THE RULES GOVERNING THE MAINTENANCE OF CAPITAL AND EXCEPTIONS

THERE TO: A CRITICAL STUDY WITH SPECIAL REFERENCE TO

JURISPRUDENTIAL ISSUES WITH CASE LAWS

A PROJECT REPORT

Submitted by

PAYAL RAJPUT

(BAL/065/18)

Of

BA.LL.B (Hons.)

DHARMASHASTRA NATIONAL LAW UNIVERSITY,

JABALPUR

Under the guidance of

Mrs. Shruti Nandwana

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 ACKNOWLEDGEMENT

I would like to extend my gratitude to the Honorable Vice Chancellor Prof. Balraj Chauhan, for
providing us with such interesting projects to widen our horizons of learning.

I also express my sincere gratitude to our Head of Department Mrs. Shilpa Jain for helping me in
completing this project I convey my heartfelt thanks to her.

I am highly indebted to Mrs. Shruti Nandwana for her enviable encouragement, untiring efforts,
for her guidance during the course of execution of the project, without whom, it would not be
possible to bring it to the stage of successful conclusion.

I also express my special thanks to all those who helped me throughout this project, without
which it was not possible to accomplish it.

PAYAL RAJPUT

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 TABLE OF CONTENT

Research methodology………………………………………………………………...3

Introduction……………………………………………………………………………4

Doctrine of Capital Maintenance………………………………………………………5

Origin and Rationale of the Doctrine of Capital Maintenance………………………...7

Position in Bangladesh…………………………………………………………………8

Position in England…………………………………………………………………….9

Position in Singapore……………………………………………………….................10

Position in India……………………………………………………………………….11

Critical Analysis of Doctrine of Capital Maintenance………………………………...12

Conclusion……………………………………………………………………………..14

Bibliography…………………………………………………………………………...15

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 TITLE OF THE PROJECT

The rules governing the maintenance of capital and exceptions there to: a critical study with
special reference to jurisprudential issues with case laws

RESEARCH METHODOLOGY

The research methodology used in this study is Doctrinal Research. This research paper involves
literature review and is entirely based on secondary data; material and information are collected
by legal sources like books on Avtar Singh, etc. written by eminent authors. Material has also
been collected from Judgments of the Supreme Court and the High Court published in various
law journals.

RESEARCH OBJECTIVES

 To study and understand the doctrine of capital maintenance.

 To study the rules and its exceptions of the maintenance of capital.
 To study the Origin and Rationale of the Doctrine of Capital Maintenance through case
laws.

RESEARCH QUESTIONS

 What is Doctrine of Capital Maintenance?

 What are the rules and its exceptions of capital maintenance?
 How the Doctrine of Capital Maintenance emerges through case laws?

MODE OF CITATION

 The researcher has adopted a uniform mode of 19 th edition of Blue Book citation
throughout the project.

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 INTRODUCTION

In order to understand the Doctrine of capital maintenance, let’s first understand the capital of a
company. The company does many activities , in order to govern those activities company
require some amount so, the amount invested in the company is refers as capital and in a
company capital is denoted as “share capital”.1

The Doctrine of capital maintenance means the company capital should be kept intact because
there is a contribution of creditors of the company and retaining of capital is expected to
guarantee return to the creditors. If there is loss at the end of year, then it will fall to reduction of
the capital, it can diminish the liability of its members and position of creditor becomes unsafe,
they are at risk. Therefore this research paper will deal with the origin, objectives and the rules
which govern the doctrine with its exemption and also deal with the application of the doctrine
and it will also find out the way to save the interest of the company’s creditors and to satisfy
their needs in modern day business era.2

The fundamental principal of company law says that the company shall obtain the proper
consideration of shares of the company which it issues and the capital which it received should
not be repay it to the member of company until and unless in certain circumstances. The
Doctrine of capital maintenance emphasizes on this fundamental duty of company for the
creditors safety only to keep the capital intact and give the mandate to courts to supervise
whether the capital is dissipated lawfully or it is not.

