Legal Provisions for Reduction of Share Capital under Companies Act, 2013

Reduction of Share Capital is a significant restructuring activity undertaken by a company to either adjust its capital structure, return surplus capital to shareholders, or write off accumulated losses. Under the Companies Act, 2013, the process is strictly regulated to protect shareholders’ interests and ensure compliance with the law. The legal provisions regarding the reduction of share capital are primarily governed by Section 66 of the Companies Act, 2013, and associated rules.

Meaning and Purpose of Capital Reduction

The reduction of share capital refers to the process by which a company reduces its issued, subscribed, and paid-up share capital. This process is typically undertaken for various purposes:

• Adjusting the company’s capital structure due to losses.
• Returning surplus capital to shareholders that is no longer needed for the business.
• Canceling unissued shares or reducing the nominal value of shares.
• Writing off accumulated losses to present a healthier balance sheet.
• Discharging shareholders who do not participate fully in the company’s growth.

Reduction of capital can be carried out in various ways, such as:

• Canceling or extinguishing the liability of unpaid capital.
• Reducing the face value of shares.
• Buying back shares, and subsequently canceling them.
• Canceling any paid-up capital that is no longer needed.

Section 66 of the Companies Act, 2013

This section lays down the legal framework for reducing the share capital of a company. Here are the key provisions:

1. Special Resolution

• The reduction of share capital can only be initiated if a special resolution is passed by the shareholders in a general meeting. A special resolution requires at least 75% of the votes cast to be in favor of the resolution.
• The resolution must clearly specify the details of the reduction, the reason for it, and its effect on the company’s capital structure.

2. Approval of the National Company Law Tribunal (NCLT)

• After passing the special resolution, the company must seek the approval of the NCLT (National Company Law Tribunal).
• The company must file an application with the NCLT, including the special resolution and detailed justification for the capital reduction.
• The tribunal will carefully examine the application to ensure that the reduction is not prejudicial to the company’s creditors or shareholders.

3. Notice to Creditors and Objections

• Before approving the reduction, the NCLT will direct the company to notify its creditors. This is done to ensure that creditors’ interests are not adversely affected by the reduction.
• Creditors have the right to object to the reduction if they believe that it will impact their claims or financial position.
• If creditors object, the NCLT may ask the company to settle the objections, provide security for their debts, or pay off the debts before proceeding with the reduction.

4. Court’s Order and Registration

• Once the NCLT is satisfied with the company’s application and resolves any objections raised by creditors, it will pass an order approving the reduction of share capital.
• The NCLT may impose conditions while granting the approval to safeguard the interests of shareholders and creditors.
• After obtaining the NCLT’s approval, the company must file a certified copy of the tribunal’s order with the Registrar of Companies (ROC) within 30 days.
• The reduction of capital takes effect only after the order is registered with the ROC.

5. Publication of the Order

The company is required to publish the order approving the reduction of share capital in a newspaper, as directed by the NCLT. This ensures transparency and informs all stakeholders of the change in the company’s capital structure.

Forms of Capital Reduction

Reduction of share capital can take various forms under the Companies Act, 2013:

Capital reduction refers to the reorganization of a company’s share capital by decreasing its issued, subscribed, or paid-up capital with the approval of the Tribunal (NCLT) under the Companies Act. It is adopted when the existing capital structure becomes unsuitable due to losses, overcapitalization, or surplus funds.

The common forms of capital reduction are explained below:

1. Reduction of Liability on Uncalled Capital

In this form, the company cancels the unpaid portion of share capital that shareholders are liable to pay in the future.
For example, a ₹10 share with ₹6 paid-up may be converted into a ₹6 fully paid share. Shareholders are relieved from the obligation to pay the remaining ₹4.

This method is used when the company realizes that it does not require the remaining capital from shareholders. It reduces financial burden on members and improves investor confidence.

2. Cancellation of Paid-up Capital Not Represented by Assets

When a company suffers continuous losses, part of the paid-up share capital is no longer represented by real assets. In such cases, the company cancels that portion of capital.

Example: A ₹10 share fully paid may be reduced to ₹6 fully paid to eliminate accumulated losses.

This is the most common method of capital reduction and helps clean the balance sheet by writing off debit balance of Profit & Loss A/c, goodwill, and other fictitious assets.

