Reduction of Capital- Sec 100

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Priyanka (Querist)
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14 September 2009 Dear Experts,
Can nyone please provide the procedure for Reduction of capital under Sec 100 of the Co act 1956.

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Priyanka

SUBRAMANYA H

SUBRAMANYA H (Expert)
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16 September 2009 1
Reduction of Capital â€“ Issues, Concerns and Legal
Responses
â™£ Tushar Tarun
INTRODUCTION
While discussing Company Law, the term capital would be encountered at almost every
possible stage; every Company needs capital to run its business. Capital is the money,
assets, value of corporationâ€™s stock or corporate equity which is available with a company
and helps generate profit.1 Halsburyâ€™s Laws of England defines capital as share capital
which is different from the borrowed money.2
The issue to be dealt in this paper is Reduction of Capital. In laymanâ€™s language
Reduction of Capital is alteration of capital where the capital is reduced due to various
reasons. Interest of creditors and shareholders are attached to the reduction of capital,
therefore the legislator has made stringent provisions for the same, even though the
reduction of capital can be necessary for a corporation at times.3
ALTERATION OF CAPITAL
Companies, generally are not incorporated with inflated capital, this is because
certain fee needs to be paid for every document that is filed with the Registrar of
Companies according to the Schedule X of the Companies Act, 1956 (hereinafter
Companies Act).4 Thus, when a company needs extra capital, or needs to reduce the
capital it needs alteration in the capital clause. Alteration of Capital can be of two types;
â™£ Author is a 4th year student of National law school of India University, Bangalore.
1 Blackâ€™s Law Dictionary (8th ed. 2004), capital
2 Lord Hailsham of St. Marlyebone, Halsburyâ€™s Laws of England, 4th ed. Vol. 7(1) (Butterworths:
London, 1982) at 141
3 A. Ramaiya, Ramaiyaâ€™s Cumulative Supplement to Guide to The Companies Act, (Wadhwa and
Company Law Publishers: New Delhi, 2006) at 207
4 M. Singh, â€œAlteration of capital clauseâ€, (2003) 3 Comp Lj at 111
2
one which leads to Reduction of Capital and the other where the authorised capital does
not get reduced.5
Alteration of Capital which does not amount to Reduction of Capital
Alteration of capital clause, which would not lead to reduction, may be done in
following two ways6 â€“
1. Voluntary alteration under Section 94;7 and
2. Compulsory alteration under Section 94 A.
Voluntary Alteration
Section 94 of the Act, provides for various ways8 like issuing new shares,
consolidating or dividing all or any of its share capital into shares of larger among than its
existing shares, etc. similarly, Section 94 (2) states that an exercise of the powers
5 K. M. Ghosh et al., K. M. Ghosh & Dr. K. R. Chandratreâ€™s Company Law, 13th ed, vol 1,
(Bharat Law House: New Delhi, 2006) at 1699
6 Supra note 4 at 112
7 94. Power of limited company to alter its share capital.
(1) A limited company having a share capital, may, if so authorised by its articles, alter the
conditions of its memorandum as follows, that is to say, it may - (a) increase its share
capital by such amount as it thinks expedient by issuing new shares; (b) consolidate and
divide all or any of its share capital into shares of larger amount than its existing shares;
(c) convert all or any of its fully paid up shares into stock, and reconvert that stock into
fully paid up shares of any denomination; (d) sub-divide its shares, or any of them, into
shares of smaller amount than is fixed by the memorandum, so however, that in the subdivision
the proportion between the amount paid and the amount, if any, unpaid on each
reduced share shall be the same as it was in the case of the share from which the reduced
share is derived; (e) cancel shares which, at the date of the passing of the resolution in
that behalf, have not been taken or agreed to be taken by any person, and diminish the
amount of its share capital by the amount of the shares so cancelled.
(2) The powers conferred by this section shall be exercised by the company in general meeting
and shall not require to be confirmed by the Court.
