13 October, 2021
Introduction
One aspect which English Company Law has always grappled with is the manner in which the capital of a company should be protected for the benefit of its creditors. Way back in 1887, in its celebrated decision in Trevor v Whitworth[1], the House of Lords held that the statutory restrictions on a company’s power to reduce its capital “is to prohibit every transaction between a company and a shareholder, by means of which the money already paid to the company in respect of his shares is returned to him”.
Based on a similar rationale, the Company Law Amendment Committee (1925-26), headed by Wilfield Greene (“Greene Committee”) recommended that the statute must prohibit a company from ‘providing money for the purchase of its own shares’.[2] The Greene Committee opined that an arrangement where a company provides money to a person, for purchase of its own shares offends the spirit of the law – “which prohibits a company from trafficking in its own shares”.[3]
This recommendation was incorporated in the English Companies Act, 1929, and was subsequently re-enacted in Section 54 of the English Companies Act, 1948, which provided that subject to the exceptions contained in Section 54, it shall not be lawful for a company to give financial assistance to any person, for the purpose of, or in connection with the purchase of its shares.
Section 67 and its genesis
Section 67 of the Companies Act, 2013 (“2013 Act”), has borrowed the principles enshrined under English Company Law, and has been enacted with the same objective of ensuring that the capital of the company is not utilised to the detriment of its creditors. Section 67 largely continues with the earlier regime contained in Sections 77 and 77A of the Companies Act, 1956 (“1956 Act”).
Section 67(1) of the 2013 Act provides that no company limited by shares or by guarantee and having a share capital shall have the power to buy its own shares unless the consequent reduction of share capital is effected under the provisions of the 2013 Act.
Section 67(2) of the 2013 Act provides that no public company shall give, whether directly or indirectly and whether by means of a loan, guarantee, 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. Section 67(3) of the 2013 Act provides certain categories of transactions, which are not covered within the prohibition prescribed under Section 67(2).
While Section 67 of the 2013 Act (and Section 77 of the 1956 Act) have their genesis in English Company Law, it is interesting to note that the rule against ‘financial assistance’ has received severe criticism in the UK. In his celebrated book on Company Law, Prof. Gower notes that “the history of this rule does not constitute one of the most glorious episodes in British company law. The rationale for its introduction was under-articulated”.[4] On the other hand, the Jenkins Committee [which submitted its report on company law reforms in 1962] took a different view, and opined that Section 54 of the English Companies Act, 1948, should be “retained and strengthened”.[5]
While the general rule prohibiting ‘financial assistance’ has been retained under English law, and has been re-enacted in Section 678 of the English Companies Act, 2006, the stringent statutory requirements were liberalised over time, and conditional exemptions were granted to private companies. The conditional exemptions have now been replaced with a complete exemption for private companies, as Section 678 of the English Companies Act, 2006 is applicable to public companies only.
Analysis of Sections 67
In Ramesh Desai v. Bipin Mehta[6], the Supreme Court (“SC”) in the context of Section 77 of the 1956 Act (which corresponds with Section 67 of the 2013 Act), held that it is a well-established principle that a transaction involving a return of capital to a member is void – and if financial assistance had been provided for subscription of shares in violation of the requirements of Section 77, this would amount to a purchase by the company of its own shares, and would invalidate the allotment.
In an interesting decision, the Bombay High Court, in SEBI v. Sterlite Industries[7], held that the prohibition on a company purchasing its own shares is not absolute, and the provisions dealing with ‘buyback’ of shares and reduction of capital act as exceptions to this general rule. Given that the statute itself provides an enabling framework for facilitating a ‘return of capital’, the prohibition on providing financial assistance should be evaluated in this context – and Section 67(2) of the 2013 Act only seeks to achieve a limited objective, by ensuring that no part of the money made available by a company is being returned to the company as payment made towards share capital.
In this context, it is pertinent to note that Section 67(2) of the 2013 Act begins with the words “no public company”, which indicates that private companies have been exempted from complying with its requirements. The same wording was also present in Section 77(2) of the 1956 Act, which implies that private companies were always exempt from complying with this provision. While the express wording of Section 67(2) is crystal clear, a notification issued by the MCA has muddied the waters.
Analysis of MCA’s Notification on Section 67
Pursuant to the powers conferred by Section 462 of the 2013 Act, the MCA, vide Notification G.S.R. 464(E), issued on June 5, 2015 (“MCA Notification”), exempted private companies from complying with various provisions of the 2013 Act. The MCA Notification provides that Section 67 will not apply to private companies, which satisfy the following conditions:
(i) In whose share capital no other body corporate has invested any money;
(ii) If the borrowings of such a company from banks or financial institutions or any body corporate is less than twice its paid-up share capital or INR 50 crore, whichever is lower; and
(iii) Such a company is not in default in repayment of such borrowings subsisting at the time of making transactions under this section.
