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Selective reduction of Capital – a balancing act

Selective reduction of Capital – a balancing act

Reduction of share capital is a very important aspect of the capital management of the company. It is a mechanism whereby the company reduces its capital through various means and for various ends. While an equal reduction in capital applies to the same proportion of shares and on the same terms and conditions for each shareholder, selective reduction differentiates between shareholders of the same class by resulting in the compulsory extinguishment of capital of some shareholders. In the last couple of years, companies have increasingly resorted to selective reduction of capital of the company.

Courts’ view:

In the Panruti Industrial Co. (P) Ltd 1 the Madras HC held that the prescribed majority of the shareholders is entitled to decide whether there should be a reduction of capital, and, if so, in what manner and to what extent it should be carried into effect. However, companies seemed to resort to selective reduction of capital as a legitimate tool to oust minority shareholders. This was particularly true in case of family owned companies where majority of shares are held by members of the same family or group. Even if family owned corporates, there have been instances where scheme of reduction of capital was used to oust a segment of the family that held minority stake. Over time, the Courts have become stringent about approving schemes of selective reduction. In Sandvik Asia Ltd Vs Bharat Kumar Padamsi & Others 2, the division bench of the Delhi HC observed that if the non-promoter shareholders were being paid fair value of their shares, there was nothing invalid in such proposal of selective reduction. The decision in the case Reckitt Benckiser (India) Ltd 3 reiterated that in determining whether a scheme for selective reduction of capital, which differentiates between shareholders of one class, is fair and equitable, it would be most relevant to consider whether the affected shareholders were treated as a separate sub-class for meetings to approve the scheme or whether the scheme contained any other safeguard to prevent a forced acquisition of shares of the targeted shareholders.

In deciding the legality of the scheme of selective reduction, Courts maintain ensure  that they do not sanction a scheme of reduction which is discriminatory, unfair and malafide to minority shareholders / non-promoter shareholders / public shareholders. At the same time, the Court also reiterated that any person or group of persons holding miniscule shareholding in a company cannot defeat a scheme that has been duly approved by majority of shareholders. The Courts have observed that so long as the procedure laid down in law has been duly followed, there is no reason why a scheme of selective reduction shall be rejected on grounds of affecting minority shareholders.

Conclusion:

A company limited by shares is permitted to reduce its shares in any manner, provided it is within the framework of law. The broad framework within which reduction of share capital (equal or selective) is allowed is (a) if it considered fair and reasonable to the shareholders as a whole and (b) does not affect the interests of creditors and shareholders.  Courts are cautious in ensuring that a scheme for reduction is not a façade by majority shareholders to forcibly acquire shareholding of minorities’ shareholding.

Selective reduction of share capital is truly a double-edged sword in the hands of the Management of the company. While the Courts have in many instances sanctioned scheme(s) of selective reduction of share capital, any scheme that does not provide for uniform treatment of shareholders, will not find favour with the Court. The bottom line is to ensure shareholder interests have been secured in just and equitable manner.

Notes:

  1. 1960 AIR (Mad)
  2. 2009 92 SCL 272 (Bom)
  3. 2005 122 DLT 612

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