LAW CORPORATE LAW Alteration of capital and its implications
Q1: E-TEXT Module ID 6:Alteration of capital and its implications Module Overview: A company may alter its share capital depending upon its need of increasing share capital or reducing share capital. Every alteration has to be in accordance with the formalities prescribed by the Companies Act, 2013. Reasons for alteration of capital are with the company only, the company law cannot prescribe any provision for this but how alteration should be carried out, is prescribed by the company law. If company is diversifying its business or expanding it, more share capital is required. Where company is in excess of share capital, it may reduce its share capital in order to avoid burden of dividend payment. The present module will introduce students to all the aspects relating to alteration of capital and the prescribed formalities. Subject Name: Law Paper Name: Corporate Law Module ID: 6 Pre-requisites: Knowledge of share capital and its kinds, types of shares, business expansion and diversification Objectives: To understand the concept of alteration of share capital and the need for such alteration To know how a company increases its capital and how it reduces the capital? To understand implications of alteration of capital Keywords: share capital, further issue of shares, reduction of share capital, bonus issue, rights issue Learning outcomes: Students will be able to understand what is alteration and how it is carried out by companies and what are the requirements of the companies to alter their share capital. They will develop an understanding why a company is increasing its capital, issuing bonus shares or reducing the share capital. They will also understand that company cannot purchase its shares without reducing its share capital. They will be able to distinguish between buy back of shares by a company and purchasing its own shares by a company.
Every alteration is carried out for a specific reason and a company may undertake alterations whenever required. Students will also understand processes and formalities involved in alteration of share capital. Introduction: A limited company having a share capital has the power to alter its share capital. This power is given to the companies by the Companies Act because only the company can know the requirement of capital according the business needs. Therefore, it can raise or reduce share capital. Besides regulating further issue of capital and reduction of capital, the Companies Act also regulates issue of bonus shares, purchase by company of its own shares and buy back of securities by companies. All sections relating to alteration of capital are discussed in the module. Alteration of capital: S. 61 of the CA, 2013 gives the power to a limited company to alter its share capital. A limited company having a share capital duly authorized by its articles association may alter its memorandum of association for the following: a. to increase its authorized share capital with the amount required; b. consolidate and divide all or any part of its share capital into shares of a larger amount that its existing shares. If such a consolidation and division results in change in the voting percentage of the existing shareholders, approval of the Tribunal will be necessary before such undertaking such an alteration; c. conversion of all or any if its fully paid-up shares into stock and reconversion that stock into such shares of any denomination; d. sub-division of all or any of its shares into shares of smaller amount than the amount fixed by the memorandum. It is necessary that the proportion between the amount paid on the shares and the balance unpaid should remain the same after sub-division also; e. cancellation of shares which have not been taken or agreed to be taken by any person on the date of passing the resolution of alteration. The amount of the share capital should be reduced the amount of the share capital cancelled. Cancellation of shares under this section is not deemed to be a reduction of share capital. Further issue of capital: When a company having a share capitaldecides toincrease its subscribed capital by the issue of further shares, s. 62, CA, 2013 mandates that such shares shall be offered to: a. existing equity shareholders of the company, as nearly as circumstances admit, in proportion to the paid-up share capital on those shares. Such shares are known as rights shares existing share holders receive them under their pre-emptive rights 1. Such shares are offered to them by a letter of offer, giving number of shares offered notifying the limit of the offer to accept within fifteen to thirty days from the date of offer and that if not accepted, the offer shall be deemed to have been declined. Shareholders have the right to renounce the shares offered or offer any of them in favour of any person. After the expiry of time or if the shareholder declines to accept them, Board of directors of the company may dispose them in the manner not disadvantageous to the company and shareholders. b. employees under a scheme of employees stock option, if the company passes a special resolution in this behalf. c. any persons if authorized by special resolution of the company. Such persons may or may not include the persons in the above two categories. Shares can be issued for cash or for a consideration other than cash, if their price is determined by the valuation report of a registered valuer. 1 Dr. Avtar Singh, Introduction to Company Law, eleventh edition, Eastern Book Company, 2014, p. 72
A company has to notify the Registrar about the alteration of share capital along with the alteration of its memorandum within a period of thirty days of such alteration. Power to convert loans into capital: Where a company has issued debentures or obtained loan from any Government and that Government considers it necessary in public interest to convert such debentures or loan or any part of them to shares of the company, it may direct the company to do so. Such a conversion will be subject to terms and conditions that appear to the Government reasonable in the circumstances even of the conversion option were not a term of the issues of debentures or loan [s. 62(4), CA, 2013]. If the terms and conditions of such order are not acceptable to the company, it may appeal to the Tribunal within 60 days of the order of the Government for conversion. After the conversion memorandum is altered and the share capital of the company increases. This has to be notified to the Registrar by the company within a period of thirty days from such alteration or increase. Bonus shares: S. 63, CA, 2013 provides that a company may issue bonus shares to its members out of its free reserves or amount lying in the securities premium account or capital redemption reserve. Reserves created from revaluation of assets cannot be utilized or capitalized for the purpose of issuing bonus shares. Bonus shares cannot be issued in lieu of dividend. The company shall be authorized by its articles and the general meeting of the company. It should not have defaulted in payment of interest or principal for fixed deposits or debt securities issued by it and statutory dues of the employees. It is also necessary that the partly paid-up shares outstanding on the date of allotment should have been made fully paidup. Reduction of share capital: A company has to maintain its share capital. Share capital is a security for the creditors of the company and shareholders put their contribution in the share capital in the form of their shareholding. The Companies Act does not allow a company to reduce its share capital unless it follows conditions prescribed by the Act. According to s. 66, CA, 2013, a company limited by shares or guarantee and having a share capital may, by passing a special resolution, reduce its share capital. It may alter its memorandum by reducing the amount of its share capital and of its shares in any of the following ways: 1. a company may extinguish or reduce the liability on any of its shares in respect of the share capital not paid 2. either with or without extinguishing or reducing liability on any of its shares a. a company may cancel any paid-up share capital which is lost or not represented by any available assets, or b. pay off any paid up share capital which is in excess of wants of the company A company is not allowed to reduce its share capital if it is in arrears in the repayment of any interest payable or deposits accepted by the company.
