A. Introduction – Historical background and context
The kernel of the legal regulation of a company’s authority to purchase its own shares – the power of “buy-back”[1] – has, in English law, traditionally always been founded upon the legal system’s well-established imperative to protect, primarily, the rights and interests of creditors of the company – in other words, those who are “owed” by the company. Nowadays, those considered as creditors covers a much wider scope of persons than just secured creditors – ranging across a broad spectrum of persons from Government (including Revenue), through employees to unsecured or trade creditors.
This broadening of the types of creditors for whose protection mainly, the law as to buy-back is embodied in our statute, also underscores the historical reluctance of the common law to recognise the concept of a company being permitted to repurchase or buy-back its own shares. This reluctance stems – in part, and from the past – from the common law’s hesitation to allow the consequential diminution of the capital of the company to potentially seriously impair, in most cases, the ability of the company to honour its debt-servicing obligations to those who have extended loans to the company based on their assessment of the long-term viability and continuing financial ability of the company to repay its debts; a critical aspect of the judicially developed, common law principle known as the “capital maintenance” rule – a subject which warrants a subsequent article and a fuller analysis of its own. Suffice it to say, that such a concept has, in this particular context, come to be embodied in the Indian statute as well.[2]
This need to prevent the company defeating its creditors by recourse to such means as repurchase of its own shares, has been most lucidly stated by Lord Justice Green in Guinness v. Land Corpn. of Ireland:
… In my opinion, it … follows that what is described in the memorandum as the capital cannot be diverted from the objects [of the company]. It is, of course, liable to be spent or lost in carrying on the business of the company, but no part of it can be returned to a member so as to take away from the fund to which the creditors have a right to look as that out of which they are to be paid.[3]
In the leading English case of Trevor v. Whitworth, the court was tasked with determining whether a claim by certain executors of a pre-deceased former shareholder, for the balance of the price of the shares of the company sold by them, back to the company prior to the initiation of insolvency proceedings, was valid – in other words, whether a company can validly and legally purchase its own shares.[4]
Lord Macnaghten summed up the position succinctly:
… If shareholders think it worth [their] while to spend money for the purpose of getting rid of a troublesome partner who is willing to sell, they may put their hands in their own pockets and buy him out, though they cannot draw on a fund in which others as well as themselves are interested. That, I think, is the law, and that is the good sense of the matter.[5]
In summary, the issue was “whether it is competent for a limited company … to invest any portion of its capital in the purchase of a share of its own capital stock, or to return any portion [of such capital] … without following the course which Parliament has prescribed”.[6] The court appears to have reached the conclusion that, despite the memorandum of association of the company authorising the buy-back, such trading represented an indirect method of reducing the capital of the company, without recourse to the proper method of doing so, as permitted and indeed, sanctioned, by the English Companies Act then in force.[7]
English law also encapsulates what one may consider the “reverse of the coin” to that of buy-back; an allied principle that travels (at least as intended) in step with the former – the rule against “financial assistance”, which prohibits (in Section 678 of the English Companies Act, 2006) a public company (or its subsidiary) from giving financial assistance to a person for the acquisition by that person of the company’s shares, whether the assistance is given in advance of, or at the same as, the acquisition taking place. Such financial assistance encompasses (amongst other types, as specified in Section 677 of the English Companies Act, 2006) that given by way of gift, by way of guarantee, security or indemnity, and by way of loan or other such assistance where the provider’s net assets (in case it is a company) are reduced to a material extent by the granting of such assistance.
Crucially, unlike the rule against buy-back which we have seen, the rule against financial assistance was not developed by the 19th century Judges as part of the capital maintenance regime; but rather it was a statutory reform introduced in the early 20th century.[8] As the leading English commentary on company law, wryly notes:
“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; it has proved capable of rendering unlawful what may seem from any perspective to be perfectly innocuous transactions; and it has proved resistant to a reformulation that would avoid these problems.”[9]
With this context and historical background in mind, we now therefore, turn to the statutory provisions in India and examine certain anomalous positions that emerge, under Indian law in particular, as regards the concept of financial assistance (crucially the extent of its coverage and application to private companies), as well as the indirect purchase of shares – the two central issues considered and analysed in this article.
