Reduction of Share Capital: Analysis

Introduction:-

”Conservation of capital is one of the main purposes of Company Law.”[1]

The share capital of a company is the only security on which the creditors rely. Any reduction of share capital, therefore, diminishes the fund out of which they are to be paid. For these specific reasons the companies limited by shares are not allowed to reduce the capital. But sometimes there may be some genuine reasons for the reduction of share capital[2].The process of decreasing a company’s shareholder equity through share cancellations and share repurchases. The reduction of capital is done by companies for numerous reasons including increasing shareholder value and producing a more efficient capital structure[3]. The need of reducing capital may arise in various circumstances, for example, accumulated business losses, assets of reduced or doubtful value, etc. As a result, the original capital may either have become lost or a company may find that it has more resources that it can profitably employ. In either of these cases, the need may arise to adjust the relation between capital and assets[4].

Reasons for Capital Reduction:-

The need for reducing the capital may arise on account of various reasons like to distribute assets to shareholders, to remedy deficit, to reduce the basis for taxes, make up for trading losses, heavy capital expenses, etc. Also, sometimes companies may have more capital resources and reserves than they can profitably employ, giving rise to the need to readjust the relation between capital and assets by reduction of capital. When a company has been making losses, the financial position does not present a true and fair view of the state of the affairs of the company[5]. The assets are overvalued, and assets side of the balance sheet consists of fictitious assets with debit balance in profit and loss account. Such situation does not depict what a real net worth ought to be. In short, the company is over capitalized. Such a situation brings the need for reconstruction[6]. Here, scheme of reduction will be to write-off that portion of capital which is already lost and to make balance sheet healthy. Reconstruction is a process by which affairs of a company are reorganized by revaluation of the assets, reassessment of liabilities and by writing off the losses already suffered by reducing the paid up of shares and or varying rights attached to the Reduction of share capital different classes of shares. The object of the reconstruction is usually to recognize capital or to compound with creditors or to effect economies. Such a process is called as Internal Reconstruction which is carried out without liquidating the Company. The aforesaid comprise is an agreement between a company and its members and outside liabilities when the company faces financial problems. Such arrangement involves sacrifice from shareholders or creditors or by all. Accounting effect of the scheme along with other is detailed below[7]. However, there may be external reconstruction which is altogether different and involves liquidation of the Company. The most common reasons why a company may want to reduce its capital are:

  1. To increase or to create distributable reserves to enable future dividends to be paid to shareholders
  2. To return surplus capital to shareholders
  3. To facilitate a share buyback or redemption of shares, or
  4. As part of a scheme of arrangement

Comparative Analysis:-

Before going to the comparative analysis it is very much necessary to know the bare provision which prescribes the Reduction of Share Capital. Reduction of Share Capital was given under Section 100 of Companies Act, 1956 earlier. But after the amendment it is now given under Section 66 of Companies Act, 2013 and was notifies on 1-04-2014.

The 2013 Act gives cognisance to one of the amendments made in the listing agreement by SEBI. A new clause 24(i) was inserted to the listing agreement which provided that a scheme of amalgamation or merger or reconstruction, should comply with the  requirements of section 211(3C) of the 1956 Act. A similar requirement has been introduced in section 66 of 2013 Act, which states that no application for reduction of share capital shall be sanctioned by the Tribunal unless the accounting treatment, proposed by the company for such a reduction is in conformity with the accounting standards specified in section 133 or any other provision of the 2013 Act and a certificate to that effect by the company™s auditor has been filed with the Tribunal. Further, the 2013 Act clarifies that no such reduction shall be made if the company is in arrears in repayment of any deposits  accepted by it, either before or after the commencement of the 2013 Act, or the interest payable thereon[8].

There are few new provisions in the new Act of 2013 which are given below:-

  • Penalty has been increased in the new Act.
  • No reduction of capital is allowed in the company in the arrear of payment deposits.
  • Provisions for notice by the Tribunal to Central Government, Registrar, SEBI and Creditors are now included in the new Act.
  • Tribunals order is to be filed within 30 days with the Registrar and mandatory published, as against the discretionary power of the tribunal in Companies Act, 1956 to order publication.

