Tag: Shareholders Rights

(a) Increase in share capital: A company can increase its share capital by issue of new shares by an ordinary resolution in the general meeting if the increase is within the authorised capital. But for increase beyond the authorised capital, the company is required to alter the capital clause of its Memorandum of Association by special resolution and to give its notice to the Registrar within 30 days of resolution.

No accounting entry is required to be passed in the books of the company for the increase in its authorized share capital. But when new shares are offered for subscription, accounting entries will be very much the same as has been explained in an earlier chapter.

(b) Decrease in share capital by cancelling the unissued shares: A company can cancel the shares which have not been subscribed or agreed to be subscribed by any person and this diminishes the amount of share capital. But no company can cancel the unpaid amount on shares already issued or agreed to be subscribed without the sanction of the Court as the same leads to reduction of capital. As the cancellation of unissued shares does not affect the issued share capital of a company, no accounting entry is required. Only the details of authorized share capital are to be changed in the Balance Sheet

(c) Consolidation of share capital: A company may consolidate any of its shares of smaller denomination (value) into shares of higher denomination. To make this change effective, share capital account with old denomination is closed and share capital account with new denomination is created. The accounting entry is:

Share Capital (Old denomination) Account                                Dr.

To Share Capital (New denomination) Account

(d) Sub-division of share capital: This implies converting shares of higher denomination into shares of smaller denomination. The entry is:

Share Capital (Old denomination) Account                                 Dr.

To Share Capital (New denomination) Account

(e) Conversion of shares into stock and reconversion of stock into shares: A company, if so authorised by its Articles, may convert any of its, fully paid shares into stock. The stock can be reconverted into fully paid up shares of any denomination. When shares are converted into stock, the share capital account will be closed by transfer to stock account by means of the following journal entry:

(Say) Equity Share Capital Account                                           Dr.

To Equity Stock Account

Conversely if stocks are reconverted into shares, stock account will be closed by transfer to share capital account.

(f) Reserve Capital: Section 99 of Companies Act provides that a company may by special resolution decide that any portion of uncalled amount on shares issued will be called up only on its liquidation. Such portion of share capital is known as reserve capital. No accounting entry is required to give effect to it.

(2) Reduction of Share Capital: Usually internal reconstruction involves reduction of share capital. Section 100 to 105 of Companies Act deal with it. Accordingly, it can be carried out by a company only It is authorised by its Articles, and a special resolution is passed to that effect. It also requires confirmation of the Court.

Capital reduction can take any of the following three forms:

• Extinguishing or reducing the liability on shares held by shareholders in respect of uncalled or unpaid amount : This does not affect the paid-up value of shares; only partly paid shares become fully paid by reducing the face value of the shares to the level of their paid-up value. No journal entry is necessary to record this event. However, some accountants prefer to pass the following entry to record this fact:

Share Capital (partly paid-up) Account                      Dr

To Share Capital (fully paid-up) Account

• Paying off the surplus paid-up capital: The share capital may be reduced by paying off the paid-up capital which is in excess of the needs of the company. This can be done with or without reducing the liability on the shares. Thus, surplus capital can be paid off in the following two ways: (a) Paying off surplus paid-up capital without reducing the face value of shares: In such a case, the following entries are passed:

(i) Share Capital Account                               Dr.                 with the amount to be paid off

To Sundry Shareholders Account

(ii) Sundry Shareholders Account                  Dr.                  with the amount paid off

To Bank Account In this case, the company shall have the right to call up in future the amount paid off on the shares.

(b) Paying off surplus paid-up capital by reducing the face value of shares: For example, for a fully paid share of Rs. 10, paying off Rs. 5 and reducing the face value of share from Rs. 10 to Rs. 5. The following entries are passed in such a case. () Share Capital (Old Face Value) Account Dr. (with total amount of old capital) To Share Capital (New Face Value) Account (with the amount to be kept as new capital)

To Sundry Shareholders Account                   Dr             (with amount to be paid oft)

(ii) Sundry Shareholders Account                  Dr. with the amount paid off To Bank Account

In this case, the company shall not have any right to call up in future the amount paid off on these shares.

