powers that could be exercised by a receiver of the whole of the property
and undertaking of the company under specified provisions of the Companies
Act.
The administrator on his appointment shall take into his custody or control, all the
property to which the company is or appears to be entitled. Furthermore the
administrator shall manage the affairs, business and property of the company at
any time before a proposal has been approved under section 407 of the Companies
Act (namely, proposals for achieving the purpose or purposes specified in the order
appointing the administrator) in accordance with any directions of the Court; and
at any time after such a proposal has been so approved, in accordance with the
proposal as from time to time revised and with any directions of the Court.
The administrator shall summon a meeting of the creditors of the company if he is

requested to do so in writing by one tenth in value of the creditors; or if he is
directed to do so by the court.
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5.5 Companies Liquidation Account
As provided by section 396 of the Companies Act, an account called the Companies
Liquidation Account shall be kept by the Registrar with a bank approved by the
Minister in charge of the subject of Finance.
Whenever the balance standing to the credit of the Companies Liquidation Account
is in the opinion of the Registrar in excess of the amount required for the time being
to meet claims as specified in the Act, the Registrar shall notify the Deputy Secretary
to the Treasury of the excess and shall pay to him, to such account as he may direct,
the whole or any part of that excess which he may require.
The Deputy Secretary to the Treasury may invest the sums paid to him or any part
of such sum in government securities, to be held to the credit of the Companies
Liquidation Account. When any part of the money paid to the Deputy Secretary in
this regard is in the opinion of the Registrar required to meet any claim as specified
by the Act, the Registrar shall give notice of that requirement to the Deputy
Secretary to the Treasury who shall repay the amount required to the Registrar to
the credit of the Companies Liquidation Account.
It is noted that the dividends on investments made under this section shall be paid
into the Companies Liquidation Account.
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 The winding up of a company is the process upon which the operations of a

CHAPTER ROUNDUP
company are brought to a close.
 The three methods in which to wind up a company are – a winding up by court; a

voluntary winding up; or a winding up subject to the supervision of court.
 Section 270 of the Companies Act sets out the circumstances upon which a company
may be wound up by court.
 Section 271 of the Companies Act specifies as to when a company is deemed unable
to pay its debts.
 A procedure for the winding up of a company is set out in the Company Winding Up
Rules of 1939
 On hearing a winding up application the court has the power to – make an order in
accordance with section 273; stay or restrain any actions or proceedings pending
against the company in any court; prevent the disposition of the property of the
company.
 Until the hearing of the application to wind up the company the court may appoint
a provisional liquidator. Subsequent to the winding up order being issued, a
liquidator may be appointed.
 A voluntary winding up may commence on the grounds set out in section 319 and
such a winding up may be a shareholders’ voluntary winding up or a creditors’
voluntary winding up.
 To qualify for a shareholders’ winding up a declaration of solvency is required from

the board of directors.
 Through a petition made under section 351 an application can be made for the
winding up of a company subject to the supervision of court.
 An official receiver for the purposes of a winding up of a company by the court

means the official receiver attached to the court for insolvency purposes.
 A liquidator refers to an officer that is specially appointed to wind up the affairs of

a company.
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 The powers of the liquidator are set out in section 292 of the Companies Act.
 An administrator is appointed with regard to the lead up to, or to avoid liquidation

proceedings.
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PROGRESS TEST
1 New Foundland Enterprises (Pvt) Ltd (NF) is a company which was incorporated in
the year 2008 and has been involved in the business of importing and selling
automobiles. However due to the recent fluctuations in the automobile industry, NF
has been facing grave financial problems and in this context the shareholders and
creditors of the company are concerned about the company’s ability to meet its
liabilities. All parties concerned are considering winding up the company.
In this context, the parties concerned have forwarded the following queries to be
addressed in relation to the winding up of a company.
a) Explain as to what is meant by winding up a company.
b) List the types of winding up available for a company.
b) Outline the key difference between a voluntary winding up and a compulsory

winding up.
2 In the event that that New Foundland Enterprises (Pvt) Ltd is to be wound up, the
parties have raised a further query in relation to the appointment of a liquidator. In
this regard, the following question has been forwarded.
Outline the powers of a liquidator as provided by the Companies Act No. 07 of 2007.
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1 a) The process upon which the operations of a company are ceased is referred
to as a winding up. A winding up should

 balance out the interests of the several stakeholders of the company;
 dispose the assets of the company;
 settle the debts of the company;
 distribute any remaining surplus between shareholders.
b) i) Winding up by court
ii) Voluntary winding up
iii) Winding up subject to the supervision of court
c) A compulsory winding up does not necessarily involve action to be taken by

an organ of the company itself. However a voluntary winding up requires
action to be taken from an organ of the company.
2 Section 292 of the Companies Act provides that the liquidator in a winding up by
the court shall have power, with the sanction either of the court or of the committee
of inspection:
a) to bring /defend any action or other legal proceeding in the name and on behalf
of the company;
b) to carry on the business of the company so far as may be necessary for the
beneficial winding up of such company;
c) to appoint an attorney-at-law to assist him in the performance of his duties;
d) to pay any classes of creditors in full;
e) to make any compromise or arrangement (within limitations) with creditors or

else person claiming to be creditors to having or alleging themselves to have any
claim;
f) to compromise
(i) all calls and liabilities to calls, debts, and liabilities capable of resulting in
debts and all claims between the company and a contributory (or alleged
contributory or other debtor or person apprehending liability to the
company) and
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(ii) all questions in any way relating to or affecting the assets or the winding up
of the company on such terms as may be agreed and take any security for the
discharge of any such call, debt, liability or claim and give a complete
discharge in respect thereof.
The liquidator in a winding up by the court shall have power;
a) to sell the movable and immovable property and things in action of the company
by public auction or private contract, with power to transfer the same to any
person or company or to sell the same in parcels;
b) to do all acts and to execute in the name and on behalf of the company, all deeds,
receipts, and other documents and for that purpose to use when necessary, the
seal of the company, if any;
c) to prove, rank and claim in the bankruptcy, insolvency or sequestration of any

contributory for any balance against his estate, and to receive dividends in
respect thereof;
d) to draw, accept, make and endorse any bills of exchange or promissory note or
like instruments in the name and on behalf of the company;
e) to raise on the security of the assets of the company any money required ;
f) to take out in his official name (with limitation) letters of administration to any
deceased contributory, and to do in his official name any other act necessary for
obtaining payment of any money due from a contributory or his estate which
cannot be conveniently done in the name of the company;
g) to appoint an agent to do any business on behalf of such liquidator;
h) to do all such other things as may be necessary for winding up the affairs of the
company and distributing its assets.
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07
CHAPTER
Securities Regime
in Sri Lanka
INTRODUCTION
In this chapter we will discuss the provisions relevant to the
regulation of the trading of securities in Sri Lanka. Emphasis will be
placed on the regulatory bodies existent for this purpose and certain
specific aspects of the regulations in place within the regime.
Knowledge Component
Securities Regime in Sri Lanka
7.1 Security trading process, 7.1.1 Explain the roles of the Securities and Exchange Commission, the Colombo
regulation and insider Stock Exchange and the Central Depository System.
dealing 7.1.2 Explain transfer of listed securities via CSE.
7.1.3 Explain “off the floor transactions”.
7.1.4 Explain “insider dealing” and relevant information.
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LEARNING
1 The purpose of securities regulation
2 The Securities and Exchange Commission 7.1.1
3 The Colombo Stock Exchange 7.1.1, 7.1.2, 7.1.3
4 The Central Depository System 7.1.1, 7.1.2, 7.1.3
5 Insider trading 7.1.4
1 The Purpose of Securities Regulation

Statutory regulation of securities reflects the perception of the state about the need
to protect the ordinary investing public from exposure to risks of fraudulent and
manipulative practices on the security exchanges and also to provide for a fair and
honest market.
1.1 What are Securities?

