Restrictions on Purchase of Own Shares, and Buy-back

Section 67(2): no financial assistance, and only for public companies. No public company shall give, whether directly or indirectly and whether by means of a loan, guarantee, the provision of security or otherwise, any financial assistance for the purpose of, or in connection with, a purchase or subscription made or to be made, by any person of or for any shares in the company or in its holding company.

Four things to notice. It binds a public company only. It covers direct and indirect assistance. It lists loan, guarantee, provision of security or otherwise, so the list is open. And it covers shares in the company or in its holding company.

Section 67(3): three exceptions. Nothing in sub-section (2) applies to:

• (a) the lending of money by a banking company in the ordinary course of its business. A bank that lends to a customer who happens to buy shares is doing its job.
• (b) the provision by a company of money in accordance with a scheme approved by special resolution and in accordance with prescribed requirements, for the purchase of or subscription for fully paid-up shares in the company or its holding company, where the shares are held by trustees for the benefit of the employees, or held by the employee of the company.
• (c) the giving of loans by a company to persons in the employment of the company, other than its directors or key managerial personnel, for an amount not exceeding their salary or wages for a period of six months, to enable them to purchase or subscribe for fully paid-up shares in the company or its holding company to be held by them by way of beneficial ownership.

The proviso adds transparency: disclosures in respect of voting rights not exercised directly by the employees in respect of shares to which the scheme relates shall be made in the Board's report in the prescribed manner.

Note the limits inside clause (c): not directors, not key managerial personnel, six months' salary, fully paid-up shares, beneficial ownership.

Section 67(4): preference shares are untouched. Nothing in the section affects the right of a company to redeem any preference shares issued under this Act or any previous company law. Redemption is governed by section 55.

Section 67(5): the penalty. On contravention, the company shall be punishable with a fine of not less than one lakh rupees and up to twenty-five lakh rupees, and every officer in default shall be punishable with imprisonment up to three years and with a fine of not less than one lakh rupees and up to twenty-five lakh rupees.

Buy-back: section 68

Section 68(1): the three sources. Notwithstanding anything in this Act, but subject to sub-section (2), a company may purchase its own shares or other specified securities out of:

• (a) its free reserves;
• (b) the securities premium account; or
• (c) the proceeds of the issue of any shares or other specified securities.

The proviso: no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or securities.

Otherwise a company could issue equity and immediately use the money to buy equity back, which is circular and achieves nothing except moving money between shareholders.

Section 68(2): seven conditions. No company shall buy back unless:

• (a) the buy-back is authorised by its articles;
• (b) a special resolution has been passed at a general meeting authorising it. Proviso: no special resolution is needed where (i) the buy-back is ten per cent or less of the total paid-up equity capital and free reserves, and (ii) it has been authorised by the Board by a resolution passed at its meeting;
• (c) the buy-back is twenty-five per cent or less of the aggregate of paid-up capital and free reserves. Proviso: for a buy-back of equity shares in any financial year, the twenty-five per cent is construed with respect to its total paid-up equity capital in that financial year;
• (d) the ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is not more than twice the paid-up capital and its free reserves. Proviso: the Central Government may notify a higher ratio for a class of companies;
• (e) all the shares or other specified securities for buy-back are fully paid-up;
• (f) a buy-back of listed securities is in accordance with SEBI's regulations; and
• (g) a buy-back of other securities is in accordance with such rules as may be prescribed.

And a proviso to the sub-section as a whole: no offer of buy-back shall be made within a period of one year reckoned from the date of the closure of the preceding offer of buy-back.

Four numbers to memorise: ten per cent for the Board route, twenty-five per cent as the ceiling, two to one as the debt to capital ratio, and one year between offers.

Section 68(3): the explanatory statement. The notice of the meeting at which the special resolution is proposed shall be accompanied by an explanatory statement stating:

• (a) a full and complete disclosure of all material facts;
• (b) the necessity for the buy-back;
• (c) the class of shares or securities intended to be purchased;
• (d) the amount to be invested under the buy-back; and
• (e) the time-limit for completion of buy-back.

Section 68(4): the deadline. Every buy-back shall be completed within one year from the date of passing the special resolution or, as the case may be, the Board resolution under the proviso to sub-section (2)(b).

Section 68(5): the three permitted routes. The buy-back may be:

• (a) from the existing shareholders or security holders on a proportionate basis;
• (b) from the open market;
• (c) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

Section 68(6): the declaration of solvency. Before making the buy-back the company shall file with the Registrar and with SEBI a declaration of solvency signed by at least two directors, one of whom shall be the managing director, if any, in the prescribed form and verified by an affidavit, to the effect that the Board has made a full inquiry into the affairs of the company and formed the opinion that it is capable of meeting its liabilities and will not be rendered insolvent within one year of the date of the declaration.

