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IN 6
M Lord Polonius advises LaertesM "This above all: to thine ownself be trueM and it must
followM as the night the dayM thou canst not then be false to any man." These lines follow his
more popular counsel about being `neither a borrower nor a lender'M and other such nuggets of
wisdom. In today's contextM when reports speak of Reliance owning Rs 12M crore of its own
stockM how nice it would have been if only Polonius had cautioned companies against owning
their own shares!

While it is remote for the Bard to have envisaged that the corporate form of organisation might
be leveraged for such a purposeM I'm sure there must be many with a simple question on their
minds: Can a company purchase its own shares? To answer thisM there is Section 77 of the
Companies ActM 1956M titledM `Restrictions on purchase by companyM or loans by company for
purchaseM of its own or its holding company's shares'.

It begins thus: "No company limited by sharesM and no company limited by guarantee and having
a share capitalM shall have power to buy its own shares." The rationale for a taboo such as this is
that otherwise a company may indulge in `trafficking' in its own sharesM and influence its share
price in an unhealthy mannerM as Ramaiya explains in  
 

 .

An oft-cited decision in this connection is 

  
M an 1887 case where Lord
Watson of the House of Lords explained the reason thus: "One of the main objects contemplated
by the legislatureM in restricting the power of limited companies to reduce the amount of their
capital as set forth in the memorandumM is to protect the interests of the outside public."

He then pointed out the risk that paid-up capital might be diminished or lost in the course of the
company's tradingM even as outsiders who dealt with the company continued to think that there
was a certain amount of capital in the company.

"They are entitled to assume that no part of the capital which has been paid into the coffers of the
company has been subsequently paid outM except in the legitimate course of its businessM" Lord
Watson said. One can trace back the reasoning behind the fundamental policy of company law
² that a company must maintain its capital ² to the 1844 Limited Liability Act of the UK.

To understand the situation of holding one's own sharesM let me take up a simple example. A
company that has raised Rs 1 lakh capital has the amount in the form of cashM say; so the assets
side show cash Rs 1 lakhM and the liabilities side shows Rs 1 lakhM as share capital. If the
company were to use all its cash to buy its own sharesM it would then have `investments' on the
assets side representing entirely own shares boughtM presumably at par valueM thus squaring off
the assets and liabilities side.

A zero-sum game no different from a snake trying to swallow its own tail. HoweverM there are
occasions where a company may have a rethink on the bloated size of its capital and so would
like to alter the size or composition of its capital.
Law recognisesM thereforeM reduction of capital in Section 1 . AccordinglyM a company may
extinguish or reduce the liability on any of its shares in respect of share capital not paid up.

There can be graver situations where the reduction cancels paid-up capital "which is lostM or is
unrepresented by available assets". A third possibility that the section speaks of is where the
company pays off any paid-up share capitalM which is in excess of the wants of the company.
Returning to Section 77M you'd find that its bar on the purchase of own shares does not cover
reduction of capital under Sections 1 to 1 4M or under Section 4 2.

The last is about the Company Law Board resolving complaints of oppression and
mismanagement by ordering the purchase of shares or interests of any members of the company
by other members or by the company; while in the former caseM the holding of the members who
buy increasesM the latter leads to reduction in share capital.

Neither a lender direct nor a lender indirect

As if in vindication of Polonius-speakM there is this sub-section 2 of Section 77 that statesM "No

public companyM and no private company which is a subsidiary of a public companyM shall giveM
whether directly or indirectlyM and whether by means of a loanM guaranteeM the provision of
security or otherwiseM 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."

In shortM a company can't lend or otherwise financially assist another to buy its shares.

Company law expert Mr N.R. Sridharan points out that the `indirectly' possibility of assistance is
what many companies in India exploit and also get away with because prosecution may often
find it tough to prove the nexus.

He also draws attention to `upstream holding' that is frowned upon by Section 42. It begins thus:
"A body corporate cannot be a member of a company which is its holding company and any
allotment or transfer of shares in a company to its subsidiary shall be void."

Simply putM holding company H can have shares in its subsidiary SM but not vice versaM but for
the exceptions mentioned in the section.

To make life easierM howeverM law provides exceptions to the above rule.

ThusM a bank can lend money in the ordinary course of its business; a company can provide
money to trustees who operate for the benefit of employees; it can lend to its employees not
exceeding six months' salary or wages for purchasing shares. AgainM redemption of preference
sharesM which Section 8 speaks ofM falls outside the ambit of Section 77's rigour.

The avid may note that Section 45 too is relevant when we discuss buying own shares because
"If at any time the number of members of a companyM is reducedM in the case of public companyM
below sevenM or in the case of a private companyM below twoM and the company carries on
business for more than six months while the number is so reducedM every person who is a
member of the company during the time that it so carries on business after those six months and
is cognizant of the fact that it is carrying on business with fewer than seven members or two
membersM as the case may beM shall be severally liable for the payment of the whole debts of the
company contracted during that timeM and may be severally sued therefor."

Lord Justice Hoffman had this to say in a decade old case c    where a member of
a company purchased the shares of the only other member of the company: "I have considerable
sympathy with the appellantM who has fallen into a trap created by an ancient and obsolete rule...
In default of compliance it strips the remaining member of the protection of limited liability."

To the judge it seemed obscure that the rule has survived through successive amendments to law.

Power to purchase own securities

It was the Companies (Amendment) ActM 1999 that brought in Section 77A to allow `buy-back'
out of free reservesM securities premium account and so on.

This is an elaborate sectionM laying down detailed procedure (such as authorisation in the Articles
of AssociationM and special resolution in general meeting) and also metrics (such as the cap of 25
per cent of total paid-up capitalM and the ratio of debt to capital).

"Where a company buys back its own securitiesM it shall extinguish and physically destroy the
securities so bought back within seven days of the last date of completion of buy-backM"
stipulates sub-section 7.

SEBI Guidelines mandate that a listed company can't use the buy-back provisions to delist its
securitiesM but let me not branch off into delistingM lest you become listless.

ZeroBase@TheHindu.co.in