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  • How to carry out reduction of share capital without sanction of the court : an overview iPleaders

    reduction of share capital, as the term suggests, pertains to the decision of a company to reduce the equity shareholding either selectively or equally through share cancellations, or repurchases/buybacks. The said reduction can be done for reasons such as restructuring the capital, or to reduce the payment of dividends, or to remedy the balance sheets. However, in ‘selective’ reduction of shares, there is differential treatment with some shareholders; which sometimes can amount to extinguishing some of the shareholders’ shares. In other words, minority shareholders can be discriminated against and their shares can be acquired, without consent, by the majority shareholders/controllers at a price they deem fit.

    Later, they argue that the decision making vis-à-vis reduction of shares, whether selective or not, must not be regulated as it affects the autonomy of the controller/majority shareholders to take independent business decisions. The authors further argue that, alternatively, there is a mechanism of oppression and mismanagement that can be used to deal with such cases. Hence, the authors propose that the scope of judicial review for reduction of shares should be limited. It becomes difficult for the courts to figure out the reason behind reducing the company’s share capital (be it rearranging its balance sheet or inducing to drive out the minority shareholders). In any case, it is the company’s responsibility to prove that reducing its share capital will not harm the minority shareholders in any way.

    1. Observe a period where creditors are given the opportunity to apply to the court if they object to the capital reduction.
    2. A copy of the court order confirming the reduction must be filed at Companies House together with a statement of capital, and the resolution to reduce the share capital becomes effective once those documents have been delivered to Companies House.
    3. This gives comfort to creditors like suppliers that the company is solvent.
    4. The reason for this rule is so that the company has a cushion of capital out of which it can pay debts to third parties.

    The company must also update its records with the RoC after the reduction is approved. In some cases, companies may be required by law to reduce their
    share capital. For example, if a company’s assets have fallen below its
    liabilities, it may need to reduce its share capital to avoid being insolvent. The net effect of a capital reduction if you have accumulated losses is to effectively wipe out those losses and put the company back into profit. If your company has accumulated losses, you may not be able to pay dividends as these losses affect your balance sheet. You may find yourself with accumulated losses if you’ve had a poor spell of trading, if the value of the company’s assets has dropped, or if a project such as an acquisition has been unsuccessful for example.

    A private limited company can also choose to have the reduction court-approved rather than following the solvency statement procedure route. You may decide to follow the court-approved route if you think one or more directors may not be willing to sign the solvency statement, or if creditors might object, or the company won’t be left with one non-redeemable share. A company is required to reduce its share capital using a set of specific steps. First, a notice must be sent out to creditors of the resolution of the capital reduction. Second, the company has to then submit an application for entry of the reduction of share capital within a certain period after publication of the initial notice.

    Reduction of share capital & procedure under Sec 66 of the Companies Act, 2013

    The obligation to pay unpaid share capital or to return paid-up share capital to shareholders can be met by the return of excess capital. Returning back capital allows a company to reduce its share capital without the consent of each individual shareholder. A share buyback reduces a company’s share capital by purchasing back shares from shareholders; however, unlike returning capital, a buyback requires the shareholders that have been offered buybacks to determine whether they want to sell back their shares or not. The reduction of share capital is a legitimate process that must be followed by a company in India. The process involves obtaining approvals from the Board of Directors, shareholders, and the NCLT.

    Why Would a Company Do a Capital Reduction?

    To access legal support from just £145 per hour arrange your no-obligation initial consultation to discuss your business requirements. Gain access to world-leading information resources, guidance and local networks. Though Incorporation of a Company requires several steps the after company incorporation involves office address re… On 07th December, 2016, Ministry of Corporate Affairs (MCA) has vide its Commencement Notification notified various sections of Companies Act, 2013 which includes arbitration, compromise, arrangements and reconstruction and winding up companies which has come into force with effect from 15th December, 2016. The Cost of Capital Observatory is an initiative from the IEA, the World Economic Forum, ETH Zurich and Imperial College London.

