Power of Company to Buy-Back its Securities: Purchase & Prohibition (S. 68 & 70)

Introduction:

Section 68 read with Section 77A of the Companies Act, 2013 implies that a private, public or unlisted company that is limited by shares or one limited by guarantee and possessing share capital, can buy its securities. A company is empowered by Section 77A of the Companies Act to purchase its own shares or other certain securities in specified cases. The Companies (Amendment) Ordinance had laid down provisions for companies to Buy-back their shares. “Buy-back” implies the repurchase of own shares by a company to reduce the number of shares that are available in the market. It is exercised either to eliminate threats from shareholders aiming for a controlling stake in a company or to increase the value of shares. In comparison to other developed nations, the concept of “buy-back” is relatively new in India. It marked a huge shift in the domain of corporate law by allowing Indian companies to effectively use the capital and enabling them to restructure their capital requirements. Section 70 of the Companies Act, 2013 lays down provisions for the prohibitions to buy-back in certain circumstances. These provisions relating to buy-back and restrictions have been elaborated upon in this article.

History

The capacity to “Buy-back” or the kernel of the legal regulation giving companies the authority to purchase their own shares finds its roots in English law. It can be traced back to the legal system’s deep-rooted imperative to safeguard the interests and rights of the company’s creditors (those who the company owes). Today, the term “creditors” encompasses within itself several persons such as secured, unsecured, trade creditors, employees or the Government. The common law has been observed to be historically reluctant to recognise companies being permitted to Buy-back their shares. This reluctance originates from the common law hesitating to permit the consequential diminution of a company’s capital to damage the ability of the company to honour its debt-servicing obligations to those who had given loans based on an assessment of continuing financial ability and long-term viability of the company to repay debts.[1] This is an essential aspect of the common law principle called the “capital maintenance rule” which has been judicially developed and embodied in the Indian statute. Lord Justice Green has talked of this need to prevent companies from defeating their creditors by resorting to recourses such as repurchase of shares in the case of Guinness v Land Corporation of Ireland.[2]

Section 68: Power of Company to Purchase its Own Securities

Buy-back is a mechanism enabling companies to repurchase the shares held by existing shareholders of the company.

Objectives

• If the company possesses unused cash reserved with no projects to invest it in, they may repurchase their shares as a reward for shareholders if they feel that the market price of their shares is undervalued.
• Instead of giving cash dividends to investors which are taxed more than capital gains, companies prefer to repurchase their shares and reward investors.
• Buy-back of shares from shareholders at an increased price is an indication that the valuation of the company shares must be higher.
• Companies may offer to Buy-back their shares that are trading in the market if they want to close companies or exit from a market in a certain country.
• They may also Buy-back shares to avoid public scrutiny of the book of accounts or market regulator’s regulations by delisting.

Conditions

• Articles of association of the company must have authorized the Buy-back.
• Specified securities or shares that are offered for repurchase must be paid fully.
• A gap of at least one year is mandatory between two Buy-back offers of the company.
• A special resolution must authorise the Buy-back.
• Once declared, the offer for Buy-back cannot be withdrawn by the company
• Money that is borrowed from banks or financial institutions cannot be used for the Buy-back of shares.
• Any proceeds from previous issues of the same kinds of securities and shares cannot be used by the company for the Buy-back.
• The ratio of debts which the company owes after repurchase should be more than twice the paid-up capital and the free reserves.

Modes

A company may Buy-back shares from

• Old lots
• The open market
• By making an offer of proportionate basis from existing shareholders
• According to schemes of sweat equity or stock option, a company may purchase securities that are issued to its employees.

Sources

Buy-back may be financed from

• Securities premium account
• Free reserves or
• Proceeds from the issue of securities are different from the ones that are proposed to be repurchased.

Time Limit

Buy-back needs to be finished within one year from the date on which the special resolution or board resolution is passed.

Advantages

• Buy-backs aid a company to utilize its free reserves and reduce excess unrequired capital.
• Returns on equity may be increased. When more undervalued shares are bought back, a greater effect is noticed.
• Companies are protected against hostile takeovers from other companies through the Buy-back of their shares.
• Buy-backs involve low-cost transactions and are regarded as the fastest method of share capital reduction.
• It serves as a tool for financial re-engineering. As dividends attract taxes, Buy-backs may boost bottom lines when companies have high dividend payments for making profits.
• The investor’s confidence in the board of directors of the company may be increased.