(3) A cancellation of shares in pursuance of this section shall not be deemed to be a reduction of
share capital within the meaning of this Act.
8 (a) increase its share capital by such amount as it thinks expedient by issuing new shares; (b)
consolidate and divide all or any of its share capital into shares of larger amount than its
existing shares; (c) convert all or any of its fully paid up shares into stock, and reconvert
that stock into fully paid up shares of any denomination; (d) sub-divide its shares, or any
of them, into shares of smaller amount than is fixed by the memorandum, so however,
that in the sub-division the proportion between the amount paid and the amount, if any,
unpaid on each reduced share shall be the same as it was in the case of the share from
which the reduced share is derived; (e) cancel shares which, at the date of the passing of
the resolution in that behalf, have not been taken or agreed to be taken by any person,
and diminish the amount of its share capital by the amount of the shares so cancelled.
3
conferred by this section shall be in the general meeting and the same is not required to
be confirmed by the Tribunal.
In the case of In Re: Jai Hanuman Trading Co. (P) Ltd.9 it was said that the
power to issue shares in a limited purpose of enabling them to raise capital for the
company is to be exercised by the company in a bona fide manner so that the company
may benefit from the same. But in the case, when the company is in no need for extra
capital, then the directors are not allowed to increase the capital of the company merely
to have control over the affairs. It was also said that it is not the court which should go
into the fact that if the company needs extra capital or not, unless data or records
furnished states the contrary. In the case, where the issue is beyond the authorised
amount, a resolution can be passed by the general meeting subsequently ratifying the
same.10
Compulsory Alteration
Section 94A of the Companies Act states that the share capital of the company
shall stand increased by an amount equal of the value of the shares into which the
debentures or loans have been converted under an order of the Union Government
under Section 81 (4)11 of the Companies Act. The reason behind this provision is that
the government can have right and control, wherever necessary and desired to convert its
loans into a participating capital.12
9 (1962) 32 Comp Cas 201 (Punj).
10 White vs Bristol Aeroplane Co, [1953] 1 All E.R. 40
11 Further issue of capital
4. Notwithstanding anything contained in the foregoing provisions of this section, where any
debentures have been issued to, or loans have been obtained from, the Government by a
company, whether such debentures have been issued or loans have been obtained before
or after the commencement of the Companies (Amendment) Act, 1963, the Central
Government may, if in its opinion it is necessary in the public interest so to do, by order,
direct that such debentures or loans or any part thereof shall be converted into shares in
the company on such terms and conditions as appear to that Government to be
reasonable in the circumstances of the case, even if the terms of issue of such debentures
or the terms of such loans do not include a term providing for an option for such
conversion.
12 Finance Ministeâ€™s Speech, Lok Sabha Debates, 1963, vol XXV, pages 2002-2003 as cited from
A. Ramaiya, Guide to Companies Act, 14th ed., (Wadhwa & Co.: Nagpur, 1998) at 1002
4
REDUCTION OF CAPITAL
Reduction of Capital is a form of Alteration of Capital. Alteration of Capital
covered under Section 94, whereas Reduction of Capital is covered under Section 100 to
104 of the Companies Act. Reduction of capital is a mode, by mean of which the
company reduces its capital to either extinguish or reduce the liability on shares, cancel
any paid up share capital which is lost or is unrepresented or pay off paid up share capital
which is in excess of the wants of the company.
Need for Reduction of Capital
In practice reduction of capital has been used for various purposes. Few of these
are13 â€“
1. to distribute assets to shareholders;
2. to remedy deficit;
3. to write down or remove asset overvaluation;
4. to reduce the basis for taxes; and
5. or to buy out dissident shareholder group.