    How To Carry Out a Reduction of Capital for Public Companies

    Equity held by shareholders refers to the sum that a company’s founders have contributed to the enterprise. This covers the funds they have directly invested as well as the total amount of profits the business has generated. This also accounts for reinvestments since the establishment of share capital. The need to reduce the share capital may arise for various reasons such as pare off debt, capital expenses, distributing assets to shareholders, making up for trading expenses etc. Additionally, when the company is suffering losses, the financial position is not shown appropriately.

    These include creating distributable reserves, so as to pay dividends in the future, returning surplus capital back to shareholders, when going through a de-merger, simplifying the capital structure to be more efficient, and reducing or eliminating paid-up or unpaid shares. Companies are only permitted to pay dividends out of retained earnings. A company may be trading profitably yet have accumulated losses that prevent payment of a dividend. A reduction of capital can be used to reduce those losses or create a distributable reserve sufficient to permit the payment of a dividend. There are two ways in which a limited company can reduce share capital, by way of a court order or by issuing a solvency statement in which the directors declare that the company can pay its debts. If the amount of paid up capital including share premium is reduced then the share capital will be debited with the amount of the reduction.

    Special Resolution Supported by a Solvency Statement

    A corporation may reduce its capital as a result of a drop in operating profits. Revenue loss that cannot be compensated in predicted future profits could also result in a reduction. Alternatively, minority shareholders can rather choose the route of Section 244 of the CA 2013. Oppression means lack of probity and fair dealing in the affairs of the company, prejudicing some members [Rajahmundary Electric Supply v. A Nageshwara Rao]. To constitute oppression, there must be a wrongful act, the conduct of which is mala fide and against good conduct [Shri V.S. Thus, if the controllers take the decision of conducting share reduction with a mala fide intention of removing a minority shareholder(s), or if the controllers set an unfair price ultimately prejudicing the minority shareholders, they can file a suit of oppression against the controllers.

    The next requirement is that the special resolution approving the reduction of capital must be passed within 15 days after the date of the solvency statement. When passed, a copy of the special resolution and the solvency statement must be delivered to Companies House together with a statement of capital, within 15 days after the resolution. One way is by making payments to shareholders out of the company’s capital for a value equal to what a shareholder paid in acquiring the company’s shares. Capital reduction is the process of decreasing a company’s shareholder equity through share cancellations and share repurchases, also known as share buybacks.

    This is also known as a ‘squeeze-out’, albeit selective reduction of shares is only one of the means for achieving this. In fact, such a squeeze-out was the central plot of the movie The Social Network, where Mark Zuckerberg removed his co-founder from Facebook (now rebranded as ‘Meta’) by significantly diluting his shares through selective share reduction. This raises concerns of corporate governance as the controllers can, essentially, drive out minority shareholders if they deem it essential without prior appraisal or consent. Often, capital reductions are used to structure mergers, acquisitions, and group reorganizations.

    NCLT may hold any enquiry or adjudication or claims or for hearing the objection give such directions as may deem proper with reference to securing the debts or claims of creditors who do not consent to the proposed reduction. The capital reduction takes effect once the filing is successfully filed with ACRA. Within 14 days after the passing of the resolution the company must lodge a Form 2205 Notification of resolutions regarding shares. Our commercial lawyers are based in or close to major cities across the UK, providing expert legal advice to clients both locally and nationally. With 750,000 shares outstanding at a share price of $25, the company has a market capitalization of $18.75 million. The buyback program resulted in a decrease of the company’s market capitalization by $12.5 million.

    Every company must fulfil these requirements because a company’s share capital is the only security that the shareholders have; hence, reducing the same leads to diminishing the fund out of which they are to be paid. Therefore, it is closely guarded by this section, providing a safe route for reducing it in case it becomes necessary to do so. If you are planning for the directors to sign a solvency statement, they will need to fully understand the consequences of the capital reduction on the company, and be sure that the company is solvent, bearing in mind any liabilities that may need to be paid in the next year.

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