(c) Cancelling the paid-up capital: Where existing capital of the company is not represented by available assets, cancellation of paid-up capital to that extent is the most common method adopted by a company in such a case. The purpose is to improve the profitability of the existing company in tune with the real values of assets as against the given book values which do not represent the actual financial position of the enterprise. Under it, a meeting of different classes of shareholders is called-up and where borrowed capital is also lost, the debenture holders and creditors are also invited in the meeting and they are made to agree to sacrifice their claims to certain extent and their sacrifices are utilized to write off the accumulated losses and fictitious assets and to adjust the over-valuation of assets. For this purpose, a new according called Capital Reduction Account (or Reconstruction Account or Reorganisation Account) is opened to which sacrifices of different parties are credited and through which accumulated losses and fictitious assets are written off and over-valuations of assets adjusted. The preparation of Reconstruction Account is preferred when debenture holders and creditors too have to accept some reduction in their claims in addition to the shareholders and/or where there is appreciation in the value of any asset. The scheme of entries is as follows:

• On reduction of paid-up capital:

Share Capital Account                                  Dr. with the amount of reduction

To Capital Reduction Account                      or To Reconstruction Account

If the denomination or description of capital is changed (e.g. the face value of shares is changed or rate of dividend is changed in case of preference shares), the old Capital Account is closed and new capital account is created with the new amount and the difference is transferred to Capital Reduction Account

Notes: (i) If any reserve appears in the books of the company, the same should be transferred to Capital Reduction Account so that no such reserve could be utilized for payment of dividend in future.

(ii) The Capital Redemption Reserve Account and Securities Premium Account can also be reduced in the same manner as the share capital account.

(iii) After granting the scheme of capital reduction, the Court may order the use of words “and reduced” after the name of the company for such period as it deems fit.

• If debenture holders and creditors too make some sacrifice:

Debentures Account                  with the amount of sacrifice Sundry Creditors Account

To Capital Reduction Account

3. If there is appreciation in the value of an asset:

Respective Asset Account                                Dr. with the amount of appreciation

To Capital Reduction Account

4. On utilizing Capital Reduction Account for writing off accumulated losses, fictitious assets, and over-valuations of assets:

Capital Reduction Account                                  Dr

To Profit & Loss Account

To Goodwill Account

To Patent Account

To Trade Marks Account

To Preliminary Expenses Account

To Discount on Shares and Debentures Account

To Unrecorded Liability Account (if any) To Asset Account

To Capital Reserve Account (with the balance left, if any)

Companies generally raise funds by issuing as share capital or through borrowing from lenders. A debenture is one of ways of company borrowing where the company agrees to repay the debt where may also be a charge over the company’s assets to ensure the repayment of this debt. Debenture is an alternative form of investment in a company that is more secured than investment in shares because company must pay interest and it will be paid before the dividend payment. Debenture holders also get privilege, if the company which issued the debentures becomes bankrupt. A disadvantage is that debenture holders have no share in the company and therefore have no control over it.

Following provisions of the Companies Act, 2013 governs the floatation, issue and allotment with regards to the debentures:

• Section 2(30): Definition;
• Section 44: Nature of debentures;
• Section 71: Provisions relating to issue and allotment of debentures;
• Rule 18 of the Companies (Share Capital and Debenture) Rules, 2014: Rules pertaining to issue and allotment of debentures.

Governing Sections:

Section 2(30): Definition of Deposit: “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Section 44: Nature of Share and Debenture.

Section 71: Provision relating to Debentures.

Section 117(3) (a)A copy of every resolution or any agreement, in respect of the matters specified in sub-section [1](3) of section 17 together with the explanatory statement under section 102, if any, annexed to the notice calling the general meeting in which the resolution is proposed, shall be filed with the Registrar within thirty days of the passing of resolution.

