by Nandish Vyas and Sayantan Banerjee.The Companies Act, 1956 (the “Act”) under Section 100 of the Act provides that a company can reduce its share capital in any manner. Sections 100 to 105 of the Act provide for the procedure by which a company limited by shares can reduce its share capital. Further, under the provisions of Section 78 of the Act, unless the securities premium account is applied for certain specific purposes, the utilisation of the securities premium account is also treated as a reduction of capital. This article seeks to analyse the manner in which the provisions of these sections are practically utilised, including in particular as part of M&A activity..Section 100 provides that a company may reduce its share capital “in any way”, including without limitation, by (a) extinguishing or reducing the liability on any of its shares in respect of share capital not paid-up, (b) cancelling any paid-up share capital which is lost or is unrepresented by any available assets or (c) paying off any paid-up share capital which is in excess of the wants of the company. The Act therefore does not place any fetters on the manner or purpose for which a capital reduction exercise may be undertaken. Amongst other things, the provisions relating to capital reduction have been utilized in M&A activity for effecting a consensual buy-out of shareholding (including paying cash consideration under schemes of arrangement), distributing excess cash to shareholders, adjusting losses and expenses (by adjustment of the securities premium account), and in certain cases for effecting a squeeze out of minority shareholders..The Act prescribes three essential conditions which must be fulfilled before any reduction of capital can take place:.(i) The power of a company to reduce its share capital should be expressly conferred on it under its Articles of Association. If the company’s Articles do not expressly permit reduction of share capital, then they must first be amended, so as to enable the company to reduce its share capital..(ii) The reduction of a company’s share capital can be effected only by passing a special resolution at a general meeting of its shareholders. The special resolution must be validly passed. This means that all procedural requirements relating to the passing of a special resolution, including the requirements of notice etc, for calling the meeting in which the special resolution is proposed to be passed, must be duly complied with..(iii) The resolution for reduction of a company’s share capital will not take effect unless it is confirmed by the Company Court, in accordance with the provisions of the Act and the Company Court Rules..The Bombay High Court in the case of P.M.P Auto Industries Limited ([1994] 80 CompCas 289) has reiterated, with respect to the provisions of sections 391 of the Act (relating to schemes of arrangement), that the ‘single window clearance’ under section 391 is not applicable when it comes to dispensation of the procedure for capital reduction, and such procedure has to be separately complied with by the company, even where the capital reduction is being undertaken along with a scheme of arrangement..The provisions relating to capital reduction are more stringent where there is a pay-out of capital by the company, or a reduction in the liability of a shareholder to pay any unpaid share capital, since these situations would result in a company paying out cash available with it or not receiving cash receivable by it. On account of section 101(2) of the Act, if the proposed reduction of share capital involves either the diminution of liability in respect of unpaid share capital or payment to any shareholder of any paid up share capital, or in any other case as directed by the High Court, the procedure prescribed under Section 101(2) relating to securing creditors has to be therefore followed. This is a fairly lengthy procedure which allows each creditor to place objections to the reduction and to potentially secure its claim as part of the capital reduction process. The legislature, under section 101 (3), has however enabled the Courts to take into account the “special circumstances” of a case and if it thinks proper so to do, to direct the waiver of the provisions of Section 101(2) as regards any class of creditors. Some of these special circumstances have been elucidated by the Andhra Pradesh High Court in IL&FS Construction Company Limited v. Wardha Power Company Limited, where the following factors were recognised as being relevant for determining the existence of “special circumstances”: (i) whether the value of the company’s liquid assets are sufficient to cover the creditors, (ii) whether no creditor, who might otherwise be entitled to object to the reduction, will be prejudiced by the capital reduction, (iii) whether it is established that the company has cash and securities of a sufficient value to cover all the provable liabilities as well as any amount proposed to be returned to the shareholders with a reasonable margin of safety to cover oversights or contingencies, (iv) whether the discharge of all the company’s provable debts is guaranteed to the court’s satisfaction, and (v) securing claims of creditors