Penalty Clause:-

New penalty clause has been inserted in the 2013 Act. The amount of penalty has also been increased. The tribunal is now giving penalty more and more for the incompliance with the clause 3 of the Section 66. The amount of penalty may vary from Re. 5lakhs to Re. 25lakhs. Now also any officer will be liable under Section 447( Fraud) if he knowingly conceals the name of the any creditor or misrepresents the nature or amount of the debt or claim[9].

Notice of the Tribunal:-

The tribunal after the commencement of the new act is under the duty to notify the central government, Registrar, SEBI and the Creditors about the reduction in Share Capital. This new provision adds on to the just provision for the creditors.

Time Limit for the Filling:-

Now according to the new Act the tribunal’s order must be filled with the Registrar. Then Secondly the order must be mandatorily Published. These two new small provisions are the breaks on the discretionary power of the tribunal given under Companies Act, 1956.

Procedure for Reduction of Share Capital:-

After passing the special resolution for the reduction of capital, the company has to apply to the tribunal by way of petition to confirm the special resolution under section 66 of the Companies Act. The creditors are entitled to object where the proposed reduction of share capital involves either:

1. the diminution of liability in respect of unpaid capital

2. the payment to any share holder of any paid-up share cap[ital, or in any other case, if the tribunal no direct[10]

To enable the creditors the tribunal settles a list of such people. If any creditor objects, either his consent to the proposed reduction should be obtained or he should be paid off or  his payment secured. However the tribunal may dispense with the consent of a creditor on the company securing payment of the debt or claim by appropriating the full amount or that fixed by the tribunal[11].

  1. 1.      Special Resolution

This is the first and main requirement for the reduction of share capital. Unless a special resolution, as authorised by the articles, is passed for reduction of the share capital, a company cannot effect share reduction.

  1. 2.      Court Sanction

Next step for the Reduction of Share Capital is to secure the sanction of the Tribunal for reduction. Before confirming the reduction the Tribunal shall be satisfied that the

  • consent of the creditors to the reduction has been obtained or
  • the creditors have been discharged or
  • their debts or claims have been discharged or settled or secured.

(The ˜creditor™ for this purpose means a person who has a debt or any claim against the company of such a nature as would have been provable in winding up.)

  • As per section 102, the Court has first to be satisfied that the creditors who had objected to the reduction that either their consent to the reduction has been obtained or their debts or claims have been discharged or settled or secured.
  • If the company does not admit or provide the full amount of debt or the amount is contingent or not ascertainable then the Court has the right to fix the amount.
  • Under the special circumstances and if the Court thinks it proper then it has the power to dispense with the provisions of securing the debts of the creditors as mentioned above.
  • In other cases the creditors can object only with the consent of the Tribunal.
  1. 3.      Court confirming reduction and power on making such order

The Court may direct the company that the words “and reduced” be added to the Company™s name for a specified period, and that the Company must publish the reasons for reduction of share capital and also the causes which led to it, with a view to giving proper information to the public.

  1. Registration & Minute of Reduction
  • As per section 103(4) minutes with a copy of the order has to be registered with the Registrar of the Companies and according to that Registrar of Companies will issue Certificate under his hand or authenticated by his seal.
  • Once the minutes get registered it shall be deemed to be substituted for the corresponding part of the memorandum of the company, and shall be valid and alterable as if had been originally contained therein. The substitution of any such minute as aforesaid for part of the memorandum of the company shall be deemed to be an alteration of the memorandum within the meaning and for the purpose of section 40.
  1. 5.      Liability of Members and Penalty
  • On the reduction of share capital, the extent of liability of any past or present member on any call or contribution shall not exceed the difference between the amount paid on the share, or the reduced amount, if any, which is to be deemed to have been paid thereon, by the member, and the amount of the shares fixed by the scheme of reduction.
  • If, however any creditor entitled to object to the reduction of share capital is not entered in the list of creditors by reason of his ignorance of the proceedings for reduction and after the reduction, the company is unable to pay his debt or claim then every person who was member at the time of the registration of the order and minutes of the reduction will be liable to contribute for the payment of the debt of the creditor.
  • If any officer of the company, who conceals the name of the creditor or misrepresents the nature of the debt or claim of the creditor who is entitled to object to the reduction of the share capital as per the provisions of section 105[12].