Legal rules of the doctrine of capital maintenance support the payment of dividends or the other
distributions to the shareholders; then reduction of the company’s share capital or reserves;
prohibition on the provision by a company of financial assistance for the purchase of its own
shares; and a company’s redemption or the purchase of its own shares.3

DOCTRINE OF CAPITAL MAINTENANCE

1
Radhika Madhukar, Capital of the company-shareholders rights and its types, CAPITAL OF A COMPANY( Nov.
22, 2020 3:46 PM), http://www.legalserviceindia.com/.
2
Md. Saidul Islam, The Doctrine of Capital Maintenance and its Statutory Developments: An Analysis, Vol. IV,
ISSN 2218-2578, 47-55, (2013).
3
id

5
The protection of shareholder is always concern because they have limited liability, for this the
doctrine of capital maintenance comes into picture. It is a collection of rules which are designed
to ensure, first thing, that the company will obtain the capital which it seems to be raise and the
second thing the capital of the company is maintained, subject to its exigency for the benefit of
creditors. However the objective of this Doctrine is to prevent the fraudulence in the company to
creditors by reducing its share capital and it also ensure the liabilities of the shareholders.4

The share capital of the company should be maintained is the basic fundamental principle of the
company. It had been said that “a company cannot without the leave of the court or, the adoption
of a special procedure return to its capital to the shareholders. It follows that a transaction which
amounts to an unauthorized return of capital is ultra vires and it cannot be validated by
shareholder ratification or approval.”5

In the field of accounting capital maintenance has two sub concepts, one is the finacianl and
another is the physical capital. Financial capital maintenance concept means a company will earn
profit only if the amount of net assets at the end of a period exceeds the amount at the beginning
of the period. It can be measured either with monetary units or the purchasing power units.
Secondly the physical capital maintenance the company will earn only a profit if it’s productive
or operating capacity at the end of the period exceeds the capacity at the beginning of the period,
excluding any owner’s contribution or distributions. However, this article only deal with the
study of the financial capital maintenance

General Rules:

 A company generally cannot purchase its own shares unless it follows the strict
procedures laid down by the Act.
 A subsidiary company generally must not be a member of its holding company.
 It is generally unlawful for a company, to give any kind of financial assistance for the
acquisition by any person of its own shares or those of its holding company.
 Dividends must not be paid to the shareholders except out of the distributable profits.

4
Id AT 2
5
Aveling Barford Ltd. v. Perion Ltd, 360 W. L. R 57, 364 (1989).

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  Where a public company suffers a serious loss of capital a meeting of the company can
be called up to discuss the issue.

Exceptions

i) If the law permits, a company may reduce its share capital with the consent of the
court
ii) A company may redeem its shares if the Act concerned allows it
iii) A company may purchase its own shares under a procedure prescribed by the law
iv) Capital may be returned to the members, after the debts of the company have been
paid in a winding up.6

6
Id AT 2

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 ORIGIN AND RATIONALE OF THE DOCTRINE OF CAPITAL MAINTENANCE

There are two reasons for the origin of this doctrine firstly to protect the interest of the
company’s creditors and secondly to make sure the decadence of the company’s assets. The
courts has always been anxious to intact the capital of the company. Let’s see Doctrine of capital
maintenance development through judicial interpretation in the company law cases:-

 Jessel M. R. in Flitcrofts Case (1882)

This is England case , in this case two concept come out one is the creditors have the right to see
that the capital of company is not dispense unlawfully and another the capital will not return to
the member of company surreptitiously. These aspects are governed by the rules of company’s
distributions and the capital reduction.7

 Trevor v Whitworth

In this particular case the company bought back the almost quarter of its own shares, at the time
of liquidation of company on e shareholder goes to court and applied for the balance of the
amount which was owned to him after the buyback. The court Held two things one he should be
paid and the house of lords held that the the buy back was ultra vires company cannot buyback
its own shares even through if it was mentioned in memorandum also, it will amount to the
reduction of the capital another thing which was held that there will be no return of the capital to
its members except a proper reduction of the capital which duly sanctioned by the court.8

 Aveling Barford Ltd. V. Perion Ltd.,

In Aveling Barford Ltd. v. Perion Ltd. it washeld that “on a winding up of the company,
shareholders can retrieve their capital only if all the creditors have been paid.”9

Hence these laws are the foundation of Doctrine of Capital Maintenance. Now, lets see the
statutory provision of other countries in the field of this doctrine.

7
Jessel M. R. in Flitcrofts Case, 21 Ch. D 57, 519(1882).
8
Trevor v. Whitworth, 12 App. Cas. 409,(1887)
9
Aveling Barford ltd v. Perion Ltd, 626 BCLC ,630(1989)

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 POSITION IN BANGLADESH

In Bangladesh in order to govern the rules of capital maintenance there is traditional restrictive
approach is followed under Companies Act, 1994.

