Need for Reconstruction and Company Law provisions

Reconstruction is an exercise of restating assets & liabilities by a company/entity whose financial position as reflected by its balance sheet is not healthy but the future is promising. When a company is suffering loss for several past years and suffering from financial difficulties, it may go for reconstruction. It refers to the transfer of a company or several companies’ business to a new company. This exercise is done to gain the confidence of different stakeholders (creditors, lenders, customers, shareholders, etc) whose support is required for the revival of the operations. If any company is suffering loss and it closes its business and join with or without other company, it creates a new company.

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership, and other structures, by revaluing assets and reassessing the liabilities.

In other words, when a company’s balance sheet shows huge accumulated losses, heavy fictitious and intangible assets or is in financial difficulties or is to overcapitalized, and then the process of reconstruction is restored. It is required when the company is incurring losses for many years, and the statement of account does not reflect the true and fair position of the business, as a higher net worth is depicted, than that of the real one.

Objectives:

• To resolve the problem of over-capitalization/huge accumulated losses/overvaluation of assets.
• To generate surplus for writing off accumulated losses & writing down overstated assets.
• To generate cash for working capital needs, replacement of assets, to add balancing equipment, modernize plant & machinery, etc.
• When the capital structure of a company is complex and is required to make it simple
• Raising fresh capital by issuing new shares.
• To generate surplus for writing off accumulated losses & writing down overstated assets.
• To generate cash for working capital needs, replacement of assets, to add balancing equipment, modernize plant & machinery, etc.

Internal Reconstruction is not always happened as it requires a lot of work and effort. It usually performs in the following condition:

• Complicate Capital Structure: The company may start from a family own which does not have a proper capital structure from the beginning. So, when the company getting bigger, the capital structure will be getting worst.
• Complex internal structure: The company may cover too many business functions which out of control of top management. It means top management does not have enough skill and competence to control all business functions.
• Mispresented financial statement: The financial statements are mispresented due to overstate of assets, undervalue of liabilities, and fictitious assets that exist on the balance sheet. The income statement does not reflect the actual business performance.
• Company overcapitalized: The company may build the asset but it capitalizes more than the actual cost.

Company Law provisions

Conditions/ Provisions Regarding Internal Reconstruction

Authorisation 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.

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.

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.

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.

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.

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.

Ways of reduction of capital

The company limited by shares and limited by guarantee can go for internal reconstruction in three ways:

By reducing or extinguishing the liability: the company can repay its liability on account of uncalled amount on the shares issued. Under this method, the paid-up shares capital of the company would remain unchanged.

Reducing the capital by returning the excess capital: In case the company has availability of surplus cash, the company can use it to repay the excess capital if it finds it profitable. The capital can be refunded after complying with the proper procedure.

Reducing the paid-up share capital: When the company suffers losses continuously due to some reasons, it is quite common that the accumulated losses and deferred expenses will appear on the assets side of balance sheet. The fictitious assets on the balance sheet makes clear that the company is unable to discharge its liability. Under such circumstances, the capital which is unpresented by available assets should be cancelled.

Modes and Procedure of Reduction

The reduction of share capital, or the internal restructuring of a company can be done in various ways. The objective is to mitigate losses and restructuring of share capital in a way to balance out the assets and the liabilities.

Following are the ways to reduce capital under Section 66 of the Act:

• Cancellation of paid-up share capital that is not presented by the existing assets with or without reduction of liabilities on any of the shares.
• Extinguishment or reduction of unpaid share capital.
• Paying off any paid-up capital, which is surplus to the requirements of the company.

For a company to avail the provision of reduction of share capital, the company shall first make an application to the Tribunal (NCLT). After obtaining a sanction from the Tribunal, the restructuring shall come into force by a special resolution passed by the company.

The Tribunal shall make sure the following conditions are fulfilled before granting the sanction:

• There is no objection from the creditors.
• In case of objection by the creditors, their consent has been obtained by the company.
• The rights of the creditors have been secured or they have been paid off.

Section 66 read with the National Company Law Tribunal (Procedure for reduction of share capital) Rules, 2016 formulate the procedure of reduction of share capital. Rule 2(1) lays down the procedure of making an application to the Tribunal. An application to this effect has to be filed with the Tribunal in Form No. RSC-1 along with a fee of Rs. 5000/-.

The application above has to be supplemented with the following:

• A list of creditors in the order of their class, along with their names, address, and amount owed, duly signed by the managing director of the company.
• The auditor shall certify the above-mentioned list of creditors.
• A declaration to the effect that the company is not in arrears in the repayment of the deposits or the interest by one of the directors of the company and certified by the auditor.
• The certificate to the effect that such restructuring is in accordance with the other provisions of the Companies Act.