Case Study:-

The researcher has taken up two different cases with different fact sheet and also time frame for the study. The first case is Tamil Nadu Newsprint and papers Ltd. v. Registrar of Companies[13] and the second case is OCL India Ltd. In Re[14].

In the first case the Madras High Court allowed the company to reduce its capital which was found to be in excess of its needs by permitting it to pay the same partly in cash and partly in the form of non-convertible debentures. The brief facts are as follows:

The company’s original issued and paid up share capital was Rs. 987,18,00,000 consisting of 9,81, 80,000 equity shares of Rs. 10 each. The company by resolution passed at a general meeting, proposed to reduce the paid up[ capital to Rs. 50crores consisting of 5crores of equity shares of Rs. 10 each by paying off paid up capital to the extent of Rs. 48.18crores divided into 4,81,80,000 equity shares of Rs. 10 each to the shareholders proportionately as the same was in excess of the needs of the company. The payment was proposed to be made partly in cash and partly by issue of 1.75 percent non-convertible debentures. The majority of the creditors also approved the proposed reduction. On the application of the company to the court[15] and Madras High Court also approved the reduction accepting the contention of the company and said that the procedure followed by the company was correct and there was the consent of every creditor[16].

In the Second case the company sought to reduce the share capital on the basis of the special resolution passed on 29-09-1997 and also for approval of minutes. The company had issues on right basis to its shareholders 18lakhs zero convertible Debentures of Rs. 140 each along with detachable warrants to part finance the expansion and/or modernisation projects undertaken by the company. As per the terms of the ZCCD was to be converted into one ordinary share of Rs. 10 each at a premium of Rs. 1340 per share. Pursuant to the scheme 18lakhs ZCCDs were duly allotted and converted, but i9n the meantime the object of the company had already been completed and the expanded plant commenced commercial production. Apart from the amounts received from the IFCIL and amounts received on the ZCCDs, the company was able to meet and generate the balance funds required for the said project from the internal accruals. Therefore, the board of directors recommended to the shareholders that the share premium on the aforesaid shares b\e reduced from Rs. 130 to Rs. 95 per share4by extinguishing the liability for the payment of the third and final call of Rs. 35 per share of the amount to be received on  second call, a sum of Rs. 5 might be appropriated towards capital and the balance sum of Rs. 30 be appropriated towards share premium, thus making the share fully paid-up. The Orissa High Court while permitting the suggested reduction i9n the share capital has to decide the desired manner in which the share capital to be reduced.  The courts task is to see that the procedure by which the resolution is carried out is formally correct and that creditors are not prejudice.  It has the further the duty to satisfy itself that the scheme is fair or not.  first of all the creditors interest must be protected.  secondly the interest of share holders must be considered but here there is no opposition to the proposed scheme. Thirdly there is public interest also. Taking into consideration the court approved the reduction[17].

Conclusion:-

From the above analysis and the case studies given it is clear that Reduction of Share Capital is very important aspect of company. It is one of the mechanism by which the company reduces the share capital and thereby increases the value of shares or deducts the unnecessary shares. But it is very important to follow the correct procedure and the court [Tribunal] is very much strict about the procedure. The main object of the courts are to protect the interest of the creditors and the shareholders. The new provision in 2013 Act is very precise and very much to the point approach adapted by the legislature. As compared to 1956 Act provisions these provisions are more simple and given under one heading.

 

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About Deban Satyadarshi Nanda

Deban Satyadarshi Nanda | Student

I am third year Law student at Bhubaneswar, Odisha.

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