What is internal reconstruction? Explain in brief the process of

What is internal reconstruction? Explain in brief the process of internal reconstruction.

Ans.

INTERNAL RECONSTRUCTION

When the prescribed scheme of financial arrangement keeps intact the entity of the existing company, i.e., neither a new company is formed nor the existing company goes into liquidation, then it is called internal reconstruction. Thus in internal reconstruction, the objective of reorganization is achieved without going into the process of liquidation. It means internal reconstruction and reorganization are synonymous in use. The following are included in internal reconstruction:

(1) Alternation in share capital,

(2) Reduction in share capital.

(1) Alternation in Share Capital-Sections 61 to 64 of Companies Act, 2013 deal with alternation of share capital. It may take the form of fresh issue of new shares, conversion of fully paid shares with stock, cancellation of unissued capital, consolidation of existing shares, sub-division of existing shares.

(a) Increase its Share Capital by making fresh issue: When a company needs additional capital and all existing shares are being fully issued, then it may increase its authorized capital creating new shares. The share capital may be increased by the issue of such new shares. The only restriction in this regard is that offer for the issue of such shares must first be made to existing equity shareholders in proportion of their holdings unless the company has decided otherwise by a special resolution or to an ordinary resolution approved by the Central Government. Each shareholder must be given at least 15 days period to decide as to purchase or not to purchase new shares offered to them. If a shareholder fails to exercise his/her option within that period, the Board of Directors will be free to issue such shares.

The Registrar of the company must be informed within 30 days of passing of resolution for increasing the authorized capital. Bookkeeping entries in respect of issue of new shares are the same as being done in the case of original issue. The expenses incurred in respect of issue of new shares are debited to an account known as “New Issue Expense Account”, which is deals with as preliminary expenses.

(b) Conversion of Shares into Stock and Vice-versa: Only fully paid-up shares may be converted into stock. Similarly stock can be reconverted into shares. Stock is not divided into equal and sequential parts and therefore the shareholders after converting shares into stock have a definite portion of share capital and not any definite number of shares. Conversion of shares into stock must be conveyed to the company registrar within a month. Provisions of Companies Act relating to shares do not apply to share capital converted with stock. Change is also recorded in the Members’ register of the company and then the amount of stock and not the number of shares is recorded against the name of the shareholder. The following entry is passed in the books when shares are converted into stock:

Equity Share Capital A/c… …Dr.

To Equity Stock A/c

Equity Stock A/c … …Dr.

To Equity Share Capital A/c On Conversion of Stock Shares

(c) Cancellation of Unissued Shares: A company has right to cancel all those shares which have not been issued on a particular date or whose issue has not been promised to any person. The prime objective of this cancellation is to get rid of unnecessary rights and duties associated with these shares. Legally speaking, such cancellation of shares does not amount to reduction in capital in the eye of law; but the capital is depreciated by this process. While passing resolution in respect of such cancellation of shares, the authorized capital be raised by the amount of such shares. No entries are passed in the books of account in respect of cancellation of shares.

(d) Consolidation of shares of smaller denomination into shares of higher denomination: A company has right to divide its share capital by consolidating shares of smaller denomination into shares of higher denomination. This does not result into change of paid up capital but the number of shares is reduced. If the shares are not fully paid i.e., all calls have not been made then it must be taken into account that after consolidation, the ratio between paid-up value and nominal value should remain the same as it was before consolidation. For example, if shares’ face value is Rs. 100 and only Rs. 80 per share is paid and now these shares are consolidated into Rs. 1,000 shares, then Rs. 800 shall be taken as paid-up. Entry is to be passed in the books just for closing the old share capital account and opening the new share capital account. Thus on the basis of above example:

Rs. 100 Share Capital A/c… …Dr. (old denomination)

To Rs. 1000 Share Capital A/c (new denomination)

(e) Sub-division of existing shares into shares of Smaller denomination: A company can also sub-divide its shares into shares of smaller denomination. Although paid-up share capital will not change but the number of shares will increase. This step is taken to motivate and attract small investors. The entry will be the same as mentioned in (d) above.

Note: In both (d) and (e) cases, necessary modifications are also made in the Member’s Register.

2. Reduction of Share Capital

Section 66 contains the provisions in regard to reduction of share capital as follows:

1. Procedure of Reduction of Share Capital: (A) to (E) steps below are included:

(A) Power of Company to reduce its share capital in different manners: Subject to the confirmation by the National Company Law Tribunal on an application by the company, a company limited by shares or limited by guarantee and having share capital may reduce the share capital, by passing a special resolution, in any manner and in particular in the following manners:

(a) It may extinguish or reduce the liability on any of its shares in respect the share capital not paid-up; or

(b) Either with or without extinguishing or reducing liability on any of it shares: (i) it may cancel any paid-up share capital which is lost or is unrepresented by available assets; or (ii)it may pay off any paid-up share capital which is in excess of the wants of the company.