Any company proposing to reduce its share capital has to apply to the Tribunal for its confirmation. The Tribunal notifies the application to the Central Government, Registrar, Securities and Exchange Board of India in case of listed companies and creditors of the company and considers their representation made within a period of three months from the date of notice. After considering the representation and satisfying itself that debt or claim of every creditor has been discharged, determined or secured or his consent obtained, it may confirm the reduction of share capital subject to terms and conditions it deems necessary. Every such application should satisfy the requirement of meeting the accounting standards specified by the Act. The company is further required to deliver to the Registrar a copy of the order of the Tribunal approving the reduction showing the amount of share capital, number of shares into which it is to be divided, amount of each share and the amount deemed to have been paid-up on each share, if any. Restriction on purchase by company or giving of loans by it for purchase of its shares: S. 67, CA, 2013 restricts companies limited by shares or guarantee and having a share capital from buying their own shares without consequent reduction of their share capitals. Therefore, without a consequent reduction of the share capital a company cannot buy its own shares. No company is allowed to give any financial assistance or loan, guarantee, security or otherwise to any person for purchase or subscription of shares in the company or its holding company. Such restrictions do not apply to: a. lending of money by a banking company in the ordinary course of its business b. provision of money by a company for purchase or subscription of fully paid-up shares of the company or its holding company if the shares are held by the trustees for the benefit of the employees or such shares are held by the employees of the company. c. lending of money by a company to its employees to buy shares in the company or its holding company. Such employees will not include directors or key managerial personnel of the company and the amount of loan should not exceed their salary or wages for a period of more than six months. Buy- back of shares: S. 68, CA, 2013 provides that a company may purchase its own shares or other specified securities i.e. buy back them out of its free reserves, securities premium account or proceeds of the issue of nay shares or other specified securities. No buy-back of any kind of shares or other securities is allowed to be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities. A company may buy-back its shares subject to fulfillment of following: a. authorization of buy-back by articles of company; b. passing of special resolution by general meeting of the company authorizing the buy-back. Such a resolution is not required where buy-back is 10% or less of the total equity share capital of the company and it has been authorized the resolution of Board of the company; c. buy-back is twenty-five percent or less of the aggregate of paid-up capital and free reserves of the company; d. ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is not more than twice the paid-up capital and its free reserves. Higher ratio can be notified by the Central Government for a class or classes of companies; e. all shares or other specified securities for buy-back are fully paid-up;
f. buy-back for listed shares or other specified securities should be in accordance with regulations made by Securities and Exchange Board of India. For other securities buy-back must be in accordance with the prescribed rules. No offer of buy back shall be made within a period of one year from the date of closure of the preceding buy-back offer, if any. Shareholders of the company are required to be notified for the meeting at which resolution for buy-back is proposed to be passed. An explanatory statement giving full disclosure of all material facts, necessity of buy-back, class of shares or securities proposed to be bought back, amount to be invested n the buy- back and the time limit for completion of the buy-back should be sent to the shareholders with the notice of meeting. Every buy-back shall be complete within one year of date of passing of special resolution for buy-back. Buy-back may be from the existing shareholders or security holders on a proportionate basis, from the open market or by purchasing the securities issued to employees of the company pursuant to scheme of stock option or sweat equity. The company has to file a declaration of solvency with the Registrar and SEBI signed by at least two directors of the company. One of the directors should be a managing director, if any, of the company with a declaration that the company is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by the Board. Only a listed company is required to file the declaration of solvency before SEBI. All shares and securities bought back have to extinguished and physically destroyed within seven days of last day of completion of buy-back. The company buying-back shares or other specified securities is prohibited from further issues of same kind of securities including allotment of new shares within a period of six months. Exception says that such securities may be issued by way of bonus issue or in discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares. After completion of the buy-back, the company has to file a return to the Registrar and SEBI both, if the company is a listed company.