At times, these above said proper reasons for reduction of capital can also act as
a veil for the more objectionable reasons.14
Concerns regarding Reduction of Capital
The reduction of capital affects various groups of persons, these are -
Protection of Creditors
The management of capital is a domestic question but, in the event of reduction
the Court intervene in the decisions of the company.15 The reason for reduction of
capital being so strictly monitored is due to the fact that the creditors depend on the
13 Note â€œThe current law regarding reduction of capital: its methodology, purpose and dangersâ€,
110U.Pa.L.Rev.723 at 724
14 Id.
15 J. B. Lindon (ed.), Buckley on the Companies Act 13th edn. (Butterworths & Co. Ltd.: London,
1957) at 155. Subject to the confirmation by the court, which is required and which acts
as a safeguard to the minority shareholders, the question of reduction is a domestic one
for the decision of the majority.
5
share capital of the company to realise their claims. If the members of the company
arbitrarily decide to reduce the capital and then use the fund available to pay the creditor
of the company is reduced therefore affecting their interest, and as mentioned the
intervention of the Tribunal16 is to ensure that the reduction is equitable between all
stakeholders.17
Historically, the creditors did not have any special protection. Later on, the need
to protect their interest through statutory provision was felt and thus stringent statutory
regime was enforced. Over a period of time the law sought to strike a balance between
the need to protect the creditors and to preserve the autonomy that the corporations
enjoy.18
The reduction processes are different, and Section 101 come into operation
where the interest of the creditors is affected which is in cases (a)19 and (c)20 and in any
other case which the Tribunal directs due to its special circumstances. Since the creditors
donâ€™t have any prima facie right to object to the proposed reduction because no asset out
of which their claim is sought to be satisfied is being given up or returned thus the
creditors are statutorily not allowed to object. The object of reducing the capital where
the capital is lost or is unrepresented by the available assets is to reintroduce reality in the
accounts of the company and to get a realistic picture of the companyâ€™s status so as to
16 Tribunal as given in section 2(49A) of the Companies Act means the National Company Law
Tribunal
17 John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in G. Morse (ed.), Charlesworth
& Morse Company Law 15th edn. (Sweet and Maxwell: London, 1995) at 176.
18 O. R. Jr., â€œCorporations: Rights of Creditors in the Reduction of Capital Stockâ€, Virginia Law
Review, Vol.21, No.5 (Mar. 1935) at 562-568.
19 Every creditor of the company who at the date fixed. by the Tribunal is entitled to any debt or
claim which, if that date were the commencement of the winding up of the company,
would be admissible in proof against the company, shall be entitled to object to the
reduction
20 where a creditor entered on the list whose debt or claim is not discharged or has not
determined does not consent to the reduction, the Tribunal may, if it thinks fit, dispense
with the consent of that creditor, on the company securing payment of his debt or claim
by appropriating, as the Tribunal may direct, the following amount:-
i. if the company admits the full amount of the debt or claim, or, though not admitting it, is
willing to provide for it, then, the full amount of the debt or claim;
ii. if the company does not admit and is not willing to provide for the full amount of the debt or
claim, or if the amount is contingent or not ascertained, then, an amount fixed by the
Tribunal after the like inquiry and adjudication as if the company were being wound-up
by the Tribunal
6
enable the company to pay dividends.21 However, the words â€œin any other case if the
Tribunal so directsâ€ protects the possible case of they being injured.22
In the case where, the reduction is sought on ground of loss of capital, evidence
regarding the same need to be adduced and case need to be made out of it.23 In case the
capital is not permanently lost then the Tribunal has to ensure that the creditors are
sufficiently secure.24 Though the nature of such a security is in doubt,25 a sound position
would be that such a security need not be permanent but should be reasonable as to
safeguard the interest of the creditors through a reasonably near future. If the former will
put the creditors in a better position than they were before the reduction which is not the
intention of legislature. The Tribunal cannot protect persons transacting with the
company from reasonable business risk.