Statute provides that “Securities” shall mean debentures, stocks, shares, funds,
bonds, derivatives inclusive of futures and options, whatever the nature of the
underlying asset relied on or notes issued, or proposed to be issued, by any
government or of any body, whether corporate or unincorporated, including any
rights, options or interests (whether described as units or otherwise) therein or in
respect thereof or any other instruments commonly known as securities, but does
not include bills of exchange or promissory notes or certificate of deposits issued
by a bank.
Securities have no intrinsic value and are created by companies for little or no cost.
The price that is set for a security depends on the rights that such a security will
represent. In the case of shares, the right is a claim to a portion of the future profits
of the company. Therefore a security is a representation of a stake in the company
which in turns creates rights in relation to that company.
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The price of the securities in question is a pivotal aspect in relation to the operation
of such securities and it is in relation to this price that attention is drawn in
securities regulation. The price of the share depends on how investors value the
future prospects of the company and this generally depends upon the investor’s
knowledge and expectation. However it is fundamental that it is the management of
the company is possessed with better knowledge regarding the future prospects of
the company than the investors. The wrongful use of this knowledge therefore can
be used for the purpose of market manipulation.
1.2 Why Regulate?
Market manipulation will destroy confidence in the country’s stock market and will
lead to a reduction in the amount of financial capital available to fuel the economy.
Securities regulation is therefore directed towards the prevention of abusive stock
market practices and to allow for informed rational investment decisions.
The objective of securities regulation is therefore ;
(a) To help the stock market operate more efficiently in order that it can contribute
to the increase in the overall wealth of the society;
(b) To discourage dishonesty and encourage those who adopt or wish to adopt high
standards to do so;
(c) To encourage honest traders to realise that they do not need to adopt dishonest
practices to compete with the dishonest, by punishing such practices;
(d) To aim to promote professional competence and integrity among personnel in

the securities market.
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2 The Securities and Exchange Commission
The Securities and Exchange Commission is established by the Securities and

Exchange Commission of Sri Lanka Act No. 36 of 1987 as amended by Act No. 26 of
1991, Act No. 18 of 2003 and Act No. 47 of 2009. The key aspects of the Commission
are set out in this chapter.
The Securities and Exchange Commission (SEC) is a body corporate having

perpetual succession which may sue and be sued in its own name. The primary
purpose of the SEC can be identified as the regulation of the securities market. The
SEC Act also sets out provisions in relation to the granting of licences to stock
exchanges, unit trusts, stock brokers and stock dealers who trade in securities, as
well as provisions in relation to the creation of a compensation fund.
2.1 Composition of the SEC
The SEC shall consist of the following persons
(a) A Deputy Governor of the Central Bank nominated by the Governor of the
Central Bank;
(b) The Deputy Secretary to the Treasury;
(c) The Registrar of Companies;
(d) The President of the Institute of Chartered Accountants; and
(e) Six persons drawn from the private sector possessing professional expertise,
wide experience and proven competency in the fields of law, finance, banking
and business.
The Minister shall nominate, from amongst the members of the Commission, one
member to be the Chairman of the Commission.
A member of the SEC shall, unless he vacates office earlier by death, resignation or
removal, hold office for a term of three years and shall be eligible for reappointment.
The members may however be removed at any time by the Minister and such
removal is unquestionable in any Court.
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A member ,without leave of the Commission fails to attend three consecutive
meetings of the Commission is deemed to have vacated his office. In this event or in
the event of vacation of office through death, registration or removal, the Minister
may appoint another to hold office for the unexpired term of office of the vacated
member.
2.2 Objectives, Powers, Duties and Functions of the SEC
As specified in section 12 of the Act, the objectives of the SEC shall be –
(a) the creation and maintenance of a market in which securities can be issued and
traded in an orderly and fair manner;
(b) the protection of the interests of investors;
(c) the operation of a compensation fund to protect investors from financial loss
arising as a result of any licensed stock broker or licensed stock dealer being
found incapable of meeting his contractual obligations; and
(d) the regulation of the securities market and to ensure that professional standards
are maintained.
Section 13 sets out the following as the powers, duties and functions of the SEC –
(a) Grant a license to a body corporate to operate as a stock exchange and ensure
the proper conduct of its business;
(b) Grant a license to any person to operate as a stock broker or a stock dealer and
ensure the proper conduct of their business;
(c) Grant a license to a managing company to operate a unit trust and to ensure the
proper conduct of the business of such unit trust;
(d) Grant a certificate of registration to any person to carry on business as a market

intermediary and to ensure the proper conduct of such business;
(e) Give general or specific directions to a licensed stock exchange or a licensed

stock broker or a licensed stock dealer or a licensed managing company or a
trustee of a unit trust or a registered market intermediary, from time to time;
(f) Issue general or specific directives to listed public companies from time to time.
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(g) Grant compensation to any investor who suffers pecuniary loss arising as a
result of any licensed stock broker or licensed stock dealer being found
incapable of meeting his contractual obligations;
(h) Advise the government on the development of the securities market;
(i) Employ such officers and servants as may be necessary for the purpose of
carrying out the work of the Commission;
(j) Regulate the listing and issue of securities in a licensed stock exchange;
(k) Direct a licensed stock exchange to reject any application made to it for listing;
(l) Cancel or suspend the listing of any securities or the trading of any listed
securities or to suspend the trading of all listed securities for not more than
three days at a time, for the protection of investors;
(m) Inquire and conduct investigations into any activity of a licensed stock
exchange, a licensed stock broker or licensed stock dealer, a licensed managing
company or a trustee of a unit trust, a registered market intermediary or any
listed public company;
(n) Publish findings of malfeasance by any licensed stock broker or licensed stock
dealer or a licensed managing company or a trustee of a unit trust, or a
registered market intermediary or any listed public company;
(o) Implement the policies and programmes of the Government with respect to the
market in securities;
(p) Acquire in any manner whatsoever and hold, take or give on lease or hire,
mortgage, pledge, sell or otherwise dispose of any immovable or movable
property;
(q) Request the Registrar of Companies, in the exercise of the powers conferred on
it by section 227 of the Companies Act, No. 17 of 1982, to call upon a private
limited liability company to become a public limited company;
(r) Regulate take-overs or mergers where they were between one or more listed
companies or at least one of the parties involved with the listed public
company;
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(s) Conduct investigations into any alleged violation or contravention of the
provisions of the Act or any rule or regulation made thereunder by any person;
(t) Do all such other acts as may be incidental or conducive to, the attainment of
the objects of the Commission or the exercise of its powers under the Act.
Section 14 and section 53 also provide powers to the SEC in respect of inspections
and rule making respectively (as specifically set out in the relevant sections).
Furthermore section 23A provides that the SEC can take over the administration
and management of a stock exchange where the public interest requires it.
The SEC is also vested with the authority to prevent fraudulent practices and has a
distinct role to play in that regard as well.
Therefore the SEC is vested with the duty to ensure that the stock market operates
efficiently, professional competence is promoted among personnel in the securities
market and that fraudulent and dishonest practices are revealed and deterrent
sanctions imposed for the prevention of the same. Furthermore the overarching
protection of investors and ensuring market stability are paramount themes that
echo throughout the Act.
3 The Colombo Stock Exchange
Constituted as a company limited by guarantee, The Colombo Stock Exchange (CSE)

