Buy Back of Securities under the Companies Act, 2013

25th April, 2023 - 7:27 am Categories: Company Act 0 Comments

Introduction

Ever since the inception of the Corporate form of business, the world has seen a rapid proliferation of companies. The various advantages that result from choosing the company form of business over sole proprietorship, partnership or LLP are a significant reason why we see so many companies around us in the present day. The significance and popularity of the company form of business have increased to such an extent that recently, it was reported that Apple Inc. had attained a net worth equal to the Gross Domestic Product of 7 countries! Such a huge scale of achievement has not only been unprecedented but will always remain out of reach of other forms of business due to numerous structural limitations that these forms of business suffer from. By transcending the limitations of a traditional brick-and-mortar shop and entering into a field of cross-border presence, the corporate form of business is definitely here to stay.

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Just like cells are the basic units of life, shares are the basic units of a company. How the company manages these basic units is one of the most fundamental factors deciding what the public thinks of it and where is the future of the company headed. If a company performs well, a high share price reflects its efficiency. If a company is struggling, the descending trajectory of the share price graph tells the world that the company is not worth its money. At the end of the day, it boils down to whether the decision of a company increases its share price or not. The success or failure of any given decision taken by the management is measured by its impact on the share price of the company.

Considering the significance attached to share price, companies strategize to achieve a high valuation which would have a positive impact on its share price and thus, would create a favourable perception of the company in the market. While some do it by earning, some companies take alternative routes to achieving the same destination. It is here that the scope for malpractices and foul play increases. The Companies Act, 2013 intends to keep a keen eye on the actions of the company and regulate their actions so as to avoid any sort of injustice or fraud with the stakeholders.

One of the ways a company can manifest confidence in its working is by returning excess money to the shareholders. By doing so, it sends a message that the result for which money was raised could be accomplished by the company by using lesser resources. For decades, this strategy has proven to rekindle a spark of confidence in the hearts of the shareholders and reinforce their faith in the company’s management. The action through which the company returns money to the shareholders is referred to as  “Buy Back of Securities”.

The concept of securities involves the company raising money from the public. The issue and allotment of securities to the holder evidences the company’s action of raising money for a specific purpose. The concept of buy back involves the company reversing this action by returning the money which it had raised in exchange of the security which it had alloted. The company basically says, “We don’t need your money anymore. We have accomplished the same result with less resources and more efficiency”. From the point of view of a stakeholder, this action of the company evokes a huge amount of trust.

However, not all buy backs happen because the companies are efficient. Some companies, despite their inefficiency and mounting losses aim to show to the world that they are standing on their feet while in reality, their knees have buckled under the pressure of competition. In such situations, companies may misrepresent the actual state of their affairs. This situation is addressed by the Companies Act, 2013 that lays down exhaustive provisions for companies intending to buy their securities back from the market. Except for due compliance with clearly set-out conditions, no company has the authority to buy its own securities back as mentioned in Section 67 of the Companies Act, 2013.

The Law Relating to Buy Back of Securities under the Companies Act, 2013

The rationale behind introducing a law for buyback of securities was beautifully expounded by the House of Lords in the case of Trevor vs Whitworth^[1]. In this case, Lord Watson stated that it is important to restrict companies form exercising unfettered power when it comes to buy back of securities. If these restrictions are not put in place, the companies may “traffick” their own securities in an attempt to wrongfully influence the price of shares in the market. This situation is unfavourable not only for the shareholders, but also for the long term sustainability of the company that runs on public money in most cases.

Section 67 of the Companies Act, 2013 states that no company limited by share capital or no company limited by guarantee having share capital can exercise the power to buy back its own shares unless a consequent reduction of share capital is effected. This section resembles Section 77 of the Companies Act, 1956 which stated the exact same thing with minor modifications. The need to prevent a company from exercising unfettered power regarding the purchase of its own securities from the public, therefore exists not since 2013, but since 1956. Till the year 1999, the law strictly prohibited the company from purchasing any of its securities no matter what. It was only in the year 1999 the the Companies (Amendment) Act was passed and the government allowed companies to buy back their own securities subject to certain specified conditions. Sections 77A, 77AA and 77B were inserted in the Companies Act, 1956. Today, we know these provisions under Sections 68, 69 and 70 of the Companies Act, 2013.