In case of reduction, the creditors object then their claim needs to be satisfied or
their claim needs to be secured.26 The Tribunal may dispense with this, if it is satisfied
that the company has sufficient cash and reserves to secure the creditors.27 The Tribunal
after satisfying itself that the creditors are not unfairly prejudiced can confirm the
reduction.28
21 Alexander Henderson Ltd. 1967 S.L.T (Notes) 17 as cited from C. M. Schmitthoff (ed.),
Palmerâ€™s Company Law 24th edn. (Stevens & Sons Ltd,: London, 1987) at 506.
22 For example in Re Marvalli High Speed Circular Knitting Machine where the actual loss was
much less than the reduction of capital of sought as cited from Supra note 15 at 162.
23 Supra note 15 at 153 - 154.
The position with respect to the requirement to adduce evidence of evidence is fairly settled after
the decision of Caldwell Co (Papermakers) Ltd v. Caldwell, 1916 1 S.L.T. 173, where the
court held that even if not necessary, at any rate it is prudent and wise to insist on
evidence of the loss. Earlier the reduction could be sanctioned with the slightest loss and
therefore it was felt that such an allegation should be supported by sufficient and
satisfactory evidence. as cited from Supra note 15 at 153 - 154
24John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17 at 180.
25 In Jupiter House Investments Ltd., [1985] 1 W.L.R. 975 it was held that the any such assets
recovered should be a part of the capital reserve and should not be available for
dividends. On the other hand in In Re Grosvenor Press Ltd., (1985) 1 B.C.C. 99412 it
was held that as a general rule such a reserve should not be set aside to indefinitely to
safeguard the interests of the creditors. Such permanent funds however can be set aside
in special circumstances.
26 The creditors in cases of application of section 101 as result will have to be notified about the
reduction, the court has to settle a list of creditors with the nature and amount of their
claims and given a chance to object.
27 John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17 at 180.
28 Paul L. Davies (ed.), Gower & Daviesâ€™ Principles of Modern Company Law 7th edn. (Sweet
and Maxwell: London, 2003 at 243.
7
Primarily, the intervention of the Tribunal seems to be a reasonable safeguard of
the interests of the creditors, the lacuna in this provision is that that the burden to prove
any irregularity lies on the creditor, who does not have all information at his disposal and
till such objection is raised the Tribunal does not get the jurisdiction to look into the
modalities of the reduction. The law presumes the bona fides of the reduction.29
Interest of the Shareholders
When the interests of the creditors are not involved, as the reduction does not
involve the decrease of any liability in respect of unpaid capital or the payment to any
shareholder of any paid up capital the Tribunal has to keep in mind the interest of the
shareholders and the members of the public who may be tempted to take shares of the
said the company.30 The interests of the shareholders during reduction are corresponding
to their interests in the event of winding up of the company.31
However it is interesting to note is that the Tribunal cannot refuse confirmation
of reduction on the grounds of â€œpublic policyâ€ and does not go into the motive of the
29 Supra note 18 at 562-568.
30 Supra note 28 at 244; see also A.J.Boyle (ed.), Gore Browne on Companies 44th edn., (Jordon
Publishing Ltd.: Bristol, 1986) at 15.005, The essential principle on which the interests of
the shareholder is decided is that similarly placed shareholders should be treated similarly
or the consent of such shareholders who are treated differently their consent should be
obtained. Also, the shareholders must be given all the information so as to enable them
to make an informed choice.
31 John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17 at 177. For
example, if preferential shareholders are not preferential with respect to share capital,
then the reduction will be borne rateably by both the preferential and ordinary
shareholders. On the other hand if they do then the reduction should normally be borne
by the ordinary share holders. And in the event that the capital is being returned, then
the shareholders who have a priority in the event of winding up will be returned first.
Prudential assurance Co. Ltd. vs Chatterley Whitfield Collieries Ltd [1949] AC 512. The inference
that needs to be gotten from the fact that the Act does not specify the manner in which
the reduction needs to be borne by the various shareholders is that loss is to borne or
money is to be returned in such a manner as under the constitution of the company loss
in respect of capital is to be borne, and if money is to be returned, it is in like manner as
capital is returable.