is responsible for the orderly and fair conduct of the stock market and also provides
the necessary facilities for the raising of capital by companies. This section
examines the role and duties of the CSE.
A stock exchange is a market in which shares of publicly held companies are issued
and traded either through exchanges or over-the-counter transactions. Also known
as the equity market, the stock exchange/market is one of the most vital
components of a free-market economy, as it provides companies with access to
capital in exchange for giving investors a slice of ownership in the company.
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The members of the CSE are the stock broker companies who operate on the trading
floor. The board of directors of the CSE is the policy-making body and the
management of the CSE is headed by a Director General assisted by a Deputy
General Manager, an Assistant General Manager, and seven Departmental
Managers. The exchange also has a full-time consultant/advisor on its staff.
In its day-to day activities, the CSE follows the CSE Rules which comprise of the
following:
 Stockbroker Rules
 Listing Rules
 Automated Trading Rules & Regulations
 Central Depository System Rules
 Capital Reorganisation
 CSE Circulars
 SEC Directives
3.1 Role of the CSE
The Rules and Regulations of the CSE expressly set out that that CSE is first and
foremost a market place for trading in the securities of listed companies. The Rules
set out and explain the requirements which apply to applicants for listing, the
manner in which in which any proposed marketing of securities is to be conducted
and the continuing obligations of listed companies. The Rules also seek to:
- secure the confidence of investors in the conduct of the market;
- ensure that all trading of securities are conducted on a fair and open basis,
allowing the public access wherever appropriate; and
- ensure that investors are treated with proper consideration at all times by
company boards even though the public may only represent a minority of the
shareholders.
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The Rules further prescribe that all companies admitted to the Official List are by
virtue of their admission and/or payment of fees are bound thereafter by the Rules
of The Colombo Stock Exchange. In this regard uniform application of regulation is
ensured and the interests of investors safeguarded.
3.2 Listing Rules
Section 1 of the Listing Rules provides that an applicant for a listing of securities is
required to forward to the CSE a listing undertaking as set out in Appendix 1A to
those Rules, which constitute a binding contract between the applicant and the CSE.
It is noted that the Listing Rules create obligations, which are additional and
complementary to statutory obligations. An applicant entity should in the first
instance, list its shares prior to applying for a listing of other class of shares.
Section 2 sets specific requirements in relation to the listing of shares and

debentures and it is important that investors comply with the same.
3.3 Purchase, sale, etc. of Listed Securities
Section 28 of the Securities and Exchange Commission Act specifies that no person
holding securities in a public company listed in a licensed stock exchange shall
without the prior approval of the SEC, buy, sell, gift or otherwise deal in such
securities except in compliance with the trading procedure adopted by such
licensed stock exchange. Certain transactions of this nature are discussed in the
subsequent sections.
3.3.1 Off the Floor Transactions
Transactions of securities off of the trading floor of the stock exchange are referred
to as an “off the floor transaction”. Such transactions have to be made in conformity
with the provisions of the aforementioned section 28, or the said transactions will
not be valid.
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4 The Central Depository System
Incorporated in 1991, the Central Depository System (CDS) is a private limited

liability company wholly owned by the Colombo Stock Exchange. The CDS is
managed by the Clearing and Settlement Division of the Stock Exchange. This
section briefly examines the role and function of the CDS.
The Central Depository System is the depository for all securities listed on the
Colombo Stock Exchange. The CDS facilitates the post trade fund settlement in
respect of equity and debt transactions. The CDS is registered with the Securities
and Exchange Commission as a 'market intermediary’ and is also a member of the
Asia-Pacific Central Securities Depository Group.
The same board of directors of the Colombo Stock Exchange serve as the directors
of the Central Depository Systems (Pvt.) Ltd. In relation to participation however,
twenty one member firms of the Colombo Stock Exchange who are licensed by the
Securities and Exchange Commission of Sri Lanka are “direct participants”, while
fifteen licensed commercial banks are “indirect participants”.
4.1 Functions of the CDS
The principal function of the CDS is to act as depository, namely to hold securities
in trust on behalf of shareholders of listed companies. In this regard the CDS
functions as a safe keeper of listed securities.
Furthermore the CDS is noted to have paved the path for scrip-less trading (trading
without having to resort to physical documentation) and has totally eliminated the
hazards that are commonplace with manual documentation. The CDS also facilitates
electronic record keeping and the automated clearing of shares (wherein buyers
can obtain title to purchased shares on the trade day itself).
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4.2 Services Offered by the CDS
The following services are offered by the CDS:

(a) Opening of client accounts
(b) Deposit of shares
(c) Withdrawal of shares
(d) Transfer of shares
(e) Settlement
(f) Rights and share splits
(g) Share repurchases
(h) Entitlements
(i) Takeovers & mergers
(j) Monthly statements
(k) Record keeping
(l) Transmissions and nominations
Furthermore the CDS also provides monthly statements to all active CDS account
holders on a monthly, quarterly and annual basis (as applicable); transaction
listings; and entitlement schedules to listed companies.
4.2 Transfer of Securities
4.2.1 Dematerialisation (Deposit) of Securities
Dematerialization is the process of converting the physical share certificates of an

investor to an equivalent number of securities in electronic form and credited in the
investors securities account in the CDS.
In this regard, share certificates are first handed over to the relevant participant
from the respective client. The participant will thereafter deliver the share
certificate to the CDS for dematerialisation. The CDS will make an electronic record
of the shares in the respective account holder’s account subsequent to which share
certificates are sent to the relevant company secretary for verification. Subsequent
to verification, the shares will be available for trading.
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4.2.2 Intra Account Transfer
An intra account transfer occurs when an account holder wishes to change the
account holder’s participant/broker. Account holders are able to transfer securities
held through one participant to another, however the beneficial ownership of such
securities will not change as a result of this type of transfer.
4.2.3 Inter Account Transfer
On the other hand, when the securities held by an account holder are transferred to
another account holder, outside the trading procedure in the CSE, it is called an inter
account transfer. To effect an inter account transfer prior written approval of the
Securities & Exchange Commission is needed and presently a stamp duty is payable
for such transfers.
4.2.4 Other Forms of Transfer
In addition to the aforementioned methods and the standard transfer of listed

securities through the Colombo Stock Exchange through buying and selling by
traders, the following methods are also observed in the CDS –
(a) Account holders may gift shares to their relatives. Herein, approval from the
Securities and Exchange Commission is required and government stamp duty is
applicable.
(b) In the event of the death of an account holder shares can be transferred to the
legal heirs. Government stamp duty is applicable.
(c) In the event of nomination, shares can be transferred to the nominees upon
death of the nominator. Government stamp duty is applicable.
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5 Insider Trading
The offence of insider trading/dealing is a controversial aspect of the law due to the
fact that arguments arise both for and against the maintenance of the offence by the
stakeholders in the securities market. It remains however an offence and therefore
merits attention as a significant corporate fraud or malpractice that is perpetuated
in the securities market.
5.1 What is Insider Trading?
Although no accepted definition exists in relation to “insider trading”, it is

