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Internal Restructuring of a Company: Causes, Modes and Procedure.

The provision of reduction of share capital, which was earlier available under Sections 100-105 of the Companies Act, 1965, has now been dealt under section 66 of the Companies Act of 2013 (hereinafter referred to as 'the Act'). Section 66 makes provision for reduction of share capital by a company, whether limited by shares or guarantee, to reduce their share capital with an objective of either mitigating their losses or refunding funds to the shareholders which are surplus with the company.[i]

A company may also reduce the share capital in order to release the liability to pay up the unpaid share capital. Such reduction has to be pre-approved by NCLT by making an application, and thereafter by a special resolution passed by the company. [ii]

Why to Reduce Share Capital?

Sometimes, when a company is incurring losses, the balancesheet does not depict a true picture of the assets and liabilities of the company. The assets, in this case the share capital are overvalued, as they hold a much greater value in the balance sheet than it actually has due to the losses incurred by the company. In order to capture a true picture of the liabilities and assets of the company, such restructuring of capital asset is necessary. [iii]

Another reason for such restructuring is that sometimes the company has more share capital, i.e. more capital resources than it can gainfully invest. In such cases, it is needed for a company to adjust or balance its assets and capital by returning the surplus to the shareholders in the proportion of their shareholding. [iv] Such form of restructuring is called internal restructuring, as opposed to the external restructuring which involves the procedure of winding up of a company by an external source. [v]

A company need not reduce the share capital against all shareholders. Bombay high court observed that the words 'any shareholders' used in the Companies Act clearly show that the intention of the legislature is clear. The reduction of the share capital may be made against all or any of the shareholders. [vi]

Following are the reasons for why a company may reduce its capital assets [vii]:

  1. When the company is not able to meet its obligations.
  2. When the company is incurring losses.
  3. When the company has more surplus than it can actually profitably invest.

Modes and Procedure of Reduction

The reduction of share capital, or the internal restructuring of a company can be done in various ways. The objective is to mitigate losses and restructuring of share capital in a way to balance out the assets and the liabilities.

Following are the ways to reduce capital under Section 66 of the Act:

  1. Cancellation of paid-up share capital that is not presented by the existing assets with or without reduction of liabilities on any of the shares.
  2. Extinguishment or reduction of unpaid share capital.
  3. Paying off any paid-up capital, which is surplus to the requirements of the company.

For a company to avail the provision of reduction of share capital, the company shall first make an application to the Tribunal (NCLT). After obtaining a sanction from the Tribunal, the restructuring shall come into force by a special resolution passed by the company.

The Tribunal shall make sure the following conditions are fulfilled before granting the sanction:

  1. There is no objection from the creditors.
  2. In case of objection by the creditors, their consent has been obtained by the company.
  3. The rights of the creditors have been secured or they have been paid off.
Section 66 read with the National Company Law Tribunal (Procedure for reduction of share capital) Rules, 2016 formulate the procedure of reduction of share capital. Rule 2(1) lays down the procedure of making an application to the Tribunal. An application to this effect has to be filed with the Tribunal in Form No. RSC-1 along with a fee of Rs. 5000/-.

The application above has to be supplemented with the following:

  1. A list of creditors in the order of their class, along with their names, address, and amount owed, duly signed by the managing director of the company.
  2. The auditor shall certify the above-mentioned list of creditors.
  3. A declaration to the effect that the company is not in arrears in the repayment of the deposits or the interest by one of the directors of the company and certified by the auditor.
  4. The certificate to the effect that such restructuring is in accordance with the other provisions of the Companies Act.[viii]

Notice: The Tribunal shall send a notice to all creditors (Form No. RSC-3), and to Security Exchange Board of India and the Registrar for Companies (in Form No. RSC-2), within 15 days of the filing of the application and shall specify in the notice, the time the creditors/ the authorities have to raise any objections to such restructuring.

Objections: The creditors or the authorities described above shall raise objections, if any to the notice within three months of receipt of such notice, failing which the Tribunal shall assume that there are no objections.

Order of reduction: The Tribunal shall pass an order confirming the reduction of share capital as sought by the company in Form No. RSC-6. Upon receiving the order, the company shall obtain a certificate to that respect from the Registrar of Companies in Form No. RSC-7.

SEBI Guidelines

SEBI has made some amendments in the listing agreement making it compulsory for the companies to obtain approval of SEBI along with the order of the Tribunal. The company has to make an application before SEBI before applyingthe reduction of share capital before the Tribunal. The company shall make sure that such restructuring does not violate any of the security laws or the stock exchange requirements such as SEBI Act, 1992, the Securities Contracts (Regulation) Act, 1956, the Depositories Act, 1996 and the requirements of the Companies Act, 1956 which are controlled by SEBI.[ix]

Can Creditors Object to Reduction?

First and the foremost, while making an application to the Tribunal, the applicant, i.e. the company shall have to satisfy the court that the interests of all creditors have been secured and dealt with. If the Tribunal observes that such restructuring might disrupt or violate the rights of the creditors, such application may not be allowed by the court. [x]
Even if the application is allowed by the Tribunal, and the company is successful in being able to get a special resolution passed in an Annual General Meeting, the creditors can again object to such restructuring within the stipulated time. Such objections will be taken into consideration by the Tribunal before passing an order in Form No. RSC-6.[xi]

Judicial Interpretation of Reduction of Share Capital

The reduction of share capital is a vastly studied and interpreted area of the companies' law. Because it is in the hands of the courts to decide whether or not a company can perform internal restructuring, the courts make observations as to why such company could/could not reduce the share capital, and in turn interpreting the law on this point.

