Reduction of Capital and Various Rights of Share Holders

In this article we will discuss about the Reduction of Capital and Various Rights of Share Holders.

Reduction of capital means the following:

(a) Extinguishing or reducing the liability on any of the shares in respect of the unpaid amount.

(b) Cancelling any paid up share capital (writing off) which is lost or unrepresented by available assets (together with or without extinguishing or reducing liability on shares).

(c) Paying off capital (already paid up) which is in excess of needs of the company (again together with or without extinguishing or reducing liability on shares).

Reduction of capital can be carried out by a company, if it is authorised by its articles and by special resolution and confirmation of the Court.

If the proposed reduction of the capital does not involve diminution of any liability in respect of paid up capital or the payment to any shareholder of any paid up share capital and if there are other special circumstances which, in the opinion of the Court, obviate the necessity of inviting objections from creditors or any class of them, the Court may confirm the proposed scheme without consulting the creditors.

But, normally, the Court will consult the creditors affected. For this purpose, a list of creditors entitled to object to the proposed scheme will be settled by the Court. The court may publish notices fixing the time before which creditors not already entered on the list may claim to be so entered.

The scheme of reduction involves either the consent of the creditors entered on the list or the settlement of their claims.

The Court may dispense with the consent of a creditor it:

(a) The company admits the full amount of the debt or claim, or, though not admitting it, is willing to provide for it and secures the necessary amount; or

(b) If the company does not admit or is unwilling to provide for the amount, the company secures payment of the amount fixed by the Court.

After the consent of the creditors has been obtained or their claims discharged or the company has secured the payment of the dissenting creditors to the satisfaction of the Court, the Court may make an order confirming the reduction of capital on such terms and conditions as it thinks fit.

The Court may direct the company to add the word, “And Reduced” to its name for such period as it thinks fit. The Court may also require the company to publish such statement, in the Press, in regard to the reduction, as the Court may think expedient, with a view to giving proper information to the public.

The order of the Court has to be registered with the Registrar. On such registration, the order takes effect. The Registrar has to certify the registration of the order and the minute. The certificate is conclusive evidence that all requirements of the Act with respect to the share capital have been complied with. The relevant parts of the memorandum then stand amended.

Every copy of the memorandum and the articles issued after the alteration or reduction of capital must be a corrected copy.

If, at the time of winding up, a creditor cannot be paid and he proves that he was ignorant of the proceedings of reduction of capital and, therefore, his name was not entered on the list of creditors, the shareholders at the time of the reduction can be called upon by the Court to contribute with a view to settling the claims of such a creditor.

Of course, they cannot be called upon to pay anything if they have already paid the full amount on their shares.

Variation of Shareholders’ rights:

If the share capital of a company consists of different classes, the memorandum or articles of association may contain provisions for the alteration of the rights attached to different classes of shares.

This is subject to the following:—

(a) the consent of holders of at least three-fourths of the shares of the class concerned (or a higher proportion if so laid down in the articles or memorandum) must be obtained; and

(b) the consent should be obtained at a separate meeting of the affected class of shareholders by means of a resolution or in writing.

If the articles or memorandum are silent on the point, the variation will not be possible if prohibited by the terms of issue of shares of the concerned class.

The holders of not less than 10 per cent of the issued shares of the class of shares, whose rights are being varied, may apply to the Court to have the variation cancelled; and if such an application is made, the variation will not have effect unless it is confirmed by the Court.

The time limit for making the application is 21 days after the consent is obtained or the resolution is passed. The decision of the Court is final. Notice of the variation has to be filed with the Registrar within 15 days of the order of the Court.

Entries to record the reduction, etc.

I. If the uncalled capital on shares is cancelled, the paid up amount is not affected; only the partly paid shares become fully paid.

To record this fact, the following entry will do:

Share Capital (Partly Paid) Dr.

  To Share Capital (Fully Paid)

(with the amount credited to share capital.)

II. Sometimes a joint stock company has paid up share capital in excess of its requirements. In such a case, it may refund a part of the share capital to its shareholders after complying with the necessary legal formalities.

The entries for such a refund may be as follows:

(a) Share Capital Account Dr.

  To Sundry Shareholders

(with the amount to be refunded)

(b) Sundry Shareholders Dr. 

  To Bank

(Payment to shareholders for refund)

Illustration 1:

Moti Ltd. with a subscribed equity share capital of Rs 70,00,000 divided into fully paid shares 110 each finds that its share capital is much in excess of its requirements and hence decides to refund Rs 3 per share its shareholders. The necessary legal formalities are complied with. Pass journal entries.

III. In the vast majority of cases, the reduction of share capital is necessitated by accumulated losses and the reduction is really another name for writing off the share capital. In a sole proprietorship concern or a partnership firm, any loss revealed by Profit and Loss Account is transferred to Capital Account or Capital Accounts respectively reducing the capital of the enterprise.

