Distinction between internal and external reconstructions

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership and other structures, by revaluing assets and reassessing the liabilities. There are two methods of reconstruction which are internal reconstruction and external reconstruction. The former is the method in which the reconstruction is undertaken without winding up the company and forming a new one, while the latter, is one whereby the existing company loses its existence, and a new company is set up to take over the business of the existing company.

Internal reconstruction is a method of corporate restructuring where an arrangement is made by the company of the organization where in changes in the assets and liabilities are made to improve the financial position without liquidating the company or transferring the ownership to external party, whereas external reconstruction is the one where an existing company is liquidated and taken over by another newly formed company and the transfer of assets and liabilities takes place, and the same is considered similar to amalgamation.

Internal Methods:

1. Authorization by Articles of Association: The company must be authorized by its articles of association to resort for capital reduction. Articles of association contains all the details regarding the internal affairs of the company and mention the clause containing manner of reduction of capital.
2. Passing of Special Resolution: The company must pass the special resolution before resorting to capital reduction. The special resolution can be passed only if the majority of the stakeholders are assenting to the internal reconstruction. This special resolution must be get signed by the tribunal and deposited to the registrar appointed under the Companies Act, 2013.
3. Permission of Tribunal: The company must get the due permission of the court or tribunal before starting the process of the capital reduction. The tribunal grants permission only it feels satisfied with the point that the company is going fair and there is positive consent of every stakeholder.
4. Payment of borrowings: As per Section 66 of the Companies Act, 2013, the company has to repay all the amounts it gets deposited and also the interest due thereon before going for capital reduction.
5. Consent of Creditors: The written consent of the creditors is required for the company which is going for capital reduction. The court requires the company to secure the interest of the dissenting creditors. The company gets the permission of the court after the court thinks fit that reduction of capital will not harm the interest of the creditors.
6. Public Notice: The company has to make a public notice as per the directions of the tribunal stating that the company is resorting to capital reduction. Also, the company has to state the valid reasons for the same.

Methods of Internal Reconstruction

Alteration of Share Capital:

Section 61 to 64 of Companies Act, 2013 deals with alteration of share capital. It may take the form of fresh issue of new shares, conversion of fully paid shares with stock, cancellation of unissued capital, consolidation of existing shares and subdivision of existing shares.

Memorandum of Association contains capital clause of a company. A company, limited by shares, can alter this capital clause, if is permitted by:

1. The Articles of Association of the company.
2. If a resolution to this effect is passed by the company in the general meeting.

A company can alter share capital in any of the following ways:

A) The company may increase its capital by issuing new shares.

B) It may consolidate the whole or any part of its share capital into shares of larger amount.

C) It may convert shares into stock or vice versa.

D) It may sub-divide the whole or any part of its share capital into shares of smaller amount.

E) It may cancel those shares which have not been taken up and reduce its capital accordingly.

Variation of Shareholders right:

Section 48 of the Companies Act 2013 states that where a share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class or by means of a special resolution passed at a separate meeting of the holders of the issued shares of that class.

Reduction of Share Capital:

Section 66 of the Companies Act 2013 provides that 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.

Compromise/Arrangement:

A scheme of compromise and arrangement is an agreement between a company and its members and outside liabilities when the company faces financial problems. Such an arrangement, therefore, also involves sacrifices by shareholders, or creditors and debenture holders or by all.

Surrender of Shares:

In this method, shares are divided into shares of smaller denominations and then the shareholders are made to surrender their shares to the company. These shares are then allotted to debenture holders and creditors so that their liabilities are reduced. The unutilized surrendered shares are then cancelled by transferred to Reconstruction Account.

External Reconstruction

External Reconstruction is a process in which the company’s financial affairs are wound up, and a new company is formed to take over the assets and liabilities of the existing company, after the reorganization of the financial position. It requires the approval of shareholders, creditors and National Company Law Tribunal (NCLT).

In external reconstruction, the undertaking is being continued by the company but is in substance transferred to a company which is not an external one, but another entity that comprises of almost same shareholders, to be carried on by the transferee company. The accounting treatment of external reconstruction is same as the amalgamation in the nature of the purchase.

External reconstruction involves several activities which generally include:

• Liquidation of the existing company.
• Issue of shares in new company to shareholders of the existing company.
• Financial arrangement can be made for settlement of liabilities of the existing company by the new company. For example, debenture holders or creditors can be discharged by way of issue of equity or preference shares.
• Formation of a new company to take over the business (all assets and liabilities) of the existing company at agreed values.
• The new company may take over assets at reduced values which more accurately represent the true value.