The proviso: no declaration of solvency shall be filed with SEBI by a company whose shares are not listed on any recognised stock exchange.

Section 68(7): destruction. Where a company buys back its shares or securities, it shall extinguish and physically destroy them within seven days of the last date of completion of the buy-back.

That is what stops a company holding its own shares as an asset and voting them.

The capital redemption reserve: section 69

Section 69(1). Where a company purchases its own shares out of free reserves or the securities premium account, a sum equal to the nominal value of the shares so purchased shall be transferred to the capital redemption reserve account, and details of the transfer shall be disclosed in the balance sheet.

The logic is identical to section 55(2) proviso (c) for redeemable preference shares: distributable reserves are converted into something treated as capital, so the fund available to creditors does not fall.

Note when it applies. Only where the buy-back is out of free reserves or the securities premium account. A buy-back out of the proceeds of a fresh issue needs no transfer, because new capital has replaced the old.

Section 69(2). The capital redemption reserve account may be applied by the company in paying up unissued shares to be issued to members as fully paid bonus shares. That is the same permission section 63(1)(iii) gives from the other side.

When buy-back is forbidden: section 70

Section 70(1). No company shall directly or indirectly purchase its own shares or other specified securities:

• (a) through any subsidiary company, including its own subsidiary companies;
• (b) through any investment company or group of investment companies; or
• (c) if a default is made by the company in the repayment of deposits accepted either before or after the commencement of this Act, interest payment thereon, redemption of debentures or preference shares, or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company.

The proviso to clause (c): the buy-back is not prohibited if the default is remedied and a period of three years has lapsed after such default ceased to subsist.

Clauses (a) and (b) stop the company doing indirectly what it may not do directly. Clause (c) is the fairness rule: a company that has not paid its depositors, its debenture holders, its preference shareholders, its ordinary shareholders' dividends or its bank may not spend money buying its own shares. And the bar does not lift the moment the default is cured; three years must pass.

Section 70(2). No company shall buy back where it has not complied with sections 92, 123, 127 and 129, that is, the annual return, the declaration of dividend, the punishment for failure to distribute dividends, and the financial statement.

A worked example

Panvel Polymers Limited, a listed public company, has paid-up equity capital of ten crore rupees and free reserves of thirty crore rupees. Its total debt after any buy-back would be sixty crore rupees.

The general rule first. By section 67(1) it cannot simply buy its own shares. Two lawful routes exist: a reduction under section 66, or a buy-back under section 68.

Financial assistance. A director proposes that the company guarantee a bank loan to a friendly investor who will then buy its shares. That is financial assistance by way of a guarantee, indirectly, in connection with a purchase of shares in the company, and section 67(2) forbids it. The company faces one to twenty-five lakh rupees and every officer in default up to three years' imprisonment and one to twenty-five lakh rupees.

A lawful employee loan. The company instead lends its factory supervisors, none of them a director or key managerial personnel, an amount not exceeding six months' salary each, to buy fully paid shares to be held by them beneficially. That is within section 67(3)(c).

The buy-back arithmetic.

• Source. Out of free reserves, the securities premium account, or the proceeds of a fresh issue, but not out of the proceeds of an earlier issue of the same kind: section 68(1).
• Ceiling, clause (c). Twenty-five per cent of paid-up capital plus free reserves is twenty-five per cent of forty crore, that is ten crore rupees. But for equity shares in a financial year the proviso measures the twenty-five per cent against total paid-up equity capital, that is twenty-five per cent of ten crore, two crore fifty lakh rupees.
• Debt ratio, clause (d). After buy-back, debt of sixty crore must not exceed twice paid-up capital plus free reserves. Twice forty crore is eighty crore, so sixty crore is within the limit.
• Resolution, clause (b). A special resolution, unless the buy-back is ten per cent or less of paid-up equity capital and free reserves, that is four crore rupees or less, and the Board authorises it by resolution at its meeting.
• Fully paid, clause (e). All the securities bought must be fully paid.
• Listed, clause (f). SEBI's regulations apply.
• One year gap. No offer within one year of the closure of the preceding buy-back offer.

Process. The notice of the general meeting carries the explanatory statement with the five items in section 68(3). Before buying, the company files a declaration of solvency with the Registrar and SEBI, signed by at least two directors including the managing director, verified by affidavit. The buy-back is completed within one year of the resolution, and the securities bought are extinguished and physically destroyed within seven days of the last date of completion.

