Capital Reduction

14
REDUCTION OF CAPITAL
14.1 Introduction
A company may reduce its share capital for several reasons, e.g., to write-off heavy
losses, to rehabilitate a sick company, to pay off capital which is far in excess of its
wants, etc. A company may also undertake a reduction of capital as a part of its
Balance Sheet Restructuring. Thus, a company which has a large share premium
account, capital reserves, etc., on one side and debit balance in profit & loss
account, miscellaneous/ deferred expenditure of the other side, may set-off the two
by undergoing a reduction of capital. Several companies have recently adopted this
mode to have a leaner balance sheet.
Reduction of capital means reducing the paid-up amount of the shares of a

company. Thus, a company with a share having a face value of Rs. 10 per share
may reduce it to Re. 1 per share. Thus, an amount equal to Rs. 9 per share is either
returned to the shareholders or written-off. Reduction is an important event in the
company’s history since the creditors of the company get impacted by such a move.
It is important to note that reduction is different from a stock split. In a stock split, the
company only divides the face value over a larger number of shares, e.g., a
company with a share having a face value of Rs. 10 per share may split it to 10
shares of Re. 1 each. In this case the value of the shareholders remains intact and
only the number of shares increases. In case of a reduction, the value of the
shareholders reduces.
14.2 Companies Act

14.2.1 Reduction of capital must be done by a High Court approved process
specified u/ss. 100-104 of the Act. Once the Second Amendment Act of 2002 gets
notified, the court approval would be replaced by the approval of the National
Company Law Tribunal.
14.2.2 A company may reduce its capital in a variety of ways. S.100 provides for the
following ways:
Reduction of Capital 71
(a) By extinguishing or reducing the liability on any of its shares in respect of the
share capital which has not been paid-up;
(b) By cancelling any paid-up share capital which is lost or is not represented by
available assets. This may or may not be accompanied by the
extinguishment or reduction of liability of its shares;
(c) By paying off any paid-up share capital which is in excess of the wants of the
company. This may or may not be accompanied by the extinguishment or
reduction of liability of its shares;
A buyback of shares would ordinarily have been covered within the purview of
reduction of capital, however, s.77A dealing with buyback of shares expressly
overrides all other sections of the Act.
14.2.3 The important steps which a company needs to follow are as follows:
(a) The provisions of the Companies Act apply to a reduction of capital by any
company limited by shares or by guarantee and having a share capital. An
unlimited liability company need not follow the procedure laid down under the
Act.
(b) The reduction must be authorised by the Articles of Association of the
company.
(c) The reduction must be authorised by a Special Resolution of the company.
(d) An application must be made to the High Court u/s. 100-104 for its approval.
(e) The company must settle a list of creditors as on a specified date and invite
objections, if any, from them to the proposed reduction. The court would then
decide the amount payable to such creditor. The court may, at its discretion,
dispense with this requirement. This is the most crucial step in the entire
reduction process and more often than not the success hinges on this step.
(f) Once the court is satisfied with respect to every creditor entitled to object,
then it may pass an order confirming the reduction. It may impose such terms
and conditions as it deems appropriate. It may order that the company would
use the words “and reduced” after its name till such time as directed. In
several cases, the court directs the use of such words for a period of 5 years.
(g) The court order and a court approved minute is then to be registered with the
Registrar of Companies. This registration signifies that the reduction is
complete and it takes effect from the date of registration. The registrar’s
certificate is conclusive evidence that all the requirements have been
complied with. The memorandum of association may then be suitably
amended.
14.2.4 The process laid down for the reduction of capital also extends to the
reduction of securities premium account, capital redemption reserve account, etc.
Even preference shares can be subject to reduction u/s. 100. Thus, they may either
be redeemed by following the procedure laid down u/s. 78 or they may be the
72 Hand Book on Capital Market Regulations
subject matter of a reduction u/s. 100. It may be noted that in case the reduction is a
part and parcel of a scheme of arrangement, merger, reconstruction, demerger, etc.,
u/ss. 391–394 of the Act, then various court decisions have held that the separate
procedure laid down u/ss. 100-104 of the Act need not be followed. This is because
ss. 391–394 of the Act is a complete code by itself.
14.3 SEBI Guidelines

There are no express guidelines or regulations by the SEBI on reduction of capital.
However, SEBI has amended the Listing Agreement to provide that any reduction
must be approved by the Stock Exchange in addition to the court approval. Thus, a
listed company cannot reduce its capital if the court grants an approval but the
exchange refuses the same. This amendment in the Listing Agreement was a result
of the reduction followed by Sterlite and several other companies which followed
suit. In Sterlite’s case, the company followed a negative consent method for the
reduction wherein the shareholders’ consent to the reduction was deemed to have
been given unless he stated otherwise. This case was very keenly contested in the
courts by Sterlite, SEBI and investors associations. The key requirements of the
listing agreement are as follows:
(a) The company must file any scheme/ petition proposed to be filed before any
Court or Tribunal under sections 101 of the Companies Act, 1956, with the
stock exchange, for approval, at least a month before it is presented to the
Court or Tribunal.
(b) The company must ensure that any scheme of reduction of capital, etc., to be
presented to any Court or Tribunal does not in any way violate, override or
circumscribe the provisions of securities laws or the stock exchange
requirements. Securities laws mean the SEBI Act, 1992, the Securities
Contracts (Regulation) Act, 1956, the Depositories Act, 1996 and the
provisions of the Companies Act, 1956 which are administered by SEBI
under section 55A thereof, the rules, regulations, guidelines etc. made under
these Acts and the Listing Agreement.
(c) In the explanatory statement, accompanying a proposed resolution to be
passed u/s 100 of the Companies Act, which is forwarded by the company to
the shareholders, it must disclose the pre and post-arrangement capital
structure and shareholding pattern.
14.4 FEMA Guidelines

If a reduction of shares involves foreign shareholders, NRIs, FIIs, etc., then the
FEMA Regulations would apply. Earlier the same required the prior permission of
the RBI. However, the Reserve Bank of India has now put the reduction of shares
from foreign investors on an automatic route. Thus, prior permission of the FIPB and
the RBI would not be required for reduction by an Indian company. The key
Reduction of Capital 73
conditions to be fulfilled in order to avail of this automatic route transfer are as

follows:
(a) the company must be eligible for automatic route investment under the FDI
policy, i.e., it must not be in a restricted sector;
(b) the pricing guidelines specified by the RBI are adhered to;
(c) Form FC-TRS along with the relevant annexures is filed with the Authorised
Dealer;
(d) this route is not available for companies operating in the financial service
sector, e.g., banks, insurances, NBFCs, etc.

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14

Reduction of capital means reducing the paid-up amount of the shares of a

14.2 Companies Act

14.3 SEBI Guidelines

14.4 FEMA Guidelines

conditions to be fulfilled in order to avail of this automatic route transfer are as

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