The Practical Lawyer

Minority Shareholders’ Position in case of Reduction of Capital — Judicial Development

Minority Shareholders’ Position in case of Reduction of Capital — Judicial Development

By Archi Agnihotri and Medha Srivastava*
Cite as: (2011) PL April S-17 Reduction of the capital of a company is usually not allowed because conservation
of capital is the cardinal rule of company law. The capital of a company is considered the security upon which the
creditors usually rely. It is for this reason that reduction of capital is considered unlawful except when sanctioned by the
court.1 Reduction of capital would include nominal share capital, whether issued or unissued and if issued whether fully
paid or not and “share― includes stock so that a company must reduce its stock.

Reduction of capital under the scheme of the Companies Act, 1956 Reduction of share capital under different
provisions of the Companies Act is:
(i) Under Section 100, reduction of share capital is by way of cancellation of shares. Such cancellation relate to that
part of share capital which has already been subscribed, whether fully paid or not. This section is to be read along with
the provisions of Sections 101 to 105.
(ii) Under provisions of Section 94, alteration of share capital involves reduction in authorised share capital by
cancellation of shares which have not yet been taken or agreed to be taken by any person.
(iii) Reduction of capital is also dealt in Section 394 where the court passes an order under a scheme of compromise
or arrangement, and also under Section 402(c) where the Company Law Board orders purchase of its own shares by the
company, resulting in reduction of share capital, on an application under Section 397 or Section 398.
Taking into consideration Section 100 of the Companies Act, it could be easily said that the three essential
requirements of reduction of capital are:

- a clause in the articles of association with regards to reduction — Power to reduce share capital shall be authorised by
the articles of association. In the absence of such a provision, the articles shall first be altered.
- special resolution to that effect — 75% vote by shareholders present and voting at a general meeting.
- confirmation by the Tribunal2. The Supreme Court summed up the process of reduction as:

15. … Firstly, there will be a resolution by the general body of a company for reduction of capital by distribution of the
accumulated profits amongst the shareholders; secondly, the company will file an application in the Court for an order
confirming the reduction of capital; thirdly, after it is confirmed, it will be registered by the Registrar of Joint Stock
Companies; fourthly, after the registration the company [will issue] notices to the shareholders inviting applications for
refund of the share capital, and fifthly, on receiving the applications the company will distribute the said profits….3

The Court can dispense with the procedure laid down for reduction of share capital if the Court having regard to any
special circumstances thinks proper to do so. However when such discretion is used the creditors would have no
opportunity to object to the reduction.4

It may be noted that while making an application for confirmation on reduction of share capital under Sections 100 to
101, the company may make an application for grant of exemption from the provisions of Section 101(2) either
independently or along with amalgamation petition under Sections 391 to 394 of the Act. The company must specify in
the petition whether the reduction in the share capital proposed is likely to affect in any manner, the interest of the
creditors or not. This would enable the Court to ascertain whether the power under sub-section (2) for giving specific
direction should be exercised or not.

It is not necessary that extinguishment of shares in all cases should necessarily result in reduction of share capital.
Section 101 and Section 102 read with Rule 85 of the Companies Court Rules do not stand attracted to a scheme of
amalgamation where there is no release of assets but which involves transfer of all the assets and liabilities. However the
same would stand attracted only to cases of compromise or arrangement involving reduction of capital.5

Judicial development prior to 2003 In the following cases, it is usually not considered to be reduction of capital:

- Redemption of redeemable preference shares in accordance with the provisions of Sections 80 and 80A.
- A surrender of shares by a member to the company.
- Forfeiture of shares for non-payment of calls.6
- Where a company is dissolved, without winding up and preference shares of amalgamating company are paid out
under a scheme of amalgamation, such a case is not a case of reduction of capital.7
- Where a company in voluntary liquidation, repays preference and ordinary share capital and thereafter introduces fresh
share capital which is less than earlier capital, it does not amount to reduction of capital.8
- Where a sum of money was received for allotment of shares but allotment could not be made. Paying back that money
to the depositor did not require procedure for reduction of capital even though the money was wrongly shown as a part of
the company’s subscribed capital.9 Before 2003 it was abundantly clear from the attitude of the courts in approving
the reduction of capital that there was an implicit squeezing out of minority. The High Courts had approved schemes of
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arrangement involving reduction of capital whereby the company would reduce the share capital of all shareholders other
than the promoters/controlling shareholders. The majority shareholders benefited because they obtained the sanction of
the Court for such an arrangement. Further, in commercial terms, the majority shareholders did not incur any financial
burden as the consideration for the reduction always came from the company. The minority shareholders though were
put in a difficult position.