B. Buy-back of its own shares
Section 67(1) of the Companies Act, 2013[10] prohibits companies limited by shares or by guarantee and having a share capital, from buying its own shares, unless the consequent reduction of share capital is effected under the provisions of the Act. As emphasised earlier, the intention behind such a seemingly blanket prohibition on a company purchasing its own shares is to preserve and protect, and not dissipate, the share capital of the company as representing the pool of funds against which (amongst others), the creditors of the company may seek satisfaction of the debts or the claims owed to, or in favour of, such creditors by such company – the “capital maintenance” rule, with the exception of certain permitted purchases of its own shares [a concept that in Section 68(1) is defined as a “buy-back”[11]], as provided for in, and in accordance with, the conditions and restrictions stipulated in Section 68.
In addition to the permitted buy-back exception mentioned above in Section 68, a company may purchase its own shares by ensuring that the resultant reduction of its share capital due to such purchase is in accordance with and subject to the conditions under Section 66[12] relating to share capital reductions. It has been made clear, judicially, that the conditions applicable to the formal process of reducing a company’s share capital in the statute cannot be imported into or made applicable to a buy-back, and vice versa; the two statutory concepts and processes operate in independent fields.[13] In furtherance of these purposes, the Companies Act, 2013 specifically prohibits under Sections 67 and 70, any other buy-back or purchase by a company of its own shares (what the headnote to Section 70[14] calls, “prohibition of buy-back in certain circumstances”) – the impact of which provisions we will further study and examine below.
C. Financial assistance
Section 67(2)[15] prohibits public companies from providing, whether directly or indirectly, any “financial assistance” such as the giving of any loans, guarantees or the provision of any security or otherwise, for the purpose of, or in connection with, a purchase or subscription made or to be made, by any person of (in the case of secondary purchase), or for (in the case of primary subscription), such company’s shares (or, of the shares in its holding company). It is pertinent to note that the statute itself, and not any delegated legislation thereunder, specifically carves out and excludes private companies from the prohibition in Section 67(2), on the granting by a company of such financial assistance to any person for the acquisition of such company’s shares.[16]
Admittedly, the Ministry of Corporate Affairs in its Notification dated 5-6-2015, specified certain exemptions or exceptions available to private companies, including the exemption of private companies from the applicability of the provisions of Section 67, subject however, to the fulfilment of the following conditions:
(a) The company shall have no shareholder which is a body corporate.
(b) Borrowings of the company from banks, financial institutions or body corporate should not exceed twice the amount of its paid-up share capital or INR 500 million, whichever is lower.
(c) There shall be no subsisting defaults in repayment of such borrowings at the time of the making of any transaction under Section 67.
This is an unfortunate situation – leading to an unhappy and uncertain outcome, importantly for purposes of this article, as regards the extent and scope of the coverage and application of the financial assistance prohibition. Without the 2015 notification, the statute in Section 67(2) is crystal clear – only public companies are prohibited from granting financial assistance to other persons to acquire its own shares. The 2015 notification muddies those waters by purportedly exempting private companies from this prohibition, provided they satisfy the above conditions – a conditional exemption which at the threshold at least, is not warranted by the express provisions of Section 67(2).
On the face of it, the conclusion is perhaps inescapable that, as the provisions of Section 67(2) of the parent legislation itself, which specifically and expressly provides that the prohibition on the granting of such financial assistance for the purpose of the purchase of its shares only applies to public companies, the section in the statute must prevail over any delegated legislation such as the 2015 notification – on the well-settled principle of statutory interpretation that subordinate legislation cannot trump or go beyond the statute itself; especially by including applicability of provisions with exemptions based on certain conditions to certain types of companies, already expressly excluded (or, at the very least, not included) in the principal legislation.
From a critical analysis point of view, however, it behooves us to ask and seek to answer the question whether the 2015 notification goes beyond its legal remit, in providing such a conditional exemption, as regards the applicability of the prohibition in Section 67(2) to private companies.