But in the case of a joint stock company, the loss is not transferred to Share Capital Account; it is shown as a fictitious asset by way of the last item on the assets side of the Balance Sheet of the company and Share Capital is continued to be shown at paid up value.

A joint stock company may incur heavy losses for a number of years and a fairly big portion of the share capital may thus be lost but the balance of Share Capital Account will not disclose this fact.

The company may turn the comer and it may like to start on a clean state by writing off the past accumulated losses and show Share Capital at its real worth.

It is done by reducing share capital under a scheme of reconsideration involving a number of legal formalities In the books of the company, Capital Reduction Account, Reorganization Account or Reconstruction Account is opened and with the amount of reduction in Share Capital Account, the following entry is passed:—

Share Capital Dr.

  To Capital Reduction Account/

  Re-organisation Account/

  Reconstruction Account.

In the process of reduction, the description of the shares may be changed; in such a case, the old Share Capital Account should be closed and new Share Capital Account should be opened with the new amount crediting the amount of reduction made to Capital Reduction Account or Re-organisation Account or Reconstruction Account.

For example 10,000 12% Preference Shares of Rs 100 each are converted into 10,000 14% Preference Shares of Rs 60 each, the journal entry will be as follows;—

12% Preference Share Capital (Rs 100 each) Account Dr. 10,00,000

  To 14% Preference Share Capital (Rs 60 each) Account

  To Capital Reduction Account/Re-organisation Account /

  Reconstruction Account 4,00,000

The amount standing to the credit of Capital Reduction Account/Re-organisation Account/ Reconstruction Account is utilised to write off accumulated losses. The amount of reduction may, because of rounding of figures, be a little more than the amount of the accumulated losses; this extra reduction is credited to capital reserve.

Thus, the entry may be:

Illustration 2:

Following is the summarised balance sheet of Reckless Co. Ltd. as at 31st March, 2012:

Illustration 3:

The following is the Balance Sheet of Nav Bharat Co. Ltd. on 31st March 2012.

 

In the case of reconstruction, the company may write off not only the debit balance of Profit & Loss account but may seize the opportunity to write off fictitious assets appearing under the broad heading of ‘Miscellaneous Expenditure’ also. Examples of such fictitious assets are Preliminary Expenses, Cost of Issue of Debentures and Underwriting Commission on Issue of Shares.

The company may also bring down the values of other assets which are overstated in the balance sheet. Goodwill account appearing in the balance sheet is written off completely because a company which has been incurring losses cannot be said to be enjoying any goodwill. Certain unrecorded liabilities may also be recorded under the scheme of reconstruction.

When the losses are rather heavy, preference shareholders may also be made to make a sacrifice. To compensate them for their sacrifice to some extent, their rate of dividend for the future may be increased although as far as arrears of preference dividend are concerned, they may be made to forget them.

If the losses to be written off are very heavy, even Trade Creditors and Debenture-holders may be persuaded to make a sacrifice. In such case Capital Reduction Account is not opened; it must be either Re-organisation Account or Reconstruction Account.

Also, when assets are revalued, there may be appreciation in the value of a few assets. For example, usually there is an appreciation in the value of Land & Buildings. Such an appreciation is also available for writing off losses. Similarly, there may be capital profits like Profit Prior to Incorporation which may also be used to write off losses under a scheme of reconstruction.

Illustration 4:

The balance sheet of a joint stock company is as follows:

Note:

Preference dividend has been in arrear for five years

The company had been incurring losses for a number of years It is now earning profits.

The following scheme of reconstruction has, therefore, been passed by the company and approved by the Court:—

(i) Equity shareholders have agreed that their Rs 50 shares be reduced to Rs 10 per share and they have agreed to subscribe in cash for three equity shares of Rs 10 each for every share held.

(ii) The preference shareholders have agreed to cancel the arrears of preference dividend and to accept for each Rs 50 preference share three new 14% preference shares of Rs 10 each and two equity shares of Rs 10 each, all credited as fully paid-up.

(iii) Lenders to the company amounting to Rs 200 lakh have agreed to convert their loan into 10 lakh 14% preference shares of Rs 10 each and an equal number of equity shares of Rs 10 each, all credited as fully paid-up.

(iv) The directors have agreed to subscribe in cash for 10 lakh equity shares of Rs 10 each in addition to any shares to be subscribed for by them under (i) above.

(v) 50% of the remaining amount of Loans and 50% of Trade Payables are discharged by payment of cash.

(vi) The reduction in equity share capital is to be applied to write off goodwill, preliminary expenses and debit balance of profit and loss account; the remaining amount of reduction is to be used to write down the value of plant.

You are required to:

(i) Pass journal entries to implement the above mentioned scheme;

(ii) show cash book and important ledger accounts; and

(iii) prepare the company’s balance sheet immediately after the reconstruction.

Illustration 5:

Following is the balance sheet of Downhill Ltd. as at 31st March, 2012: