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Published : April 14, 2010 | Author : ASIFBASHA.A
Category : Banking and Finance laws | Total Views : 8952 | Rating :

A student of NALSAR, pursuing LL.M. in Corporate Law and Governance.I would like to mention a special thanks to my parents and dedicate this article to them without whom nothing is possible in my life.

                 "In this article, I would like to deal with the basis of reduction of capital and how unfairly the minority shareholders are eliminated from the company in certain occasions with the help of reduction of capital.

             Before going inside the article, I would like to raise two questions, to which we will find out the solution available through various provision of company law and other cases. The question is, say if there are A, B, C, D and E who are the share holders of a company limited by shares called Z. A, B & C are the members of a same family who hold 80% of the shares of Z company. They want only their family member to remain as members of company Z. They want to eliminate D & E out of the company Z. So, they call for a reduction of capital to eliminate D & E who hold 20% of the shares. The question of the hour is can they eliminate D & E? The second question and its solution shall be provided in the later part of the article.

            Before going inside to find a solution for the above raised question, let us look at what the term minority and capital means with regards to this article. "Minority" mean persons who hold relatively less number of shares compared to other shareholders in the company.

            The word "Capital" involved in "reduction of capital" includes nominal share capital, whether issued or unissued and if issued whether fully paid or not and "share" includes "stock" so that a company must reduce its stock. Every reduction of capital must reduce the nominal capital, and a reduction of unissued capital may be combined with a reduction of issued capital, while issued capital may be reduced, whether fully paid or not.

            Provision which deal with reduction of share capital.
 Sections 100 - 105 of the Companies Act, 1956, provide for the reduction of capital. Similarly a scheme of arrangement having the ingredients of demerger and " reduction of share capital" was permissible under the provision of section 391-394 and could not said to be beyond the purview of the Companies Act 1956.

Section 100 of Companies Act:
would like to mention section 100 of the companies Act, which states that:-

            (1) Subject to confirmation by the (Tribunal) a company limited by shares or a company limited by guarantee and having a share capital, may, if so authorized by its articles, by special resolution, reduce its share capital in any way; and in particular and without prejudice to the generality of the foregoing power, may-

 (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, or is unrepresented by available assets; or

 (c) Either with or without extinguishing or reducing liability on any of its shares, pay of any paid up share capital which is in excess of the wants of the company; And may, if and so for as is necessary, alter its memorandum by reducing the amount of its share capital and of its shares accordingly.

            (2) A special resolution under this section is in this Act referred to as "a resolution for reducing share capital".

            To sum up section 100, a company may if so authorized by its articles of association, by special resolution may reduce its share capital, which needs to be confirmed by an order of (tribunal). The three primary ways of making such a reduction are:-

            (1) The extinction of liability on shares not fully paid up:-

            (2) The cancelation of paid up share capital which is lost or not represented by assets;

            (3) Pay of any paid up share capital which is in excess of the wants of the company.

Essential Requirements for Reduction:-
            Taking into consideration section 100 of companies Act, it could be easily said that a clause in the articles of association with regards to reduction, secondly special resolution to that effect and lastly confirmation by the (Tribunal), these three form the basic elements of reduction of share capital.

Manner of Reduction:
            There is no particular manner which is provided by the act for the reduction of capital and the manner to eliminate the shareholder from the company. Section 100 does not prescribe the manner in which the reduction of capital is to be effected. Nor is there any limitation on the power of the (Tribunal), to confirm the reduction of capital, except that it must be first satisfied that all the creditors entitled to object to the reduction have been consented or have been paid or secured.

 Process of Reduction:
          Although, there is no particular process of reduction of capital as contemplated by the Act, Yet the Supreme court in Punjab Distilleries India Ltd., V. CIT, (1965) 35 Comp Cases 541, 544 summed up the process of reduction thus: "First, there will be a resolution by the general body of a company for reduction of capital by distribution of the accumulated profits amongst the shareholders. Secondly, the company will file an application in the court for an order confirming the reduction of capital. Thirdly, after it is confirmed, it will be registered by the Registrar of Companies. Fourthly, after the registration the company will issue notices to the shareholders inviting application for refund of the share capital and fifthly on receiving the applications the company will distribute the said profits.

Internal Issue:
            The majority of share holders involve themselves in reducing the share capital without any hassle as it is considered to be an internal issue or an issue of domestic concern. This principal has been taken into consideration is a number of cases. Let us look at a few of them and how they enunciate the above said statement. The issue of reduction of capital is a matter of domestic concern, one for the decision of the majority, of the shareholders of the company. In other case it was held that reduction of the share capital of a company is a domestic concern of the company and the decision of the majority would prevail. If the majority by special resolution decides to reduce the share capital of the company, it has the right to decide, how this reduction should be effected. While reducing the share capital the company can decide to extinguish some of its shares without dealing in the same manner with all other shares of the same class. A selective reduction is permissible within the frame work of law for any company limited by shares. The same was upheld even  in the case of Re Panruti Industrial Co. (Private) Ltd., AIR 1960 Madras 537 (V47 (179).