If the company does pass a resolution contrary to this equitable principle, the court will not
confirm such a resolution unless with the assent of every single shareholder who is
adversely affected by the resolution. In Re Union Plate Glass Co. (1889) L.R. 42 Ch.D.
513.
When the reduction is rateable between the ordinary and preference share holders, the resolution
cannot be challenged on the ground that the effect of such a reduction will be to
diminish the amount of future of dividends receivable by the latter. In Re Mackenzie &
Co., [1916] 2 Ch. 450.
8
reduction.32 The Tribunal is only concerned with the fact whether the reduction is
equitable and fair.33 Therefore if a company wants to reduce its capital with a motive to
escape nationalization or tax liability and the reduction is found to be equitable to the
interest of the various stakeholders then the Tribunal cannot refuse reduction solely on
the grounds that the motive of the reduction is not in consonance with the public
policy.34 But, one of the principle reasons why there is need for sanction reduction is to
safeguard the interests of the members of the public. But in the light of the above
decisions the commitment of the Tribunal or Tribunal to this seems rather weak and it
seems well established that the interests of the community at large is not covered while
confirming the reduction of capital.35 The interpretation of â€œpublic interestâ€ seems to be
restricted to the interests of the investing public and to the society at large as is generally
understood.36
Safeguards
Section 100 of the Companies Act deals with reduction of capital and plain
reading of the section lays down few guidelines to be followed. These guidelines are â€“
1. Only a Company limited by shared or a company limited by guarantee
having a share capital alone can reduce its share capital. The provision of
this section does not apply to unlimited companies having a share capital.
An unlimited company whenever registered, if approved by its article can
reduce its share capital by passing a special resolution.37 This is due to the
fact that in an unlimited company the capital clause appears in the
Articles of Association and not in the Memorandum of Association and
since the articles of association of a company is freely38 alterable by a
company, the company can reduce its share capital merely by passing a
special resolution. The reason for this difference between the unlimited
32 John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17 at 178.
33 Supra note 15 at 156.
34 David Bell Ltd., [1954] S.C. 33 as cited in John Avery & Co. Ltd., Petitioners (1890) 17 R 1101
as cited in Supra note 17 at 178.
35 A.J.Boyle (ed.), Gore Browne on Companies 44th edn., (Jordon Publishing Ltd.: Bristol, 1986)
at 15.004.
36 L. C. B. Gower, â€œCompaniesâ€™ Reduction of Capitalâ€, The Modern Law Review, Vol.14, No.3
(Jul. 1951), 330-333.
37 Supra note 2 at 168.
38 Section 31 of the Companies Actis worded positively and provides that â€œSubject to the
provisions of this Act and to the conditions contained in its memorandum, a company