commonly understood to mean the unfair trade of securities to which an “insider”
has non-public information which provides an unfair advantage.
Insider trading revolves around the ability that a trader gains to obtain
considerable short term profit by trading on shares prior to the release of
information to which only parties with inside information on the operations of the
company will possess. Therefore an unfair advantage is provided to such traders at
the expense of other traders who are not privy to such information.
However it is noted that the usage of information has to be at a moment prior to

such information entering the public domain. Subsequent to the information
entering the public domain, trading on such information does not amount to the
offence of insider trading.
For the purposes of securities regulation, preventing insider trading enhances

investor confidence in the securities market by creating a more level playing field
between investors. Therefore the regulation of insider trading is a vital component
to these regulations.
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5.2 Regulation of Insider Trading
The provisions relating to the regulation of insider trading are found in section 32
of the Securities and Exchange Commission Act where it is set out that an individual
who is, or at any time during the preceding six months has been knowingly
connected with a company, shall not trade in listed securities of that company if he
has information which,
a) he holds by virtue of being connected with the company;
b) it would be reasonable to expect a person so connected and in the position by
virtue of which he is so connected, not to disclose except for the proper
performance of the functions attaching to that position; and
c) he can reasonably be expected to know is unpublished price sensitive
information in relation to those securities.
It is noted that section 32 extends similar qualifications on,

a) an individual trading with other companies involved in transactions with the
connected company;
b) an individual trading with information obtained from individuals connected
with the company;
c) an individual making a takeover a bid on the company;
d) an individual who has obtained information regarding a takeover bid of the
company;
e) an individual from the aforementioned list who seeks to act through another
party;
above subjects however to the exceptions as expressly set out in the section.
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Furthermore section 33 sets out restrictions on the abuse of information obtained
in an official capacity.
For the purpose of the aforementioned, section 34 provides that an individual “is
connected with a company” if,
a) he is a director of that company or a related company; or
b) he occupies a position as an officer or employee of that company or a related

company or a position involving a professional or business relationship
between himself and the first company or a related company; or
c) he has access to information in relation to listed securities, which he knows, is

unpublished price sensitive information and which it would be reasonable to
expect him not to disclose except in the course of performing his duties.
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CHAPTER ROUNDUP
 Securities regulation is directed towards the prevention of abusive stock market

practices and to allow for informed rational investment decisions.
 The Securities and Exchange Commission is established by the Securities and

Exchange Commission of Sri Lanka Act No. 36 of 1987 as amended by Act No. 26 of
1991, Act No. 18 of 2003 and Act No. 47 of 2009.
 The primary purpose of the SEC can be identified as the regulation of the securities
market.
 The objectives of the SEC are specified in section 12 of the Act while section 13 sets
out the powers duties and functions of the SEC.
 The Colombo Stock Exchange is a company limited by guarantee and is responsible

for the orderly and fair conduct of the stock market
 The CSE is a market place for trading in the securities of listed companies and is
governed by the CSE Rules.
 All parties admitted to the Official List are by virtue of their admission and/or
payments of the fees are bound thereafter by the Rules of the CSE.
 Transactions of securities off the floor of the trading floor of the stock exchange are
referred to as an “off the floor transaction” and have to conform to section 28 of the
Securities and Exchange Commission Act.
 The Central Depository System is the depository for all securities listed on the
Colombo Stock Exchange.
 The functions of the CDS and the role the CDS plays in the transfer of securities are
to be noted.
 Insider trading is taken to mean the unfair trade of securities to which an “insider”
has non-public information which provides an unfair advantage.
 Section 32 and 33 of the Securities and Exchange Commission Act set out the
regulations that are imposed against insider trading.
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PROGRESS TEST
1 Explain the roles played by the Securities and Exchange Commission, the Colombo
Stock Exchange and the Central Depository System.
2 Mr. Fernando is a director of several public listed companies trading in the Colombo
Stock Exchange. As such he is privy to confidential information that is not freely
available to the public in relation to these companies. It is also noted that several of
these companies are market competitors.
Recently Mr. Fernando has brokered a trade between two of the companies in which
he is a director which would amount to the merger of the two companies, which are
incidentally the holders of the largest market share in the textile industry in Sri
Lanka.
Mr. Fernando has recently informed his family members to invest heavily in the two
companies as he says that he has a “good feeling that it would be an investment
which will reap much reward.” However his brother has informed him that if he is
making this suggestion based on “inside information”, it would be an offence under
the law.
In these circumstances, Mr. Fernando requests you to:
Explain to him what is meant by “insider trading” and the manner in which it is
regulated.
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1 Securities and Exchange Commission

 Granting of licences to stock exchanges, unit trusts, stock brokers and stock
dealers.
 Section 12 of the Act sets out the objectives of the SEC as:
o The creation and maintenance of a market in which securities can be issued

and traded in an orderly and fair manner;
o The protection of the interest of investors;
o The operation of a compensation fund to protect investors from financial

loss arising as a result of any licensed stock broker or licensed stock dealer
being found incapable of meeting his contractual obligations; and
o The regulation of the securities market and to ensure that professional

standards are maintained in such markets.
 Section 13 of the Act sets out the powers, duties and functions of the SEC.
 The SEC has a duty to ensure that the stock market operates efficiently;
professional competence is promoted among personnel in the securities
market; and that fraudulent and dishonest practices are revealed and deterrent
sanctions imposed for the prevention of the same.
The Colombo Stock Exchange
 Provide a market place for trading in the securities of listed companies.
 Secure the confidence of investors in the conduct of the market.
 Ensure that all trading of securities are conducted on a fair and open basis,
allowing the public access wherever appropriate.
 Ensure that investors are treated with proper consideration at all times by
company boards even though the public may only represent a minority of the
shareholders.
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Central Depository System
 Facilitate the post trade fund settlement in respect of equity and debt
transactions
 Hold securities in trust on behalf of shareholders of listed companies, namely to

function as a safe keeper of listed securities.
 Facilitate scrip-less trading.
 Facilitate electronic record keeping and the automated clearing of shares.
2 No proper definition exists in relation to insider trading. However,
 The unfair trade of securities to which an “insider” has non-public information

which provides an unfair advantage is often referred to as insider trading.
 Revolves around the ability that a trader gains to obtain considerable short term
profit by trading on shares prior to the release of information to which only
parties with inside information on the operations of the company will possess.
Regulation:
 An individual who is, or at any time during the preceding six months has been
knowingly connected with a company, shall not trade in listed securities of that
company if he has information which,
a) he holds by virtue of being connected with the company;
b) it would be reasonable to expect a person so connected and in the position

by virtue of which he is so connected, not to disclose except for the proper
performance of the functions attaching to that position; and
c) he can reasonably be expected to know is unpublished price sensitive

information in relation to those securities.
It is noted that section 32 and 33 extend the aforementioned restrictions to broader

categories of persons and information to which Mr. Fernando and his relatives may
qualify.
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08
CHAPTER
Alternate Dispute
Resolution
INTRODUCTION
This chapter focuses on the systems in place for the resolution of disputes
outside of the formal court structure of the legal system. It is an area of
growing importance globally and therefore attention will be concentrated
on the three primary models in use for the settlement of disputes in this
manner.
Knowledge Component
Alternate Dispute Resolution
8.1 Mediation 8.1.1 Explain the Process of mediation.
8.1.2 Explain the role of the Mediation Board.
8.1.3 Explain the role of the Commercial Mediation Board.
8.2 Conciliation 8.2.1 Explain the process of conciliation.
8.2.2 Explain the role of the Debt Conciliation Board.
8.3 Arbitration 8.3.1 Identify “arbitrability” disputes.
8.3.2 Explain the process of arbitration.
8.3.3 Explain the role of the Arbitral Tribunal.
8.3.4 Explain enforcement of the Arbitral Award.
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KB3 | Chapter 8: Alternate Dispute Resolution
LEARNING
1 The need for alternate dispute resolution
2 Mediation 8.1.1, 8.1.2, 8.1.3
3 Conciliation 8.2.1, 8.2.2
4 Arbitration 8.3.1, 8.3.2, 8.3.3,
8.3.4
1 The Need for Alternate Dispute Resolution
In a commercial context, time is money. The faster a commercial dispute is settled,

the better. In these circumstances a growing need for a more expedient, efficient
and cost effective method for dispute resolution than the formal court structure has
been a pressing need. Alternate dispute resolution seeks to fulfil this need.
1.1 The Growing Demand for Alternate Dispute Resolution