The answer to that conundrum must lie in the interpretation of Section 462(1) – a provision which did not exist in the Companies Act, 1956; and, therefore, its introduction in the 2013 statute must be treated as deliberate.[17] This statutory provision empowers the Central Government in exercise of its admittedly delegated or subordinate powers, to direct by notification in the public interest, that any of the provisions of the statute shall not apply to such class or classes of companies; or, shall apply to such class or classes of companies, with such exceptions, modifications and adaptations as may be specified in such notification itself.
At the outset, Section 462 appears to be what some would call a “Henry VIII” clause in primary legislation.[18] While a full discussion on what such “Henry VIII” clauses are, or what they purport to do, or what their ramifications are, falls beyond the scope of this article, it is pertinent to mention that the Notes on Clauses of the Companies Bill, 2011 (to Clause 462, which was ultimately adopted as Section 462, in the 2013 statute) records that “this clause gives power to [the] Central Government by notification [to direct] that any provisions of this Act … apply or not … apply to such class or classes of companies as specified in the public interest”.[19]
In light of the foregoing discussion, the crux of this issue to our mind, to reiterate, turns on a plain reading of Section 462(1), read with the 2015 notification, insofar as it relates to the treatment of Section 67(2) as regards private companies. Framed thus, two key points of analysis emerge:
Firstly, the 2015 notification, as regards the application of Section 67, is structured as an exemption [that does not by the express words of Section 461(1)(a), permit any qualifications to such exemptions] and not as an extension to application [which alone carries with it, under Section 462(1)(b), the right to prescribe exceptions, modifications and adaptations] – in other words, while exempting private companies from the provisions of Section 67, such an exemption could only properly in law, be a blanket one, which is tautological given that the principal statute in Section 67(2) anyways so expressly exempts private companies from its application.
Secondly, is it at all possible that the 2015 notification has an error in referencing? In that, the exemption sought to be made is to Section 67(1) – while the notification simply states Section 67. The logic for this stems from the fact that, since Section 67(2) anyways excludes in its very terms, all other companies other than public companies, the only other provision in Section 67 that is capable of receiving such an exemption is Section 67(1) – although the validity of even that exemption, assuming it is correct, remains to be judicially tested, in particular; as is the 2015 notification, more generally. As an aside, the 2015 notification stipulates the condition that no other body corporate has invested any monies in the share capital of the private company – a condition that appears to apply only when an overseas corporation and not another Indian company, has invested in the equity share capital.[20] The logic for such a stipulation is also unclear.
Our conclusion tends towards the view that the Central Government in exercise of its admittedly delegated or subordinate powers under Section 462(1), cannot properly in law direct either:
(i) the non-applicability to private companies of a provision of the principal statute [such as for instance, Section 67(2)], which is anyways by its very express terms mandated by Parliament itself, as not being applicable to such private companies; or
(ii) the applicability of the provisions of Section 67(2), subject to such exceptions, modifications or adaptations as the Central Government may specify, to private companies, since such entities are by the principal statute itself, already exempt therefrom;
and, as a result, the stipulated conditions of the 2015 notification above, have we strongly believe, no basis in law for the present purposes – that, private companies are entitled to render financial assistance in terms of Section 67(2), regardless of the 2015 notification and its conditions or stipulations.
D. Other purchases of its shares; indirect purchases
This article does not examine or analyze the buy-back provisions of Section 68 (and the associated rules), in and of themselves – that again is to be left to another occasion; and, indeed, forms the subject-matter of a plethora of other articles. We are concerned here with indirect purchases. Section 70(1) prohibits inter alia the purchase by a company – and this prohibition applies across all types of companies – of its own shares either directly or indirectly, through a subsidiary company (including its own subsidiary company) or through any investment company (or group of investment companies).
The provisions of Section 70(1) need careful reading and analysis – it is clear the statute is seeking to impose a condition that the purchase by the subsidiary or the investment company (for ease of reference, let us call that as the “acquiring company”) of the shares of its parent company (or any other company; for ease of reference, we will refer to that as the “target company”), must involve the acquiring company purchasing the shares of the target company, in its (i.e. the acquiring company’s) own name, and not as a nominee of, nor for or on behalf of, the target company – in other words, it is important that the shares so purchased are held as of the record and beneficially by the acquiring company, without any beneficial interest of the target company in such shares, in order to obviate the impact of the prohibition contained in Section 70(1).