may, by special resolution, alter its articlesâ€
9
company and the company limited by shares or a company limited by
guarantee having a share capital is that in the latter two cases, the liability
of the member of the company is restricted to the number of shares a
member owns in a company39 or to the extent of the guarantee40 and the
personal property of the members cannot be used in the event that the
assets of the company is not sufficient to pay off its debt, whereas, in an
unlimited company the liability of the members is unlimited and their
personal property can be attached to pay the liabilities of the company.41
2. A reduction should be authorized by its Articles of Association and if the
articles do not have this clause, then the Articles have to be subsequently
modified by a special resolution conferring that authority.42 Such a power
in the memorandum is not effective and it should be a specific power to
reduce. 43 The articles of Association jurisprudentially are contractual
documents between the company and its members. So unless the
members have an agreement to reduce the capital of the company at any
later pint of time, the company cannot unilaterally proceed with
overlooking the Articles and assuming to itself such a power.44
3. The decision should be passed by a special resolution. The notice of the
resolution should specify the amount of the reduction and any change in
the amount no matter how small will render the resolution void and the
Tribunal will lose its jurisdiction to confirm the reduction. However, a
minor error in the notice or the resolution can be ignored.45
4. Such a resolution has to be confirmed by the Tribunal, except where
reduction is affected by forfeiture of shares for the non payment of, or by
a surrender (made in circumstances which would justify forfeiture) and
where a company cancels its nominal shares which has not been taken by
any person.46 The purpose of this requirement is to ensure that the
39 Schedule I Table B Clause 4 & 5 of the Companies Act, 1956.
40 Schedule I Table C Clause 4 & 5 of the Companies Act, 1956.
41 Supra note 28 at 243
42 Supra note 28 at 242.
43 John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17, 174.
44 Supra note 28 at 243
45 Supra note 5 at 1699
46 If the company reduces its capital in any of the methods so mentioned then such an alteration
of capital has to be informed to the Registrar of Companies within the prescribes time
limit failing which the officer of the company who is in default is liable to be summarily
convicted. Supra note 2 at 168.
10
reduction safeguards the interests of the shareholders, creditors and the
public47 and the company does not alter its capital according to its.48 The
Tribunal cannot condone a reduction which has been carried out without
its prior approval, and retrospective approval of Tribunal cannot be
sought.49
The reduction process is so regulated is because the capital affects the creditors
and the members far more seriously than any other alteration and are imposed to assure
that the assets of the company are not released to the prejudice of the creditors or
between the various members of the company and therefore it would be unfair if a
company is allowed to escape its responsibility towards these classes.50
However certain transactions which though amount to reduction do not result in
a temporary or permanent loss of capital is allowed without the consent of the Tribunal
or Tribunal. That is because in these cases there is no real threat to the creditors. These
practices essentially include cancellation of unissued capital,51 forfeiture of shares or
surrender of shares,52 and any other kind of reduction.53
47 Supra note 28 at 243 - 244. See also John Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as
cited in Supra note 17 at 173.
48 Supra note 28 at 243 - 244.
49 Alexander Henderson Ltd. 1967 S.L.T (Notes) 17 as cited from Supra note 21 at 506.
50 These prohibitions initially were deduced from the earlier provisions of the Act by the court
but later they were specifically included in the statute. R. A. Pennington, Penningtonâ€™s
Company Law, 7th ed. (Butterworths: London, 1995) at 214 - 215.
It was held in In Re Exchange Banking Co., (1882) 21 Ch D 519 that, â€œThe creditor has no
debtor but that impalpable the corporation, which has no property except the assets of
the company. The creditor therefore gives credit to that capital, gives credit to the
company on the faith on the representation that the capital shall be applied only for the
purposes of the business and he has therefore the right o say that the corporation shall
keep its capital and not return it to its shareholder.â€ as cited from R. A. Pennington,
Penningtonâ€™s Company Law, 7th ed. (Butterworths: London, 1995) at 214 - 215.
51 Such cancellation is not covered by section 100 which related to the reduction of capital
requiring the consent of the Court. Such cancellation is covered by section 94 (1)(e)
which authorises the company to cancel shares which have not been or promised to be
taken up by any person and section 94 (3) which specifically mentions that a cancellation
of shares in pursuance of this section shall not be deemed to be a reduction of capital
within the meaning of this act. It can only be considered as a reduction within the
meaning of section 100 if it is combined with the reduction of issued capital. The same
position also prevails in English law. There is a distinction between the diminution of
capital and reduction of capital and cancellation of unissued shares falls within the
meaning of the former. Alexander Henderson Ltd. 1967 S.L.T (Notes) 17 as cited from
Supra note 21 at 506.