 In terms of reduction of the capital no company which is limited by the shares should
have any power to buy its own shares or the public company share which it is subsidiary
to it, until and unless the if there is effected reduction of the capital and it is sanctioned in
the manner provided under section 59-70.10

The creditor can bring objection to the court at the time if the given reduction of the share capital
will involve either diminution of liability in the respect of unpaid share capital or if the payment
to any of the shareholder of any paid-up share capital. If the court satisfy with the creditor of that
particular company who is also under the Act is also entitled to object the reduction or he may
consent to reduction which he has been obtained or his debt or the claim been discharged or it
has been determined or the way it is secured and may make the order confirming the reduction or
as it may deem fit.

 Financial Assistance
No company which are limited by shares other than the private company or a the
subsidiary company of the public company, should give it whether directly or indirectly,
and whether it by means of the loan guarantee the provision of security or otherwise any
financial assistance, for the purpose of or in connection with a purchase made or it to be
made by any person of any of the shares in the company. 11

Dividends – In terms of dividend there shall be no dividend paid otherwise than out of the
profits of the year or any of the other undistributed profits.

Purchase of own share – A Company which is limited by the shares is not entitled generally to
buy back its own shares until and unless they follow the particular procedure which is prescribed
under the Companies Act 1994.

10
Md. Saidul Islam, The Doctrine of Capital Maintenance and its Statutory Developments: An Analysis, Vol. IV,
ISSN 2218-2578, 47-55, (2013).

11
id

9
 POSITION IN ENGLAND

The rules are governed under the Companies Act 2006, also known as CA 2006, so the general
principles were originally developed by the courts then later it was superseded by the other
statutes. The most notably are the Part V of the CA 1985. The rules of unlawful financial
assistance which came in effect from 1 Oct. 2008 will no longer be applicable to any of the
private companies in most of the circumstances and the pvt. Companies without going to court
can reduce their share capital.

Under the part 23 of CA 2006 the provision related to Distributions dealt which it come into
force from 6 Apr. 2008 which will apply to distribution made on this date or after this datePart
23 Of this Act will deal with the permissible distributions. A dividend distribution to the
members cannot me done except the profit will is available for the purpose with reference to
“relevant accounts”

Reduction of the share capital is the new procedure but only for pvt. Companies which came into
force from 1 Oct. 2008 is to able to reduce the share capital by passing a special resolution which
should be supported by the solvency statement and it should be supported by all directors and
this procedure does not require any court approval for the reduction of capital. The Directors
should have reasonable ground for giving the solvency statement and it will also depend upon
the circumstances.

In the light of the above, before it applies to private company only, but now reduction of capital
route of the court is applicable to both public and the private company with subject to procedure
and certain amendments which come into force from 1 oct. 2009.

In the aspect of purchase of the own shares, the general rule is the limited company will not
acquire its own shares, by purchase or the subscription or otherwise, except it is as permitted.
Part 18 CA 2006 which comes into force on 1 October 2009, brings it together the current
methods by which a limited company can acquire its own shares and the section 658 CA 2006,
prohibits the acquisition by a limited company of its own shares, except in accordance with the
provisions of the Part.12
12
Md. Saidul Islam, The Doctrine of Capital Maintenance and its Statutory Developments: An Analysis, Vol. IV,
ISSN 2218-2578, 47-55, (2013).

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 POSITION IN SINGAPORE

In Singapore the Companies Amendment Act 2005 has reformed the law of Singapore on the
capital maintenance substantially. It has inter alia enabled the company which satisfies the
requisite solvency tests to reduce the capital, engaging in financial assistance and share buyback.
It is also argued that the whilst reforms have reduced the compliance costs and failure to bring
the solvency based reforms to their logical conclusion has made Singapore law’s on capital
maintenance incoherent.13

POSITION IN INDIA

In the Indian Companies Act, contain the sufficient number of the provisions which are
restricting a company capital to deal with it. This Act passionately deal with the Doctrine of
Capital Maintenance, if a company’s share are purchased back then it will turn into reduction of
capital. In terms of capital reduction, when a company buy back its own shares out of the free
reserves, then it will considered as the capital reduction. And the said Act prevents the capital
reduction under Section 69. A preference shares are issued by the limited companies, and when
this amt. will reduce it will amount to capital reduction but the section 80 says that the
redemption should be done only from the profits of the company for the purpose of dividend
distribution. 14

The fundamental principal says that the capital of the company must be maintained, if the
preference the preference share are redeemed from the any other sources the company must build
up the capital redemption reserve account.