            Thus, from the above mentioned provision, we get the answer to the question raised in the beginning of article. "Yes", D & E can be eliminated from the company, on fulfillment of the above said provision.

            My second question which I would like to raise in this article, which is actually a continuation of the first question, is? Is it fair? i.e. elimination of the members D & E. Isn't against the democratic right of the shareholder from holding his share? The answer is 'Yes and I would provide you with number of reasons for jumping in to this conclusion. Let us look at the reasons one by one.

 Alterable Article of Association:
            One of the basic ingredients for bringing into effect reduction of capital is a clause in the articles of association to that effect. If suppose there is no clause in the articles of association with regards to this and the person subscribes for being a shareholder, with the conception that his stay in the company is secured, then also on the will of the majority, if they want to eliminate him, it could be done easily by the majority. That is just by introducing a clause in the articles of association with regards to reduction of capital. The majority could simply bring on alteration in the articles of association through section 31 of the Companies Act; this is definitely a kind of deception practiced by the majority shareholders.

Fair Price Denied:
            In most of the cases, a company on the pretext of reducing capital utilizes its accumulated profits to pay to the minority shareholders whole or part of the paid up amount on the shares. A minority shareholders though in form gets back the whole or a part of the capital contributed by him, in effect he gets a share of the accumulated profit, which if a straight forward course was followed, he should have received dividend. This is elimination of minority under the guise of reduction of capital.

            In case of unlisted company, how do you decide a fair price for the share, what is fair and equitable, must depend on circumstances of each caseThus, fair price is denied to the minority shareholders in most of the cases.

General Rule of Reduction:
            The general rule of reduction of capital, is that the prescribed majority of shareholders are entitled to decide whether there should be a reduction of capital and if so, in what manner and what extent it should be carried into effect .As the saying goes; "power corrupts and absolute power tends to corrupt absolutely" here also the majority is given absolute power, which instigates the majority to act according to their whims and fancies.

Objective not taken into consideration:
            There are a number of reasons why the majority share holders want to reduce their share capital. Some of the reasons may be doubtful value, to mislead the government, to remove the minority etc. When send to the court to get its nod for reduction, the court doesn't look at the motive behind the reduction.  When exercising its discretion the court is concerned to see that the reduction is fair and equitable as held in British and American Trustee and Finance Corporation V. Couper 1894 AC 399 (HC) but is not concerned to consider the motive for the reduction; as for example, that it was to avoid the effects of a threatened nationalization, Exparte, Westburn Sugar Refineries Ltd., (1951) All ER 881 (HL), or to distributed accumulated profits in such a way as to avoid or diminish liability to tax, David Bell Ltd., (1954) SC 33, or to pay for the payment of estate duty, on the death of a large shareholder Re, Rea Bros. Ltd., unreported No. 00916 of 1949, Panruti Industrial Co. P. Ltd., Re AIR 1960 Mad 537, in all these cases reduction was confirmed by the court.  The majority shareholders mishandle this principle followed by the court while granting permission for reduction and use it in whatever way which suits their objective. Like for instance use it to eliminate the minorities from the company.

Majority Affairs:
            Even though the court has said that reduction of capital is a domestic affair in number of cases. Virtually specking it is majority affairs and not domestic affairs, since it is only the majority which decides what needs to be done. Reduction of capital is a sort of power which has been entrusted in the hands of the majority promoter shareholder. An issue could be said to be domestic or inside issue when it involves the active participation of all the persons existing inside the family or company, but here it is not the case.

Natural Justice:

             The majority of share holders under the guise of reduction of capital don't follow natural justice, which is they don't give equal treatment to everyone. The basic principle of democracy is equality and freedom. The democracy it wants to achieve or establish equality and equal access to everyone. But, through the elimination of minority shareholders, by the majority for its whim and fancies the democracy loses its shine. The constitution says that no person shall be deprived of property unless it is through authority of law. Constitutions objective was only to preserve public policies, but this also could be done only by authority of law. But here in most of the cases the elimination or acquisition of shares is done for private purposes, which doesn't substantiate the cause.

 A kind of fraud:
            I would like to mention that reduction of capital for the sole purpose of removing minority from the company could be brought inside the purview of the term fraud. In the words of Lord Davey, in Burland V. Earle (1902) A.C. 83, fraud embraces all cases where the wrongdoers," are endeavoring, directly or indirectly, to appropriate to themselves money, property or advantages  in which the other shareholders are entitled to participate".