Alternate Dispute Resolution (ADR) is the process adopted for the resolution of
disputes that does not involve the formal court structure of a legal system.
Adjudication by a court is costly, time consuming, subject to legal and procedural

technicalities and the court may lack technical expertise in certain matters.
Furthermore litigation may be perilous, uncertain, time consuming and costly –
aspects that are gravely prejudicial to the interests of commerce. Litigation also
tends to revolve around the dictates of lawyers who have limited interest in
reducing the time and cost involved with lawsuits.
These problems are only enhanced in jurisdictions such as Sri Lanka where laws
delays are commonplace which not only prevent the litigant from being provided
with an expedient solution, but also escalate the already high cost of the whole
process.
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ADR seeks to serve as a substitute for lawsuits in taking the adjudication process
out of the hands of judges and lawyers, and provide potential litigants with a more
expedient, cost effective and hands-on mechanism in order to resolve disputes. ADR
operates on the presumption that at times, the parties themselves are in the best
position to know the strengths and weaknesses of the respective positions and
therefore a more practical solution can be reached by providing those parties with
a greater role in the adjudication process.
1.2 Advantages of ADR
The advantages sought to be obtained by ADR are as follows:
i) Expedient adjudication of disputes.

ii) Adjudication at a lower cost.
iii) Involvement of sector specific personnel to adjudicate on disputes which
will lead to more informed and reasonable resolution of disputes.
iv) Resolution of disputes without the involvement of judges and lawyers.
v) Less focus on legal technicalities and more focus on the actual dispute.
vi) More involvement by the parties to the dispute encourages a more amicable
resolution of the dispute.
vii) Greater level of confidentiality (depending on the process adopted by the
parties).
viii) The adjudication body only has to focus on one dispute and not on multiple
disputes as found in a court of law, which allows a more focused decision.
ix) More flexible procedure which allows the parties to circumvent unnecessary
documentation, evidence, etc. and allows more stringent time limits to be
imposed on presentation of arguments.
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2 Mediation
More focused on the “settlement” of disputes, mediation provides the parties the
opportunity to reach a solution to a dispute with the aid of an independent third
party. The salient features of mediation are discussed below.
2.1 General Characteristics of Mediation
Mediation is a process by which parties at dispute engage the assistance of a

neutral third party to act as a mediator, or in other words as a facilitating
intermediary. It is a non-binding mechanism of dispute resolution without the
involvement of a court room drama.
A mediator has no authority to make any binding decisions, but uses various
procedures, techniques and skills to help the parties resolve their disputes by
negotiating an agreement without adjudication. The mediator may also be called
upon by the parties themselves to provide a non-binding evaluation of the merits of
the dispute, but here also he cannot make any binding adjudicatory decisions. A
mediator also usually points out to the parties the probable consequences of failure
to mediate and if litigation or arbitration is to follow.
The mediator is appointed by the parties and the process/procedure to be followed

is usually at the discretion of the mediator and the parties themselves. Usual
practice dictates that the parties forward to each other and to the mediator a
summary of the key facts and issues on which the dispute revolves and thereafter
the parties meet with the mediator to resolve the dispute.
2.2 Mediation Boards Act No. 72 of 1988
No formal mediation process was available in the Sri Lankan legal system until
given the pressing need, the Mediation Board Act was passed in the 1988. According
to the Act when the value of a claim is less that Rs. 25,000/- it is mandatory that
mediation is resorted to first since court action is permitted only in the event such
mediation fails. If the mediation is unsuccessful, a non-settlement certificate is
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issued by the Mediation Board. It is only subsequent to the non-settlement

certificate having been issued that a party to the dispute can resort to a court action.
Under the Act, once the application for mediation has been lodged with a mediation
panel, the procedure can be summarised as follows.
A matter can come to mediation in one of four ways:
1. Voluntary referral – subject to a number of exceptions, parties can voluntarily

refer a dispute to a mediation panel. The exceptions include where one of the
disputants is the state; where the dispute relates to the recovery of any
property, money or other dues on behalf of the state; or where the Attorney
General has instituted proceedings for any offence.
2. Mandatory referral (civil matters) – as aforementioned, there is mandatory

referral to mediation for civil disputes relating to property, debt, damage or
demand not exceeding 25,000 rupees. There are a number of exceptions to this
category, for example matrimonial disputes which may be dealt with in the
Family Court conciliation procedures and fundamental rights applications to the
Supreme Court.
3. Mandatory referral (criminal matters) – there is mandatory referral to

mediation for criminal offences specifically set out in the Act. These include
property offences, assault, trespass and defamation.
4. Court referral – any court may refer a dispute to a mediation panel with the
consent of the parties.
In each of the above cases, the mediation panel refers the matter to a mediation
board, which comprises three mediators from the panel. The board will then decide
if any interested third parties (other than the disputants) should attend the
mediation, and will send the disputants and all nominated parties a notification of
the mediation. Legal representatives may not attend the mediation. Neither the
disputants nor other interested parties can be compelled to attend the mediation.
If however if a disputant does not appear at the mediation, the certificate of non-
settlement subsequently issued by the board will state the name of the party who
did not attend the mediation.
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2.3 Commercial Mediation
A more specialised form of mediation has now been introduced in Sri Lanka in the
form of the Commercial Mediation Centre. The principle focus of introducing a
specialised forum of this nature is to deal with business disputes in a commercially
sensible manner which will lead to increased confidence among investors – both
local and foreign, in the legal system and the economy of Sri Lanka.
The Centre was established through the Commercial Mediation Centre of Sri Lanka
Act No. 44 of 2000. Essentially the Act provides for the establishment of the centre,
its structure, functions and powers. Under section 3 of the Act, the functions of the
centre are:
(a) to promote the wider acceptance of mediation and conciliation for the
resolution and settlement of commercial disputes;
(b) to encourage parties to resolve commercial disputes by mediation and

conciliation;
(c) to conduct, and facilitate the conduct of proceedings for -
i) the settlement of commercial disputes.
ii) the adjustment of differences arising between parties in commercial

matters by mediation and conciliation.
The process adopted in this regard is voluntary on the part of the parties to the
dispute and leaves out the involvement of lawyers.
2.4 Companies Disputes Board
Part XX of the Companies Act provides for the establishment of a Companies