Section 205 of the Act deal with the prohibition on that distribution when the dividend can be
paid out of the profit which is current or the profit which was accumulated earlier years. As per
the Act the board decides on how much it should be transferred to the reserve account.
15
Therefore in this manner the capital should be maintained in the reserve account and it will help
the creditors in there protection and company is not allowed to touch it. But the Act also provide

13
Id
14
The Companies Act, 2013. Acts of Parliament, 2013,India.
15
Id At 14.

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the departure provisions , from section 100-10516 deal with reduction of share capital and it could
be passed through the special resolution or the courts order.

DOCTRINE OF CAPITAL MAINTENANCE: A CRITICAL STUDY

This doctrine of capital maintenance has many merits, but there are some of the weaknesses also
with the doctrine. In practice, it is very great that the difficulty of making the legal assessment of
the value of the share capital and its maintenance. But this doctrine is not supported by many
lawyers-economists as the basis for the practice creditor protection. So, this doctrine is placed in
a doubt, as to whether it has any need or not. It provides protection to the creditors but we can
also say that creditors can have more alternative measures.

The rules of the share capital is appear to be irrelevant for significant majorities of companies,
which draw there line to such a low level that the law will not place any restriction at the time of
dealings. Usually the share capitals are not measured with the reasonable expectation of the
accuracy and hence they are not adequately protecting the creditors. In the case of commercial
viable investment project can hinder it because of the restrictive nature of absolute prohibition on
the buyback, in reduction of capital, dividend distribution and the financial assistance.17

Financial viability of the company and the credit worthiness are the two on which creditors base
their lending which are based on its cash flow and the balance sheet solvency. If we take
example of US where this concept is not deeply rooted, creditor usually take loan covenants in
the large scale lending agreements, so this will amount to restriction on the distribution of
payment to the shareholders.18

Hence, there is a need to repeal or abolish the deficiency in the doctrine and strengthened and
improve in better way the existing rules of capital maintenance. However still the doctrine will
play an important role to the investors and to the capital market. Another aspect it is not possible
for the court to always protect the sections of shareholders interest or if the creditors unfairly
prejudice by the reduction of the capital and that provision should be made where the court can
obtain the independent assessment of justice in reduction scheme.
16
Supra 14.
17
Roman Tomsic, The rise and fall of capital maintenance Doctrine in Australian corporate law, 26 SSRN 174,
174-187(2015).
18
Samish Dhakal, Capital maintenance in India, CAPITAL MAINTENANCE IN INDIA AND UK, (Dec. 2, 2020,
9:20 PM), https://www.scribd,com/presentation/36

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CONCLUSION

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By this research paper we can conclude that the protection of shareholder is always concern
because they have limited liability, for this the doctrine of capital maintenance comes into
picture. It is a collection of rules which are designed to ensure, first thing, that the company will
obtain the capital which it seems to be raise and the second thing the capital of the company is
maintained, subject to its exigency for the benefit of creditors. However the objective of this
Doctrine is to prevent the fraudulence in the company to creditors by reducing its share capital
and it also ensures the liabilities of the shareholders.

In the limited company they are expressly prohibited in the national legislation from reducing
their capital any buying its own shares and the procedure should protect both the creditors and
the shareholders. From this research paper I would like suggest that it is not possible for the court
to always protect the sections of shareholders interest or if the creditors unfairly prejudice by the
reduction of the capital and that provision should be made where the court can obtain the
independent assessment of justice in reduction scheme.

BIBLIOGRAPHY

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1. Jessel M. R. in Flitcrofts Case (1882)
In this case two concept come out one is the creditors have the right to see that the capital
of company is not dispense unlawfully and another the capital will not return to the
member of company surreptitiously. These aspects are governed by the rules of
company’s distributions and the capital reduction.

2. Trevor v Whitworth
In this case the company bought back the almost quarter of its own shares, at the time of
liquidation of company on e shareholder goes to court and applied for the balance of the
amount which was owned to him after the buyback. The court Held two things one he
should be paid and the house of lords held that the the buy back was ultra vires company
cannot buyback its own shares even through if it was mentioned in memorandum also, it
will amount to the reduction of the capital another thing which was held that there will be
no return of the capital to its members except a proper reduction of the capital which duly
sanctioned by the court

3. Aveling Barford Ltd. V. Perion Ltd.,

In Aveling Barford Ltd. v. Perion Ltd. it washeld that on a winding up of the company,
shareholders can retrieve their capital only if all the creditors have been paid.

15