Till 31-10-1998, an Indian company could not purchase its own shares and a company could not provide financial assistance to any person for the purchase of its shares. The main reasons behind such restrictions are (i) such a purchase lead to the reduction of its share capital, which may against the interest of its creditors and (ii) through this the company can indulge in trafficking in its own shares for controlling its prices.
Through the Companies (amendment) Act, 1999 (which deemed to have come into force with effect from 31-10-1998) new Sections (Section 77A, 77AA, and 77B) have been inserted in the Act which granted power to Companies to buyback their shares. This amendment enabled a company to purchase its own shares or other specified securities. Here specified securities include employee stock option; or other securities as may be notified by the Central Government from time to time. Even though it is a simple process, it is encircled by a strong structure.
The Act specifically prescribes the source of fund for such buyback. The Companies are not allowed to use any money to buyback its own shares except: - money out of its free reserves or security premium account or the proceeds of any shares or other specified securities. The buyback shall not be made from the proceeds of an earlier issue of same kind of shares or other specified securities.
Section 77 prohibits a company from purchasing its own shares. A company cannot purchase or cancel its own shares unless it complies with provisions of Sections 100 to 104 of the Companies Act, 1956. Also it is an exception to Section 100. Thus the buyback of shares does not amount to reduction of share capital.
Other Conditions to be satisfied:
| 1. | Buyback should be authorized by the Articles of Association of the company. | |
| 2. | Buyback should be supported by a special resolution in a general meeting. | |
| 3. | The notice to general meeting should accompanied by an explanatory statement with full disclosures such as i\necessity for buyback, amount involved, class of security to be purchased etc. | |
| 4. | Only fully paid up shares eligible for buyback | |
| 5. | As far as a listed company is concerned, it should be in accordance with the guide lines issued by SEBI. | |
| 6. | Before the buyback, the company should file with Registrar of Companies a Declaration of solvency. | |
| 7. | Buyback should be completed within twelve months from the date of passing special resolution. | |
| 8. | The buyback is restricted to twenty five percent of the net worth of the company (in any financial year the buyback shall not exceed twenty five percent of its total paid up equity capital). | |
| 9 | The company should maintain the ratio of the debt owed by the company is not more than twice the net worth after such buyback. Here debt includes both secured and unsecured debts. | |
| 10. | The buyback may be from | |
| | i. | From existing share holders on proportionate basis; or |
| | ii. | From open market; or |
| | iii. | From odd lots; or |
| | iv. | Shares issued under stock option or sweat equity. |
| 11. | After the completion of buyback, within seven days, the company should extinguish and destroy the securities so bought back. | |
| 12. | After completion of buyback, the company is not allowed to make further issue of the same kind of shares or other classified securities for a year except by way of bonus shares. | |
| 13. | The company should maintain a register which contain all details regarding the buyback. | |
| 14. | Within 30 days of completion, the company should file a return with Registrar of Companies. Listed Companies are required to file return with SEBI also. | |
| 15. | Default to this Section will attract imprisonment (maximum for two years) or fine (maximum Rs. 50000.00) or with both. | |
A working note:
Extract from a Balance sheet is given:
| Paid up capital | : | 600 Lakh |
| Share Premium Account | : | 100Lakh |
| Reserves and surplus | : | 400 Lakh |
| Secured loans | : | 400 Lakh |
| Unsecured Loans | : | 300 Lakh |
To what extent the company can buyback its shares?
Solution:
| Paid up capital | : | 600 Lakh |
| Share Premium Account | : | 100Lakh |
| Reserves and surplus | : | 400 Lakh |
| Total | : | 1100 Lakh |
| 25% of the paid up capital & reserves | : | 275 Lakh |
Here in this case, the company can buyback its shares to the extent of Rs. 275 Lakh.
| Buyback enables Companies to improve their future earnings per share and it is an effective toot to guard against takeover theats. |
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