By Meenakshi Menon, NUALS
Editor’s Note: Buying back of shares which is often taken as a defense against takeovers has been recently given legal recognition in India. Sections 77A and 77B have been added in the Companies Act to deal with it specifically. The author discusses the basics and the procedure involved in buying back of shares.
1.1 What does ‘buy backing of shares’ mean?
Share capital is very important for the company whether listed or unlisted. The two main types of shares are equity and preferential shares, the shareholders can vote at the general meetings, receive dividends and other benefits as may be prescribed and also realise the price of the shares by transferring shares to another.
There are certain provisions in the Company Act which allows the shareholders to sell the shares back to the company which is often termed as buy back of shares. Buy back of shares can be understood as the process by which a company buys its share back from its shareholder or a resort a shareholder can take in order to sell the share back to the company.
1.2 Objectives behind buy back of shares and the restrictions placed on it.
Shares may be bought back due to one or many reasons like inorder to increase promoters holding, increase earnings per share, to rationalise the capital structure by writing off capital not represented by available assets, to support share value, to thwart takeover bid, to pay surplus cash not required by business
A reduction of capital is unlawful except when sanctioned by the court (now tribunal) according to section 100 of the Companies Act. Conservation of capital is one of the main principles of company law. The share capital of a company is the only security on which the creditors rely. Any reduction of capital therefore diminishes the fund out of which the creditors are to be paid. It is for this reason that companies limited by shares are not allowed to purchase their own shares because the capital is thereby reduced.
Closely fenced power is therefore given by section 100. Complete details of the procedure to be followed for effecting a reduction are given in the Act itself. Authority to reduce capital must be present in the articles. In pursuance of that authority, a special resolution must be passed which should authorise the contemplated reduction of capital
Traditionally subject only to a few exceptions specified in section 77 companies were not permitted to purchase their own shares. The laws as to the buying of its share by the companies were very stringent. Some of the ways by which a company could buy its shares back were as follows:-
- Reduction of share capital as given in Sections 100 to 104.
- Redemption of redeemable preferential shares under Section 80.
- Purchase of shares under an order of the court for a scheme of arrangement under Section 391 in compliance with the provisions of Sections 100 to 104.
- Purchase of shares of minority shareholders under the order of the company law board under Section 402(b).
Section 77-A brought in by the Companies (Amendment) Act, 1999, has caused this structural change in the theme and philosophy of company law that, subject to the restrictions envisaged in this section a company may buy back its own shares. Sub section (1) indicates the fund out of which the exercise of buy back of shares is to be financed.
The sources allowed are the company’s free reserves, securities premium account, proceeds of an earlier issue. No,buy back of any kind of shares or other specified securities can be made out of the earlier proceeds of the same kind of shares or the same kind of other specified securities.
Section 77, Companies Act, 1956
The companies (Amendment) Act, 1999 vide Sections 77A, 77AA, and 77B and the guidelines issued by SEBI and Department of company Affairs in this regard allow companies to purchase their own shares or other securities subject to certain conditions. The provisions of the Amendment Act along with related SEBI guidelines are as follows:-
Section 77 of the Companies Act deals with purchase by a company of its own shares, it declares in so many words that no company limited by shares and no company limited by guarantee and having a share capital shall have the power to buy its own shares unless the consequent reduction of capital is effected and sanctioned in pursuance of Sections 100 to 104 or of Section 402. The object of this section is to prevent a person acquiring control of a company and paying for its share out of the accumulated assets of the company itself, in other words, to prevent a person from plundering the coffers of the company for his own benefit.[i]
The sub section 77 (2) further places a prohibition on giving of a loan, guarantee, the provision of security or any other financial assistance to purchase its own shares. However, it shall not affect:
- The lending of money by a banking company in the ordinary course of its n business. A mere provision in the objects clause of the memorandum enabling the company to do the business of lending money is not sufficient.[ii]
- The provision by a company of money in accordance with any scheme for the time being in force for the purchase of fully paid up shares in the company or its holding company for the benefit of employees of the company including any director holding a salaried office or employment in the company.
- The making by a company of loans to persons (other than directors or manager) bona fide in the employment of the company to enable them to purchase fully paid shares in the company or its holding company to be held by themselves by way of beneficial ownership.