â€œThe company can reduce the amount of share capital available for issue and this does not
operate as reduction within the meaning of section 66 of the Companies Act, 1948.â€
11
Methods of Reduction
The Act does not specify the manner in which the reduction has to be effected.54
The section empowers the company to reduce the capital in any way55 and not
prejudicing this power lays down three ways in which the company can reduce its share
capital. They are56 -
1. Extinguish or reduce the liability on any if its shares in respect of share
capital not paid up;57
2. Either with or without extinguishing or reducing liability on any of its
shares, cancel any paid up share capital which is lost, or is unrepresented
by available assets;58
3. Either with or without extinguishing or reducing liability on any of its
shares, pay of any paid share capital which is in excess of the wants of the
company.59
Kenneth Smith & Denis Keenan, Company Law 5th ed. (Pitman Publishing: London,
1985), 87. See also supra note 12 at 869.
This is effected by an ordinary resolution and it does not need the confirmation of the court as
cancellation does not prevent the company from subsequently increasing its capital.
Supra note 50 at 216.
52 A company has the power to forfeit shares for the non payment of calls or instalments and also
to accept the voluntary surrender of shares. The shares are not cancelled by being
forfeited or surrendered but are merely in abeyance till they are re issued. The amount
received by a company on the re issue of forfeited or surrendered shares is not paid up
capital of the company except in so far as it is appropriated by agreement to pay calls or
instalmemts of the issue price which are owing but unpaid. Supra note 52 at 217.
53 For example a company may purchase its own shares. Alexander Henderson Ltd. 1967 S.L.T
(Notes) 17 as cited from Supra note 21 at 520. Another question that comes up in this
context is whether the reduction of capital in the process of arrangement, compromise
or amalgamation is a reduction requiring the compliance with the above mentioned
sections or not.
54 The power of reduction is general and is inclusive of methods such as cancellation of uncalled
capital, surrender for re issue of unpaid shares of smaller amount and attributing the
whole amount paid to the shares not to be surrendered, the repayment of paid up capital
which is in excess of the wants of the company, cancellation of unissued capital etc.
Supra note 15 at 153, 154.
55 This express authorization for the first time appeared in the Companies Act, 1908 thereby
conferring jurisdiction to the court to confirm any reduction duly passed by a special
resolution, including a reduction by cancelling paid up capital not lost or unrepresented
by the available assets. Supra note 15 at 154.
56 Section 100 of the Companies Act, 1956.
57 Supra note 5 at 1699
58 This usually occurs when the company some sort of trading loss or reduction in the value of
assets as a result of which the value of the assets after deducting the liabilities is less than
the value of the paid up capital. Supra note 50 at 224.
59 A company may effect this reduction where it has sold a part of the asset and wished to restrict
its business activities to the remaining assets and thereby reducing the capital in excess of
12
A reduction may not always be paid back in cash. It also can be done by
transferring to its shareholders shares to another company or to create a reserve which
will be then available to set off against that surplus on consolidated account. The money
released as a result of reduction can be then used to purchase companyâ€™s own shares or
to convert ordinary shares into redeemable shares. However, the reduction cannot be
used to raise new capital.60
Buy Back of Shares
Another mode of reduction of share is buyback of shares. It is governed by
section 77A of the Companies Act, 1956. The introduction of the buy back power was a
controversial issue since there were strong arguments both for and against it. The conflict
was essentially between the need to protect the creditors, and the economic exigencies
which necessitated the creation of a more flexible process than the then existing ones for
reduction of capital and redemption of shares. In the end a compromise was reached.
Buy backs were to be permitted but under strict regulation.61
The rule against buy-back hinges primarily on the concept of capital maintenance
and is intended to protect the creditors of a company against unauthorized return of
capital to the shareholders, this capital supposedly being the only buffer available to them
for the recovery of their debts.62 The principle was explained in Trevor v. Whitworth.63 It
its wants. This happened in a large scale in the 1940s and 50s when companies which
were carrying on two or more businesses were compelled to transfer one of them to a
public corporation due to nationalisation. Another reason for this is to obtain fresh
capital more cheaply to replace it. Supra note 50 at 222 - 223.