            I believe that I have convinced the reasons for the answer given by me the second question. The need of the hour is to impose restrictions on the reduction of capital, since it is also against jurisprudential aspect of doctrine of maintenance of capital. An appropriate solution needs to be provided to the minority shareholders, so that they aren't stamped in the future. Court needs to look at the objective behind the reduction and similarly when there is no clause in the articles of association with regards to reduction of share capital, alteration should be allowed only with the unanimous consent of the shareholders. Moreover, the advice or recommendations of the SEBI or stock exchanges to where the company is situated nearby could be taken in deciding what the fair price of the share is, finally, all the above mentioned steps need to be taken to safeguard the minorities. This should definitely, be done in our country, which gives utmost protection to the minorities in all walks of life.

W.M. James, L.J., said:
"The defendants, who have a majority of shares in the company, have made an arrangement by which they have dealt with matters affecting the whole company, the interest in which belongs to the minority as well as to the majority. They have dealt with them in consideration of their obtaining for themselves certain advantages... The minority of the shareholders say in effect that the majority has divided the assets of the company, more or less, between themselves, to the exclusion of the minority. I think it would be a shocking thing if that could be done, because, if so, the majority might divide the whole assets of the company, and pass a resolution that everything must be given to them, and that the minority should have nothing to do with it. Assuming the case to be as alleged in the bill, then the majority have put something into their pockets at the expense of the minority. If so, it appears to me that the minority have a right to have their share of the benefits ascertained for them in the best way in which the court can do it, and given to them."

In re Panruti Industrial Co. Private Ltd., AIR 1960 Mad 537 (U47C176.
Larson and Toubro Ltd., In re, (2004) 121 Comp Cas 523 (Bom).
Substituted for "Court" by the Companies (Second, Amendment) Act, 2002, w.e.f. a date yet to be notified.
Substituted for "Court" by the Companies (Second, Amendment) Act, 2002, w.e.f. a date yet to be notified.
The Securities and Exchange Board of India V.Sterlite Industries (India) Ltd., (2003) 113 Comp  cases 273.
C.A. Ramaiya, "Guide to the Companies Act", 16th ed.2006,p1150.
In Re:Elpro Interational Ltd., (2009) 149 Comp Cas 645 (Bom)
In re Siel Ltd., (2008) 144 Comp Cas 469 (Delhi).
Scottish Insurance Corp. Ltd., V. Wilsons & Clyde Co Ltd., (1949) A.C. 462
Westburn Sugar Refineries Ltd.,( 1951) 1 All E.R. 881
C.A. Ramaiya, "Guide to the Companies Act", 16th ed.2006, pp.1152-1153.
A.K.Majumdar, "Company Law and Practice", 12th ed. 2007,p 943.
Pennington's, "Company Law",5th ed.1985,p734.

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Article Comments

Posted by Summit Ensign on February 19, 2011
This is something I feel like calling - "an illegal law" !

So because, by forceful return of capital, you are compelling the recipient members to withdraw from the venture they once helped begin.

"Forceful ! This is not forceful - this is in line with the law - perfectly legal" - I've heard many say. Hey, the truth is, the law is silent on this - so how can this be "in line with the law"? Does Silence mean Consent?

But, the law is being wrong in being silent on something as crucial as this. IT NEEDS TO SPEAK - AND SPEAK HARD! Else we, the common man of this nation, from whom the law derives its power, need to GET it to speak.

You might be giving them a "fair price" - whatever that means - and even if it's at all "fair" - but what you're denying them is a gazillion times more valuable - the OPPORTUNITY COST.

Where would the company have been if the members hadn't contributed the capital at the inception? I guess, nowhere. Would the company have even started?

Secondly, even if weren't the original members, but rather their inheritors, who hold the shares today, they are enjoying the benefits of the hard work and resources put in by their predecessors. How can a majority suddenly from nowhere gain enough power to rid them of their legitimate possessions?

Is this "Daylight Robbery"? No, not at all. This is, in fact, "Daylight Dacoity"! Financial Hooliganism. Corporate Goondaism. Malicious Muscle of the Majority.

Even if it's "in line with the law", it's - INHUMAN! A Gross violation of human rights!

This is a law that I feel contradicts other laws - contradicts the very fundamental rights of human beings in a democracy - hence to me - "an illegal law"!

You're right - an outright mockery of Democracy, this is.

Posted by Bhuvana on May 05, 2010
The issue relating to reduction of Share Capital was dealt with by the Division Bench of the Hon'ble High Court Bombay in the case of Sandvik Asia limited. Sandvik Asia dealt with both aspects of the issue of reduction of share capital and has upheld the principle that the Companies Act does not restrict the Company from reducing the share capital by reducing the shares of someshareholders of a company provided the other aspects of Sections 100 to 105 are complied with.

Posted by ASIFBASHA.A on April 15, 2010
a very good article

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