Prior to the amendment of the Companies Act, 1956, buyback of securities in India was prohibited. Section 77 of the Act, imposed a blanket ban on companies from buying their own securities. The concept of buy-back of securities was introduced in the Companies Act, 1956 by the Companies (Amendment) Act, 1999 by the insertion of Sections 77A, 77AA and 77B.
Apart from the above provisions, a company has to comply with the conditions mentioned in Section 77 of the Companies Act, 1956 and Private Limited Company & Unlisted Public Limited Company (Buyback of Securities) Rules, 1999 simultaneously. As a result of the amendment, companies need not resort to lengthy process of reduction of share capital under Sections 100 to 104 of the act which required High Court approval.
What is Buy-back?
Buyback of Securities (Buyback) is the reverse of issue of shares by a company wherein the company offers to take back its securities owned by the investors at a specified price; this offer can be binding or optional to the investors.
Objectives of Buyback of Securities
Eligibility & Conditions
However, no buy-back of any kind of shares or other specified securities can be made out of the proceeds of an earlier issue of the same kind of shares or the same kind of other specified securities.
Here “Securities” means equity shares, preference shares and any other securities as may be notified by the Central Government from time to time.
Further provided that the buyback of equity shares in any financial year shall not exceed 25% of its total paid up equity capital in that financial year.
Paid up capital includes both preference and equity.
Restrictions on Buy-back of Securities in the following Circumstances:
A Company should not buyback its securities or other specified securities in case there is a default:
However, compounding of the above mentioned defaults or subsequent curing of the default may qualify as an enabling provision for buyback.
(b) through any investment company or group of investment companies.
Section 77B(1)(a) and (b).
Companies going for Buyback may avail the following benefits
1. Buy back enables companies to get rid of their surplus unwanted share capital without recourse to reduction of share capital through High Court route under sections 100 to 104 of the Companies Act.
2. Buy back entails repurchase of its own shares by a company which are subsequently extinguished, thus resulting in decrease in the number of outstanding shares. Consequently, Earning Per Share (EPS) improves which in turn leads to higher market value in the stock market since EPS closely influences market price of shares quoted on stock exchange. Let us consider the following scenario:
|Pre –buyback||Post buyback|
|Profits available to equity shareholders||Rs. 1,00,000/-||Rs. 1,00,000/-|
|No of shares||25000||20000|
|EPS||Rs. 4/-||Rs. 5/-|
Thus, it is evident that buy back results in improvement in EPS.
Amendments in Private Limited Company & Unlisted Public Limited Company (Buyback of Securities), Rules 1999
Amendment I in the year 2000 – Clause (ix) of Schedule II was amended by Substituting the word “by the Central Government” in place of ‘by the board’. So the amended clause is:
“Audited Financial information for the last 3 years and the company and its Directors shall ensure that the particulars (audited statement and unaudited statement) contained therein shall not be more than 6 months old from the date of the offer document together with financial ratios as may be specified by the Central Government”
Amendment II in the year 2003 – Clause (xix) of Schedule II i.e., The letter of offer shall contain Pre & post buyback debt equity ratios was amended as:
“The debt equity ratio for housing finance companies as may be specified by the National Housing Bank being the regulator in consultation with the Central Government.”
Procedure for Buy-back of securities by a Private Limited Company or an Unlisted Public Limited Company:
The Buyback of securities of an unlisted public limited Company & Private Limited Company are governed by Private Limited Company & Unlisted Public Limited Company (Buyback of Securities), Rules, 1999 (here in after “the Rules”) and the amended Companies Act 1956.
Securities not available for Buyback by unlisted and private companies:
1. Disputed securities kept in abeyance:
Securities which are under dispute and have been kept in abeyance Under Section 206A or in respect of which transfer or transmission has not been effected, are not available for buyback.
Before undertaking any buyback, the company should ensure that no transfer deed is pending for registration.
2. Income Tax Aspect:
Section 46A has been inserted in the Income Tax, 1961 with effect from the assessment year 2000-01. The said Section provides that any consideration received by a security holder from any company on buy back shall be chargeable to tax on the difference between the cost of acquisition and the value of consideration received by the security holder as capital gains.
The computation of capital gains shall be in accordance with the provisions of Section 48 of the Income Tax Act, 1961.
FEMA Compliance for buyback of shares:
Buy-back of securities falls under General Permission under automatic route and is considered as transfer of shares from non-resident to resident and requires filing of Form FC-TRS as per FEMA.
Case Law : MCX Stock Exchange Limited vs. Securities & Exchange Board of India & Ors., Decided on March 14, 2012
A recent decision of the Bombay High Court introduces greater clarity regarding the enforceability of options in securities of Indian public unlisted companies, an issue that has vexed corporate practitioners for over two decades now.
The court was concerned with two issues pertaining to buyback and option arrangements that were entered into between certain shareholders of MCX-SX. The first pertained to the lack of disclosure of these arrangements to SEBI. The second pertained to the legal validity and enforceability of buyback and option arrangements under law, more specifically the Securities Contracts (Regulation) Act, 1956 (SCRA).
The matter related to the SEBI denying a stock exchange licence to MCX Stock Exchange (MCX-SX) to offer trading in segments like equities and equity derivatives, citing failure to comply with shareholding norms and illegal buyback agreements by promoters, among several other issues. SEBI stated that the promoters and their associates had arrangements with three shareholders of MCXSX – Punjab National Bank, IL&FS and IFCI — where the sale of shares between the parties were based on buyback offers at or within a specified time in the future. SEBI alleged that MCX-SX had been dishonest by withholding material information on the buyback arrangements of its promoters with other shareholders. And that the buyback arrangements were illegal under the Securities Contracts Regulation Act.
The Court set aside SEBI’s order of 23 September 2010 and directed SEBI to reconsider MCX’s application afresh in the light of the Court’s observations. The Court ruled on the following:
(a) whether options in securities constitute a forward contract that is illegal;
(b) whether the SCRA applies to unlisted public companies; and
(A) Whether options in securities constitute a forward contract that is illegal.
With regard to the first issue, the High Court came to the conclusion that what is prescribed under the SCRA are firm buyback contracts (or forward contracts), and not options. The distinction between the two types of arrangements was carefully considered by the court as follows:
“In a buy back agreement of the nature involved in the present case, the promissory who makes an offer to buy back shares cannot compel the exercise of the option by the promisee to sell the shares at a future point in time. If the promisee declines to exercise the option, the promissor cannot compel performance. A concluded contract for the sale and purchase of shares comes into existence only when the promisee upon whom an option is conferred, exercises the option to sell the shares. Hence, an option to purchase or repurchase is regarded as being in the nature of a privilege.
(B) Whether the SCRA applies to unlisted public companies
In respect of the second issue, the Court considered the available case law on
whether the SCRA encompasses public unlisted companies as well as listed ones. On this question, the Court relied upon Supreme Court‟s rulings in Naresh K. Aggarwala v. Canbank Financial Services Ltd. (2010) 6 SCC 178 and Bank of India Finance Ltd. v. The Custodian AIR 1997 SC 1952 to suggest that the SCRA applies even to public unlisted companies. Hence, the scope and applicability of that continues to be quite wide in nature.
However, from all that is discussed above, it can be safely concluded that buy-back is a win-win situation for both companies as well as shareholders. In the present era of Corporate Governance, Companies should resort to buyback only if it is really necessary while upholding the spirit and objective of buyback.
Disclaimer: The entire contents of this document have been developed on the basis of relevant provisions and are purely the views of the authors. Though the author has made utmost efforts to provide authentic information however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.