Section 179 (3) (c,d): (c) to issue securities, including debentures, whether in or outside India;

*(d) to borrow monies;

Section 180(1) (c): The Board of Directors of a company shall exercise the powers “borrow money”, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, only with the consent of the company by a special resolution, namely.

Section 56(4) (d): Within a period of six months from the date of allotment in the case of any allotment of debenture.

Section 42: Offer or invitation for subscription of securities on Private Placement.

Governing Rules:

• Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014:
• Rule 24 The Companies (Management and Administration) Rules, 2014: Resolutions and agreements to be filed.
• Rule 1(c) of The Companies (Acceptance of Deposits) Rules, 2014: “Deposit” does not include

“Any amount raised by the issue of debentures secured by a first charge or a charge ranking paripassu with the first charge on any assets referred 73 Proviso to in Schedule III of the Act excluding intangible assets of the company or debentures compulsorily convertible into shares of the company within five years.”

Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014: Process of Issue and allotment of Securities (Debentures).

Stocks/Shares

Stocks or shares are popular investment tools, issued by corporate entities through which they sell a portion of their proprietorship to general investors and raise funds through it. These are also known as scrips or owned capital.  As an owner of stocks, you are holding a part of the company’s financial capital. It entitles you to receive a portion of the company’s profit in return.

Types of stocks are

• Equity shares
• Preference shares

The price that you pay to buy shares is called share price. In return, you qualify to receive dividends as decided by the company. Profit is announced during the end of a financial year, which means, the longer you stay invested, higher will be your gain from the share.

Share prices depend on various factors, including market performance, macroeconomic parameters, sectoral performance, and individual company performance. As investment instruments, share are highly liquid and traded in the exchanges.

Debentures

Debentures are debt tools; issued by companies to raise funds as loans from the public. It is an acknowledgement from a corporate entity that it has taken a loan from you. However, a debenture isn’t a secured loan. It is backed solely by the creditworthiness of the issuing firm. But it carries some amount of assurance. It is why, in India, if a company declares bankruptcy, debenture holders have the first claim over the company’s assets.

Categories of debentures

Debentures also have different types, based on their intrinsic characters.

• Perpetual Debentures: Perpetual debentures don’t have a maturity value and treated much like equities. These bonds create a lifelong stream of income for the investors, and they can trade those the market like equities.
• Convertible Debentures: Some corporate give the offer to receive maturity value on debenture or get it converted to equity. This allows investors to alleviate some of the uncertainties associated with investing in unsecured bonds.
• Non-convertible Debentures: It is a traditional type of bond that pays out the maturity and accrued interest at the end of the tenure without giving any opportunities to convert to equity.

Debentures can be either floating or fixed in nature. The payout on floating rate debenture varies with the market movement. But, for fixed-rate debentures, final payout remains assured.

The term ‘collateral security’ implies additional security given for a loan. Where a company obtains a loan from a bank or insurance company and the security offered to the company is not sufficient, the company may issue its own debentures to the lender as collateral security against the loan. In such a case, the lender has the absolute right over the debentures until and unless the loan is repaid.

Debentures can also be issued by a company as collateral security against a bank loan or any such borrowings. A collateral security is like a parallel security which is provided along with the actual security against the loan taken. Debentures issued as such a collateral liability are a contingent liability for the company, i.e. the liability may or may not arise. Only when the company defaults on such a loan will this liability arise.

On repayment of the loan, however, the lender is legally bound to release the debentures forthwith. But in case the loan is not repaid by the company on the due date or in the event of any other breach of agreement, the lender has the right to retain these debentures and to realize them. The lender is entitled to interest only on the amount of loan, but not on the debentures issued as collateral security.

Generally, because it is a contingent liability no entry is passed in the books of the company against such an issue of debentures. However, if some companies opt to pass an entry to record such a transaction, the following entries may be passed

Accounting Treatment:

When debentures are issued as a collateral security there are two treatments in the accounting books.

