Power of Company to Purchase its own security

Section 77A[i] of the Companies Act provides for the power of a company to purchase its own securities. A small section for reference has been posted below:

(1) Notwithstanding anything contained in this Act, but subject to the provisions of sub-section (2) of this section and section 77B, a company may purchase its own shares or other specified securities (herein after referred to as “buy-back”) out of:

(i) its free reserves; or

(ii) the securities premium account; or

(iii) the proceeds of any shares or any other specified securities;

Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

(2) No company shall purchase its own shares or other specified securities under sub-section (1) unless:

(a) the buy-back is authorized by its articles;

(b) a special resolution has been passed in general meeting of the company authorizing the buy-back.

(c) the buy-back is or less than twenty-five percent of the total paid-up capital and free reserves of the company ;

Provided that the buy-back of equity shares in any financial year shall not exceed twenty-five percent of the total paid-up capital in that financial year.[ii]

The core of the legal control of a business’s capacity to acquire its own shares, the power of “buy-back,” is based on the well-established requirement to safeguard, principally, the rights and interests of creditors of the firm, or those who are “owed” by the company. Nowadays, the term “creditor” encompasses a considerably broader group of people than only secured creditors, including the government, workers, and unsecured or trade creditors.

The historical reluctance of the common law to recognise the concept of a company being permitted to repurchase or buy back its own shares is underscored by the expansion of the types of creditors for whose protection the law as to buy-back is embodied in sections like Ss. 68[iii], 69[iv], and 70[v] of the companies Act, 2013. This reluctance originates from the common law’s historical reluctance to permit the consequential lessening of the capital of the company to seriously impair the company’s ability to honour its debt-servicing obligations. This is based on the lender’s assessment of the borrower’s long-term viability and continuing financial ability to repay the debt. This idea has been codified in the Indian law with respect to this matter.[vi]

In the landmark English case of Trevor v. Whitworth[vii], the court was asked to rule on the validity of a claim by the executors of a deceased shareholder to recover the remaining balance of the purchase price of the shares of the firm sold by them back to the company prior to the beginning of bankruptcy proceedings.

In a nutshell, Lord Macnaghten said, ” “If shareholders decide it is in their best interest to spend money to buy out a difficult partner who is prepared to sell, they may do so from their own resources, but they may not use funds in which other shareholders have a stake. I believe that to be the case because it makes the most legal and ethical sense.

The question boils down to “whether it is competent for a limited business to invest any portion of its capital in the acquisition of a share of its own capital stock, or to return any portion of such money without following the route which Parliament has prescribed?” The court concluded that, despite the company’s memorandum of association allowing for the buy-back, such trading constituted an indirect method of reducing the capital of the company.

Companies limited by shares or by guarantee with a share capital are prohibited from purchasing their own shares under section 67(1)[viii] of the Companies Act, 2013 unless the resulting decrease in share capital is performed in accordance with the Act. The “capital maintenance” rule prohibits a company from buying its own shares, with limited exceptions, in order to prevent the company’s share capital from being wasted. This is because the share capital serves as the pool of funds from which the company’s creditors can collect on any debts or claims owed to or in favour of those creditors.

In addition to the authorised buy-back described above in Section 68, a business may acquire its own shares, provided that the resulting reduction of its share capital is in line with and subject to the restrictions under Section 66[ix] related to share capital reductions. It has been held by the court in cases like SEBI v. Sterlite Industries (India) Ltd[x] that a buy-back and the official process of decreasing a company’s share capital are two separate legislative realms, and that the requirements applicable to the former cannot be imported into or made relevant to the latter. In order to achieve these goals, Sections 67 and 70 of the Companies Act, 2013 forbid companies from engaging in any other buy-back or purchase of their own shares.

There is a certain process that is involved in buying back of shares if the company must do so. First, the company’s articles of association (AOA) must permit the repurchase of its shares. If there’s no provision for doing so in the articles of association (AOA), they’ll need to amend the AOA before moving further. Depending on the repurchase ratio, the buyback must be approved by the board of directors at a board meeting or by a special resolution of shareholders at a general meeting. Up to 10% of the company’s paid-in equity capital and unrestricted cash reserves can be used with approval from the board of directors. As long as shareholders provide their consent, the firm can use up to 25% of its paid-in capital and any available reserves. The notice of general meeting in which the special resolution is proposed to be enacted must include an explanatory statement in which the required particulars must be provided pursuant to section 68(3) (a) to (e) and rule 17(1) (a) to (n) of the Companies regulations, (share capital and debentures) 2014[xi]. Shares in private and unlisted public firms are bought back using the buyback strategies. One of the options is to proportionally buyback from the current stockholders. The second one is buying the company’s shares or other securities that were distributed to employees as part of a sweat equity plan or stock option.

An offer letter (FORM SH-8) will be sent to the firms’ registrar before the share buyback is finalised. Immediately after filing the offer letter with the registrar of companies, but no later than 20 days after filing the offer letter with the registrar of companies certifying the matters mentioned in the sub-rule of rule 17 of the Company’s Rules (share capital and debentures), 2014, the company must send the offer letter to the shareholders.

To conclude, the buyback of shares is particularly advantageous for the firm and is described in full under section 68 of the Companies Act, 2013. Since it benefits both shareholders and businesses, it is a win-win situation. Shareholders benefit from increased value and higher returns on their investments, while shareholders can sell their shares if they are underperforming. However there should be a strict adherence to the rules mentioned in the companies Act 2013 in relation to the buyback of shares so that the company doesn’t come under the radar of SEBI.

[i] Companies Act 2013, § 77A, No.18, Acts of Parliament, 2013 (India)

[ii] Advocate Khoj- https://www.advocatekhoj.com/library/bareacts/companies/77a.php?%20Title=Companies%20Act,%201956&STitle=Power%20of%20company%20to%20purchase%20its%20own%20securities#:~:text=Sec%2077A%20%2D%20Power%20of%20company%20to%20purchase%20its%20own%20securities&text=(2)%20No%20company%20shall%20purchase,company%20authorizing%20the%20buy%2Dback.

[iii] Companies Act 2013, § 68, No.18, Acts of Parliament, 2013 (India)

[iv] Companies Act 2013, § 69, No.18, Acts of Parliament, 2013 (India)

[v] Companies Act 2013, § 70, No.18, Acts of Parliament, 2013 (India)

[vi] SCC Online- https://www.scconline.com/blog/post/2021/02/11/financial-assistance-and-indirect-purchases-of-shares-some-vexatious-issues/#_ftn13

[vii] Trevor v. Whitworth, (1887) 12 App Cas 409

[viii] Companies Act 2013, § 67(1), No.18, Acts of Parliament, 2013 (India)

[ix] Companies Act 2013, § 66, No.18, Acts of Parliament, 2013 (India)

[x] SEBI v. Sterlite Industries (India) Ltd., 2002 SCC OnLine Bom 1411

[xi] Companies regulations, (share capital and debentures) 2014, https://www.sebi.gov.in/sebi_data/attachdocs/apr-2017/1492085873402.pdf

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