[Aastha Bhandari is a fourth-year student at Jindal Global Law School]
On 28 July, 2022 the National Company Law Appellate Tribunal (“NCLAT”) passed its judgement in Precious Energy Services Limited v. Regional Director, holding that the negative financials of a company vis-à-vis its net worth and book value per share do not hold any relevance in determining whether the company possesses liquidity. Therefore, it shall be allowed to effect a reduction of capital under section 66 of the Indian Companies Act, 2013. (“CA”) The present holding comes as a result of a Company Appeal (AT) No. 17 of 2021 filed by Precious Energy Services Limited (“Appellant”), being aggrieved with the order passed by the National Company Law Tribunal (“NCLT”). It signifies the settlement of a significant question of law: what is the lawful basis for a court and regulator (through the Regional Director) to intervene in approving and sanctioning a scheme for reduction of capital of a company? More importantly, the judgement reiterates the threshold beyond which said intervention is impermissible and when credence must be given to the decision of the parties filing for an application for the purposes of said reduction.
In this post, the author seeks to analyze the judgement of the NCLT and the NCLAT and examine whether they are in consonance with past precedents on similar questions of law in the domain of reduction of capital. Finally, the post seeks to provide clarity on the present position of law.
Factual Background
The Appellant presented their balance sheet as on 28 April 2020 to the NCLT in an application made under section 66 of the CA. Herein, the NCLT observed that the Appellant had negative net worth/shareholders’ funds amounting to Rs. (-) 1609.66 lakhs and a book value of Rs. (-) 23.04 per share coupled with high borrowings. The terms of the scheme being undertaken in the present case showed that the Appellant had proposed to return the capital to its shareholders at Rs. 77.49 per share, with the final amount totaling to Rs. 5404.93 lakhs. In line with these facts, the NCLT passed its verdict holding that the reduction of capital would not be allowed as it was against the overall interests of the Appellant as well as the interests of the relevant stakeholders. The NCLT’s decision flows from the observations of the Regional Director of the Ministry of Corporate Affairs. (“RD”) The RD made a conclusive link between the company’s books of accounts showing a negative net worth with the fact that the company will then not be allowed to reduce its capital on grounds of insufficient liquidity to pay the exiting shareholders, even though the procedure prescribed under section 66 of the CA had been complied with.
Aggrieved by the order, the Appellant filing for the Company Appeal before the NCLAT contended that its shareholders had unanimously voted for the reduction by way of passing a special resolution. Further, the secured and unsecured creditors of the Appellant were not prejudiced by this reduction. The Appellant also highlighted that the reduction was being undertaken on the commercial basis of reducing the overall weighted average cost of capital and improving earnings per share and that it possessed sufficient liquidity to undertake the same. Put simply, it argued that as long as the reduction had been approved by the shareholders and the creditors (together the “relevant stakeholders”) complying with other requirements prescribed under section 66, the commercial decision of the Appellant must be accepted as it is the domestic affair of a company. On the other hand, the RD yet again argued that while the Appellant may have certain investments along with cash and bank balance amounting to Rs. 5618.26 lakhs, it had sizeable current liabilities, which were to be paid within the same financial year. In fact, the Appellant had borrowed inter-corporate loans to pay the shareholders, and this signaled towards the lack of liquidity to undertake the reduction. As such, it was prayed that the reduction shall not be sanctioned by the NCLAT.
Issue
The issue before the NCLAT was whether the NCLT’s action of rejecting the reduction on grounds of the Appellant’s negative net worth and resultant lack of liquidity to make payments was contrary to section 66 of the CA and signified a judicial overreach.
Ruling and Analysis
The NCLAT finally held that the reduction of share capital in the present case, as approved by the majority shareholders of the Appellant, by way of a special resolution would be sanctioned.
At the outset, reference shall be made to section 66(1) of the CA, which reads as follows:
“Subject to confirmation by the Tribunal on an application by the Company, a company limited by shares or limited by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner and in particular, may –
- a) extinguish or reduce the liability on any of its shares in respect of the share capital not paid up; or
- b) either with or without extinguishing or reducing liability on any of its shares, –
(i) cancel any paid-up share capital which is lost or is unrepresented by available assets;
(ii) pay off any paid-up share capital which is in excess of the wants of the Company, alter its memorandum by reducing the amount of its share capital and of its shares accordingly.” [emphasis added]
Reduction of Share Capital Being a Matter of Domestic Concern
The NCLAT conceded to the Appellant’s argument regarding reduction of capital being the domestic concern of a particular corporation. The basis for this reasoning was a string of past precedents ranging from the House of Lords, the NCLT to various decisions from different High Courts of India (together the, “relevant Courts”):
First, the landmark judgement delivered by the Madras High Court in Re. Panruti Industrial Company (Private) Ltd. set the initial precedent for questions of reduction of capital of a company to be treated as “one for the decision of the majority of the shareholders of the company.”
Second, the above approach saw an expansion in Reckitt Benckiser (India) Ltd. wherein the Delhi High Court opined that the question of reduction is to be treated as a matter of domestic concern. This essentially means that the decision of the majority shareholders prevails over everything else. Consequently, this majority also has the right to decide how the reduction will be carried into effect. It must be noted, though, that this judgement was passed pre-enactment of the CA 2013. The phraseology of current section 66 reads “reduce the share capital in any manner.” As such, the NCLAT in the present case, by relying on this precedent, has emphasized upon the fact that section 66 does not prescribe the manner in which reduction must take place.
Third, the NCLAT in Economy Hotels India Services Limited v. Registrar of Companies emphasized that reduction of capital, being a domestic affair decided by the majority, implies that ordinarily the tribunal does not have the power to interfere in such a decision.