On the question of whether it is unlawful to give financial assistance in contravention to S. 77(2), English Courts have given divergent opinions. In Victor Battery Co Ltd v. Curry’s Ltd[iii] it was held that if a company provides financial assistance by way of giving security for raising a loan for the purpose of purchasing its own shares the transaction is not illegal and the security not invalid or unenforceable. This view was reversed in Selangor United Rubber Estates Ltd v. Credock[iv].
The Calcutta High Court held that the giving of financial assistance by the company does not render the sale of shares for valuable consideration void but only entail a punishment for the company and its officers as provided in sub section 4.[v]
Section 77(3) states that the loan made to any employee for this purpose shall not exceed his salary or wages at that time for a period of 6 months.
A few important things that relates to this section are:-
- A company may buy its own shares from any member for prevention of oppression and mismanagement in pursuance of CLB’s order under s.402 of the Act.
- A private company not being a subsidiary of a public company though not allowed to buy its own shares may advance loan or financial assistance for the purchase of its shares or shares of its holding company.
- The section does not apply to the case of any holding company purchasing shares of its subsidiaries.
- The section would also not include the lending of money in accordance with the company’s memorandum and articles to the shareholders on the security of the company’s shares. It creates only a lien on the shares.[vi]
A penalty is stipulated for as per Section 77(4) which is a fine of Rs1000 payable by a company and every officer who is in default.
Section 77 (5) states that nothing in this section shall affect the right of a company to redeem any shares issued under S. 80 or under any corresponding provision in any previous companies law.
Section 77 A-Sources to buy back:
Section 77A inserted by the Amendment Act, 1999 allows [subject to the provisions of section 77B (2)] a company to buy its own shares and other specified securities out of :
- Its free reserves; which means those reserves which as per the latest audited balance sheet of the company are free for distribution as divided and shall include balance to the credit of the securities premium account but shall not include the share application money. (As defined for S.372 A)
- The securities premium account. Thus not only share premium money but debentures or other securities premium money can also be used: or
- The proceeds of any shares or other specified securities. Specified securities include employees’ stock option or other securities as may be notified by central govt from time to time.
However no buy back shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
In case shares are bought back out of free reserves then S. 77AA stipulates that a sum equal to the nominal value of shares bought back shall be transferred to a reserve account to be called Capital Redemption Reserve Account [as referred to in clause (d) of the proviso to sub section (1) of section 80] and details of such transfer shall be disclosed in the balance sheet. This account as per SEBI guidelines, shall be allowed to be used for issue of fully paid bonus shares.
CONDITIONS FOR BUY BACK
Section 77 A (2) provides that no company shall purchase its own shares or other specified securities unless:
- The buy back is authorised by its articles;
- A special resolution has been passed in general meeting of the company authorising the buy back
- The buy back is 25% of the total paid up capital and free reserves of the company purchasing its own shares or other specified security. However, as regards buy back of equity shares it may be noted that it cannot exceed 25% of its paid up equity capital in that financial year. The Companies Amendment Act 2001 has authorised the buy back by passing a resolution at a meeting of the board of directors provided the buy-back does not exceed 10% of the total paid up capital and free reserves of the company.
However, there cannot be more than one such buy back in any period of 365 days.
4. The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buyback. However, the Central Government may prescribe a higher ratio of the debt for a class or classes of companies ‘debt’ includes all amounts of secured and unsecured debts.
5. All the other shares or other specified securities are fully paid up;
6. The buyback with respect to listed securities is in accordance with the regulations made by the SEBI of India in this behalf.
7. Separate guidelines shall be issued with respect to unlisted specified securities.
II) The notice of the meeting at which special resolution is proposed to be passed shall be accompanied by an explanatory statement stating:
- full and complete disclosure of all material facts;
- the necessity for buyback
- the class of security intended to be purchased under the buyback;
- the amount to be invested under the buyback
- the time limit for completion of the buyback
- the price at which buyback of securities shall be made and
- if the promoter intends to offer their shares: (i) the quantum of shares proposed to be tendered and (ii) the details of their transactions and their holdings for the last six months prior to the passing of the special resolution for buyback including information on number of shares acquired the price and the date of acquisition.
Every buy-back shall be completed within 12 months from the date of passing the special resolution under subsection (2) of section 77A. It may be observed that since a buyback would take place only for cancellation of the shares so there is no necessity for registration of transfer in the books of the company and also there is no need for affixing stamps in respect of shares bought back.
Buyback shall be permissible:
- from the existing shareholders on a proportionate basis through the tender offer.
- from open market through either book building process or stock exchange.