There is, however, an aspect of Section 70(1) that is troubling in the way it is drafted. The reference to “own subsidiary company” is unclear – for that term is neither defined or used elsewhere in the statute, nor does its usage sit well in sub-clause (a) of the provision. Surely, it was not intended that the subsidiary company of any other parent company falls within the prohibition on the indirect purchase of shares through any subsidiary, including one’s own subsidiary. The intention may have been to refer to direct subsidiary companies, where the holding company itself holds the required shareholding, and not such subsidiaries which are next level subsidiaries arising out of a chain holding.[21]
What is clear though, is that the proscription of Section 70(1) lies in the indirect purchase of a company shares “through” any subsidiary or investment company[22] – terminology that is also used in Section 19(1) where a company (whether by itself or through its nominees) cannot hold shares in its holding company (of course, excepting situations where such shares were acquired prior to the company becoming such a subsidiary of its parent company). Section 70(1) therefore imposes no blanket ban on indirect purchase – only those that are beneficially acquired for the target company, which is prohibited.[23]
It appears that the scheme of the Act as regards the issue of the permitted purchases by a company of its shares is a threefold one – firstly, that any company’s buying of its own shares can only be achieved legally either through the routes of permitted share capital reductions (Section 66) or permitted buy-backs (Section 68); secondly, that public companies alone are prohibited from providing “financial assistance” in connection with or for the purposes of a purchase by a company of its shares by any person [Section 67(2)], as dealt with in detail above; and thirdly, that any company is prevented, by means of a nominee relationship or through any beneficial interest by or on behalf of the company itself, from indirectly purchasing its own shares through a subsidiary or an investment company.
Before parting with this issue, one must examine the prohibition on the purchase by a company of its own shares, indirectly through an investment company. Explanation (a) to Section 186 defines the term “investment company” (albeit only for the purposes of that section), as a company whose principal business is the acquisition of shares, debentures or other securities, or a company will be deemed to be principally engaged in such business, if its assets in the form of investment in shares, debentures or other securities constitute not less than 50% of its total assets, or if its income derived from such investment constitutes not less than 50% as a proportion of its gross income. The determination of an “investment company” is therefore, a factual or objective one – in any event, even if the acquiring company is treated as an investment company, the prohibition on indirect purchase by a target company of its own shares in Section 70(1) is only relevant or arises where there exists a nominee or a beneficial relationship between the acquiring company and the target company.
E. Conclusion
This article has considered two issues of interpretation that arise in the context generally of shares buy-back – indirect purchases through or using the vehicles of subsidiaries or investment companies, and the financial assistance rule’s coverage to private companies. Clearer and more specific drafting (in the case of indirect purchases) and greater tabs on delegated legislation (when it comes to the financial assistance rule) would have obviated both issues – and made life much more certain and stable for contracting parties. Perhaps what is required is to suppress the mischief and advance the benefits that both these constructs truly provide to corporate India.
†By Siddharth Raja, Partner at Saakshya Law
Note: The article and its contents do not constitute legal advice, and readers are urged to seek specific legal advice and inputs to their particular issues, facts and circumstances.
[1] See, Ss. 77-A, 77-AA and 77-B, as first introduced and inserted into the Companies Act, 1956 by the Companies (Amendment) Act, 1999. These provisions have largely been retained as Ss. 68, 69 and 70, respectively, of the Companies Act, 2013, other than some textual modifications.
[2] See, S. 68(6) of the Companies Act, 2013 [analogous to S. 77-A(6) of the Companies Act, 1956], requiring every company proposing a buy-back to file with the Registrar and the Securities and Exchange Board of India, a declaration of solvency in specified form and content, to the effect that its Board of Directors has made a full inquiry into the affairs of the company, as a result of which they have formed an opinion that the company is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of such declaration.
[3] See, (1882) 22 Ch D 349, 375; emphasis supplied. Cited and quoted with approval in the leading English case on buy-back, namely, Trevor v. Whitworth, (1887) 12 App Cas 409, by both Lords Herschell (at pp. 419-20) and Macnaghten (at p. 433).
