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2 BUY-BACK OF SHARES
Introduction
By virtue of section 77(1) of the Companies Act, 1956, a company limited by shares could not
buy its own shares as the same would amount to illegal reduction of capital. This section spe-
cifically laid down that “no company limited by shares and no company limited by guarantee
and having a share capital, shall have power to buy its own shares, unless the consequent
reduction of capital is effected and sanction obtained in pursuance of sections 100 to 104 and
section 402”.
In response to the persistent demand from the corporate sector for buyback, the Central Gov-
ernment promulgated the Companies (Amendment) Ordinance, 1998, permitting companies
to buy-back their own shares. The Ordinance, which amended the Companies Act to become
Companies (Amendment) Act, 1999, made provision for the insertion of three new sections,
viz., section 77A, 77AA and 77B which authorize companies to buy-back their shares subject to
fulfillment of the conditions laid down therein. Besides that, SEBI has also issued its own
guidelines seeking to regulate buy-back of securities.
What is of buy-back?
Buy-back of securities is similar to a company purchasing its own debentures for cancellation
or redemption of preference shares.
In the case of buy-back, the company, which has issued shares to the public, repurchases its
own shares.
How buy-back?
As shares may be issued at par, at a premium or at a discount, re-purchase may also be done at
par, at a premium or at a discount.
talization may be avoided. This method may also be resorted to in order to increase the share
value, by enhancing the earning per share.
Conditions of buy-back.
As per Section 77A(2) of the Companies Act,1956 the conditions for buy-back are:
The company’s articles should authorize the buy-back. If not, the same has to be amended to
include a provision to that effect;
A special resolution should be passed in the general meeting authorizing the buy-back;
a. The buy-back should be less than 25% of the total paid-up capital and free reserves of the
company;
b. The buy-back of equity shares in any financial year should not exceed 25% of its total
paid-up equity capital in that financial year;
c. The Companies (Amendment) Act, 2001 has authorized the buy-back by means of a reso-
lution at the company’s Board provided the buy-back does not exceed 10% of the total
paid-up equity capital and free reserves of the company. But, there cannot be more than
one such buy-back in a period of 365 days.
d. Debt-equity ratio shall not exceed 2:1 after such buy-back. The Central Government may
however, prescribe a higher ratio for a class or classes of companies;
e. All the shares or other specified securities are fully paid up;
f. The buy-back of the shares or other securities listed on any recognized stock exchange is
in accordance with the regulations made by the Securities and Exchange Board of India in
this behalf;
g. The buy-back of shares or other securities not listed on any recognized stock exchange is
in accordance with the guidelines as may be prescribed.
Notice of the meeting.
The notice of the meeting at which the special resolution on buy-back is proposed to be passed,
shall be accompanied by an explanatory statement mentioning:
A full and complete disclosure of all material facts regarding;
1) The necessity for the buy-back;
2) The class of security intended to be purchased under the buy-back;
3) The amount to be invested under the buy-back;
4) The time limit for completion of buy-back;
5) The price at which buy-back of shares is to be made;
6) If the promoters intend to offer their shares:
a) The quantum of shares proposed to be tendered, and
b) The details of their transactions and their holdings for the last six months prior to the
passing of the special resolution including information on the number of shares ac-
quired, the price and the date of acquisition.
7) Every buy-back should be completed within 12 months from the date of passing the spe-
cial resolution.
Where a company has passed a special resolution or the Board has passed a resolution to buy-
back its own shares or other securities, it shall before making such buyback,
a. File with the Registrar and the Securities and Exchange Board of India. a declaration
of solvency in the form as may be prescribed; and
b. verified by an affidavit to the effect that the Board has made a full inquiry into the
affairs of the company as a result of which they have formed an opinion that it is
capable of meeting its liabilities; and
c. will not be rendered insolvent within a period of one year of the date of declaration
adopted by the Board; and
d. signed by at least two directors of the company, one of whom shall be the managing
director, if any.
e. No such declaration of solvency need to be filed with the Securities and Exchange
Board of India by a company the shares of which are not listed on any recognized
stock exchange.