Disputes Board for the purposes of mediating disputes arising in giving effect to the
provisions of the Companies Act or disputes which relate to the affairs or
management of any company.
The Companies Disputes Board consists of not less than three and not more than
five persons appointed by the Minister. Such persons should possess substantial
experience in relation to the law relating to companies or the administration of
companies. One of these members will be appointed as the President of the Board.
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Disputes may be referred to the Board by the parties to the dispute (with the
approval of the President of the Board); or by Court, with the consent of all parties
to a proceeding before the Court. When the parties to a dispute or proceeding
referred to mediation before the Board agree to settle that dispute, the settlement
agreement shall be recorded in writing and signed by the parties and by the
member of the Board who acted as mediator and a certified copy of the settlement
agreement shall be filed in the Court. This settlement agreement shall have effect as
if it were a judgment of the court. Where however the parties to a dispute referred
to mediation before the Board do not agree to settle that dispute within three
months of the reference to mediation, or within any extended period agreed to by
all those parties, the member of the Board shall forthwith give notice to the parties
and (if the matter was referred to mediation by the court) to the court that the
mediation has not resulted in a settlement.
3 Conciliation
Conciliation is a similar form of dispute resolution to that of mediation. The

principle difference being that the mediator who consults the parties separately has
to draw up terms which the mediator considers to be fair in order to make the
parties solve the dispute. Separate consultations are not a feature of conciliation. It
however remains a tool utilised in the settlement of disputes outside of the formal
process of litigation and therefore merits attention.
3.1 Key Features of Conciliation
Conciliation is a process where the parties to a dispute nominate a neutral third

party called a “conciliator” to assist the parties reach an agreement. Conciliation is
consensual and utilises a non-binding adjudication process which does not involve
a court of law.
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A conciliator will actively participate in a discussion with the disputants and

contribute to the discussion between them by listening and analysing the views and
positions taken by each party and in turn expressing the conciliator’s views on the
same. Therefore conciliation takes the form of a “round table settlement
negotiation”.
The principal advantage in conciliation is the active participation taken in the

resolution process by the parties to the dispute, with the guidance of the conciliator.
However it is important to note that conciliation does not derive any form of judicial
power and therefore cannot make any direction that is binding in nature. Therefore
the resolution of the dispute and the adherence to the same is entirely in the hands
of the parties to the dispute, and given the fact that the parties are already in
disagreement, success of this process can have limitations.
It cannot be stated that conciliation is actively adopted in Sri Lanka as limited

legislation has been introduced in this regard.
3.2 Debt Conciliation Board
Legislation has however been adopted in the form of the Debt Conciliation
Ordinance No. 39 of 1941 which has the objective of introducing relief measures to
save from indebtedness the people who are indebted on unsecured loans (obtained
on documents such as promissory notes, cheques etc.) or secured loans (obtained
on conditional transfers or mortgages of immovable property such as land, paddy
fields, plantations or housing property). In addition the Debt Conciliation Board is
authorized to intervene in respect of loans obtained on the basis of a transfer deed
executed exclusively for a loan transaction and to assist in arriving at a settlement
in respect of immovable property subject to mortgage or conditional transfer, in
conditions acceptable both to the debtor and the creditor.
The Debt Conciliation Board consists of five members, appointed by the Minister
one of whom shall be nominated by the Minister to be Chairman of the Board. The
Chairman of the Board shall be
a) a person who holds or has held a substantive appointment as a Judge of the

Court of Appeal or as a District Judge; or
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b) a person who is or has been a member of the Class I of the Sri Lanka
Administrative Service and who holds or has held office as a District Judge; or
c) an Attorney-at-Law of not less than fifteen years standing.
Of the four remaining members of the Board, at least one shall be a person engaged
in trade or commerce in Sri Lanka.
The Chairman and every other member of the Board shall hold office for a period of
three years from the date of appointment.
As aforementioned, the proceedings before the settlement arrived at between the

parties is not an agreement imposed by the Board, but one arrived at voluntarily by
the parties. However, the Board has the power to reduce the unreasonable rates of
interest charged, or in case of failure on the part of the parties to accept the
suggestions made by the Board, to issue a certificate under the Act to the debtors.
Further, if the creditors fail to appear before the Board at the final hearing in
response to the notice issued, an expert hearing is held after which a certificate is
issued to the debtor.
4 Arbitration
The most formal model of the ADR methods, arbitration is an increasingly popular
option opted for by parties to a dispute. As such the inclusion of arbitration clauses
is increasingly witnessed in commercial agreements and therefore the
methodology upon which arbitrations operate is important to be aware of.
Arbitration is a well-established and widely used form of ADR which provides

parties to a dispute with a choice to select an impartial person (known as an
arbitrator) or tribunal (known as the arbitral tribunal); agree in advance to comply
with the arbitrator's award; and then participate in a hearing at which both sides
can present evidence and testimony. The arbitrator's decision is usually final, and
courts rarely re-examine it. Therefore a notable feature of arbitration is the fact that
a binding decision is reached at the conclusion of the proceedings – a feature which
sets this form of ADR apart from the likes of mediation and conciliation.
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In Sri Lanka, arbitrations are governed by the Arbitration Act No. 11 of 1995. This
Act has been heavily influenced by the United Nations Commission on International
Trade Law (commonly referred to as “UNCITRAL”) Model Law on Arbitration and
the Swedish Law on International Commercial Arbitration. It is noted that the Act
provides as follows:
a) A valid agreement for arbitration prevents any party from taking the dispute
before a court of law. In effect therefore an arbitration clause is a bar to
litigation.
b) Arbitral awards are final and a court of law has no jurisdiction to interfere in the
merits of the award. A court can only be set aside an award only on the limited
grounds which have been set out in the Act.
It remains however that arbitration is a form of ADR which must be voluntarily

opted for by the parties, either once the dispute arises, or in the form of an
arbitration clause incorporated into a commercial agreement from which the
dispute arises.
4.1 The Arbitration Clause

An arbitration clause is a clause contained in a contract – usually a commercial
agreement, wherein the parties to the contract expressly agree that in the event a
dispute arises out of that contract, the parties will refer such dispute to be resolved
through arbitration. In the presence of an arbitration clause, as aforementioned, a
court of law is barred from hearing such a dispute.
Typically an arbitration clause sets out the procedure that is to be followed in

setting up the arbitration tribunal. Namely, the number of arbitrators; the language
in which the arbitration is to be conducted; the relevant law upon which the
arbitration will be adjudicated; the procedure to be followed in conducting the
arbitration (subject to the provisions of the Act); and the venue of the arbitration
are generally set out. In this manner party autonomy is safe guarded and the
intentions of the parties are given prime place.
Furthermore it has been stressed that an arbitration clause must drafted in such a
manner to refer any dispute arising from or out of or in connection with the
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contract in question so that disputes that are referred to arbitration are disputes
arising in relation to the contractual relationship between the parties, and not any
other disputes.
4.1.1 Example: Arbitration Clause
The following is an example of an arbitration clause that can be found in a standard

commercial agreement:
Dispute Settlement
In the event of a question, dispute, controversy or difference relating to this