- from odd-lots, ie. Where the lot of securities of a public company whose shares are listed on a recognized stock exchange is smaller than such marketable lot, as may be specified by the stock exchange.
- By purchasing the securities issued to employees of the company pursuant to a scheme of stock opt `ion or sweat equity.
Where a company has passed a special resolution or the board has passed a resolution to buy back its own shares or other securities under this section it shall before making such purchases file with the registrar and the SEBI a declaration of solvency in the form prescribed verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration adopted by the Board. The declaration shall be signed by atleast two directors of the company one of whom shall be the managing director if any.
However, no declaration of solvency shall be filled with the Securities Exchange Board of India by a company whose shares are not listed or any recognized stock exchange. It may be noted that exemption in this regard shall be available for only those companies whose shares are not listed irrespective of any of its other security being listed.
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 the buyback. SEBI guidelines in this regard stipulate that the share certificates bought back shall be destroyed in the presence of a registrar or the merchant banker and the statutory auditor. A certificate to this effect shall be furnished to SEBI duly signed by whole time directors including the managing director and verified by the Registrar, Merchant Banker and statutory auditor.
Where a company completes a buy-back of its shares and other specified securities under this section it shall not make further issue of the same kind of shares including by way of rights or other specified securities within 6 months except by way of bonus issue or in discharge of subsisting obligations such as conversion of warrants, stock option scheme, sweat equity or conversion of preference shares or debentures into equity shares.
Where a company buys back its securities under this section it shall maintain a register of the securities so bought the consideration paid for the securities bought back the date of cancellation of securities the date of extinguishing and physically destroying of securities and such other particulars as may be prescribed
A company shall after the completion of the buy backfile with the ROC and SEBI a return containing such particulars relating to the buyback within 30days of such completion as may be prescribed
However, the aforesaid return shall not be required to be filed with SEBI if the company is not a listed company.
Section 77A has been introduced to provide an alternative method by which a company can buy back up to 25% of its total paid-up equity capital in any financial year and it does not supplant or take away any part of pre-existing jurisdiction of Company Court to sanction a scheme under sections 100 to 104 and under section 391.[vii]
Section 77A which is merely an enabling provision providing for alternative mode by which a company can buy back its shares up to a certain percentage is no given an overriding effect over provisions of Section 391 and 394.[viii]
Section 77 B
As per section 77 B buy back of shares are prohibited in certain circumstances. This section says that a buy-back of shares has to be done directly and not through the medium of other companies or subsidiary companies. It should also not be done through any investment company or a group of investment companies. A company shall not resort to buying back if it is in default in the payment of deposits, the redemption of debentures or preference shares or repayment of a term loan to any financial institution or a bank.
No company is allowed to purchase its own share directly or indirectly if the company has not complied with the provisions of Section 159(annual return), Section 207 (default in paying declared dividend within specified time) and Section 211(i.e. form and contents of Balance sheet and profit and loss Account and compliance with the Accounting standards).
Clarifications made by the finance minister in his budget speech:-
- Buyback of share cannot be treated as a deemed dividend at the hands of the shareholders and therefore shall not be subject to income tax under the Income Tax Act, 1961.
- Buy back shall not amount to a reduction of share capital.
- The buyback will not result in capital gains at the hands of the shareholders.
In the following cases however a company is not taken to have purchased its own shares i.e. Where it redeems its preference shares, forfeits shares for non-payment of calls, accepts a valid surrender of shares.
Although a company cannot purchase or hold its own shares a bequest (transfer through ‘will’) of its shares by shareholders to the company is not illegal. Also, the company may have the shares transferred to a nominee being a person qualified to hold shares under a company’s Articles of Association.[ix] Similarly receiving of shares as a gift cannot be prohibited under this section.
The regulations called the Securities and Exchange Board of India (Buy Back of Securities) Regulations, 1998 came into existence through the exercise of the powers conferred by sub-sections (1) and (2) of section 11 and section 30 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) read with clause (f) of sub-section (2) of Section 77A of the Companies Act, 1956 (1 of 1956) as inserted by [the Companies (Amendment) Act 1999 (21 of 1999)]. Some important provisions of the same are:-
- Chapter II states that these regulations apply to buy-back of shares or other specified securities of a company listed on a stock exchange.
- Buy-back offer shall remain open for not less than 15 days and not more than 30 days.
- The verification of shares received in buyback shall be completed within 15 days of the closure of the closure of the offer and payments made within 7 days.
