The Hindu Business Line : No company shall buy its own shares ...

IN Hamlet, Lord Polonius advises Laertes, "This above all: to thine ownself be true, and it must follow, as the night the day, thou canst not then be false to any man." These lines follow his more popular counsel about being `neither a borrower nor a lender', and other such nuggets of wisdom. In today's context, when reports speak of Reliance owning Rs 12,000 crore of its own stock, how nice it would have been if only Polonius had cautioned companies against owning their own shares!

While it is remote for the Bard to have envisaged that the corporate form of organisation might be leveraged for such a purpose, I'm sure there must be many with a simple question on their minds: Can a company purchase its own shares? To answer this, there is Section 77 of the Companies Act, 1956, titled, `Restrictions on purchase by company, or loans by company for purchase, of its own or its holding company's shares'.

It begins thus: "No company limited by shares, and no company limited by guarantee and having a share capital, shall have power to buy its own shares." The rationale for a taboo such as this is that otherwise a company may indulge in `trafficking' in its own shares, and influence its share price in an unhealthy manner, as Ramaiya explains in Guide to the Companies Act.

An oft-cited decision in this connection is Trevor vs Whitworth, an 1887 case where Lord Watson of the House of Lords explained the reason thus: "One of the main objects contemplated by the legislature, in restricting the power of limited companies to reduce the amount of their capital as set forth in the memorandum, is to protect the interests of the outside public."

He then pointed out the risk that paid-up capital might be diminished or lost in the course of the company's trading, even as outsiders who dealt with the company continued to think that there was a certain amount of capital in the company.

"They are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business," Lord Watson said. One can trace back the reasoning behind the fundamental policy of company law — that a company must maintain its capital — to the 1844 Limited Liability Act of the UK.

To understand the situation of holding one's own shares, let me take up a simple example. A company that has raised Rs 10 lakh capital has the amount in the form of cash, say; so the assets side show cash Rs 10 lakh, and the liabilities side shows Rs 10 lakh, as share capital. If the company were to use all its cash to buy its own shares, it would then have `investments' on the assets side representing entirely own shares bought, presumably at par value, thus squaring off the assets and liabilities side.

A zero-sum game no different from a snake trying to swallow its own tail. However, there are occasions where a company may have a rethink on the bloated size of its capital and so would like to alter the size or composition of its capital.

Law recognises, therefore, reduction of capital in Section 100. Accordingly, a company may extinguish or reduce the liability on any of its shares in respect of share capital not paid up.

There can be graver situations where the reduction cancels paid-up capital "which is lost, or is unrepresented by available assets". A third possibility that the section speaks of is where the company pays off any paid-up share capital, which is in excess of the wants of the company. Returning to Section 77, you'd find that its bar on the purchase of own shares does not cover reduction of capital under Sections 100 to 104, or under Section 402.

The last is about the Company Law Board resolving complaints of oppression and mismanagement by ordering the purchase of shares or interests of any members of the company by other members or by the company; while in the former case, the holding of the members who buy increases, the latter leads to reduction in share capital.

Neither a lender direct nor a lender indirect

As if in vindication of Polonius-speak, there is this sub-section 2 of Section 77 that states, "No public company, and no private company which is a subsidiary of a public company, shall give, whether directly or indirectly, and whether by means of a loan, guarantee, the provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company or in its holding company."

In short, a company can't lend or otherwise financially assist another to buy its shares.

Company law expert Mr N.R. Sridharan points out that the `indirectly' possibility of assistance is what many companies in India exploit and also get away with because prosecution may often find it tough to prove the nexus.

He also draws attention to `upstream holding' that is frowned upon by Section 42. It begins thus: "A body corporate cannot be a member of a company which is its holding company and any allotment or transfer of shares in a company to its subsidiary shall be void."

Simply put, holding company H can have shares in its subsidiary S, but not vice versa, but for the exceptions mentioned in the section.

To make life easier, however, law provides exceptions to the above rule.

Thus, a bank can lend money in the ordinary course of its business; a company can provide money to trustees who operate for the benefit of employees; it can lend to its employees not exceeding six months' salary or wages for purchasing shares. Again, redemption of preference shares, which Section 80 speaks of, falls outside the ambit of Section 77's rigour.

The avid may note that Section 45 too is relevant when we discuss buying own shares because "If at any time the number of members of a company, is reduced, in the case of public company, below seven, or in the case of a private company, below two, and the company carries on business for more than six months while the number is so reduced, every person who is a member of the company during the time that it so carries on business after those six months and is cognizant of the fact that it is carrying on business with fewer than seven members or two members, as the case may be, shall be severally liable for the payment of the whole debts of the company contracted during that time, and may be severally sued therefor."

Lord Justice Hoffman had this to say in a decade old case Nisbet vs Shepherd where a member of a company purchased the shares of the only other member of the company: "I have considerable sympathy with the appellant, who has fallen into a trap created by an ancient and obsolete rule... In default of compliance it strips the remaining member of the protection of limited liability."

To the judge it seemed obscure that the rule has survived through successive amendments to law.

Power to purchase own securities

It was the Companies (Amendment) Act, 1999 that brought in Section 77A to allow `buy-back' out of free reserves, securities premium account and so on.

This is an elaborate section, laying down detailed procedure (such as authorisation in the Articles of Association, and special resolution in general meeting) and also metrics (such as the cap of 25 per cent of total paid-up capital, and the ratio of debt to capital).

"Where a company buys back its own securities, it shall extinguish and physically destroy the securities so bought back within seven days of the last date of completion of buy-back," stipulates sub-section 7.

SEBI Guidelines mandate that a listed company can't use the buy-back provisions to delist its securities, but let me not branch off into delisting, lest you become listless.

ZeroBase@TheHindu.co.in

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