Agreement, a party to that question, dispute, controversy or difference shall be
entitled to serve a notice invoking this clause and making a reference of such matter(s)
to a sole arbitrator. If the parties to the dispute cannot agree as to the appointment
of the sole arbitrator, within 30 (thirty) days of receipt of the notice of the party
making the reference, then each disputing party shall appoint one arbitrator and the
arbitrators so appointed shall jointly appoint an arbitrator as the presiding
arbitrator. The arbitration proceedings shall be held in the English language and
governed by Sri Lankan law.
4.2 Process of Arbitration
4.2.1 Appointment of Arbitrators
Once a dispute is referred to arbitration, the first step to be taken is for the arbitral
tribunal to be constituted. The parties are free to determine the number of
arbitrators, but if it is an even number, then the arbitrators so appointed must
jointly appoint an additional arbitrator to act as the chairman. Where the parties
have not determined the number of arbitrators to be appointed, the Act provides
that the number of arbitrators shall be three. Usually the procedure upon which the
arbitrators are appointed is pre-determined by the parties, but in the event that
such a procedure has not been set out or the agreed procedure fails, the High Court
can make the appointment as specified in the Act.
It is noted that an arbitrator nominated by a party to the dispute need not

necessarily be an attorney-at-law or a judge or any other party connected with the
legal profession. Instead the arbitrator could be a personality experienced in the
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relevant sector in relation to which the dispute has arisen. Therefore the process of
arbitration allows more practical and informed decisions to be made in relation to
disputes as opposed to the legal centric decisions made in a court of law.
4.2.2 Settlement
It is not beyond the power of an arbitrator to encourage a settlement between the

parties or with the consent of the parties to resort to mediation, conciliation or any
other procedure to encourage a settlement. However, it is important that in the
event that the dispute referred to arbitration is settled, such settlement must be
recorded as an award for the purposes of enforcement.
Case Law: A formal award on agreed terms to a settlement has to be prepared

and signed by an arbitrator
In the course of arbitration the parties to the dispute arrived at a settlement in

terms of the Act. The agreement was recorded and signed by the parties and the
arbitrator. However, subsequent thereto, no arbitral award was made in terms of
the Act, nor was a copy of such award made and signed by the arbitrator delivered
to the parties as required by the Act. Thereafter one of the parties sought to
enforce the settlement before the High Court. However the High Court refused to
do so, on the basis that the proper procedure had not been followed.
The Supreme Court agreed with the finding of the High Court and held that,
The document containing the settlement did not qualify as an “award” in

terms of the law. A formal award on agreed terms should have been
prepared and signed by the arbitrator in terms of the Act and a copy thereof
should have been delivered to the other party. The mere recording of the
agreement was unenforceable in terms of the Act.
Lanka Orix Leasing Company Ltd v Pinto and Others (2002) 1 SLR 115
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4.2.3 Hearing
As aforementioned, the procedure upon which the hearing of the arbitration is to

be conducted can be agreed on between the parties (subject to the provisions of the
Act). The Act does however provide that arbitrators must hear the dispute in an
impartial, practical and expeditious manner and must afford all parties an
opportunity to present their respective cases and of examining all documents and
other material furnished by the other party or by any other person.
During the process of hearing the parties, evidence will be allowed to be led in
support of the respective position taken by a party. The Act provides that unless
agreed upon by the parties, evidence before the arbitral tribunal may be given
orally, in writing or by affidavit. However it is important to note that for the
purposes of expedient resolution of the dispute, unlike a court of law, the arbitral
tribunal is not bound by the provisions of the Evidence Ordinance. It is left to the
arbitral tribunal to determine the admissibility, relevance and weight to be given to
any evidence that is led by the parties.
It is noted that, subject to the agreement of the parties, a party to an arbitration may
appear before the tribunal either personally; or if a body corporate or not corporate
then by an officer, employee or agent of that body; or through an attorney-at-law.
Therefore arbitration at times runs the risk of being dragged into the same formal
process of a court room and defeating the intended purpose of ADR.
Subsequent to providing the parties to the dispute with a reasonable opportunity

to forward the respective position of each party and evidence in support of the
same, the arbitral tribunal will make a ruling on the dispute in the form of an
“arbitral award”.
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4.3 Arbitral Award
The final decision reached by the arbitrators in relation to a dispute referred to the
respective panel is known as the arbitral award. Such award must be made in
writing and must be signed by the arbitrators. Unless the parties agree otherwise
or unless it is an agreed award, reasons upon which the decision has been reached
have to be set out in the award.
It is reiterated that a factor that sets arbitration apart from the likes of mediation
and conciliation is that the arbitral award is final and binding on the parties to the
dispute.
4.4 Enforcement of the Arbitral Award
For the enforcement of an arbitral award an application must be made to the High
Court within one year after the expiry of fourteen days of the making of the award.
Thereafter (subject to the provisions regarding the setting aside of the award), the
High Court shall, on a day notified to the parties proceed to file the award and give
judgement in accordance with that award. Subsequent to a judgement so given, a
decree shall be entered which shall be enforceable like any other decree of a civil
action.
It is noted however that an award can be set aside by the High Court (on limited
grounds) on an application made within sixty days on the grounds as set out in the
Act.
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Case Law: The High Court has no power on its own decision to set aside an
arbitral award
Subsequent to an arbitrator having delivered the arbitral award, one of the

parties applied to the High Court to enforce the same. The other party objected to
the application on the basis that the award was contrary to public policy (as set
out in the Act). In response it was argued that the said objection had not been
raised earlier and in fact had been taken up for the first time in the written
submissions of the parties.
The Supreme Court upheld this argument and held that –
The High Court has no power ex mere motu (on its own decision) to set aside
the award on the ground stated in the Act in the absence of material
supporting such a finding being contained in the application.
Southern Group Civil Construction (Pvt) Ltd v Ocean Lanka Pvt Ltd (2002) 1
SLR 190
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CHAPTER ROUNDUP
 Alternate Dispute Resolution (ADR) is the process of resolving a dispute without

the involvement of a court of law.
 The advantages of ADR as set out in section 1.2 must be noted – in particular the
benefits of ADR providing a more expedient resolution of disputes at a lower cost.
 Mediation is a process by which parties at dispute engage the assistance of a neutral

third party to function as a facilitating intermediary.
 A mediator has no authority to make any binding decisions, but uses various
procedures, techniques and skills to help the parties resolve their disputes by
negotiating an agreement without adjudication.
 The mediator is appointed by the parties and the process/procedure to be followed

is usually at the discretion of the mediator and the parties themselves.
 According to the Mediation Boards Act when the value of a claim is less that Rs.
25,000/- it is mandatory that mediation is resorted to first since court action is
permitted only in the event such mediation fails. A certificate of non-settlement is
issued in the event of such a failure.
 A more specialised form of mediation has now been introduced in Sri Lanka in the
form of the Commercial Mediation Centre.
 Conciliation is a process where the parties to a dispute nominate a neutral third

party to assist the parties reach an agreement.
 A special form of conciliation was introduced through the Debt Conciliation Board
with a principal focus on persons indebted on unsecured or secured loans.
 Arbitration is the most formal format of ADR where parties appoint an impartial
arbitrator or arbitral tribunal to come to a binding decision on the matter in dispute.
 An arbitration clause sets out the procedure that is to be followed in setting up the
arbitral tribunal.
 The final decision reached by the arbitrators in relation to a dispute referred to the
respective panel is known as the arbitral award.
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 An arbitral award must be enforced or set aside (in limited circumstances) by an