by appropriating sufficient sum. These considerations are therefore extremely pertinent where the objective of the capital reduction is to effect a consensual pay-out to some or all of the shareholders – for example, as a buy-out of some part of the shareholding or a payment in substitution for an equal distribution to shareholders where such distribution may not be undertaken as a dividend or a buy-back..The Court is empowered to pass an order confirming the reduction of capital if it believes that the interests of the creditors have been duly safeguarded. Where the Court passes an order confirming the proposed reduction, it may if it thinks fit to do so, direct the company to, for a specified period, add the words “and reduced” as the last words of its name and may make an order requiring the company to publish, in accordance with its directions, reasons for reduction or such other information in regard thereto for the information of the public..After the court approval, a certified copy of the order of the Court confirming the reduction and a minute approved by the Court, showing with respect to the share capital of the company as altered by the order, (i) the amount of the share capital, (ii) the number of shares into which it is to be divided, (iii) the amount of each share and (iv) the amount, if any, at the date of the registration deemed to be paid-up on each share, must be delivered to the Registrar of Companies who then registers the order and minute. The reduction of capital takes effect only after it has been registered as aforesaid. Notice of the registration must be then published in accordance with the directions of the Court..Whilst a capital reduction involves a detailed court process, it is also sometimes used as an alternative to the provisions of section 77A relating to the buyback of shares of a company, on account of the relatively stricter substantive conditions pertaining to buy-backs of shares such as those relating to source of funds, quantum of buy-back, etc..One of the specific purposes for which a capital reduction has sometimes been used is a squeeze-out by the controlling block of shareholders to buy-out the shares held by the minority shareholders in a company. Section 395 of the Companies Act, 1956 allows controlling shareholders, in certain circumstances, to force minority shareholders to sell their shares and exit a company. However, Section 395 of the Act has rarely been used by companies due to the procedural difficulties involved. Not only are the conditions in section 395 onerous (thereby diminishing its utility in practice), but also leave several matters ambiguous and uncertain. Promoters of companies therefore have tended to prefer the use of capital reduction as a means to extinguish the holding of the non-promoter shareholders. In a case where a minority squeeze-out involved payment of fair value to the minority shareholders, and where the special resolution was approved by an overwhelming majority of such non-promoter shareholders, a Division Bench of the Bombay High Court in the case of Sandvik Asia Limited [(2009) 59 SCL 457] permitted such reduction, overruling the decision of the single judge of the Bombay High Court. After Sandvik, a single judge of the Bombay High Court in the case of Organon (India) Private Limited, appears to have confirmed that the Sandvik case would have value as a precedent only where it is established that a fair value is being paid to the minority that is being squeezed out and where such minority is overwhelmingly in favour of the capital reduction..Therefore, the provisions of section 100 are not always a sure-shot method for reduction of capital. In one case involving a delisted public company, whilst the special resolution relating to the capital reduction was passed with the requisite majority, an investor grievance forum, as well as certain minority shareholders, opposed the scheme for a number of years inter alia on the grounds that the price being offered to the minority shareholders was not the fair price. During the course of proceedings, whilst the Bombay High Court appointed an independent valuer to value the shares, the valuation of the independent valuer was also challenged..Whilst the process of capital reduction may therefore face hiccups or roadblocks on occasions, it is suffice to state that these provisions are nevertheless important for companies for restructuring exercises, particularly in conjunction with the provisions pertaining to arrangements and reconstructions under Section 391-394 of the Act. However, prior to embarking on an exercise of capital reduction, it would be important for the company to undertake a holistic assessment of the likelihood of challenge to the reduction from creditors or shareholders, the special circumstances that may be sufficient to require dispensation of the creditor-related process in a case of pay out of capital, and to also ensure full procedural compliances such as due approval and registration of minutes, dispensation with portions of the procedure under sections 100 to 105 as may be required, etc..Nandish Vyas is a Senior Associate and Sayantan Banerjee is an Associate at the Mumbai office of AZB & Partners.