Sandvik Asia Ltd. and its impact But the trend suffered a halt with a judgment of the Single Judge in Sandvik Asia
Ltd., In re10. The court held that such a proposal was highly inequitable, unjust and unfair because the promoter group
(controlling shareholders) could completely ruin the interest of the minority shareholders. Hence, the company petition
was dismissed. An appeal was filed by Sandvik Asia soon thereafter before a Division Bench of the Bombay High Court.
The decision led to a lot of confusion as the Courts had previously accepted such schemes and their stand was being put
to question. Moreover the shareholders felt that their doubts regarding their rights such transactions would finally be
resolved.

In Sandvik Asia Ltd. v. Bharat Kumar Padamsi11 a Division Bench of the Bombay High Court overturned the Single
Judge’s order and approved the scheme on appeal. The Court sanctioned the scheme and held that there was nothing
contrary to law in it. The Court identified the issue as follows:

Perusal of Section 100 further shows that a company can reduce its share capital in any way. In the present case, it
is nobody’s case that the special resolution passed by the company is invalid or has not been passed by following the
procedure laid down by the Companies Act. It is also nobody’s case that in the articles of association of the Company
there is no provision authorising the company to reduce its share capital. It is also nobody’s case that the amount that is
being offered to the nonpromoter shareholders is not just or fair. The only objection raised is that the scheme for the
reduction of share capital proposed by the special resolution wipes out a class of shareholders, namely, the nonpromoter
shareholders and this, according to the objectors, is unfair and inequitable. The question, therefore, that is to be
considered is whether the special resolution which proposes to wipe out a class of shareholders after paying them just
compensation can be termed as unfair and inequitable.

In appeal, the Division Bench held that they were bound by the law laid down by the Hon’ble Supreme Court in
Ramesh B. Desai v. Bipin Vadilal Mehta12 where the Supreme Court recognised the judgment of the House of Lords in
British and American Trustee and Finance Corpn. v. Couper.13 The judgment is crucial in throwing light on the rights of
the shareholders in India. The company in question was not a listed company — it had already been delisted. Listed
companies would require stock exchange approval for reduction of capital under the listing agreement, and it is unlikely
that stock exchanges would approve such a transaction. However, for an unlisted company, regardless of whether a
company is a public company or a private company, shareholders’ rights can be affected harshly.

The private equity investors having small holdings without serious rights could be pushed out of the way by using
such resolutions. A major aftereffect would be that in family-run companies, a segment of the family that holds a minority
stake could get thrown by the rest of the family by a special resolution. This would pose as a serious problem because in
India most of the corporate houses are family-run enterprises where there are serious possibilities of internal disputes.

The most important issue which arises is whether an owner of shares in India has a vested right to keep his property,
or whether other shareholders can force him to divest his property. The Court in this regard clarified that:

In our opinion, once it is established that non-promoter shareholders are being paid fair value of their shares, at no
point of time it is even suggested by them that the amount that is being paid is any way less.

That an overwhelming majority of the non-promoter shareholders voted in favour of the resolution too weighed with
the court, which held that “the court will not be justified in withholding its sanction to the resolution―.

The court considered the question of squeezing out the minority and held, after examining the various Supreme
Court decisions, that there is nothing invalid in that proposal. But the facts indicate that a proper and fair scheme would,
have been one where all other shareholders, other than the promoters, who wanted to retain their shares, were excluded
from the resolution so that their shares would not be subject to the forcible reduction of capital by compulsory acquisition.
This would have allowed all those other shareholders, who otherwise support the scheme to give the remaining
shareholders an exit option, to vote in favour of the scheme alongwith the promoters, without their shareholding getting
affected. In other cases under Section 100 of the Act, where a scheme has been sanctioned, this safeguard was a part of
the scheme and shareholders who did not want their shares to be forcibly acquired were allowed to indicate so, and their
shares were then not affected by the scheme for reduction. Moreover, the unfairness in the scheme in this connection is
also manifest in the fact that there was no separate class meeting for the subclass of those shareholders who were
affected by the scheme.