application made to the High Court.
 Arbitration is a unique form of ADR as it provides a binding decision to the dispute.
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PROGRESS TEST
1. Silva & Sons (Pvt) Ltd. (S) is a company involved in the manufacture of textiles. S
obtains the services of Textiles Are Us Ltd. (T) for the production of materials
under a supplier contract. The supplier contract between S and T contains the
following clause:
“Dispute Resolution
In the event of a dispute arising between the parties to this agreement in relation to
this agreement, the parties agree that such dispute will be resolved through
arbitration conducted under Sri Lankan Law.”
Recently S has been undergoing financial difficulties and has been unable to pay T
the payment due for the previous five stocks delivered. In these circumstances, T
seeks to institute legal action against S for the recovery of the money due to T.
Advise the parties in relation to the following:
i) Identify the nature of the clause highlighted above.
ii) Outline the probability of success that T may have in commencing

litigation against the S.
2. Outline the key differences between Mediation, Conciliation and Arbitration.
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1. i) A clause of this nature will be identified as an arbitration clause. It gives rise

to an obligation to resolve any dispute that may arise through the process of
arbitration and thereby give effect to party autonomy.
ii) In all likelihood any attempt to litigate on the part of T will fail because -
 In the presence of an arbitration clause, submitting a dispute to resolution
through arbitration is mandatory.
 An arbitration clause operates as a bar to litigation.
 Therefore a court of law will in all probability refuse to hear the dispute
since both parties have opted to resolve any disputes that may arise out of
the agreement through a special procedure which has been pre-
determined at the time of entering into the contract.
 The principle of party autonomy respects the freedom of the parties to
contract in any manner as they wish, therefore a wish to resolve disputes
without the use of the formal court system must be respected.
 In such circumstances an attempt to institute legal proceedings in a court
of law may not be successful.
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2.
Mediation Conciliation Arbitration

1. Adjudicated by a  Adjudicated by  Adjudicated by
mediator a conciliator an arbitrator or
an arbitral
tribunal
2. Seeks to  Seeks to assist  Hears both
negotiate a parties to arrive parties and
settlement at a mutual reaches a
agreement finding in the
form of an
award
3. Cannot make  Cannot make  Decisions are
binding decisions binding binding
decisions
4. Does not usually  Does not  Lawyers are
involve lawyers usually involve allowed to
lawyers participate
5. No formal  No formal  Formal
procedure is procedure is procedure as
generally set out usually set out decided by the
parties or as set
out in the Act
6. Mandatory if the  No such  Mandatory if an
claim is less than requirement arbitration
Rs. 25,000/- clause is
present
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References
 Cabral, H. (2007) Companies Act No. 7 of 2007 and the Corporate Law of Sri
Lanka
 Cabral, H. (2011) Duties of Company Directors & Corporate Governance in

Sri Lanka
 Davies, P. and Worthington S. (2012) Gower and Davies’ Principles of

Modern Company Law (9th Edition) Sweet and Maxwell
 Neelakandan, K. (2013) New Companies Act Simplified (2nd Edition)
 Pennington, R.R. (2001) Pennington’s Company Law (8th Edition) LexisNexis

UK
 The Companies Act No. 07 of 2007
 Wickramanayake, A.R. (2007) Company Law in Sri Lanka (1st Edition )
 http://www.investopedia.com/terms/s/stockmarket.asp
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Index
A M
Administrator 125 Major transactions 62
Annual General Meeting 90 Mediation
Annual return 101 - Mediation Board 156
Arbitration - Commercial Mediation 158
- Arbitration clause 162 - Companies Disputes Board 158
- Arbitral award 166
Articles of Association 31 O
Official receiver 120
C Oppression and mismanagement 60
Central Depository System 142
Code of Best Practice on 24 P
Corporate Governance 77 Perpetual succession 7
Colombo Stock Exchange 139 Pre-incorporation contracts 35
Committee of inspection 124 Private Limited Company 25
Companies Limited by Guarantee 26 Promoter 29
Companies Liquidation Account 127 Provisional liquidator 116
Company auditor 80 Public Limited Company 23
Company secretary 78
Conciliation S
- Debt Conciliation Board 160 Securities 134
Corporate veil (veil of incorporation) Securities and Exchange Commission
12 136
Shareholders resolution in writing
D 96
Debentures 48 Shares
Debt capital 56 - Ordinary shares 47
Derivative actions 60 - Preference shares 47
Directors - Deferred shares 48
- Executive directors 71 - Non-voting shares 48
- Non-executive directors 71 - Redeemable shares 48
Solvency test 52
E Special resolution 96
Equity capital 57 Sri Lanka Accounting Standards 81
Extraordinary General Meeting 92
U
I Ultra vires doctrine 32
Indoor management rule 37 Unlimited Companies 25
Insider trading 145
W
L Winding up
Legal personality 7 - Winding up by court 113
Limited liability 7 - Voluntary winding up 117
Liquidator 120
- Winding up subject to the
supervision of court 119
Winding up rules 115
176
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CA SRI LANKA CURRICULUM 2015

National Library and Documentation Services Board – Cataloguing-In-Publication Data

Business Taxation and Law: Part B – Business Law – Colombo:

The Institute of Chartered Accountants of Sri Lanka

The copyright in this publication is owned by

All rights reserved. No part of this publication may be

The contents of this book are intended as a guide and

Every effort has been made to contact the copyright

We are grateful to BPP Learning Media Ltd for

ii KB3 Business Taxation and Law – Part B

KB3 Business Taxation and Law

KB 3 Business Taxation and Law

Main Syllabus Area Weighting

iv KB3 Business Taxation and Law – Part B

Examples These are illustrations of particular techniques or concepts with a

Case Law Law formulated through a legal case.

vi KB3 Business Taxation and Law – Part B

1 Features of a Company and Organisational Personality

Knowledge Knowledge Knowledge Chapter

Knowledge Knowledge Knowledge Chapter

viii KB3 Business Taxation and Law – Part B

Knowledge Knowledge Knowledge Chapter

x KB3 Business Taxation and Law – Part B

7 Securities Regime in Sri Lanka

xii KB3 Business Taxation and Law – Part B

8.2 Conciliation Conceptual Comprehension 8.2.1 Explain the process of conciliation. 8

8.3 Arbitration Conceptual Remember/ 8.3.1 Identify “arbitrability” disputes. 8

Learning Outcomes xiii

Knowledge Process Verb List Verb Definitions

Tier-1 Remember Define Describe exactly the nature, scope

Relate To establish logical or causal

xiv KB3 Business Taxation and Law – Part B

Tier-3 Application Apply Put to practical use

Graph Represent by means of a graph

Prepare Make ready for a particular

Solve To find a solution through

Action Verbs Checklist

Tier – 5 Evaluate Advise Offer suggestions about the best

Evaluate To determine the significance by

Tier – 6 Synthesis Compile Produce by assembling information

xvi KB3 Business Taxation and Law – Part B

1 The Law Governing Companies in Sri Lanka

1.1 The Companies Act No. 07 of 2007

 The Companies Act No. 17 of 1982, as amended by the Companies

1.2 Features of the Companies Act No.07 of 2007

Incorporation of a company made convenient

Single shareholder companies

Simplified internal operating procedures

It also dispenses with certain administrative and reporting requirements for

Simplified formal procedures

2.1 Definition of a Company

A company can be generally defined as an independent legal entity established by

2.2 General Characteristics of a Company

Year Company Current Field Sources

578 Kongō Gumi Japan Construction

717 Koman Japan Hotel

718 Hoshi Ryokan Japan Hotel

803 Stiftskeller St. Peter Austria Restaurant

862 Staffelter Hof Germany Wine

885 Tanaka-Iga Japan Religious goods

A list of some of the oldest companies of the world

Separate Legal Personality