Reduction Of Capital: A Domestic Affair?

A reduction of capital occurs when a company reduces the amount of its share capital. A company may reduce its share capital in a variety of ways. The capital reduction can be done by reducing the share in issue, the nominal value of a share in issue, or the amount paid upon the share in issue. A company may want to reduce its share capital for various reasons, including to create distributable reserves to pay a dividend or to buy back or redeem its own shares; to reduce or eliminate accumulated realized losses in order to be able to make distributions in the future; to return surplus capital to shareholders, or to distribute non-cash assets to shareholders (usually in the context of a demerger).

In a recent case, a Coram consisting of Justice Venugopal, Judicial Member Kanthi Narhari, ruled that "Reduction of Capital", is a domestic affair of the company and a tribunal will generally not interfere because majority shareholder's decision will prevail. In the landmark Common law case of British and American Trustee and Finance Corporation Ltd and Reduced v. John Couper, the house of lords was of the view that the reduction of capital is a domestic concern of the company and because the legislative act itself does not specify any manner in which the reduction should be carried out, therefore going by the intent it was in the hand of majority shareholders to decide on whether the reduction will be there and if so the manner to materialize the same, the Supreme Court used this judgment as an authority in the Case of Ramesh B. Desai v Bipin Vadilal Mehta. In the present case, the company/ appellant was aggrieved by the decision of NCLT in rejecting the petition filed for reduction of capital under section 66 of the companies Act and granting liberty to file a fresh application. The appellant was seeking confirmation for the same as the members of the company have passed the special resolution in the Annual General Meeting and the company needed approval from the tribunal to go ahead with the reduction.

Initially, the reduction of capital was covered under sections 100-105, instead of Section 66 of the Company Act which provides a guarded mechanism for the capital reduction. As the reduction of shares in a company, directly affects the creditors, the mechanism is heavily secured and requires a lot of disclosure by the company. For a valid reduction of shares, the procedure is given under this section along with NCLT rules, 2016 should be necessarily followed. By virtue of section 66, the company can reduce its share to any amount it deems fit, meaning thereby the company can extinguish the share of certain shareholders while leaving others untouched. This has led to the extensive usage of this provision and created a situation in which the controllers of the company try to forcibly acquire the minority shares by Squeezing Out, a process which enables the majority shareholder to compulsorily acquire the equity shares of the minority shareholders of a company, by giving them fair compensation in return. Through this the majority, shareholders try to manifest their control over the minority for easy compliance requirements and to have greater control. Though, this practice of Squeezing out existed for a long time however it has been categorically provided by the 2013 act under section 236, which lists out instances in which the shares of the minority can be acquired by the majority. To effectuate a squeeze-out Reduction given under section 66 is the most popular way as it has the least onerous procedural requirements as compared to other methods. Unlike the case of compulsory acquisition, It only requires a special resolution i.e. majority of 75% of the shareholders as opposed to the consent of 90% shareholders in the case of compulsory acquisition and 75% majority of each class of shareholders as in schemes of arrangement. Another advantage of utilizing section 66 to engineer a squeeze-out is that the corporate funds can be used to pay the shareholders and the controllers are saved from bearing any financial costs, while they end up becoming the owners of the company.

Conditions To Squeeze Out

To materialize squeezing out three primary ingredients is needed to be fulfilled by the company firstly the article of association of the company must have a provision for reduction secondly, a special resolution must be passed by the majority of the shareholders for reduction and lastly, there must be no objection from any of the creditors regarding the proposed reduction and the company must take approval from NCLT. Once the NCLT approved, the Registrar of the company issues a certificate of reduction which acts as conclusive proof for reduction irrespective of any existing procedural irregularities during the reduction.

In re: Reckitt Benckiser (India)Ltd it was argued that reduction is essentially a buyback, therefore the requirements under Section 77 of the Companies Act should also be fulfilled and the reduction by the company should be done proportionally. The court basing its decision on Securitiesand Exchange Board of India v. Sterlite Industries held that buyback and reduction operate in two entirely different fields, and by virtue of the wording of section 77 which states 'notwithstanding anything contained in this act,' buyback under section 77 and reduction under section 100 are two separate provisions, independent to each other. There is no requirement of proportionate reduction and it can be in any manner including selective reduction given under section 100. Unlike reduction, there is no requirement of getting approval from NCLT in cases of buyback. However, both of them invariably lead to capital reduction and thus distinction is just procedural.

When we analyze the cases related to the selective reduction by squeezing out we can see that courts have limited their intervention, if the shareholders get a fair price for the shares they hold at the time of acquisition by the company. The courts have followed the policy of non-interference and have abstained themselves from invalidating the reduction in the cases where there is a support of the majority citing their non-expertise in commercial matters as well as legislative intent of providing companies on their internal matters. Here, the approach seems to favor the majority as the burden of proof on the objecting shareholders i.e minority has been made onerous. In a country like ours, where a lot of companies are family-run, a situation can arise where the majority shareholding sect of the family will be in a position to take over the shares of the minority sect of the family.

In India, the most feasible way to effectuate a squeeze-out is by reduction of capital given under section-66. The legal view is also fairly settled and the courts have limited their intervention to the extent the resolution is supported by the majority and the shareholders have given a fair price. The judicial inclination along with legislative intent favors the reduction being a domestic concern, but in the context of the Majority of the Minority vote, there still exists a grey area. In the recent past, where the courts have given due consideration to the public interest and the interest of the minority, it is unclear how will the courts deal when the MoM will refuse to support the reduction. Mr. Somasekhar Sundaresan, a corporate and capital market law enthusiast has pointed out that the issue is not the payment of a fair amount to the shareholders but whether he can be compelled to divest his property of which he is a lawful owner by the promoters. An important role by regulatory bodies should be played here and the courts are required to maintain a healthy balance between the interest of minority shareholders and ensure minimum intervention by not encroaching on the domestic matters of the company.

Views are personal.