[Shikha Rawal is an Associate at a law firm in Mumbai. The views in this post are personal.]
Over the years, several companies have increasingly resorted to selective capital reduction as a means of share capital management. A reduction of capital often 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 other hand, a ‘selective’ reduction of capital differentiates between shareholders of the same class by resulting in compulsory extinguishment of capital of some shareholders, while leaving the other shareholders untouched.
Section 66 of the Companies Act, 2013 (CA, 2013) allows a company to undertake a capital reduction in any manner subject to, amongst other things, (i) the approval of the shareholders by way of special resolution; (ii) the approval of the National Company Law Tribunal (NCLT); and (iii) the accounting treatment for such reduction being in conformity with the accounting standards specified under the CA, 2013.
If a company decides to selectively reduce its capital, the articles of association of the company ought to allow the company to reduce its capital from time to time, and in any manner for the time being authorised by law.
Jurisprudence on Selective Capital Reduction under the CA, 2013
The NCLT is only authorised to sanction a reduction of uncalled liability or a repayment of capital if it is satisfied that creditors have agreed, or have been paid, or have their debts secured. Here, it would be useful to examine the extent to which selective reduction of capital has been permitted by the courts in India. Note that the High Court was vested with the jurisdiction to consider reduction of capital under the erstwhile Companies Act, 1956 (CA, 1956), a power that has been transferred to the NCLT under CA 2013. A substantial part of the jurisprudence developed under CA, 1956 would hold good under the current legislation as well.
While considering a scheme of reduction of capital, the court may use its discretion to examine whether the reduction is fair and equitable, but the court is not concerned with the motive of the reduction[1]. The court is empowered to pass an order confirming the reduction of capital if it believes that the interests of the creditors have been duly safeguarded.
Ability of a Company to Undertake ‘Selective’ Reduction of its Capital
In Reckitt Benckiser (India) Ltd. vs Unknown[2], the Delhi High Court summarized the following principles applicable to capital reduction based on various judicial precedents:
i. The question of reduction of share capital is treated as matter of domestic concern, i.e. it is the decision of the majority which prevails.
ii. If majority by special resolution decides to reduce share capital of the company, it has also right to decide as to how this reduction should be carried into effect.
iii. It is purely a domestic matter and is to be decided as to whether each member shall have his share proportionately reduced, or whether some members shall retain their shares unreduced, the shares of others being extinguished totally, receiving a just equivalent.
iv. The company limited by shares is permitted to reduce its share capital in any manner, meaning thereby a selective reduction is permissible within the framework of law (see Re. Denver Hotel Co., 1893 (1) Chancery Division 495).
v. When the matter comes to the Court, before confirming the proposed reduction the Court has to be satisfied that (i) there is no unfair or inequitable transaction and (ii) all the creditors entitled to object to the reduction have either consented or been paid or secured.
[Emphasis added]
The question of reduction of capital has been treated as a domestic concern. If the requisite majority of the shareholders of the company has approved the scheme of reduction of capital, then the court only needs to exercise its discretion to determine whether the scheme of reduction is fair and equitable to all concerned shareholders.
In Sandvik Asia Limited vs. Bharat Kumar Padamsi and Others[3] the Bombay High Court upheld the principle set out in the judgement of the House of Lords in the case of British and American Trustee and Finance Corpn[4] that “the question whether each member shall have his share proportionately reduced or whether some members shall retain their shares unreduced, the shares of others being extinguished upon their receiving a just equivalent is a purely domestic matter, and it might be greatly for the advantage of the company that the latter alternative should be adopted.”
As such, the Bombay High Court and the Delhi Court have consistently held that, in so far as the matter of capital reduction is concerned, it is ‘a purely domestic matter’. The Bombay High Court went one step further to state that the shares of the dissenting shareholders can be extinguished on receiving an equivalent and just consideration.
Approval of the Majority of the Minority Shareholders
While Section 66 of the CA, 2013 simply requires a special resolution of the shareholders while approving a scheme for a selective capital reduction, Indian courts have placed considerable importance on such approval having been obtained from a majority of the minority (“MoM”) shareholders. The obiter dicta of the Court in Sandvik was that once it is established that non-promoter shareholders are being paid fair value of their shares and “even overwhelming majority of the non-promoters shareholders having voted in favour of the resolution shows that the court will not be justified in withholding its sanction to the resolution.”