First Method:

(i) No journal entry is made in the account books at the time of issue of such debentures. A note is appended below the loan on the liabilities side of the balance sheet to the fact that they have been secured by the issue of debentures.

This will be shown in the balance sheet as follows:

Second Method:

(ii) Sometimes issue of debentures as collateral security is recorded by making journal entry as follows:

Debentures Suspense a/c Dr.

To Debentures a/c

(With nominal value of debentures)

The Debentures Suspense Account will appear on the assets side of the balance sheet and Debentures on the liabilities side. When the loan is re-paid the entry is reversed in order to cancel it.

Debentures can be issued for non-cash considerations. The company may have purchased assets from some vendors or acquired some other business. Then instead of paying cash, the company may issue debentures to such vendors. Such an issue for debentures can be at par, or for a discount or at a premium.

Sometimes, a company purchases a running business (assets and liabilities) and issues to vendor, debentures as consideration. It is called issue of debentures in consideration, other than cash.

In such situation following entries are recorded.

(i) For Acquisition of Assets:

Sundry assets a/c Dr. (with amount of purchase consideration)

Vendor’s a/c

(Being sundry assets purchased)

(ii) For issue of Debentures at par:

Vendor’s a/c Dr. (with amount of purchase consideration)

Debentures a/c

(Being debentures issued as consideration for assets purchased)

(iii) For issue of Debentures at discount:

Vendor A/c Dr.

Discount on Issue of Debentures A/c

To Debentures A/c

(iv) For issue of Debentures at Premium:

Vendor A/c Dr.

To Debentures A/c

To Securities Premium Reserve A/c

Formula to find out No. of Debentures Issued

No. of Debentures Issued = Amount Payable/Issue Price

Debentures are an instrument of debt. So, when their term expires they have to be redeemed (paid back). So, the terms of such redemption are generally mentioned when issuing the debentures. The terms on which the money will be repaid to debenture holders are the terms of the issue of debentures.

Issue of debentures is referred to as the action of issuing a certificate by a company under its seal in acknowledgement of any debt that is taken by the company.

The issuing of debentures follows a process which is similar to that of issue of shares by a company. There will be issuing of prospectus, applications will be invited from interested parties and there will be issuing of letters of allotment.

The application money is refunded in case the application is rejected and in case of partial allotment, the excess amount of application money will be used in further calls.

• At Par: This is when debentures will be redeemed at their face value/nominal value. So, a debenture issued for face value 100/- will be redeemed also at 100/-
• At Premium: This is when the redemption is at a higher value than the face value of the debenture. Such a premium to be paid will be treated as a capital loss. And while the premium amount is only paid at redemption, it will be shown as a liability since the issue of the debentures.
• At Discount: This is when the debentures are redeemed at a price lower than face value. However, this is now only a theoretical concept. Such debentures now cannot be issued.

Accounting Treatment for Terms of Issue

Let us now see the journal entries for the six different scenarios of the terms of issue. These are the entries passed for the issue of the shares in these different cases.

1) Issued at Par & Redeemable at Par

2) Issued at Discount & Redeemable at Par

3) Issued at Premium & Redeemable at Par

4) Issue at Par & Redeemable at Premium

5) Issued at Discount & Redeemable at Premium

6) Issued at Premium & Redeemable at Premium

The loss or discount on the issue of debentures is typically a capital loss or a fictitious asset and, hence, has to be written-off during the debentures’ lifetime. The amount of loss or discount on issue of debentures has to be not be written-off during the year of its issue since the benefit of the debentures would accumulate to the enterprise till their restitution or redemption.

Discount on issue of debentures is a loss of capital nature. It will appear on the asset side of balance sheet till it is written off. It is desirable that it is written off as quickly as possible. Discount on issue of debentures, being a loss of capital nature, it can be written off in two ways.

First Method:

In this case, the total amount of discount on debenture is spread over the life of debentures equally. Suppose the debentures are issued at discount, to be redeemed after five years. The amount of discount will be divided by five and the amount so arrived at will be charged to profit and loss account for five years. This method is followed where debentures are redeemed at the end of a specified period.

