Is a 99% Reduction in Share Capital of A Company Allowed?
The process of reduction of share capital may be adopted by companies for myriad reasons such as wiping out accumulated losses, paying out shareholders and providing them an exit opportunity, for valuation reasons, etc. Most of the time, a company’s members will decide without interference from regulatory authorities to reduce the share capital in accordance with Section 66 of the 2013 Companies Act. The National Company Law Tribunal (the “Tribunal”) examines the legality of the process adopted to reduce share capital, but since it is a domestic affair, in most cases it does not interfere with the judgment of the board of a company and confirms such reduction.
Section 66 of the Companies Act, 2013 strikes a balance between the interests of creditors and the company’s independence in making commercial decisions as reduction can be undertaken “in any manner.”
The question therefore arises that whether there is a limit to such reduction of share capital which can be undertaken by a company in a single scheme? There have been cases where a company’s share capital has been reduced by 98% to 99%.
The erstwhile Companies Act, 1956 had mandated that the articles of association must authorize capital reduction. The current statute does not, however, include this prerequisite. To confirm a special resolution adopted by a company for a reduction in share capital, the Tribunal is currently required to look into only three conditions, which are:
- Take into account any objections made by statutory bodies regarding the proposed reduction.
- Ensure that all debts or claims have been settled, established, secured, or the consent of the creditor has been acquired.
- The proposed reduction conforms with accounting treatment standards.
The JJ Irani Committee Report had recommended that in the process of capital reduction, due safeguards must be provided for the interests of creditors. Consequently, a prohibition has been added in the Companies Act, 2013 whereby, reduction cannot be carried out if the company has defaulted in the repayment of deposits or payment of interest. Further, the Tribunal has to satisfy itself that the claims of creditors have been determined/discharged or appropriately considered.
Section 66 of the Act specifies two ways by which reduction of share capital can be undertaken which is either by cancelling or extinguishing shares of the company or by paying out the share capital which is in excess to the wants of the company. It is pertinent to note that the language of the provision states “in excess to the wants of the company”, rather than stating any criteria like sufficient profits, etc.
The JJ Irani Committee Report recommended that in the process of capital reduction, due safeguards must be provided for the interests of creditors. Consequently, a prohibition has been added in the Companies Act, 2013 whereby reduction cannot be carried out if the company has defaulted in the repayment of deposits or the payment of interest. Further, the Tribunal has to satisfy itself that the claims of creditors have been determined, discharged, or appropriately considered.
Section 66 of the Act specifies two situations by which reduction of share capital can be undertaken. Firstly, by canceling or extinguishing shares of the company or by paying out the share capital which is in excess of the wants of the company. It is pertinent to note that the language of the provision states “in excess to the wants of the company”, rather than stating any criteria like sufficient profits, etc.
Reduction of Share Capital by cancellation/extinguishment of shares
The Hon’ble Tribunal, Guwahati bench reasoned in the matter of In Re: Assambrook Limited[1], that the proposed reduction of share capital by the company by canceling 99.37% of the total paid-up share capital was undertaken simply to window dress the books of accounts of the company, to attract new investors and raise additional funds. The company had accumulated losses of Rs. 32.26 crores, and in the proposed reduction of share capital, it had resolved to reduce the issued and paid-up share capital and not utilize its Security Premium Reserve of around Rs. 16.78 crores. The company had three financial creditors, who received convertible securities in lieu of the loans. These three financial creditors constituted around 44% of the total credit availed by the company and their consent was not taken to the proposed reduction. If the proposed reduction was allowed to be carried out, these creditors would have lost almost 100% of their investments. Therefore, in the interest of the creditors, the Tribunal rejected the application for a reduction of share capital.
However, if there is no objection from the creditors of the company, the special resolution has been duly passed in the annual general meeting of the company, and the company is not in arrears in repayment of deposits or payment of interest, then even a 98% reduction in share capital by canceling and extinguishing shares was allowed by the Tribunal. (In Re: Tine Agro Limited[2])
Reduction of Share Capital by paying out share capital
In the matter of Precious Energy Services v. The Regional Director, North-Western Region[3], the Hon’ble National Company Law Appellate Tribunal allowed an appeal filed against an order passed by the Tribunal wherein, the reduction of share capital was rejected by the Tribunal on account of negative net worth of the company. The company resolved to reduce its share capital by around 99.8% of its paid-up share capital by returning the share capital and paying off the shareholders an amount of Rs. 77.49 per share totaling Rs. 54.04 crores. The Company had a negative net worth and other borrowings/other current liabilities, and the book value per share was Rs. (-) 23.04. The Appellant Company argued that firstly, its negative net worth was due to the depreciation of the solar power plant and was not real losses. Secondly, it was a going concern and had adequate cash flow as it had a long-term power purchase agreement through which it was generating revenues. The Hon’ble National Company Law Appellate Tribunal cited various cases in which reduction of share capital is described as a matter of domestic concern of the company and if the majority of shareholders have passed the resolution and the provisions of the Act are being adhered to, then the Tribunal ought to sanction the scheme for reduction of capital. Therefore, the appeal was allowed and the company was allowed to carry out the proposed reduction of share capital.
In the matter of Connectwise India Private Limited v. the Registrar of Companies, Karnataka[4], the scheme for reduction of share capital was approved which envisaged a 97% reduction in share capital by paying out the holding company (sole shareholder) of the applicant company even when the company had accumulated losses. The scheme stated that Rs. 14.15 crores would be returned to the shareholder in lieu of 2,41,75,120 equity shares having a face value of Rs. 10 each held by it. Said shares would be canceled in the books of the Applicant Company. Therefore, the Tribunal has reinforced the freedom of the company to allow a reduction of share capital by paying out a shareholder even in such a case where there are huge accumulated losses, for allowing exit to a foreign shareholder and without a valuation report. The reasoning provided by the Tribunal is that reduction of share capital is a matter of domestic concern and the board of the company can best take the decision depending on the needs and wants of the company.
Conclusion
These judgments highlight situations wherein virtually the entire share capital of these companies has been wiped out through the reduction of share capital. From the aforementioned decisions of the Tribunal, it can thus be ascertained that the Tribunal primarily satisfies itself with two criteria while approving a scheme for the reduction of share capital. Firstly, it should not be detrimental to the interests of creditors and secondly, there must be no arrears in payment of deposit and interest. If the company duly satisfies the Tribunal that it is not detrimental to the interests of the creditors and due procedure has been followed, then it can reduce capital to such extent of 99%. Reduction of share capital is thus a business decision and can be freely undertaken by the company.
[1] C.P. No. 14/66/GB/2020
[2] CP No. 50/(AHM)/2020
[3] Company Appeal (AT) No. 17 of 2021
[4] CP No. 51/BB/2021
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