Another condition to be complied with by a company buying back its own shares is that the
company shall after buy-back extinguish and physically destroy the securities so bought within
seven days of the last date of completion of buy-back.
The SEBI guidelines in this regard stipulate that the securities bought back should be destroyed
in the presence of a Registrar/Merchant Banker, and the statutory auditor.
(a) the lending of money, by a banking company in the ordinary course of its business or
(b) the provision of money by a company for the purchase of fully paid up shares in the
company or its holding company for the benefit of employees of the company including
any director holding a salaried office or employment in the company;
(c) the making by a company of loans to persons other than directors or managers bonafide
in the employment of the company to enable them to purchase fully paid up shares in the
company or its holding company to be held by themselves by way of beneficial owner-
ship.
However, the loan made to any employee for this purpose shall not exceed his salary or wages
at that time for a period of six months.
Sources of Buy-Back.
Section 77 A read with Section 77B(2) permits a company to buy its own shares or other speci-
fied securities out of:
(i) its free reserves: or
(ii) the securities premium account; or
(iii) the proceeds of any shares or other specified securities.
However, no buy-back shall be made out of the proceeds of an earlier issue of the same kind of
shares or same kind of other specified securities.
The expression ‘specified securities’ includes employees’ stock option or other securities as
may be notified by the Central Govemment from time to time. ‘Free reserves’ means those
reserves which, as per the latest audited balance sheet of the company, are free for distribution
as dividend and shall include balance to the credit of securities premium account but shall not
include share application money.
SEBI Guidelines.
The Securities and Exchange Board of India, has issued the following guidelines with regard to
buy-back of shares or other specified securities by companies, having been empowered to do
so by the Companies (Amendment) Act, 1999. These guidelines came into effect from 14-11-
1998.
Modes of buy-back.
Buy-back is permissible:
(a) from the existing security holders on a proportionate basis through the tender offer; or
(b) from the open market through
1. book-building process,
2. stock exchange;
(c) from odd lots, that is to say, where the lot of securities of a public company whose shares
are listed on a recognized stock exchange is smaller than such marketable lot as may be
specified by the stock exchange: or
(d) by purchasing the securities issued to employees of the company pursuant to a scheme of
stock option or sweat equity.
Price at which shares shall be bought back has to be determined by shareholders through a
special resolution. A copy of their resolution has to be filed with the SEBI as well as the stock
exchanges where the shares of the company are listed, within 7 days from the date of passing
the resolution. Companies buying back through stock exchanges should disclose purchases
daily. Buy-back offer shall remain open for not less than 15 days and not more than 30 days.
The verification of shares bought back has to be completed within 15 days of the closure of the
offer and payments made within 7 days. The onus of complying with the SEBI guidelines is on
the merchant banker who has to file a ‘due diligence certificate’ with the SEBI.
Escrow Account.
Regulation 10(1) of the Securities and Exchange Board of India provides that a company shall,
as and by way of security for performance of its obligations on or before the opening of the
offer of re-purchase, deposit in an escrow account such sum as is specified in 10(2), that is:
(i) If the consideration payable does not exceed Rs. 100 crores, 25% of the consid eration;
(ii) If the consideration payable exceeds Rs. 100’crores, 25% up to Rs. 100 crores, and 10%
thereafter.
Escrow account means an account in which money is held until a specified duty is performed,
i.e., till the consideration for buy-back of shares is paid to the shareholders. This account con-
sists of cash deposited with a scheduled commercial bank, or bank guarantee in favour of the
merchant banker, or deposit of acceptable securities with appropriate margin, with the mer-
chant banker, or combination of these.
Advantages of Buy-back.
(ii) Free reserves which are utilized for buy-back instead of dividendenhance the value of the
company’s shares and improve earnings per share.
(iii) Surplus cash may be utilized by the company for buy-back and avoid the payment of
dividend tax.
(iv) Buy-back may be used as a weapon to frustrate any hostile take-over of the company by
undesirable persons.