- These regulations mention the general obligations that a company buying back its shares would have.
4.1 The company shall within 2 days of the completion of buyback issue a public advertisement in a national daily, inter alia, disclosing:
i)Number of shares bought;
ii)Price at which bought
iii)Total amount invested in buyback;
iv)Details of shareholders from whom shares exceeding 1% of the total shares bought back and
v)The consequent changes in the capital structure and the shareholding pattern after and before the buyback
4.2 The letter of offer, the public announcement of the offer or any other advertisement, circular, brochure, publicity material shall contain true, factual and material information and shall not contain any misleading information and must state that the directors of the company accept the responsibility for the information contained in such documents;
4.3 The company shall not issue any [shares or other specified securities] including by way of bonus till the date of closure of the offer made under these regulations;
4.4 The company shall pay the consideration only by way of cash;
4.5 The company shall not withdraw the offer to buy-back after the draft letter of offer is filed with the Board or public announcement of the offer to buy-back is made;
4.6 The promoter or the person shall not deal in the [shares or other specified securities] of the company in the stock exchange during the period the buy-back offer is open.
4.7 No public announcement of buyback shall be made during the pendency of any scheme of amalgamation or compromise or arrangement pursuant to the provisions of the Companies Act.
4.8 The company shall nominate a compliance officer and investors service center for compliance with the buy-back regulations and to redress the grievances of the investors;
4.9 The particulars of the [security certificates] extinguished and destroyed shall be furnished by the company to the stock exchanges where the [shares or other specified securities] of the company are listed within seven days of extinguishment and destruction of the certificates.
4.10 The company shall not buy-back the locked-in [shares or other specified securities] and non-transferable [shares or other specified securities] till the pendency of the lock-in or till the [shares or other specified securities] become transferable.
4.11 The company in addition to these regulations shall comply with the provisions of buy-back as contained in the Companies Act and other applicable laws.
i) According to chapter IV of the regulations, the Board may, suo-motu or upon information received by it, cause an investigation to be made in respect of the conduct and affairs of any person associated with the process of the buyback, by appointing an officer of the Board.
It also talks about a penalty by which a company making a default in complying with the provisions of this section or any rules regulations made there under the company or any officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years or with fine which may extend to 50000 RS or both.
Securities and Exchange Board of India (Buy-back of Securities) Regulations, 1998, the principal regulations, were published in the Gazette of India on November 14, 1998; vide S.O. No. 975 (E). It was subsequently amended in 1999, 2001, 2004, 2006, 2007, and 2008. By the 2008 amendment, it is being called the Securities and Exchange Board of India (Payment of Fees) (Amendment) Regulations, 2008. It was also amended in 2012
The major regulatory framework for buy back of shares is Section 77 of the Companies Act and the regulations by the Securities Exchange Board of India. In dealing with those aspects of such transactions like the conditions for buy back, prohibitions on it, the sources for buy back etc and also lays down the procedure and the penalties for a breach of the same, it tries to be a comprehensive regulatory framework but however the quality of implementation and rate of convictions it is seen that it has failed to do so.
Many big corporates take advantage of the fluctuating market condition and the poor quality of accounting and auditing standards to offer the shareholders an exit price much lower than the price the shares rise upto in a few weeks after the buy back and thereby the promoters benefit themselves while the shareholders suffer. In 2007, Abott India was accused to have given a very low exit price to its shareholders.
The fast growth of Indian markets and the emergence of corporate control requires immediate attention to the above mentioned issues. Recently Reliance industries, global energy firms like Exxon Mobil, Conoco Phillips and Chevron Corp etc have got into huge buy back of its shares.
Formatted on March 2nd, 2019.
[i] Fowlie v. Slater (1979) 129 New LJ 465 in 1980 JBL 48
[ii] Life Insurance corporation of India v. D.B. Kadabi  1 Comp LJ
[iii] 1 All ER 519
[iv] 2 All ER 1073
[v] Unity Company (P) Ltd v. Diamond Sugar Mills AIR 1971 Cal 18
[vi] Batu oahat Bank v. Official Assignee AC 961
[vii] SEBI v. Sterlite Industries (India) Ltd  45 SCL 475 (Bom)
[viii] TCL Industeries Ltd, In Re  50 SCL 450 (AP)
[ix] In re Indian Iron & Steel Co. Ltd AIR 1957 Cal 234