Capital reduction of companies: Safeguarding interest of creditors and minority shareholders

Company is an artificial person formed with certain objectives to implement with its capital which is divided into a number of indivisible units of a fixed amount known as share. With the expansion of business a company may require to increase its capital or borrow money from divergent creditors like banks, financial institutions etc. Again, in certain circumstances like existence of share capital unrepresented by available assets, presence of surplus capital etc., the company may decide to reduce the same. Reduction of share capital may cause prejudice to creditors if the reduction diminishes company's ability to satisfy its liabilities. Reduction scheme should not be designed in a manner to injure the rights of minority shareholders whose rights are always in de facto risk. No capital reduction scheme shall take into effect without confirmation by the company court. That's why, company court requires to satisfy itself concerning the reservation of the rights of creditors and minority shareholders at the time of confirming any capital reduction scheme of a company.

Reduction of share capital implies subscribed and/or paid up capital reduction and not authorised capital. For a company to reduce its share capital, it must have authority given to it under its Articles of Association (AOA). If the Articles do not contain any provision for reduction of capital, the Articles must first be altered so as to give the authority [(1868) LR 9 Ch App 11]. It may be noted that an authority to reduce share capital given by the Memorandum of Association (MOA) is of no use.

The need for reducing share capital may arise in numerous circumstances like in the case of trading losses, heavy capital expenses, substantial losses of assets etc. Consequently, the company requires to adjust the relation between capital and assets by reducing its share capital. In Tamil Nadu Newsprint and Papers Ltd. versus Registrar of Companies (1995), the Mardas High Court permitted the company to reduce its capital which was found to be in excess of its needs by allowing it to pay the same partly in cash and partly in the form of non-convertible debentures.

According to section 59 of the Companies Act, 1994 a company may reduce its share capital 'in any way' and in particular (a) extinguish or reduce the liability on any of its shares in respect of share capital not paid up, (b) either with or without extinguishing or reducing liability on any of its shares, cancel any paid up share capital  which is lost and (c) either with or without extinguishing or reducing liability on any of its shares, pay off any paid up share capital  which is in excess of the wants of the company. The phrase 'in any way' means in any manner, by any manner of means, without any particular way or method (Random House Webster's Unabridged Dictionary). The three kinds of reduction of capital which are particularised above are the commonest, but the permissible modes of reduction are not limited by them. Any scheme of reduction may be sanctioned by the court (Pennington's Company Law, 8th Edition, page 208).

A capital reduction scheme 'by which moneys are to be returned to some shareholders and not to all shareholders may be resolved upon and confirmed if it be fair and equitable. In an Indian case the company has framed a capital reduction scheme to extinguish the holding of non-promoter shareholders on payment of fair value for their shares. The reduction was approved by a majority of the equity shareholders including majority of non-promoter shareholders. On finding the scheme fair the court sanctioned the same [(2009) 151 Com Cases 251].

If the sole reason for capital reduction is that capital is lost or unrepresented by available assets, the court requires some prima facie evidence in support of the contention and the loss should be permanent in nature. The valuation report of an expert supported by his affidavit may be relied upon. If a company has created reserve fund out of retained profits and subsequently suffers a loss, the normal practice is to write off the loss against the reserve fund, and to reduce capital only if the said fund is insufficient to cover the loss [(1900) 2 Ch 846].

The General Meeting for consideration of capital reduction scheme is to be convened by 21 days' prior notice and the scheme must be approved by a special resolution i.e. 3/ 4 (three-fourth) majority of the members. A company has the right to determine the extent, the mode and incidence of the reduction of its share capital. But the court, before it proceeds to confirm the reduction of capital, must see that the interests of the minority shareholders and that of creditors are adequately protected and there is no unfairness to them, even though it is a domestic matter of the company [(1989) 66 Comp Case 387 (MP)]. "The general rule is that the prescribed majority of the shareholders are entitled to decide whether there should be a reduction of capital, and, if so, in what manner and to what extent it should be carried into effect. When the reduction is consequent on a change in the method of carrying on the company's business, it is for the shareholders to decide to what extent its capital is in excess of its wants, and on the adequacy of the consideration for the reduction of their share capital, but the powers of the shareholders must be exercised so as to safeguard the rights of creditors, the just and equitable treatment of shareholders and the interest of the investing public" [1894 AC 399 (HL)].

After approval by shareholders the company shall submit a petition before the company court for confirmation of the reduction scheme. After admission of petition the court may pass order to publish advertisement in national dailies stating the subject matter.

In exercising discretion in sanctioning reduction scheme, the company court will consider whether the reduction is fair and equitable. The scheme should not be prejudicial to creditors and minority shareholders. Sir George Jessel observed: "The creditor has no debtor but that impalpable thing the corporation, which has no property except the assets of the business. The creditor, therefore, I may say, gives credit to that capital, gives credit to the company on the faith of the representation that the capital shall be applied only for the purposes of the business and he has therefore a right to say that the corporation shall keep its capital and not to return it to the shareholders" [(1882) 21 Ch D 519].

The court shall finalise a list of creditors of the company with their respective claims. If any officer of the company intentionally conceals or abets to conceal the name of any creditor entitled to object to the reduction scheme, every such officer shall be punishable with imprisonment which may extend to two years, or with fine, or with both. In case of reduction of share capital of minority shareholders, the value of the shares must be assessed by independent valuer.

After publication of advertisement, the copies must be submitted to the court by a petition of compliance. The court may allow any creditor who desire to advance verbal representation before it. If the company furnishes sufficient security by making a deposit of money against the claim of creditors as per order of the court, the requirement of creditors' consent may be dispensed with. In fact, the interest of creditors and minority shareholders must be adequately guarded in all circumstances. The court will…refuse to confirm a reduction which is shown to be unfair to some class or minority of shares (Palmer's Company Law, 25th edition, volume 1, para 4.311)

It's a legal obligation of the petitioner to make full and frank disclosure of all facts relating to the proposed scheme so that the court may satisfy itself that the proposed scheme is not contrary to public interest or public policy.

The court after being satisfied about the bona fide character of the capital reduction scheme especially the arrangement for protection of creditors may confirm the same on such terms and conditions as it thinks fit. At the time of approving scheme the court may direct the company to pay an amount of charity to some charitable institutions as fixed by the court.

The scheme will take into effect after communication of the order to the Registrar of Joint Stock Companies and Firms who will register the same and issue a certificate. The certificate shall be the conclusive evidence that all the required formalities under the law with respect to reduction of share capital have been duly complied with.

We have experienced a number of instances where members of companies distributed the capital among themselves without compliance of the prescribed procedures. Any such action is completely unlawful and the concerned members are liable to refund the money. The company by a reduction scheme may also dispose of its movable and immoveable assets in favour of its members without execution of registration deeds. Such practice is very much common in our country but in very limited cases the compulsory formalities are adhered to. 

Md. Nazrul Islam Khan in an Advocate of the Supreme Court of Bangladesh.

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