Buy-back of shares is just the opposite of issue of shares. Just as shares may be issued at par, at
a premium or a discount, even buy-back may be at par, at a premium or at a discount. The basis
of accounting for buy-back is Section 77 A of the Amended Companies Act. This Section not
only permits a company to buy-back or redeem its equity shares, but also specifies the sources
from out of which re-purchase is to be effected.
According to this Section, a company may buy-back its shares or other specified securities
from out of
However, no buy-back of shares shall be made out of the proceeds of an earlier issue of the
same kind of shares. This Section also lays down that all the shares or other specified securities
for buy-back are fully paid up.
As per to Section 77 AA, When a company purchases its own shares out of free reserves. then
a sum equal to the nominal value of the shares so purchased shall be transferred to the capital
redemption reserve account and details of such transfer should be disclosed in the balance
sheet.
Buy-back of Shares
Deermination of quantum for buy-back. Sec. 77A
The maximum number of shares to be bought back is determined as the least number of
shares arrived by performing the following tests :
(1) Share outstanding test
(2) Resource test
(3) Debt-Equity Ratio test.
(Buy-back at par)
X Co. Ltd. buys back its own 2,00,000 equity shares of Rs. 10 each at par. The company has
sufficient profits otherwise available for dividend besides general reserve. No fresh issue of
shares is made for this purpose. The shares are fully paid up.
Solution.
Illustration.
The BCG Co. Ltd. resolved by a special resolution. to buy-back 2,00.000 of its equity shares of
the face value of Rs. 10 each on which Rs. 8 has been paid up. The general reserve balance of
the company stood at Rs. 50.00,000 and no fresh issue of shares was made.
2Journalize the transactions.
Solution.
Illustration.
The share capital of a Beta Co. Ltd consists of 100,000 equity shares of Rs. 10 each, and 25.000
preference shares of Rs. 100 each, fully called up. Besides, its security premium account shows
a balance of Rs. 40,000 and general reserve Rs. 7.00,000. The company decides to buy-back
30.000 equity shares of Rs. 12 each. For this purpose, it utilises the security premium in full and
general reserve to the extent necessary.
Pass the necessary journal entries.
Solution.
JOURNAL ENTRIES
Illustration.
(Where shares are bought-back at a discount).
The PTC Co. Ltd. has a share capital of Rs. 15.00,000, comprising 1.00.000 equity shares of Rs.
10 each. and 50.0008% preference shares of Rs. 10 each, both of which fully called up and paid
up. The company has sufficient general reserve to its credit to enable it to comply with the
legal formalities connected with buy-back of shares. It decides to buy-back 20% of its equity
share capital at Rs. 9 per share. Record the transactions in the books of the company.
Solution.
In the Books PTC Co. Ltd.
JOURNAL ENTRIES
Alpha Co. Ltd. has a paid up equity share capital of Rs. 20.00.000 in 2.00,000 shares of Rs. 10
each. It resolved to buy-back 50,000 equity shares at Rs. 15 per share. For this purpose. it issued
20,000 12% preference shares of Rs. 10 each, at par, payable along with application. The com-
pany has to its credit. Rs. 2.50,000 in securities premium account and Rs. 10.00,000 in the
general reserve account. The company utilized the whole of the securities premium and for the
balance, general reserve. Pass the necessary journal entries.
Solution.
JOURNAL ENTRIES
Illustration.
On 31st March, 2007 following was the balance sheet of Ispat Ltd.:
(Rs. in lakhs)
On 1st April, 2007. the company announced the buy-back of 25% of its equity shares @ Rs. 15
per share. For this purpose, it sold all of its investments for Rs. 150 lakhs and issued 2,00,000
14% preference shares of Rs. 100 each at par the entire amount being payable with application.
The issue was fully subscribed. The company achieved the target of the buy-back. Later, the
company issued one fully paid-up equity share of Rs. 10 by way of bonus share for every four
equity shares held by the equity shareholders.
Show journal entries for all the transactions including cash transactions.
EXERCISE