Second Method:

In this method discount is written off every year in proportion to the amount of debentures used every year. This method is followed where debentures are redeemed every year by serving a notice and by draw of lots.

Accounting entry for writing off discount is as under:

A promoter is someone, who has been connected with the business from the start. He can also be referred to as the starter of a business or the founder. He is responsible for raising capital from various sources and entering into the first agreements for the start of a business and incorporation of a company.

SEBI’s Substantial Acquisition of Share Takeover Rules state that a Promoter is

• He is someone at the cusp of a company
• A person whose name is there in any of the filing papers of the company or according to the shareholding pattern filed by the company.

The concept of promoters is explained in the Indian Companies Act, 2013. Before 2013 there was no legal position defined in the Old Version of the Act of 1956. In the Old Act, the subscribers to the M.o.A was regarded as the promoters since they had subscribed to the company from its inception.

Role of Promoters

1. Duty to disclose secret profits

He is allowed to make profits but not secretly which will be harmful to the company. He can profit only with the consent of the company which makes this a fiduciary relationship as that of a principal-agent.

2. The duty of Disclosure of Interest

He must also declare his interest in every transaction that the company and he himself enters into. He must also request the company’s consent when he shows his interest.

3. Duty under the Indian Contract Act

As said by the courts in due course of time, there is a business relationship between a company and a promoter, therefore a contract before incorporation with a promoter shouldn’t be depended upon. Thus his liabilities come within the purview of the ICA, 1872.

4. Termination of the Promoter’s Duties

The duty of a promoter doesn’t end even after he has appointed the Board of Directors or he himself is on the board. It ends when the capital has been acquired (First Call) and the BoD have taken the control and have started managing. That is when his fiduciary relationship with the company ends.

Nominee Directors

A nominee director is an individual nominated by an institution, including banks and financial institutions, on the board of companies where such institutions have some ‘interest’. The ‘interest’ can either be in form of financial assistance such as loans or investment into shares. Such strategic investment may have a direct bearing on the profitability of a nominator and therefore, the appointment of nominee director becomes essential to facilitate monitoring of the operations and business of the investee company.

The main purpose of appointment of such person(s) is to safeguard the interest of the nominator, without conflicting with his/ her fiduciary duty as a director. Such a director has several roles and responsibilities, including adequate disclosure of interest, reporting to the nominator and protection of the interest of the company in its entirety. In case of holding such a position in widely held companies or publicly listed/traded companies,, the person should act in accordance with the operations of such entities, guided by industry specific statutory provisions in addition to the general roles and responsibilities expected of them.

Roles and Responsibilities of Nominee Director

1. Act as a ‘watchdog’

A nominee director needs to oversee the operations of the investee company and ensure the policy decisions are based on sound commercial lines, rationale and adequate safeguards and also act as liaison between the investee company and the nominator.

2. Participation and decision making

A nominee director is a non-executive director; however, he should be actively involved in decisions pertaining to financial performance of the investee company, fund-raising plans including debt-raising, investments, etc. He should make his presence felt by placing his expertise at the disposal of the Board of the investee company and actively participate in such meetings, which have a bearing on the interests of the nominator. He should also not abstain from voting on resolutions considered at the meetings of the Board of the investee company, involving the nominator, unless involving any personal interest of the nominee director.

3. Maintain Confidentiality

A nominee director should exercise adequate care and caution while dealing with unpublished price sensitive information, in case of listed entity, having come to know of the same or being in a position where he is likely to be aware of such information. The nominee director is always required to abide by the code of conduct to regulate, monitor and report trading by insiders framed by the listed entity.

4. One who safeguards the interests of the nominator

A nominee director oversees the operations of the company, to ensure that the policy decisions are based on sound commercial lines and rationality, with adequate safeguards such that the interests of the nominator are not jeopardized;

5. An Information Bridge

The nominee director also acts as liaison between the investee company and the nominator for regular flow of information. Here, it must be noted that the question of confidential information being shared by the Nominee Director would crop up.