Section 68 of the Companies Act states that the company may buy back its own shares, subject to fulfillment of specified conditions wither from its free reserves, or from its securities premium account or from the proceeds of issue of any other kinds of securities. Section 68 is a non-obstante clause. It overrides every other provision of the Companies Act, 2013. Furthermore, Section 69 requires the company to transfer an amount equal to the nominal value of securities bought back to the Capital Redemption Reserve (CRR). Section 70 of the Companies Act, 2013 lays down the situations in which the company would not be allowed to buyback its own securities. The three sections lay down the following reuqirement ot be fulfilled by the companies intending to buy back their own securities:

1. The Buy Back needs to be duly permitted by the Articles of Association of the Company
2. The company should obtain the permission for buyback from the sharheolders by means of a special resolution passed in the General Meeting. The buyback represents no more than 10% of the company’s paid-up equity capital and free reserves, and it has been approved by the Board of Directors via a formal resolution;
3. Company buybacks may not exceed 25% of the sum of paid-in capital and free reserves.
4. The reference to 25% in this paragraph shall be understood with regard to its total paid-up equity capital in that financial year in relation to the buy-back of Equity shares in that financial year;
5. After the buyout, the company’s total debt, including secured and unsecured, cannot exceed twice its paid-in capital and its free reserves. The Debt-to-Equity Ratio may be loosened by the Central Government for a certain category of enterprises, but not for any individual company.
6. All of the shares or other instruments on the buyback list are current in their dividend payments. In line with the rules established by the Securities and Exchange Board in this regard, the company may repurchase its shares or other designated securities trading on an established stock exchange.
7. Each buyback must be completed within 12 months of the date of the Special Resolution or Board Resolution, as applicable.
8. No buyback offer shall be issued according to this subsection 68 (2) for a period of 1 year beginning on the date on which the prior buyback offer expired.

Critical Analysis of the Concept of Buy Back

The Companies Act, 2013 allows a company to buy back its shares for various reasons such as returning surplus cash to shareholders, improving the financial ratios, reducing the number of outstanding shares, and preventing a hostile takeover. However, it is important to note that buyback should not be used as a tool to manipulate the market price of shares. The Companies Act, 2013 has set a limit on the maximum number of shares that a company can buy back. The limit is 25% or less of the aggregate of its paid-up share capital and free reserves. This limit ensures that the company does not exhaust its resources on buyback and has sufficient funds for its operations. The Companies Act, 2013 does not allow a company to fund its buyback through borrowed funds, except for certain cases such as debt securities. The company can only use its free reserves, securities premium account or proceeds from the sale of assets to fund its buyback. The Companies Act, 2013 lays down a detailed process for buyback of shares.

Author: Archi Ghiya, A student at  Hidayatullah National Law University, Raipur, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.

Refereneces

1. Securities and Exchange Board of India. (2018). Buyback of Securities. https://www.sebi.gov.in/legal/circulars/may-2018/buyback-of-securities_38924.html
2. Ministry of Corporate Affairs. (2018). Companies Act, 2013. https://www.mca.gov.in/Ministry/pdf/CompaniesActNotification2018_15.08.2018.pdf
3. Institute of Company Secretaries of India. (2019). Buyback of Securities. https://www.icsi.edu/media/portals/0/Buyback%20of%20Securities.pdf
4. Bajaj Finserv. (2022). How to buyback shares in India? https://www.bajajfinserv.in/insights/how-to-buy-back-shares-in-india
5. Economic Times. (2021). What is a share buyback and how it works. https://economictimes.indiatimes.com/markets/stocks/news/share-buyback-what-is-it-and-how-it-works/articleshow/73487971.cms

^[1] (1887) 12 App Cas 409