60 Avery & Co. Ltd., Petitioners (1890) 17 R 1101 as cited in Supra note 17 at 175, 176. For
example, Rs. 100 paid up share cannot be converted into Rs.100 shares with Rs. 75 paid
up as this would impose additional burden on the shareholders.
61 S. Singhal, â€œBuy Back of Shares: A Critical Analysisâ€, (2005) 2 Comp
62 Before the emergence of the concept of limited liability, a company could easily buy back its
own shares since the remaining shareholders were personally liable for the debts of the
company. With the introduction of the principle of limited liability, a need was felt to
preserve the capital as a buffer for the creditors. Hereafter, any reduction of capital
required the Courtâ€™s stamp of approval. In addition to that the creditors had the option
of raising objections and in appropriate cases, getting arrangements made to safeguard
their debts. It was much later that express provisions permitting buy backs were
incorporated in the statutes. See, I. Levy, â€˜Purchase by an English Company of its own
Sharesâ€™, 79(1) University of Pennsylvania Law Review and American Law Register 45
(1930) for the development of the general rule against buy back. It may be noted that
even before the introduction of the buy back power, companies could purchase their
shares using the formal rules of capital reduction, or by redemption of redeemable
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was observed that though the creditors voluntarily assume the risk which results from a
reduction of capital in the course of business, they are entitled to assume that the capital
would not be wasted away otherwise, without the sanction of the Tribunal.64
Under the current legal regime, companies can buy back shares for any purpose.
Some of the purposes may be unethical or economically inefficient.65 Currently, law does
not monitor the purpose for which the power is exercised.66
CONCLUSION
The laws regarding Reduction of Capital, in the opinion of the researcher is
enough to provide safeguard of creditors and shareholders, which is ensured by tribunal
and the special resolution which need to be passed. But, the tribunal and the company
should not only be concerned about the creditors and members, but also to the society,
therefore while confirming the scheme of reduction, the tribunal should not overlook the
motive of reduction and keep in view the greater good. Though the decision, more or
less is left at the discretion of the tribunal, it should be duty of the tribunal to look into
prudence of the reduction. It is submitted that companies are as much liable towards
public and society as they are towards the creditors and members, and since legislator can
not specify the grounds, it should be duty of the tribunal and court to ensure this. The
researcher also is of the opinion that the current provision under the companiesâ€™ act,
shares. See, The Securities and Exchange Board of India vs Sterlite Industries (India)
Ltd. (2003) 113 Comp Cas 273. In this case it was held that buy back was permissible
under both S. 391 read with Ss. 100-104 as well as under the newly introduced S. 77A of
the Companies Act, 1956. This shows that the buy back power did exist even before the
inclusion of S. 77A but the latter provision made the process less cumbersome. as cited
from Id.
63 (1887) L.R. 12 App. Cas. 409. In this case a company, whose articles permitted purchase of its
own shares, bought back substantial shares from one of its shareholders. The whole
amount was not paid immediately. Before it could be paid, the shareholders decided to
voluntarily wind up the company. The shareholder whose shares had been bought
claimed the balance amount due to him from the company.
64 This principle is upheld in all the separate opinions given in the case. For instance, Lord
Hershell said that â€œa part of it [capital] may be lost in carrying on the business operations
authorized. Of this all persons trusting the company are aware, and take the risk. But I
think they have a right to rely, and were intended by the Legislature to have a right to
rely, on the capital remaining undiminished by any expenditure outside these limits, or by
the return of any part of it to the shareholders.â€
65 For instance, buy back power to defend against hostile takeovers may act as a double-edged
sword by enabling an inefficient management to entrench itself.
66 Supra note 61.
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where there are separate provisions for reduction of capital, alteration of capital and buy
back of share are justified. This is so, because, as discussed above, all three have different
purposes and aims, and thus by binding companies under similar provisions for all of
these, would lead to great loss of their independence and functioning thus hampering
profits.