The Buy-Back Conundrum – A Critical Analysis of Section 67

Aayush Akar is a penultimate year student at National Law University Odisha and Ria Chaudhary is a pre-penultimate year student at National Law University Jodhpur.

Background to Section 67

That the rights and interests of a company’s creditors must be adequately protected has been a well-recognized axiom of the legal system, more so when these rights are evaluated against the company’s power to ‘buy-back’ the shares issued and allotted by it. In furtherance of this, Section 67 of Companies Act, 2013 (Act) imposes a strict threshold as far as a company wanting to repurchase its own shares is concerned, such that the same is only allowed if absolute abidance by the provisions of the Act has been made. In part, the logic behind this conventional unwillingness of several common law jurisdictions, to accept the implications of a company being able to buy back its shares, is attributable to the apprehension of the company's consequential potential disability to make good its debts due to a diminution of its financial capability. Today, the term ‘creditor’ itself has come to encompass a much broader range of stakeholders than merely secured creditors, adding to the complexity in interpretation and implementation of the section. In light of this, the present article attempts to make an interpretative analysis of Section 67.

Analysis of the Provision

The first sub-clause to Section 67 suggests that as a strict rule, a company shall be precluded from purchasing its shares so allotted unless the resulting diminution in the capital is carried out in accordance with the specific requirements under the Act. The latter part of the provision is implicative of the seriousness that a change in the company’s capital composition and subsequent change in the memorandum entails. The purpose of such an ostensibly sweeping restriction on a company wanting to acquire the shares it had allotted is to protect and preserve, rather than to deplete, the company's share capital. This share capital is presumed to be the likely ‘e/safety-net of financial resources’ against which, inter alia, creditors who have extended financial support to the company may seek satisfaction of their debts or claims, i.e. the ‘capital maintenance rule’, save for certain permissible transactions, such as the one provided for a buy-back under Section 68 of the Act.

In addition to the Section 68 buy-back exemption, a company also might repurchase its own shares if the resultant drop in its share capital is compatible with and subject to the requirements outlined in Section 66 of the Act regarding the criteria for share capital reduction. Jurisprudence reflects that courts have established that the legislative criteria governing the official procedure of decreasing a company's share capital can’t be allowed to directly be made applicable, without any tailoring or consideration to the distinct realms in which the two statutory processes operate, to a buy-back, and vice versa. It is to accomplish these purposes, that the section expressly forbids as well as restricts a buy-back from being effectuated.

Section 67(2) of the Act further restricts public companies from facilitating, both explicitly or implicitly, any ‘financial assistance’, be it in the form of securities, guarantees, etc., undertaken with the sole objective of or in relation to either subscription or purchase of such company’s shares to be made. What is relevant to understand for the purpose of the present article is that the parent statute i.e. the Act itself, and not a delegated or subordinate legislation, expressly exempts and excludes a private company from the prohibition on providing such financing assistance for the objective of acquiring such company's shares.

In furtherance of this, the apex court, in Ramesh Desai v Bipin Mehta has held that it is a well-recognized principle that any agreement involving the return of capital to a member is void – and that if financial assistance was extended for the subscription of shares in contravention of the requirements of Section 77 [of the Companies Act, 1956, equivalent to Section 67 of the Companies Act, 2013], this would amount to the company purchasing its own shares, thus invalidating the allotment.

The 2015 MCA Notification & its Implications – Critical Appraisal

The Ministry of Corporate Affairs (MCA), vide its notification back in 2015 (Notification), specified several instances wherein a private company was to be accorded a waiver, as an exception, from abiding by certain provisions of the Act. Inter alia, these provisions were inclusive of Section 67, subject to certain criteria being satisfied by a private company:

(1) No shareholder who has invested in such company shall be in the category of a body corporate;

(2) The company’s cumulative borrowings from banks, other lending institutions or body corporates shall not be in excess of — either two times the value of its paid up capital a sum of fifty crore, whichever is lower.

(3) The company shall not be in default for repaying such debts at the relevant time of entering into an agreement under the section.

This amendment is undesirable. It creates circumstances that will result in a murky and unpredictable consequence, more significantly in terms of the degree and scope of application of the ‘financial assistance’ restraint under Section 67(2). The notification considerably exacerbates a previously non-existing issue, by exempting private entities from this restraint if they meet the aforementioned requirements- a conditional exemption that, at the very least, is not justified as far as the plain meaning of Section 67(2) is concerned.

Prima facie, it appears abundantly clear that Section 67(2), which originates in the parent legislation and applies specifically and expressly to 'public' companies, must take precedence over a delegated legislation. In essence, the Notification cannot surpass the vires of the main statute itself based on the doctrine of statutory interpretation that accords precedence to the parent legislation. Nonetheless, the critical question is whether the impugned Notification exceeds its legal backing in giving such a conditional exemption to the prohibition in Section 67(2)'s applicability to entities that are ‘private’ in nature.

The solution to this conundrum must be sought in an in-depth understanding of Section 462(1) of the Act, which, most notably, did not appear in the old Companies Act of 1956. The eventual inclusion points make it abundantly evident that its inclusion in the new Act was explicitly intended by the legislature. The section essentially equips the government to direct, in the exercise of its ‘delegated power’ and more importantly in pursuit of public interest, that a provision of the Act may be excepted from application to a specific class/classes of companies when a notification to that effect is issued. A bird’s eye view reflects that the section is worded in a manner similar to a ‘Henry VIII Clause’, pertaining to a primary legislation.

The impugned Notification, as far as the application of Section 67 is concerned, can be categorized as an exemption, which in accordance with Section 461(1)(a), doesn’t allow a ‘qualified’ exemption, as compared to an extension to the application, that entails the right to prescribe exceptions, modifications and adaptations, which implies that if at all an exemption is made, it would be considered legally sound only if it is made applicable to all private companies without any restrictions, which was already the position of the law under Section 67(2), making the criteria enlisted by the Notification unacceptable in law.

Furthermore, the first criteria under the Notification specify that no other body corporate should have invested any funds in the private company's share capital — a criterion that looks likely to apply solely when a foreign entity, rather than another Indian one, invests in the company's equity share capital, pertaining to the difference in treatment of a ‘body corporate’ and a ‘company’ under the Act’s definitions in Section 2. The reasoning, if any, for such a restriction is consequentially not well-founded.

Conclusion

This above-discussed conundrum occurs particularly when private equity/ institutional investors seek to divest or withdraw from a private entity, and the company intends to offer financial assistance to an existing shareholder in exchange for acquiring the shares from such investors. There still exists a lack of clarity regarding the validity of this Notification, i.e. whether it can be discarded altogether using the tool of interpretation discussed above or can it be harmonized with the parent statute. With the growing complexity of business transactions, it would only be wise for the MCA to clarify the stance of law on this aspect.