What is a reduction of share capital?

Posted by Bizlegal01 on January 6th, 2020

Selective reduction of share capital -

Background -

Reduction of the share capital of a company was initially not allowed because conservation of capital is the cardinal rule of company law. The capital of a company is considered the security upon which the creditors usually rely.

So, any reduction of share capital diminishes the fund out of which they are to be paid and prejudices their interest. However, there may be genuine reason to reduce capital. It is for this reason that reduction of capital is considered unlawful except when sanctioned by court (now tribunal).

Selective reduction is one such way by which a company can decide to extinguish some of its shares and reduce the share capital of the company without dealing in the same manner with all other shares of the same class. But the process of selective reduction of share capital of the company is much more complex than the non-selective one.

Analysis -

A non-selective reduction of share capital involves the reduction of the same proportion of the shares of the company on similar terms and conditions offered to each shareholder whose shares are being reduced.

On the contrary a selective reduction of capital is targeted towards a particular class of shareholders. Selective reduction of capital is mandated by Section 66 of the Companies Act, 2013 but is subject to the confirmation of the tribunal along with other conditions that are approval of shareholder by way of special resolution and accounting treatment of for such reduction being in conformity with the accounting standards as provided under section 133 of the Companies Act, 2013.

In addition to this the articles of association must also provide for reduction of share capital and in case they do not they need to be altered accordingly. The important issue that arises is that non-compliance with Section 66 of the Companies Act, 2013 is the sole ground to challenge validity of selective reduction of share capital or are there any other conditions imposed. To answer that we must go into the jurisprudence of the selective reduction of capital which in India dates back to 1894 House of Lords of England know as the case of British and American Trustee and Finance Corporation v. Couper.

In that case the Court held that the prescribed majority of the shareholders of a company is entitled to decide whether there should be a reduction of capital, and if so, in what manner and to what extent it should be carried into effect. In the words of Lord Macnaghten “if there is nothing unfair or inequitable in the transaction, I cannot see that there is any objection to allowing a company limited by shares to extinguish some of its shares without dealing in the same manner with all other shares of the same class. There may be no inequality in the treatment of a class of shareholders, although they are not all paid in the same coin, or in coin of the same denomination.”

In India issue with regard to the validity of selective reduction of capital was discussed at length in the landmark case of Reckitt Benckisser (India) Ltd. v. Unkown. While dealing with validity of proposed reduction of share capital, which ultimately the Delhi High Court approved. However, the court laid down certain principles in relation to capital reductions and held that a selective reduction of capital is permissible but the court has to be satisfied that there is no unfair or inequitable transaction at play.

Further in SIEL Ltd., In re. the court was of the view that reduction of the share capital of a company is a domestic concern of the company and the decision of the majority would prevail. If the majority by special resolution decides to reduce the share capital of the company, it has the right to decide to reduce the share capital of the company and it has the right to decide how this reduction should be affected. While reducing the share capital, the company can decide to extinguish some of its shares without dealing in the same manner with all other shares of the same class. A selective reduction is permissible within the frame work of law for any company limited by shares.

The court reiterated the same principles in case of Elpro International Limited and Sandvik Asia Limited.

Conclusion

As far as the selective reduction of capital is concerned the courts have formed unanimous view that it is a purely domestic matter of the company. Yet the courts are of the view that the mechanism of selective reduction can be a tool to prejudice the rights of the minority shareholders. Thus, the courts have evolved grounds to challenge the validity of selective reduction. That being: –

Price offered by the company for extinguishment of shares is not adequate. Reduction is unfair and non-equitable. Reduction will prejudice the rights of minority shareholders.

And in all of the abovementioned cases the onus lies on the company to prove that the reduction of share capital is fair and equitable. Therefore, to ensure a smooth and successful reduction of capital, the reduction must be approved by the majority of the minority (MoM) shareholders and fair and just methodology must be adopted for purpose of valuation of shares.

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