Thereafter, it may alter its Memorandum of Association and reduce the amour of its share capital and of its shares accordingly.

However, no such reduction shall be made if the company is in arrears in the repayment of any deposits accepted by it, either before or after the commencement of the Companies Act, 2013, or the interest payable thereon.

(B) Tribunal’s notice to invite representations (objections): When a company makes an application to the Tribunal for reduction of its share capital, then the Tribunal shall give notice of every application to the Central Government, Registrar and to the Securities and Exchange Board (SEBI) in the case of listed companies and to the creditors of the company. Then, the Tribunal shall take into consideration the representation, if any, made to it by that Government, Registrar, the Securities and Exchange Board, and the creditors within a period of three months from the date of receipt of the notice. However, where no representation has been received from them within the said period, the Tribunal shall presume that they have no objection to the reduction of share capital by the company.

(C) Confirmation order by Tribunal: If the Tribunal is satisfied that the debt or claim of every creditor of the company has been discharged or determined or has been secured or his consent is obtained, then it may make an order confirming the reduction of share capital on such terms and conditions as it deems fit. However, n application for reduction of share capital shall be sanctioned by the Tribunal unless the accounting treatment proposed by the company for such reduction is it conformity with the accounting standards specified in Section 133 (recommended by the Institute of Chartered Accountants of India in consultation with and afte examination of the recommendations made by the National Financial Reporting Authority), or any other provision of the Companies Act, 2013 and a certificate to that effect by the Company’s auditor has been filed with the Tribunal.

(D) Publishing of confirmation order of the Tribunal : The order of confirmation of the reduction of share capital by the Tribunal shall be published by the company in such manner as the Tribunal may direct. If a company fails 10 comply with this direction, it shall be punishable with fine which shall not be less than Rs. 5 lakh but which may extend to Rs. 25 lakh.

(E) Delivering a certified copy of Tribunal’s Confirmation Order to the Registrar: The company shall deliver a certified copy of the order of the Tribuna confirming the reduction of share capital and a minute approved by the Tribuna showing: (a) the amount of share capital, (b)the number of shares into which it is divided, (c) the amount of each share, and (d) the amount, if any, at the date of registration deemed to be paid-up on each share, to the Registrar within 30 days of the receipt of the copy of the order. Then, the Registrar shall register the same and issue a certificate to that effect.

It may be noted that nothing mentioned above shall apply to buy-back of its own securities by a company.

(2) No member liable to any call or contribution: A member of the company, past or present, shall not be liable to any call or contribution in respect of any share held by him exceeding the amount of difference between the amount paid on the share, or reduced amount which is to be deemed to have been paid thereon (as the case may be), and the amount of the share as fixed by the order of reduction.

(3) Liability of members to pay debt or claim of a creditor entitled to object but whose name was not entered on the list of creditors: Where the name of any creditor entitled to object to reduction of share capital is not entered on the list of creditors by reason of his ignorance of the proceedings for reduction or of their nature and effect with respect to his debtor claim, and after such reduction, the company is unable to pay the amount of his debt or claim (when it is under the process of ‘winding up’ by the Tribunal), then :

(a) every person who is a member of the company on the date of the registration of the order for reduction by the Registrar, shall be liable to contribute to the payment of that debt or claim, an amount not exceeding the amount which he would have been liable to contribute if the company has commenced winding up on the day immediately before the said date; and

(b) if the company is wound up and any such creditor makes an application to the Tribunal’ along with proof of his ignorance as aforesaid, then the Tribunal if it thinks fit, may settle a list of persons so liable to contribute and make and enforce calls and orders on the contributories settled on the list, as if they were ordinary contributories in a winding up.

Nothing in (3) above shall affect the rights of the contributories among themselves.

(4) Liability of the guilty officer of the company: If any officer of the company commits any of the following offences, he shall be liable under Section 447 for being guilty of fraud and shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud but which may extend to three times the amount involved in the fraud, however, where the fraud in question involves public interest, the term of imprisonment shall not be less than three years:

(a) if the officer knowingly conceals the name of any creditor entitled to object to the reduction;

(b) if the officer knowingly misrepresents the nature or amount of the debt or claim of any creditor, or

(c) if the officer abets (assists or encourages) or is privy (participates in the shared secret knowledge) to any such concealment or misrepresentation as aforesaid.