The issue of reduction of capital is a matter of domestic concern, one for the decision of the majority, of the
shareholders of the company.14 In other case it was held that reduction of the share capital of a company is a domestic
concern of the company and the decision of the majority would prevail. If the majority by special resolution decides to
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reduce the share capital of the company, it has the right to decide, how this reduction should be effected. While reducing
the share capital the company can decide to extinguish some of its shares without dealing in the same manner with all
other shares of the same class. A selective reduction is permissible within the framework of law for any company limited
by shares.15

Once it is established that non-promoter shareholders are being paid fair value of their shares, at no point of time it is
even suggested by them that the amount that is being paid is any way less and that even overwhelming majority of the
non-promoters shareholders having voted in favour of the resolution shows that the court will not be justified in
withholding its sanction to the resolution.16

A public company that has invited participation from the public and which wishes to retain its character as a public
limited company, cannot be permitted in law to extinguish the entire class of public shareholders by mooting a scheme
for reduction of capital under Sections 100 to 105 of the Act, so as to facilitate the real object of the scheme, that being to
make the company a 100% subsidiary of the promoters. This proscription by the law would be more so applicable where
the public company would continue to remain a public company, albeit unlisted, even after the scheme for reduction is
sanctioned, and would therefore be able to invite participation of the very public after having forced out the erstwhile
public, by use of the brute majority/voting strength of the promoter shareholders, by compulsory purchase/reduction of
their shareholding.

Although Section 100 of the Act speaks of reduction of share capital of “any of its shares― and “in any way―, the s
cannot be applied and interpreted to undermine and negate the overwhelming legislative policy and intent which can be
gathered from the other provisions of the Act and related legislation, which is directed towards preventing the forced
acquisition of shares of the public or the extinguishment of the entire class of public shareholding.

A basic attribute of a public company is (i) that it enables a private company entitled to invite the public to subscribe
to its shares, and (ii) that its shares are freely transferable under Section 111A(2) of the Act. It is submitted that the right
to transfer shares freely, includes the right to retain or hold shares. A scheme of reduction that forcibly acquires shares of
the entire class of public shareholding, would abrogate this basic principle, which allows shareholders of a public
company to retain its shares.

In the light of the above provisions, a scheme for reduction cannot be resorted to in order to extinguish, entire class
of public shareholders.17 Section 100 of the Act, while recognising that it is for a company to frame a scheme for
reduction and much autonomy is left to the company in this regard, cannot be applied to undermine and destroy the
basis fabric of the Act and related provisions of law that are intended to protect the rights of the public shareholding in a
public limited company. Every scheme for reduction of capital, after compliance with the requirements of Sections 100 to
104 of the Act, is subject to confirmation of the court. The mandatory requirement of confirmation of a reduction of capital
by the court is a statutory safeguard for the protection, inter alia, of the minority shareholders.18 In exercising its
supervisory jurisdiction when considering an application for confirmation of a reduction of capital, the court has to
consider whether the reduction of capital is fair and equitable qua creditors, shareholders (of every class individually and
collectively), and in the interest of the public. The fairness and equity standards applicable are to be understood in the
broad sense and not in the technical and narrow sense.19

Conclusion The inequity in allowing the promoter (majority) alone to vote and decide the fate of the minority public
shareholders, is that whilst they are being treated as a class apart and are outside the scheme of reduction, that
classification is not maintained for voting on the scheme, and they are given a right to vote, it is not being suggested that
this class meeting would be a substitute for the special resolution that would be required under the procedure of Section
100 of the Act, however, this would meet with the standard of fairness so that the affected class can consider and
determine the fairness of a scheme uninfluenced by the presence and voting strength of the majority, who are differently
placed.

On the question of minority rights, the landmark case of Miheer H. Mafatlal v. Mafatlal Industries Ltd.20 might be
helpful,

It has to be kept in view that the question of bona fide of the majority shareholders or the alleged suppression by
them of minority shareholders or their attempt to suffocate their interest has to be judged from the point of view of the
class as a whole. Question is whether the majority shareholders while acting on behalf of the class as a whole had
exhibited any adverse interest against the appellant’s minority shareholders also having a similar interest as members of
the same class, while approving the scheme, or had acted with any oblique motive to whittle down such a class interest
of the minority. (para 38)

In the leading case of British and American Trustee and Finance Corpn. v. Couper21 Lord Macnaghten observed on
the point:

… If there is nothing unfair or inequitable in the transaction, I cannot see that there is any objection to allowing a
company limited by shares to extinguish some of its shares without dealing in the same manner with all other shares of
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the same class.

However, in the same case, Lord Herschell, L.C. made the following observations:

There can be no doubt that any scheme which does not provide for uniform treatment of shareholders whose rights
are similar, would be most narrowly scrutinised by the Court, and that no such scheme ought to be confirmed unless the
Court be satisfied that it will not work unjustly or inequitably.21-a

The Madras High Court, while referring to the same judgment in Panruti Industrial Co. (P) Ltd., Inre22 held that the
Court’s power to sanction any reduction is to be determined by whether such reduction is fair and equitable.

