Sunday, April 19, 2015

Internal Reconstruction and Capital Reduction

Reconstruction of a Company
A company can be reconstructed in any of the two ways. These are:
(i) ‘External’ Reconstruction and 
(ii) ‘Internal’ Reconstruction.
(i) External Reconstruction: The term ‘External Reconstruction’ means the winding up of an existing company and registering itself into a new one after a rearrangement of its financial position. Thus, there are two aspects of ‘External Reconstruction’, one, winding up of an existing company and the other, rearrangement of the company’s financial position. Such arrangement shall be approved by its shareholders and creditors and shall be sanctioned by the National Company Law Tribunal (NCLT). Such a step usually involves the writing off of a debit balance on Profit and Loss Account, elimination of all fictitious assets if any from the Balance Sheet, and the consequent readjustment of share capital.
(ii) Internal Reconstruction: Internal reconstruction means a recourse undertaken to make necessary changes in the capital structure of a company without liquidating the existing company. In internal reconstruction neither the existing company is liquidated, nor is a new company incorporated. It is a scheme in which efforts are made to bail out the company from losses and put it in profitable position. Internal reconstruction of a company is done through the reorganization of its share capital. It is a scheme of reorganization in which all interested parties in the capital structure volunteer to sacrifice. They are the company’s shareholders, debenture holders, creditors etc. Under internal reconstruction, the accumulated trading losses and fictitious assets are written off against the sacrifice made by these interest holders in the form of reduction of paid up value of their interest.

Differences between Internal Reconstruction and External Reconstruction
a.       No new company is formed in case of Internal Reconstruction. A new company is formed in case of External Reconstruction.
b.      In case of Internal Reconstruction, no company is liquidated. In case of External Reconstruction one company is liquidated
c.       Internal Reconstruction requires court’s confirmation. But External Reconstruction can be affected without court’s confirmation
d.      Internal Reconstruction is a slow and tedious process. But External Reconstruction can be carried out easily
e.      In the case of Internal Reconstruction, the company is able to set off its past losses against future profits. Whereas, in the case of External Reconstruction, the past losses of the old company can’t be set off against the future profits of the new company.

Forms of Internal reconstruction of a company (Scope of Internal reconstruction)
Internal reconstruction of a company can be carried out in the following different ways. These are as under:
(A) Alteration of Share Capital; and
(B) Reduction in Share Capital
Alteration of Share Capital: Memorandum of Association contains capital clause of a company. Under Section 61 of the Companies Act 2013, a company, limited by shares, can alter this capital clause, if is permitted by (i) the Articles of Association of the company; and (ii) if a resolution to this effect is passed by the company in the general meeting. A company can alter share capital in any of the following ways:
(a) The company may increase its capital by issuing new shares.
(b) It may consolidate the whole or any part of its share capital into shares of larger amount.
(c) It may convert shares into stock or vice versa.
(d) It may sub-divide the whole or any part of its share capital into shares of smaller amount.
(e) It may cancel those shares which have not been taken up and reduce its capital accordingly.
To alter capital by any of the above modes require a resolution at a general meeting, but does not require confirmation by the National Company Law Tribunal. The company is required to give a notice to the Registrar within thirty days of alteration.

The accounting treatment of the above five types of capital alteration is discussed below.
(a) If the company has issued all of its authorised capital, then, for the purpose of raising fund by the issue of fresh shares, it will have to increase its authorised capital first. For increasing the authorised capital, the Capital clause of Memorandum of Association of the company is required to be altered and permission of S.E.B.I. is also required to be obtained.  No accounting entry is necessary for increasing authorised share capital. The company will have to observe the formalities prescribed under the Companies Act, 2013.
(b) The company may decide to change the shares of smaller denomination into larger denomination. This process is called consolidation of shares. On account of consolidation, the total amount of capital of the company will not change but the number of shares will decrease.
(c) A company, in order to alter its share capital, may convert all or any of its fully paid up shares into Stock or Stock into fully paid up shares. In case, shares are converted into Stock, the members get a part of Stock Capital in place of shares. By converting Shares into Stock, any amount of Stock Capital can be transferred to any other person.
(d) When the shares of a company are sub-divided in shares of small value, it is known as sub-division of shares. In sub-division of shares, the face value of a share is converted into smaller denomination from larger denomination. The total capital of the company remains unaffected by sub-division but the total number of shares increase.
(e) Cancellation of capital may take the following form:
(i) Cancellation of unissued capital; and
(ii) Cancellation of uncalled capital.
(i) Cancellation of unissued capital: Cancellation of unissued capital means cancellation of unissued shares by a company. It means that the part of the authorised capital which has not yet been issued to the public may be cancelled by the company.
(ii) Cancellation of uncalled capital: Cancellation of uncalled capital means cancellation of that part of the face value of the share which has not yet been called by the company.
Reduction of Capital: Sometimes there may be a genuine necessity for the reduction of capital. This power is, given by Section 66 of the Companies Act, 2013, subject to the compliance of conditions. According to this, a company may,
(1) Extinguish or reduce the liability on any of its shares in respect of share capital not paid up
(2) cancel any paid-up share capital which is lost or is unrepresented by any available assets;
(3) pay off any paid-up share capital which is in excess of what is required by the company. Conditions for effecting a reduction
Following conditions are required to be fulfilled by a company to reduce its share capital –
(a) The Articles of Association of the company must permit it to reduce its capital;
(b) The company in general meeting shall pass a special resolution to reduce its capital; and
(c) The approval of National Company Law Tribunal (previously Court) shall be obtained for the scheme of reduction in share capital.

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