The Orissa HC in OCL India Pvt. Ltd. (1998)[xii] observed that the court is not concerned with how a company carries out its reduction of share capital. The court, while granting the sanction is only concerned with the fact that whether a proper procedure has been adopted by the company as prescribed in the Act. The court also has to make sure that the rights of all creditors and shareholders have been secured and there are no objections from any of the two.

In a nutshell, the following three criteria are considered by the courts while passing the order of reduction:

  1. There are no objections from the creditors, and the company has secured their rights.
  2. There are no objections from the shareholders, andthe company has secured their rights.
  3. The company has followed the procedure prescribed under Section 66 of the Companies Act, 2013 r/w the National Company Law Tribunal (Procedure for reduction of share capital) Rules, 2016.
In Sandvik Asia Ltd. v. Bharat Kumar Padansi [xiii], the company filed an application for extinguishing a class of shareholders called the non-promoter shareholders. The non-promoter shareholders opposed the said application and the single judge ruled in favour of the said shareholders. The said order was challenged before the appellate court where the order was reversed. It was observed by the appellate court that because majority shareholders have voted in favour of the restructuring, there is no reason for the court of refuse sanctioning it.

The Bombay High Court observed that if a company made an application for reduction of share capital, such application could not be rejected by the Tribunal merely based on the fact that another method of restructuring might be more beneficial to the shareholders or the creditors. If the creditors and the shareholders have given their consent, the court shall be bound to approve such an application. [xiv] The reduction shall be final only when the Court registers its order with the Registrar. The Registrar shall then give a certificate to the effect of reduction of share capital as prescribed by the company.

Conclusion
Section 66 of the Companies Act deals with the reduction of share capital by the company in case the company is in loss or has surplus money, more than it can profitably invest in the business of its company. Such reduction can either be done by reduction of the unpaid share capital or by paying off the paid share capital that is in surplus. S. 66, along with rules discussed above, lay down the procedure by which a company limited by guarantee or by shares can reduce its share capital.

The company shall take approval from the Tribunal after getting a special resolution passed in the AGM of the company. The company then sends notices to the creditors, Registrar and the SEBI regarding the applied restructuring to raise objections, if any. In case, none of the creditors or the authorities raise any objection within the stipulated time of 3 months from the date of receipt of the notice; the Tribunal assumes that there are no objections and sanctions the restructuring.

The courts have interpreted the provisions and have laid down the law. Suppose the courts are satisfied that the right of the creditors and shareholders are secured, and there seem no objections whatsoever, they shall allow the application, even when there is an alternate remedy available which seems more beneficial.

The courts have also held that the Tribunal only has to make sure there are no objections and not dwell into the matter of how the company is carrying out the restructuring. While winding up of companies is called external restructuring, such measures taken by the company in order to curb its losses, as dealt in this articles is called the internal restructuring of the company.

End-Notes:
  1. Ketan Dalal, “Capital Reduction - Regulatory & Tax Issues: Part 1”, LSI, (Aug 01, 2019), http://www.lawstreetindia.com/experts/column?sid=314#:~:text=As%20would%20be%20seen%20from,AOA')%20to%20do%20so.&text=Thereafter%2C%20a%20special%20resolution%20for%20reducing%20share%20capital%20must%20be%20passed.
  2. S. 66, the Companies Act, 2013.
  3. Indian National Press (Indore) Ltd., In re. (1989) 66 Com Cases 387, 392 (MP).
  4. Deban Satyadarshi Nanda, “Reduction of Share Capital: Analysis”, Corporate Law Reporter, (Feb 23, 2015), http://corporatelawreporter.com/2015/02/23/reduction-share-capital-analysis/.
  5. N Venkiteswaran, “Restructuring of Corporate India: The Emerging Scenario”, (Oct 02, 2020), https://journals.sagepub.com/doi/pdf/10.1177/0256090919970301.
  6. Elpro International Limited, (2008) 86 SCL 47 (Bom).
  7. Corporate Restructuring, Corporate Restructuring, Valuations and Insolvency, the Institute of Company Secretaries of India, (Oct 3, 2020),https://www.icsi.edu/media/webmodules/publications/3.%20Corporate%20Restructuring,%20Valuatuion%20and%20Insolvency.pdf, page 177
  8. M. Govindaranjan, “Procedure for Reduction of Share Capital under Companies Act, 2013”, TMI,(January 9, 2017), https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=7191
  9. Amendment to the listing agreement regarding disclosure pertaining to schemes of arrangement/merger/amalgamation /reconstruction filed before the Court”,SEBI, (May 08, 2003), https://www.sebi.gov.in/legal/circulars/may-2003/amendment-to-the-listing-agreement-regarding-disclosure-pertaining-to-schemes-of-arrangement-merger-amalgamation-reconstruction-filed-before-the-court_15867.html.
  10. Ocl India Ltd. v. Unknown, AIR 1998 Ori 153.
  11. Radhe Developers and Others v. ITO 113 TTJ (Ahd) 330.
  12. Supra note 10.
  13. Sandvik Asia Ltd. v. Bharat Kumar Padansi (2009) 92 SCL 272.
  14. Chetan G. Cholera v. Rockwool (I) Ltd. (2010) 102 SCL 93.
Written By: Pushkaraj Ghorpade 3rd Year BA.LLB(Hons) from NMIMS, School of Law Navi Mumbai

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