The reserve. Because the buy-back is funded from free reserves, a sum equal to the nominal value of the shares bought is transferred to the capital redemption reserve account and disclosed in the balance sheet: section 69(1). That account may later be applied to issue fully paid bonus shares: section 69(2).

Now a bar. Suppose the company defaulted on a term loan to a bank eighteen months ago and cured it twelve months ago. Section 70(1)(c) prohibits the buy-back, and the proviso does not help, because three years have not lapsed since the default ceased to subsist.

Another bar. Suppose the company has not filed its annual return under section 92. Section 70(2) prohibits the buy-back outright.

Distinctions that carry marks

What this does NOT mean

It does not mean a private company may give financial assistance freely. Section 67(2) binds public companies, but section 67(1) binds any company limited by shares or by guarantee with a share capital, and the prescribed rules impose their own conditions.

It does not mean a buy-back always needs a special resolution. Ten per cent or less of paid-up equity capital and free reserves, authorised by a Board resolution, is enough.

It does not mean the twenty-five per cent is always measured the same way. For equity shares in a financial year it is measured against total paid-up equity capital, not against capital plus free reserves.

It does not mean curing a default reopens the door at once. Three years must pass after the default ceased to subsist.

Quick revision

• 67(1): no company limited by shares or by guarantee with share capital may buy its own shares unless the consequent reduction is effected under the Act.
• 67(2): no public company may give financial assistance, directly or indirectly, by loan, guarantee, provision of security or otherwise, for a purchase of or subscription for shares in it or its holding company.
• 67(3): exceptions for a banking company lending in the ordinary course; a scheme approved by special resolution for fully paid shares held by trustees for employees or by employees; and loans to employees other than directors and KMP, up to six months' salary, for fully paid shares held beneficially. Board's report to disclose voting rights not exercised directly by employees.
• 67(4): does not affect redemption of preference shares. 67(5): company one to twenty-five lakh rupees; officer in default up to three years and one to twenty-five lakh rupees.
• 68(1): buy-back out of free reserves, securities premium account or the proceeds of an issue; not out of the proceeds of an earlier issue of the same kind.
• 68(2), seven conditions: articles; special resolution, or Board where ten per cent or less of paid-up equity capital and free reserves; twenty-five per cent ceiling, measured against paid-up equity capital for equity in a financial year; debt not more than twice capital plus free reserves; fully paid; SEBI regulations if listed; prescribed rules otherwise. No offer within one year of the closure of the last one.
• 68(3): explanatory statement, five items. 68(4): complete within one year. 68(5): proportionate, open market, or from employees' stock option or sweat equity securities.
• 68(6): declaration of solvency to the Registrar and SEBI, two directors including the managing director, verified by affidavit, not insolvent within one year. Not filed with SEBI by an unlisted company.
• 68(7): extinguish and physically destroy within seven days.
• 69: transfer the nominal value to the capital redemption reserve account where funded from free reserves or securities premium, disclosed in the balance sheet; usable for fully paid bonus shares.
• 70(1): no buy-back through a subsidiary, through an investment company or group, or where there is default on deposits, interest, redemption of debentures or preference shares, dividend, or a term loan or interest to a financial institution or bank; the bar lifts three years after the default ceases. 70(2): no buy-back where sections 92, 123, 127 or 129 have not been complied with.

Test yourself

1. May a public company lend money to a person to buy its own shares? No. Section 67(2) prohibits a public company from giving, directly or indirectly, by loan, guarantee, provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase of or subscription for shares in it or in its holding company, subject only to the three exceptions in section 67(3).

2. Out of what may a buy-back be funded? Free reserves, the securities premium account, or the proceeds of the issue of any shares or other specified securities, but not out of the proceeds of an earlier issue of the same kind of shares or securities: section 68(1) and its proviso.

3. When may a buy-back be done without a special resolution? Where the buy-back is ten per cent or less of the total paid-up equity capital and free reserves and has been authorised by the Board by a resolution passed at its meeting: proviso to section 68(2)(b).

4. What is the debt condition? The ratio of the aggregate of secured and unsecured debts owed by the company after the buy-back must not be more than twice the paid-up capital and its free reserves, unless the Central Government notifies a higher ratio for a class of companies: section 68(2)(d).

5. What must the company do with the shares bought back, and when? Extinguish and physically destroy them within seven days of the last date of completion of the buy-back: section 68(7).

6. Name three circumstances in which a buy-back is prohibited. Through any subsidiary company; through any investment company or group of investment companies; and where the company is in default in repayment of deposits or interest, redemption of debentures or preference shares, payment of dividend, or repayment of a term loan or interest to a financial institution or bank, unless the default has been remedied and three years have lapsed: section 70(1).