Disadvantages

• Money used for the Buy-back of securities can be utilised in other profitable alternatives such as hiring new staff, installing manufacturing units or increasing market expenditure to boost sales and increase profits.
• Innocent investors may often be misled when the company buys back shares as the stock prices increase.
• A harmful image of the company may be created in the market and give rise to the presumption that the company is using excess cash to Buy-back shares as it is not profitable anymore. It creates a negative impact on long-term investors who seek capital appreciation for the company’s growth.

In the case of National Consumer Disputes Redressal, Ritu Bhargava v Godrej Industries Ltd & Others, Godrej Industries Limited had laid down a scheme for the repurchase of 40% paid-up capital of the company and had sent out offer letters to shareholders after receiving a sanction from the High Court. The issue in the case was whether a shareholder could be made to sell shares of a company without consent. The question also arose as to whether such a scheme was unfair and harmful to the interest of shareholders. As for the first issue, it was held that if the shareholder had not used the option of retaining shares within the specified time as per the scheme, it would be assumed that the shareholder agreed to the Buy-back of shares and did not have any objections when the scheme had been made known to them through publication and notices. As to the second issue, it was laid down that the company had the right to proceed with the scheme as it had been approved by the Court and because it had taken all appropriate measures to make the scheme be known to shareholders.

In the case of Re: Shalibhadra Infosec Ltd, personnel were charged for issuing unsubstantiated and misleading advertisements relating to the Buy-back of shares despite the company not performing well. Though the company did not possess resources to meet obligations of repurchase of shares, the advertisement was used to create an interest of investors in it.

Section 70: Prohibition for Buy-back in Certain Circumstances

Section 70 of the Companies Act, 2013 provides that a company should not repurchase securities indirectly or directly (i) through any subsidiaries including its own, (ii) by investment companies or investment,(iii) when a company has failed to file a financial statement, declaration of dividend and annual return or (iv) when a company has failed to repay deposits or interest payable on it, failed to pay back any term loan or defaulted in the redemption of preference shares or debentures. Section 70(1) prohibits the purchase by any type of company either through any investment company or subsidiary company by direct or indirect means. This provision implies that the statute seeks to impose a condition that when the acquiring company(investment or subsidiary company) purchases shares of the target company(or parent company), it must be done in the name of the acquiring company and not on behalf of or as a nominee of the target company. Hence the shares bought must be held on record and for the benefit of the acquiring company without the target company possessing any beneficial interest in such shares. However, a troubling aspect of Section 70(1) is that the term “own subsidiary company” is neither defined nor referred to elsewhere in the statute to illustrate its meaning. The intention of the legislators may have been to refer not to next level subsidiaries that arise out of chain holdings but those direct subsidiary companies wherein the required shareholding was held by the holding company.[3] This section does not ban all indirect purchases- it only prohibits or bans those that are acquired for the benefit of the target company.

Conclusion

Buy-back of stock signifies that the issuing company is prospering financially. Buy-backs may often include giving back a part of the company’s profit to its shareholders in terms of dividend payments to reward them for investing in terms of dividend payments, excluding the unwanted immediate taxation. After the utilization of equity capital for growth, the business produces enough revenue to return capital to investors and invest in continual expansion. It also enables a business to purchase back its shares at decreased or low prices and sell them when the prices increase. It aids the business to increase the total equity while keeping the total outstanding number of shares stable. However, a Buy-back may also indicate a hostile takeover of a company. The Buy-back of shares stipulates that the issuing company has become a target for another company that has taken over and is using the target company to pay off the liabilities.

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References:

[1]Siddharth Raja, Financial Assistance and Indirect Purchases of Shares: Some vexatious issues, SCC ONLINE (Feb 11, 2021), https://www.scconline.com/blog/post/2021/02/11/financial-assistance-and-indirect-purchases-of-shares-some-vexatious-issues/

[2]1882 G. 2624.

[3]Siddharth Raja, Financial Assistance and Indirect Purchases of Shares: Some vexatious issues, SCC ONLINE (Feb 11, 2021), https://www.scconline.com/blog/post/2021/02/11/financial-assistance-and-indirect-purchases-of-shares-some-vexatious-issues/