In this regard, reference may be made to guiding judicial principles which suggest that while the Nominee Director has the right to receive information about the Company, a nominee director is not bound to share information with the nominator merely by virtue of such nomination; rather, such duty of sharing information may arise out of separate agreement entered into between the nominator and the nominee. The said principle was also appreciated in Hawkes v Cuddy.

6. Participation in decision making

The nominee director actively involves in discussions pertaining to the financial performance of the company, future plans, fund raising, etc. The objective is to apply his/her expertise on the matters placed before the board with the intent to protect the interests of the nominator.

7. Maintenance of confidentiality

Though a nominee director has allegiance towards the nominator, the nominee director is always expected to abide the code of conduct for directors & key managerial personnel. The responsibility adds up where the investee company is a listed entity, as there are compliance requirements in respect of un-published price sensitive information.

Mismanagement

The process or practice of managing ineptly, incompetently, or dishonestly.

The value of the firm’s stock fell precipitously when word leaked out that officers of the company were under investigation for gross mismanagement.

Corporate governance has been defined as “a set of systems, processes and principles, which ensure that a company is governed in the best interest of all stakeholders.” Its objective is to ensure commitment to values and ethical conduct of business, transparency in business transactions; statutory and legal compliances, adequate disclosures and effective decision making to achieve corporate objectives. Good governance is simply good business, but, the moot question is as to whether the Indian companies are really, in spirit, committed to corporate governance or it is only a superficial compliance in letter and cost. The regulators are forcing the corporate governance regulations on the Indian Companies without measuring its benefits and advantages commensurate the cost in terms of resources of money, man hour and paper consumption. Importance, necessity and quality of corporate governance that Indian Companies needs cannot be undermined. Indian Companies are very intelligent and comply with all requirements of corporate governance in full, in letter, without meaning it in most cases. Ministry of Corporate Affairs, SEBI or stock exchanges have not yet put any mechanism in place to weigh and measure the effectiveness, usefulness or benefits of compliance of corporate governance commensurate with cost spent on its compliance.

A shareholder can be a person, company, or organization that holds stocks in a given company. A shareholder must own a minimum of one share in a company’s stock or mutual fund to make them a partial owner. Shareholders typically receive declared dividends if the company does well and succeeds.

Also called a stockholder, they have the right to vote on certain matters with regard to the company and to be elected to a seat on the board of directors.

If the company is getting liquidated and its assets are sold, the shareholder may receive a portion of that money, provided that the creditors have already been paid. When such a situation arises, the advantage of being a stockholder lies in the fact that they are not obliged to shoulder the debts and financial obligations incurred by the company, which means creditors cannot compel stockholders to pay them.

Roles of a Shareholder

Being a shareholder isn’t all just about receiving profits, as it also includes other responsibilities. Let’s look at some of these responsibilities.

• Brainstorming and deciding the powers they will bestow upon the company’s directors, including appointing and removing them from office
• Deciding on how much the directors receive for their salary. The practice is very tricky because stockholders must make sure that the amount they will give will compensate for the expenses and cost of living in the city where the director lives, without compromising the company’s coffers.
• Making decisions on instances the directors have no power over, including making changes to the company’s constitution
• Checking and making approvals of the financial statements of the company

The shareholders are the owners of the company and provide financial backing in return for potential dividends over the lifetime of the company. A person or corporation can become a shareholder of a company in three ways:

• By subscribing to the memorandum of the company during incorporation
• By investing in return for new shares in the company
• By obtaining shares from an existing shareholder by purchase, by gift or by will

The Role of Stakeholders in Corporate Governance

The rights of shareholders, investors and all other stakeholders that are established by law or through mutual agreements are to be respected.

Performance-enhancing mechanisms for employee participation shall be permitted to develop.

Where stakeholders participate in the corporate governance process, the Company shall ensure them access to relevant, sufficient and reliable information on a timely and regular basis, as by law and Company’s governing documents.