Primary Consideration: Commercial Wisdom of the Company and its Majority Shareholders
Linked to their assessment of reduction being a domestic affair, the NCLAT further opined that the question of reduction of capital is one wherein the primary consideration must be given to the discretion and commercial wisdom of the company and its shareholders. This holding follows from a long list of precedents that have been given out by the relevant courts:
First, the House of Lords in British and American Trustee and Finance Corporate v. Couper (1894) observed: “If the parties to the transaction come to the conclusion that the bargain is a fair one; why should the Court say that there is a preference on the one side or on the other. 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.”
Second, in Elpro International Limited the Bombay High Court observed that the reduction of capital is based on commercial consideration undertaken by businesspersons who are in the best position to know the interests and necessities of their own company.
Third, the Andhra Pradesh High Court in IL&FS Engineering and Construction Company Limited v. Wardha Power Company Limited held that a court cannot interfere with the discretion and commercial wisdom of the stakeholders in a scheme for the purposes of reduction. Therefore, if the reduction is one that is properly passed by the shareholders who are treated equitably, have had the facts explained to them, and provided the creditors are safeguarded, the court will habitually sanction reductions.
In the present case, the Appellant was involved in the business of producing energy through solar power plants. Going back to the RD’s argument related to insufficient liquidity, the Appellant explained that the negative net worth in the books of the company was only because they operated in a capital-intensive industry, where depreciation was being charged on their assets. In fact, the Appellant had entered into a Power Purchase Agreement with a customer for supplying electricity on a long-term basis and consideration of projected cash flows from the same would show that there was liquidity. The shareholders were aware of these commercial realities and had approved the reduction through the understanding of the commercial justification provided by the company. That should have been the end of the matter, anything further being a judicial overreach.
Compliance with Statutory Requirements under Section 66
Reduction of capital being a domestic affair of a company where the commercial wisdom of the company and its majority shareholders prevails is always subject to compliance of the procedure for reduction prescribed under section 66 of the CA which includes the following:
- A special resolution must be passed by the shareholders in compliance with section 103 of the CA.
- The Company should not be in any arrears.
- The Company must not be obligated to repay any deposits.
- The reduction should not be prejudicial to the interests of any creditors.
Court’s Role Limited to Safeguarding Interests of the Relevant Stakeholders
Through its judgement, the NCLAT clearly demarcated the limits of when judicial and quasi-judicial bodies have a say in a matter of reduction of capital. One must note that reduction under section 66 read with National Company Law Tribunal (Procedure for reduction of share capital of Company) Rules of 2016 is a process wherein there is involvement of regulators such as the RD and the Securities and Exchange Board of India (in case of listed entities) along with the Tribunal. The line gets blurred because the legal provisions do not specify the threshold for the degree of said intervention and as such this question of law has been left for the determination of courts. As such, herein, the NCLAT observed the following:
At the outset, in IL&FS Engineering, the High Court held that the court does not exercise any appellate power over the decision of the company or its management, in matters of reduction of capital. “The courts have a ‘discretion’ to confirm or not to confirm, which it is their duty to apply in ‘every proper case,’ and this discretion is to be exercised by reference to – whether the scheme would be ‘fair and equitable,’ ‘just and equitable,’ ‘fair and reasonable’ or ‘not unjust or inequitable’.”
Similarly, the case of RHI India Pvt. Ltd. represents a situation wherein the NCLT failed to point out any material illegality in a scheme that had been approved by 99.95% of the relevant stakeholders, but still went on to reject the application on the grounds that it was contrary to public policy. This was held by the NCLAT to be an invalid exercise on the part of the NCLT.
Lastly, the Andhra Pradesh High Court in Hyderabad Industries Ltd. observed that the court has two essential duties when reviewing an application: satisfying itself that (i) the procedure of passage of the special resolution is good in law and has not prejudiced any of the relevant stakeholders; and (ii) the scheme is not unjust or inequitable to anyone.
The NCLAT’s holding is in line with several other recent judgements passed by other benches of the NCLT and the NCLAT on the question of judicial interference in effecting a reduction of capital under the CA. In the matter of Haryana Malleable and Alloy Castings Limited (2022) represents a case wherein the shareholders were not being paid any cash or consideration for the reduction of their capital because the Company had accumulated high losses. This arrangement was approved by the majority of the shareholders and no creditor objected to it. However, the RD objected stating that the Company was attempting to undertake a takeover under the guise of losses. The NCLT finally opined that the present position of law is that if none of the relevant stakeholders are objecting then the application deserves to be admitted post consideration of merits. A similar judgement was also passed in Ovobel Foods Limited v. Registrar of Companies, Karnataka (2022).
Concluding Remarks
The present judgement rightly defines the contours of court and regulatory interference in questions of reduction of capital. The present position of law on reduction of capital can be summarized as follows:
- It is a domestic affair of a company, and the decision of the majority shareholders prevails in every situation.
- The court must respect and give due consideration to the commercial wisdom of the parties undertaking reduction.
- The above is subject to: (i) compliance with requirements under the statute and rules thereunder; (ii) no prejudice being caused to any creditor; and (iii) the reduction not being unjust or inequitable in any manner. However, it must be noted that with respect to point (iii), one must not construe this to mean that a selective reduction is impermissible.
There is yet to be a final conclusive position from the Supreme Court of India on this point of law. Nevertheless, the present case sets a significant precedent setting out the limited role to be played by the court in matters of reduction. Companies intending to reduce their shareholding on grounds of overcapitalization, unfair reflection of real value of assets or otherwise may resultingly see a smoother process.
– Aastha Bhandari