[4] (1887) 12 App Cas 409: the company’s memorandum of association did not authorise the company to purchase its own shares, although several articles in its articles of association, did – one article empowered the Board to purchase “any share” at such price “not exceeding the then marketable value thereof”. The decision on merits proceeded only on the general question of whether the company did have a power of repurchase in the first place – the court unanimously holding that it did not, and thereby Lord Herschell (at p. 414) and Lord Watson (at p. 421), in particular, avoiding the question whether the purchase had indeed taken place in accordance with the articles of association.
[5] (1887) 12 App Cas 409, 436; emphasis supplied. See also, Lord Watson (at p. 430) and Lord Herschell (at p. 417).
[6] (1887) 12 App Cas 409, 432.
[7] See, Lord Herschell (at p. 417) and Lord Watson (at p. 423). See also, Lord Macnaghten: “When Parliament sanctions the doing of a thing under certain conditions and with certain restrictions, it must be taken that the thing is prohibited unless the prescribed conditions and restrictions are observed.” – in an obvious reference to the statutory procedure for the reduction of capital.
[8] See, Paul L. Davies QC, et al.; Gower’s Principles of Modern Company Law; 10th edn., South Asian Edition, Sweet & Maxwell, 2018, at p. 333.
[9] Id., at p. 332.
[10] Analogous to S. 77(1) of the Companies Act, 1956.
[11] Earlier, S. 77-A(1) of the Companies Act, 1956.
[12] Analogous to S. 100 through S. 105 of the Companies Act, 1956.
[13] See, SEBI v. Sterlite Industries (India) Ltd., 2002 SCC OnLine Bom 1411 : (2003) 113 Comp Cas 273, A.P. Shah, J., at para 22 – albeit, while dealing with the provisions of the erstwhile Companies Act, 1956, which specifically in S. 77(1), called out the provisions of Ss. 100 to 104 or of S. 402, to which the reduction of capital was to be subject to.
[14] Earlier, S. 77-B of the Companies Act, 1956.
[15] Analogous to S. 77(2) of the Companies Act, 1956. The erstwhile provision also covered within the prohibition on financial assistance a private company which is a subsidiary of a public company – a concept that has been done away with in our new law, and a subject worthy of an independent, separate and holistic analysis by itself.
[16] See, as and by way of contrast: erstwhile S. 90(2) of the Companies Act, 1956 statutorily exempted pure private companies (i.e. which are not subsidiaries of public companies) from the application of erstwhile Ss. 85 to 89; a position that is no longer extant in the Companies Act, 2013, unless specifically exempted by subordinated rules under the statute.
[17] See, Ss. 620 and 620-A through S. 620-C, of the erstwhile Companies Act, 1956 – which inter alia only empowered the Central Government to modify the statute in its application to certain specified types of companies (such as government companies); or, to companies in certain parts of the country (like Jammu & Kashmir), but which did not grant far-reaching powers to exempt any class or classes of companies, as is contained in S. 462(1) of the Companies Act, 2013.
[18] See, generally, Priya Garg and Amrita Ghosh, The Henry VIII Clause: Need to Change the Colour of Our Shades, CALQ (2017) Vol. 3.3, accessed on 10-2-2021.
[19] See, Sudipto Sarkar and Arvind P. Datar, Chief Editors; A. Ramaiya: Guide to the Companies Act; 19th edn.
[20] See, S. 2(11), as to the definition of “body corporate” – as contrasted with S. 2(20), as to the definition of “company”.
[21] See, S. 2(87) as to the definition of “subsidiary”, read with the Companies (Restriction on Number of Layers) Rules, 2017.
[22] Note the difference in drafting – ordinarily shares are acquired “by” a company; not “through” – the latter’s usage thereby indicates beneficial interest, where the acquisition must be one on behalf of the other.
[23] Prof Gower draws the connection between the financial assistance rule and indirect purchases, thus (emphasis supplied): “If a company lends £100,000 to someone to purchase its shares from another investor and that person does not act as a nominee for the company but acquires the shares beneficially, the company’s share capital, share premium account and capital redemption reserve will not be in any way altered by that loan or the subsequent purchase of shares.” See, supra note 8, at p. 333.