Shareholders, employees and all other stakeholders shall be able to freely communicate their concerns about illegal or unethical practices to the Management Board, and their rights shall not be compromised for doing this.

The corporate governance framework the Company shall complement by an effective, efficient insolvency framework and by effective enforcement of creditor rights

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership and other structures, by revaluing assets and reassessing the liabilities. It refers to the transfer of company or several companies’ business to a new company. This, therefore, means that the old company will get put into liquidation, and shareholders will therefore agree to take shares of equivalent value in the new company. Reconstruction 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.

In other words, “Reconstruction” involves the winding up of an existing company and the transfer of its assets and liabilities to a new company formed for the purpose of taking over the business and undertaking of the existing company. Shareholders in the existing company become shareholders in the new company. The business undertaking and shareholders of the new company are substantially the same as those of the old company.

Objectives of Reconstruction

1. To resolve the problem of over-capitalization/huge accumulated losses/over valuation of assets.
2. When the capital structure of a company is complex and is required to make it simple
3. When change is required in the face value of shares of the company
4. To generate surplus for writing off accumulated losses & writing down overstated assets.
5. Raising the fresh capital by issuing new shares.
6. Changing altogether the memorandum of association of the company.
7. To generate cash for working capital needs, replacement of assets, to add balancing equipment’s, modernise plant & machinery etc.

Types of Reconstruction

1. External Reconstruction and
2. Internal Reconstruction.

External Reconstruction: When a company is suffering losses for the past several years and facing financial crisis, the company can sell its business to another newly formed company.

Actually, the new company is formed to take over the assets and liabilities of the old company. This process is called external reconstruction. In other words, external reconstruction refers to the sale of the business of existing company to another company formed for the purposed. In external reconstruction, one company is liquidated and another new company is formed. The liquidated company is called “Vendor Company” and the new company is called “Purchasing Company”. Shareholders of vendor company become the shareholders of purchasing company.

Internal Reconstruction: Internal reconstruction refers to the internal re-organization of the financial structure of a company. It is also termed as re-organization which permits the existing company to be continued. Generally, share capital is reduced to write off the past accumulated losses of the company.

Conditions/Provisions regarding Internal Reconstruction

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; or

(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.

Accounting Treatment

There are so many reasons which arises the need for internal reconstruction are as-financial position does not show a true and fair view, assets do not present true book values, overdue outside liabilities and inflated share capital. Thus, reorganize the company by revaluing the assets, reduction in liabilities and capital through internal reconstruction. Hence, no new company is formed. Therefore, it only involves the internal overhauling or reorganization of the company. It involves the issue of fresh share capital, sub-division of shares and cancellation of unsubscribed share capital.

Also, there is reduction of share capital and outside liabilities like creditors etc to reduce their claim. An imperative feature of internal reconstruction is the necessary corrections in the assets of the balance sheet which involves removal of useless intangible assets, accumulated losses and a proper valuation of tangible fixed assets.

There are various methods which are generally used to improve the financial position of a firm are as-Alteration of share capital, change in shareholders rights, reduction of share capital, compromise and arrangement, surrender of shares. Under alteration of share capital, it is done by issue of new share capital, consolidation of shares of smaller nominal value into shares of higher nominal value etc. Therefore, alteration does not mean any reduction of share capital.

When a company issues different classes of shares with which different rights are attached to such shares for example right as to dividend, voting rights etc and however any of the right can be changed. For example, the company may change rate of dividend on preference shares without changing the amount of share capital. Hence, it all comes under the change in shareholders rights. Reduction of share capital may take place in more than one way viz reducing the liability in respect of uncalled or unpaid amount, reducing by refunding the excess capital, reducing the paid up capital. Compromise and arrangement is an agreement between a company and its members and outside liabilities when a company faces any financial problems, shareholders, creditors etc sacrifices their share of profit or claim and it is credited to the reconstruction account. Internal reconstruction does not involve the take over of the business.