a. authorization by articles of company; b. passing of special resolution; resolution is not required where buy-back is 10% or less of the total equity share capital of the company and it has been authorized the resolution of Board of the company; c. buy-back is twenty-five percent or less of the aggregate of paid-up capital and free reserves of the company; d. ratio of the aggregate of secured and unsecured debts owed by the company after buy-back: not more than twice the paid-up capital and its free reserves. Higher ratio can be notified by the Central Government; e. all shares or other specified securities for buyback are fully paid-up; f. buy-back for listed shares or other specified securities in accordance SEBI regulations. For other securities buy-back must be in accordance with the prescribed rules Prohibition of buy-back: S. 70 of the CA, 2013 prohibits buy-back in certain circumstances. It provides that no company shall directly or indirectly purchase its own shares or any other specified securities:
a. through any subsidiary company including its own subsidiary companies; b. through any investment company or group of investment companies; c. if the company has defaulted in repayment of deposits, their interest payment, redemption of debentures or preference shares or payment of dividend to any shareholder, repayment of any term loan or interest payable on it to any financial institution or banking company. Unlimited company to provide for reserve share capital on conversion into limited company: According to s. 65, CA, 2013, any unlimited company having a share capital may by passing a resolution for registration as limited company may do either of the following two or both of them: a. increase the nominal share capital of the company by increasing the nominal amount of each of its shares. This increase is subject to the condition that increased capital shall be capable of being called up only in the event and purposes of the company being wound up. b. provide that a specified portion of its uncalled share capital shall be called up only in the event of and for purposes of company being wound up. Buy-back under S. 77A of the Companies Act, 1956: Under CA, 1956, a company was allowed to buy-back its shares subject to following restrictions: a. Fund to be used for buy- back: free reserves, securities premium a/c, proceeds of an earlier issue b. Formalities for buy-back: i. provision for buy-back in articles of the company, ii. special resolution passed by shareholders or Board of directors of the company, iii. amount involved in buy- back had to be less than 25% of co s total paid-up capital & free reserves, iv. after buy-back, ratio between debts owed by company was not be more than twice the capital & free reserves of the co, v. shares to bought back were required to be fully paid, vi. buy-back was required to comply with SEBI regulations. c. Declaration of Solvency was required to be filed with Registrar of companies and SEBI that it will not be insolvent for a period of 12 months d. Physical Destruction of securities was required to be done within 7 days of the last day of completion of buy-back process
e. Further issue after buy-back- Company was not allowed to issue same type of securities within a period of 6 months after buy-back f. Return of buy-back had to be filed with the Registrar g. Transfer of money to CRR account-a sum equal to nominal value of shares purchased had to be transferred to Capital Redemption Reserve and details were to be disclosed in Balance sheet. h. Buy-back had to be done by the company directly and not through the medium of other companies i. A co was not allowed to resort to buy-back if it was: In default of payment of deposits; Default of redemption of debentures/ preference shares Default of payment of a term loan from any financial institution or bank j. No company could directly or indirectly resort to purchase its own shares without complying with S. 159 : annual return S. 207: default in paying declared dividend S. 211: filing of annual report or accounts Securities and Exchange Board of India: SEBI came up with Buy-back Regulations in 1998 for regulating buy-back of shares by companies. According to frequently asked questions on website of SEBI, a company can buy back its shares in any of the following manners : a. from existing shareholders on a proportionate basis through the tender offer; b. from open market through book building process and stock exchange, c. from odd lot holders. Securities and Exchange Board of India (Buy Back of Securities) (Amendment) Regulations, 2013 2 : Buy-back regulations were amended by SEBI in 2013. Some of the proposed amendments have been controversial and debatable. Some important amendments are as under: a. companies were mandated to buy at least 50 % of the offer size, otherwise there is a provision for forfeiture of 2.5% of the total amount earmarked for buy-back b. companies are mandated to keep 25% of the amount earmarked for buy-back in an escrow account and have to complete share buy back within a period of six months instead of 12 months. c. promoters have been restricted from executing any transaction either on-market or offmarket during the buy-back period. d. companies are prohibited from raising further capital for one year from the closure of the buy-back or make another buy-back offer within a period of one year from the date of closure of the preceding offer. e. companies are required to buy-back 15% or more of capital only by way of tender offer which is similar to a book building process. [Companies must buy back at least 50 per cent under new sebi rules, ET Bureau, Jan 26, 2013] 2http://www.sebi.gov.in/cms/sebi_data/attachdocs/1375961931576.pdf
Recent Buy-backs by companies in India: About eight companies have completed their share buy-back procedure in 2014. According to SEBI, they had targeted to buy back shares from the public for Rs 297 crores through the open market route on the stock exchanges. Maharashtra Seamless, Motilal Oswal Financial Services, Gujarat Apollo Industries are major companies that offered buy-back. [Eight companies buy back shares worth Rs 222 crore in April-June quarter, The Economic Times, July 24, 2014] Summary: In this module, alteration of share capital, the process of alteration and its implications for the company are also discussed. The provisions of the Companies Act, 2013 relating to further issue of capital, issue of bonus shares and reduction of share capital by the companies have also been discussed. The difference between purchase of shares by a company and buy-back of shares by companies has been highlighted in order to provide full knowledge to students about alteration of capital by companies.