3. Reduction by Returning Excess Capital to Shareholders

Sometimes a company has surplus funds which are not required for business operations. The company may return a portion of the paid-up share capital to shareholders.

Here, shareholders receive cash or other assets, and the nominal value of shares is reduced accordingly.

This method prevents over-capitalization and increases return on capital employed, thereby improving financial efficiency.

4. Reduction of Face Value of Shares

Under this form, the nominal value (face value) of shares is reduced.

Example:
Shares of ₹100 each are reduced to ₹50 each.

The number of shares remains the same, but the paid-up capital decreases. The amount reduced is used to write off losses or overvalued assets.

5. Consolidation and Subdivision (Reorganization of Shares)

Although technically a capital reorganization, it may accompany capital reduction.

• Consolidation: Small shares are combined into larger denomination shares (e.g., five ₹10 shares into one ₹50 share).

• Subdivision: One large share is split into smaller shares (₹100 share into ten ₹10 shares).

This helps in better marketability of shares and smoother trading.

6. Reduction by Compromise or Arrangement with Creditors

In some reconstruction schemes, creditors agree to accept a lower payment than the actual amount due. The sacrifice made by creditors forms part of the capital reduction process.

This usually occurs when the company is in financial distress and wants to avoid liquidation. Both shareholders and creditors share the loss to revive the company.

7. Reduction through Surrender of Shares

Shareholders voluntarily surrender a portion of their shares to the company. The surrendered shares are cancelled and the share capital is reduced.

This generally occurs during internal reconstruction, where members cooperate to improve the company’s financial position.

Restrictions and Prohibitions

The reduction of share capital is subject to certain restrictions. A company that is in default of repaying deposits or interest thereon cannot reduce its share capital unless it rectifies the default. Capital reduction must not result in the company holding shares in itself, as this would violate the provisions regarding the prohibition of owning treasury shares.

Impact of Capital Reduction

1. Cleaning of Balance Sheet

Capital reduction helps in eliminating fictitious and intangible assets such as preliminary expenses, underwriting commission, discount on issue of shares/debentures, and accumulated losses. These items are written off against the reduced capital.

As a result, the balance sheet reflects the true financial position of the company. It removes inflated figures of capital and presents realistic asset values, thereby increasing reliability of financial statements.

2. Adjustment of Accumulated Losses

Companies suffering heavy losses often carry a debit balance in the Profit and Loss Account. Through capital reduction, this loss is adjusted against share capital.

After adjustment, the company starts with a clean financial record, which is important for future profitability. It allows the company to declare dividends in the future once profits are earned because past losses no longer appear in the books.

3. Reduction in Share Capital

The most direct effect is the decrease in paid-up share capital. Either the face value of shares is reduced or the number of shares is cancelled.

This reduces the company’s capital base. Although total capital decreases, the capital becomes more realistic and proportionate to the company’s assets and earning capacity.

4. Effect on Shareholders

Shareholders may experience a reduction in the nominal value of shares or the number of shares they hold. Sometimes they may also receive repayment of excess capital.

Although their investment value may reduce on paper, shareholders benefit in the long run because the company becomes financially stable and capable of earning profits and paying dividends.

5. Effect on Market Value of Shares

After capital reduction, the company’s financial statements appear healthier. Investors gain confidence as the company no longer shows heavy losses.

Consequently, the market value of shares often improves. A smaller but stronger capital base generally increases earnings per share (EPS), which positively influences share prices.

6. Impact on Creditors

Creditors’ interests are protected by law during capital reduction. The Tribunal ensures that their claims are either paid or secured before approval.

Once capital reduction is completed, creditors feel more secure because the company’s financial structure becomes stable and the risk of insolvency decreases.

7. Improvement in Profitability Ratios

Reduction of capital decreases the denominator in profitability calculations such as Return on Capital Employed (ROCE) and Earnings Per Share (EPS).

With the same level of profits and lower capital, these ratios improve significantly. Better ratios attract investors and enhance the company’s financial reputation.

8. Prevention of Overcapitalization

Overcapitalization occurs when a company has more capital than required for its operations. Capital reduction eliminates surplus capital.

This ensures efficient utilization of funds and increases operating efficiency. The company can now operate with an optimum level of capital suited to its business activities.

Non-compliance and Penalties

If a company reduces its capital without following the legal provisions, it will be considered void and illegal. Any directors or officers involved in such a reduction may face penalties, including fines or imprisonment, as per the Act.