Capital reduction is a policy adopted by companies to diminish their share capital through varied means, such as share cancellations and repurchases. Serving multiple purposes, this strategic move enhances shareholder value and aids in optimizing the enterprise’s capital framework for greater efficiency.
Section 66 of the Companies Act, 2013, has been particularly introduced to facilitate this process, while upholding fairness and equity. The legislation safeguards the operational integrity of the company, and it ensures that the rights/interests of the creditors remain guarded throughout the reduction procedure.
A company organized as a limited liability entity can reduce its share capital by passing a special resolution, which requires approval from the National Company Law Tribunal. During this procedure, the company may also adjust its memorandum by decreasing both the total share capital amount and the corresponding number of shares.
Reduction of the Paid-Up Capital – Company Benefits
Before Capital Reduction
| Liabilities |
Amount |
Assets |
Amount |
|
Equity
(100 shares of INR 10) |
1000 |
Fixed Assets |
500 |
| Reserve & Surplus |
(800) |
Trade Receivable |
400 |
| Current Liabilities |
1000 |
Other Current Asset |
300 |
| Total |
1200 |
Total |
1200 |
- The accumulated loss of INR 800 be reduced from the Equity Share Capital
- The Reserve and Surplus will be Nil after the reduction of the paid-up capital.
- The company can reduce the share capital either by the number of shares or the face value of the shares.
After Capital Reduction
| Liabilities |
Amount |
Assets |
Amount |
|
Equity
(20 shares of INR 10) |
200 |
Fixed Assets |
1000 |
| Reserve & Surplus |
|
Trade Receivable |
400 |
| Current Liabilities |
1000 |
Other Current Asset |
300 |
| Total |
1200 |
Total |
1200 |
- The company will have benefits such as improved EPS, elimination distribution of dividends, and improved liquidity.
- The company can purchase the shares back.
- The company can raise the funds from the external financial institutions.
Procedure for Reduction of Share Capital
The procedure for the Reduction of Share Capital under the applicable laws is as below:
1. Board Meeting - Initiate a Board Meeting to sanction the reduction of share capital and arrange for a general meeting of the company to secure member approval.
2. Shareholders Meeting – Conduct the general meeting and pass a Special Resolution endorsing the reduction of share capital. Report the resolution's approval to the Registrar of Companies within a period of 30 days.
3. National Company Law Tribunal – The application to the National Company Law Tribunal to validate and confirm the reduction of share capital. The application must be accompanied by the following:
- A Certificate from the auditor of the company stating that the list of creditors is correct and in accordance with the records of the company verified by the auditor.
- The company is required to provide a certificate from the auditor and a declaration from the director stating that, as of the application filing date, the company is not lagging in repayment of deposits or interest.
- Any other relevant documents.
4. Notice Submission: The notice shall be submitted to the Registrar of Company and Creditors seeking representation and objection in the reduction of the Share Capital. The notice must include the amount of the proposed reduction, locations for creditor list inspection, and the timeframe for creditor objections, as determined by the Tribunal.
5. Publication: NCLT has necessitated the publication of the notice in a leading English and vernacular language newspaper in the state wherein the company's registered office is held.
6. Confirmation Order: The National Company Law Tribunal issues an order confirming the reduction of share capital, upon the satisfaction that creditors' claims are resolved or secured. It is done so with stipulated terms and conditions, and in a prescribed format.
7. Registrar Notification: The company is required to provide a certified copy of the order of the National Company Law Tribunal to the Registrar of the Company. The Registrar will issue the certificate to reduce the capital of the company.
8. Foreign Exchange Compliances: A transfer of shares by a non-resident to an Indian company under the capital reduction scheme of the company is mandated to comply with the provisions of the Foreign Exchange Management Act, 1999, Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 read with Foreign Direct Investment (FDI) Policy 2020.
National Company Law Tribunal Order
Below are various scenarios in which the National Company Law Tribunal has either ruled in favour of or against the company:
1. Case A
The company proposed a substantial reduction of its capital by 75 per cent of the shareholding without any consideration, with the reduced amount intended to be transferred to the capital reserve account. Despite the company indicating strong financial statements, the NCLT, upon analyzing the submitted documents, rejected the petition. The tribunal's decision derives from the analysis that the current case is not in alignment with the provisions outlined in Section 66 of the Companies Act, 2013.
2. Case B
The reduction of the capital scheme received united approval from the shareholders, with no consideration involved. However, the Regional Director brought up concerns regarding the selective and unjust nature of capital reduction, particularly considering the company's profitability.
Albeit these objections, the NCLT approved the petition, highlighting that decisions concerning capital reduction are mainly domestic affairs, and the will of the majority shareholders would prevail in such matters.
3. Case C
Herein, the proposal aimed to cancel a substantial 99.85% of the Paid-up Equity Share Capital. Shareholders will receive a nominal amount as compensation. Despite the company having a negative net worth, creditors did not oppose the scheme.
However, the National Company Law Tribunal (NCLT) rejected the application, with their reason being that the proposed capital reduction, achieved by returning capital to shareholders, did not align with the overall interests of the company and its stakeholders.
Conclusion
In summary, capital reduction stands out as a strategic mechanism that allows companies to fine-tune their share capital to achieve a variety of goals, such as mergers, restructuring, and increasing shareholder value. Companies effectively manage their equity and cultivate distributable reserves by using methods such as share cancellations or repurchases.
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