While the wording of Section 67(2) clearly specifies that the provision is not applicable to private companies, the MCA Notification provides that Section 67 will not apply to only those private companies that satisfy the three additional conditions prescribed in the notification. Hence, although the statute exempts all private companies, a delegated legislation makes Section 67 applicable to those private companies that do not satisfy either of the three conditions discussed above.
In this context, it is pertinent to note that unlike the 1956 Act, the scheme of the 2013 Act is to grant exemptions on a case-by-case basis – by invoking the powers conferred by Section 462 of the 2013 Act. Section 462(1) provides that the Central Government, may in the public interest, by notification direct that any of the provisions of this Act:
- shall not apply to such class or classes of companies; or
- shall apply to the class or classes of companies with such exceptions, modifications and adaptations as may be specified in the notification.
As Section 462(1)(b) uses the words “shall apply…with such modifications and adaptations”, perhaps one could argue that Section 462 confers the MCA with the power to make the provisions of the 2013 Act applicable to a specified class of companies, with such modifications and adaptations that are necessary in the public interest. Further, it could be argued that the conditions prescribed in the MCA Notification directly relate to safeguarding the interests of investors and creditors, and the MCA Notification only ‘modifies and adapts’ the applicability of Section 67 to those private companies, which fail to satisfy either of the three conditions that have been prescribed.
At this juncture, it is pertinent to note that the 1956 Act did not contain any provision which directly corresponds to Section 462. Unlike the broad power conferred by Section 462, the 1956 Act conferred the Central Government with a limited power to modify and adapt the applicability of the Act to specific classes of companies only, such as Government Companies (Section 620), Nidhi companies & Mutual Benefit Societies (Section 620A), Producer Companies (Section 581ZT) and body corporates incorporated under any other Act (Section 616). Hence, it could also be argued that the wording of Section 462 indicates that the Parliament consciously chose to broaden the scope of the MCA’s power to modify and adapt the applicability of the Act, in relation to any class or classes of companies.
However, one must not lose sight of the cardinal rule that a delegated legislation cannot contravene the express provisions of the parent statute.[8] Further, as held by the SC in its landmark decision in Re: The Delhi Laws Act[9] – the ‘formulation of legislative policy’ is an ‘essential legislative function’ that rests only with the legislatures, and cannot be delegated to the executive.
Given that Section 67(2) expressly provides that it is applicable to public companies only, it could be argued that a notification which makes it applicable to private companies would be ultra vires the parent statute, and would not be saved by Section 462. Further, basis the SC decision in Re: Delhi Laws Act, it could be argued that if Section 67 is applicable to public companies only, the power to make the provision applicable to private companies rests only with the Parliament, and such an ‘essential legislative function’ cannot be delegated to the MCA.
Concluding Thoughts
As there are persuasive arguments both in favour of and against the validity of the MCA Notification, one question that arises is whether we should ignore the MCA Notification, or read it down? Perhaps a view could be taken that the MCA Notification is applicable to Section 67(1) only, and private companies which do not satisfy either of the conditions prescribed in the MCA Notification can exercise the power to buy its own shares only if the consequent reduction of share capital is effected under the provisions of the 2013 Act.
However, pursuant to the power conferred by Section 462(1)(b) of the 2013 Act, the MCA may take a view that the MCA Notification, which is issued in public interest, ‘adapts’ and ‘modifies’ the applicability of Section 67(2) as well, and only those private companies which satisfy the three conditions prescribed in the MCA Notification will not be prohibited from providing financial assistance for the purchase of its shares.
As both views have their merits and demerits, there is lack of clarity in the industry on which view would prevail. This ambiguity arises especially in situations where private equity and institutional investors intend to divest their shareholding or exit from a private company, and the private company in turn wishes to provide financial assistance to one or more existing shareholders, for purchasing the shares from such investors.
As the validity of the MCA Notification has not been challenged in court, there is no judicial pronouncement of the High Courts and the Supreme Court on this issue. Given the prevailing ambiguity in the industry, the MCA would be well advised to clarify its position on this issue at the earliest.
For further information, please contact:
Bharat Vasani, Partner, Cyril Amarchand Mangaldas
bharat.vasani@cyrilshroff.com
[1] (1887) 12 App Cas 409.
[2] Report of the Company Law Amendment Committee, chaired by Mr. K.C. Wilfield Greene, at Para 30 and 31.
[3] Ibid.
[4] Professor Paul Davies; Professor Sarah Worthington, Gower – Principles of Modern Company Law, 10th Ed., at Pg. 332.
[5] Report of the Company Law Committee, chaired by Lord Jenkins, June 1962, at Para 173.
[6] AIR 2006 SC 3672.
[7] (2003) 113 Comp Cas 273.
[8] See In Re: The Delhi Laws Act, 1912, AIR 1951 SC 332; Ramesh Birch v. Union of India, AIR 1990 SC 560; St Johns Teachers Training Institute v. Regional Director, National Council for Teacher Education and Ors. AIR 2003 SC 1533.
[9] AIR 1951 SC 332. See also Rajnarain Singh v. The Chairman, Patna Administration Committee, AIR 1954 SC 569.