The Bombay High Court in Re: Cadbury India Limited[5] weighed heavily on the approval of a majority of the non-controlling shareholders and observed “the court will take into account, but not be bound by, the views of the majority. In particular, the court will see what the views are of most of the non-promoter (minority) shareholders at the meeting. If the bulk of them have voted in favour, the court will not lightly disregard this expression of an informed view, one that lies in the domain of corporate strategy and commercial wisdom…
Scheme for Selective Capital Reduction to be Fair and Justifiable
In Cadbury, the Bombay High Court examined whether the scheme was fair, just and reasonable and held that a scheme must not unfairly ‘prejudice’ a class of shareholders. The Court categorically observed that ‘prejudice’ in this context must mean something more than just receiving less than what a particular shareholder may desire. It meant a concerted attempt to force a class of shareholders to divest themselves of their holdings at a rate far below what is reasonable, fair and just.
The Court in Reckitt Benckiser (India) Ltd. vs Unknown held that the majority had the right to decide the manner in which the shareholding is to be reduced and in the process they can decide to target a particular group (subject to this being without with mala fide and unfair motive). However, the Court observed that if there is a ploy to oust inconvenient shareholders in a scheme for reduction, the Court can treat the same in a particular case, as unfair and inequitable and reject the proposed reduction.
Valuation in a Scheme for Selective Capital Reduction
Indian courts have refrained from undertaking a microscopic examination of the valuation reports and the processes or methodologies followed in cases of capital reduction. In Cadbury, the Court adopted the view that:
it is not possible for a Court to go into the exercise of carrying out a valuation itself. That, as the Supreme Court said in Miheer H. Mafatlal, is not the Court’s remit. Courts do not have the expertise, the time or the means to do this. I do not believe that they are expected to do it. What the Court’s approach must be to examine whether or not a valuation report is demonstrated to be so unjust, so unreasonable and so unfair that it could result and result only in a manifest and demonstrable, inequity or injustice..
However, under the CA 2013, no scheme can be sanctioned unless the auditor’s certificate is filed with NCLT stating that the accounting treatment, if any, proposed in the scheme is in conformity with the accounting standards prescribed under Section 133 of CA 2013, applicable for both listed and unlisted companies.
Arrears in Repayment of any Deposits
This condition has been newly introduced under CA 2013, as there was no pre-condition for undertaking a reduction in share capital under CA 1956. As a result of this development, any company, in arrears in repayment of any of its deposits or interests thereon either before or after the commencement of CA 2013, will not be entitled to undertake reduction.
Conclusion
To ensure a smooth and successful reduction of capital, it is imperative that a scheme carry the following three components: (i) the majority of the minority shareholders approve the scheme, (ii) the reduction of share capital is fair and equitable and (iii) fair and just methodology adopted for valuation of the shares. Further, the jurisprudence on selective reduction of capital indicates that shareholders might use selective reduction of capital as a ground to challenge the reduction in the price offered by the company for extinguishment of the shares. Thus, while reducing capital, the price offered by the company to the shareholders, in other words the valuation of the shares, is of paramount importance. It then becomes critical for the valuer to provide rationale in the valuation report, consider the previous position of the company in relation to the bonus shares, dividends, if any issued by the company, buyback of shares and takeover offers made by the company in order to arrive at a consistent price.
It is difficult for the courts to decipher the intent behind selectively reducing the share capital (whether the reduction in the capital is induced to drive out the minority shareholders or for a rearrangement of the balance sheet of the company). However, the onus lies on the company undertaking the reduction to demonstrate that the reduction is fair to minority shareholders.
– Shikha Rawal
[1] Ex parte Westburn Sugar Refineries Ltd (1951) AC 625.
[2] 122 (2005) DLT 612.
[3] 2009 111 (4) Bom LR 1421.
[4] [1894] AC 399 (HL).
[5] Company Petition No. 1072 of 2009, Decided on 25 February 2014 (Bombay High Court).