In Organon (India) Ltd., In re23 Kathawalla, J. observed after discussing the previous cases:

This Court is bound by the decision of the learned Division Bench (in Sandvik24) and cannot withhold sanction to the
special resolution for reduction of capital, unless there is some patent unfairness regarding the fair value of the shares or
there is lack of an overwhelming majority of nonpromoter shareholders who vote in favour of the resolution….

If the observation in Organon25 is to be read as laying down the law on the point, the effect of Sandvik could easily
be reduced to a great extent. A mere special resolution would not be enough — that special resolution would need an
overwhelming majority of non-promoter shareholders backing it. This is almost equal to giving a veto power to the
nonpromoter minority shareholders. Interestingly, on the facts of the case, this had no effect on reduction of share capital
— of more than thousand nonpromoter shareholders, only one had objected.

After analysing the recent judgments it becomes clear that the authority rests on the Courts as the statutory
provisions seem open to misuse by the majority shareholders. It seems that the obvious question is that why can the
Court not intervene in the favour of minority shareholder as all schemes of reduction require sanction of the Court? While
fairly substantial powers are conferred on the High Courts while approving schemes of reduction, they are usually
exercised cautiously. The Courts tend to rely on statutory interpretation and construction of the law and are hesitant to
indulge in lawmaking or policy-making. The Courts also normally assume the validity of schemes, unless they are
challenged convincingly.

Whilst the law permits, and the Courts have the power to confirm, a scheme for reduction, which applies selectively to
some shareholders of a class, and not all, any such scheme that does not provide for uniform treatment of shareholders,
would be most narrowly scrutinised by the Court. No such scheme ought to be confirmed unless the Court is satisfied
that it will not work unjustly or inequitably. The Court must examine whether the reduction is fair between classes of
shareholders or whether the reduction would work injustice between different classes of shareholders. In determining
whether a scheme for selective reduction of capital, which differentiates between shareholders of one class by resulting
in the compulsory extinguishment of capital of some shareholders of that class, is fair and equitable, it would be most
relevant to consider whether the affected shareholders were treated as a separate subclass for the purpose of meetings
to approve the scheme or whether the scheme contained any other safeguard to prevent a forced acquisition of shares of
the targeted shareholders.

*Fourth year students of BA LLB (Hons.) at National Law Institute University, Bhopal.
- Section 100 of the Companies Act, 1956 (1 of 1956). This section applies to a company limited by shares or a
company limited by guarantee having a share capital.
- Substituted for “Court― by the Companies (Second Amendment) Act, 2002 w.e.f. a date yet to be notified.
- Punjab Distilling Industries Ltd. v. CIT, AIR 1965 SC 1862, 1867, para 15 : (1965) 35 Comp Cas 541, 544.
- Cosmosteels (P) Ltd. v. Jairam Das Gupta, (1978) 1 SCC 215 : (1978) 48 Comp Cas 312.
- Asian Investments Ltd., In re, (1992) 73 Comp Cas 517 (Mad).
- Naresh Chandra Sanyal v. Calcutta Stock Exchange Assn. Ltd., (1971) 1 SCC 50 : (1971) 41 Comp Cas 51.
- T. Durairajan v. Waterfall Estates Ltd., (1972) 42 Comp Cas 563 (Mad).
- Mcleod & Co. v. S.K. Ganguly, (1975) 45 Comp Cas 563 (Cal).
- Rupak Ltd. v. Registrar of Companies, (1984) 56 Comp Cas 206 (Pat).
- (2004) 121 Comp Cas 58 (Bom).
- (2009) 3 Bom CR 57.
- (2006) 5 SCC 638.
- 1894 AC 399 : (1891-94) All ER Rep 667 (HL).
- Elpro Interational Ltd., In re, (2009) 149 Comp Cas 646 (Bom).
- SIEL Ltd., In re, (2008) 144 Comp Cas 469 (Del).
- Poole v. National Bank of China Ltd., 1907 AC 229 : (1904-07) All ER Rep 138 (HL).
- Westburn Sugar Refineries Ltd., ex p, 1951 AC 625 : (1951) 1 All ER 881 (HL).
- Reckitt Benckiser (India) Ltd., In re, (2005) 122 DLT 612.
- Supra, n. 13.
- (1996) 11 SCL 70.
- Supra, n. 13, 415-16.
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- Ibid, 406.
- AIR 1960 Mad 537.
- (2010) 101 SCL 270 (Bom).
- Supra, n. 11.
- Supra, n. 23.
- Supra, n. 11.

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