RECONSTRUCTION OF COMPANIES

SUBJECT: Law of Corporate Finance and

Securities Regulations
GGSIPU, UNIVERSITY SCHOOL OF LAW AND LEGAL STUDIES

2019-20
 SUBMITTED BY: RUCHI SHARMA

ROLL NO: 02716507019

LLM

ACKNOWLEDGEMENT

I express my deepest regard and gratitude towards DR. Rakesh Kumar, GGSIPU, New Delhi. His
constant supervision, consistent inspiration and invaluable guidance have been of immense help in
understanding and carrying out the nuances of this project report.

I take this opportunity to thank the University, Vice Chancellor and the Dean of Faculty of law for
providing extensive database resources in the library and through internet.
I would be grateful to receive comments and suggestion to improve this project report.
 TABLE OF CONTENTS

➢ INTRODCUTION

➢ KINDS OF RECONSTRUCTION

➢ RECONSTRUCTION AND AMALGAMATION

➢ RECONSTRUCTION IN VOLUNTARY WINDING UP

➢ INTERNAL RECONSTRUCTION AND ITS TYPES

 ➢ RECONSTRUCTION IN OTHER COUNTRIES

➢ CONCLUSION

ASTRACT

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership

and other structures, by revaluing assets and reassessing the liabilities. It refers to the transfer of

company or several companies’ business to a new company. This, therefore, means that the old company

will get put into liquidation, and shareholders will therefore agree to take shares of equivalent value in
the new company. Reconstruction is required when the company is incurring losses for many years, and

the statement of account does not reflect the true and fair position of the business, as a higher net worth

is depicted, than that of the real one. In other words, “Reconstruction” involves the winding up of an

existing company and the transfer of its assets and liabilities to a new company formed for the purpose

of taking over the business and undertaking of the existing company. Shareholders in the existing

company become shareholders in the new company. The business undertaking and shareholders of the

new company are substantially the same as those of the old company.
1.INTRODUCTION

The term ‘Reconstruction’ implies the process followed for reorganisation 1 of a company with respect to
its capital structure including the reduction of claims of both the shareholders and the creditors of the
company. Reconstruction of a company is required when it faces acute financial problems due to over
capitalization or accumulation of operating losses.

Many companies or groups undergo a reorganisation or reconstruction at some stage in their

development. This may be through choice (for example, in preparation for the sale of certain assets or to
set up an advantageous tax structure) or necessity (as part of a rescue or recovery package in
insolvency).

Reorganization normally involves a fundamental change in the structure of a company or group, i.e., by
the movement of assets from one member of the group to another, the creation of one or more new
companies to form a different tax structure, or the issue of alternative classes of shares. Another instance
would be the merger or amalgamation of two distinct businesses to form a single integrated corporate
structure. Conversely2, a client’s business strategy may entail segregating or disposing of part of a

1 https://freebcomnotes.blogspot.com/2016/04/reconstruction-and-its-types.

2 http://allfactslegal.blogspot.com/2014/12/meaning-of-reconstruction-of-company.html
business or a division from the remainder of the business, which can be achieved by the demerger of the
overall business into separate business entities.

A reconstruction often occurs in an insolvent situation- for example, in order to reach a compromise
between creditors, subject to the approval of the court - and may be designed to preserve all or part of
the business of the company or group so it can be carried on after the reconstruction by the same or a
similar management team.

2.KINDS OF RECONSTRUCTION

A company can be reconstructed in any of the two ways. These are3:

(i) ‘External’ Reconstruction and

(ii) ‘Internal’ Reconstruction.

2(i) External Reconstruction: The term ‘External Reconstruction’ means the winding up of an existing
company and registering itself into a new one after a rearrangement of its financial position. Thus, there

3 http://www.legalservicesindia.com/article/1423/Reconstruction-and-Amalgamation.html
are two aspects of ‘External Reconstruction’, one, winding upof an existing company and the other,
rearrangement of the company’s financial position. Such arrangement shall be approved by its
shareholders and creditors and Court order. Such a step usually involves the writing off of a debit
balance on Profit and Loss Account, elimination of all fictitious assets if any from the Balance Sheet,
and the consequent readjustment of share capital.

2(ii) Internal Reconstruction: Internal reconstruction means a recourse undertaken to make necessary
changes in the capital structure of a company without liquidating the existing company. In internal
reconstruction neither the existing company is liquidated, nor is a new company incorporated. It is a
scheme in which efforts are made to bail out the company from losses and put it in profitable position.
Internal reconstruction of a company is done through the reorganization of its share capital. It is a
scheme of reorganization in which all interested parties in the capital structure volunteer to sacrifice.
They are the company’s shareholders, debenture holders, creditors etc. Under internal reconstruction, the
accumulated trading losses and fictitious assets are written off against the sacrifice made by these
interest holders in the form of reduction of paid up value of their interest.

3.RECONSTRUCTION AND AMALGAMATION

The company wished to avoid being wound up and negotiated a scheme in which the existing
shareholdings in the company would be transferred to a new company which would take over the
company’s undertaking and assets as well as its debts. This was to be effected 4 by a scheme for
reconstruction which would result in the old company’s shareholders holding four per cent of the shares
in the new company. An arrangement embraces such diverse schemes as conversion of debt into equity,
subordination of secured or unsecured debt, conversion of secured claims into unsecured claims and vice
versa, increase or reduction of share capital and other forms of reconstruction and amalgamation.

According to Halsbury’s Laws of England “Neither ‘reconstruction nor amalgamation’ has a precise
legal meaning. Where an undertaking is being carried on by a company and is in substance transferred,
not to an outsider, but to another company consisting substantially of the same shareholders with a view
to its being continued by the transferee company, there is a reconstruction. It is none the less a
reconstruction because all the assets do not pass to the new company, or all the shareholders of the
transferor company are not shareholders in the transferee company, or the liabilities of the transferor
company are not taken over by the transferee company. ‘Amalgamation’ is a blending of two or more
existing undertakings into one undertaking, the shareholders of each blending company becoming
substantially the shareholders in the company which is to carry on the blended undertakings. There may
be amalgamation either by the transfer of two or more undertakings to a new company or by the transfer
of one or more undertakings to existing companies.”

It requires companies to make application to the court under section 228, which empowers the court to
sanction the compromise or arrangement proposed by the companies. Section 229 further empowers the

4 http://www.lawvedic.com/article/what-is-the-basic-concept-of-amalgamation-and-reconstruction-of-a-company-179
High Court to enforce a compromise or arrangement ordered by the court under section 228 of the
Companies Act, 1994. Section 230 provides supporting provisions for compliance with the provisions or
directions given by the court. Sections 231 and 232 are supplementary provisions.

Section 229 provides that where a petition has been made under Section 228 and it is shown that the
compromise or arrangement is made in connection with a scheme for the reconstruction of any company
of amalgamation of any or two more companies and that under the scheme of the whole or any part of
the undertaking or property of the company is to transferred to any other company the Court may, either
by the order sanctioning the compromise or arrangement or by any subsequent order, make provision for
any of the following5:

a. the transfer to the transferee

company of the whole or any part of the undertaking and of the properties of liabilities of any
transferor company;
b. the allotting or appropriation
by the transferee company of any shares, debentures, policies or other like interests in that

5 http://letspedia.com/explaining-concept-merger-amalgamation-reconstruction/
 company, which under the compromise or arrangement are to be allotted by that company to or
for any person;
c. the continuation by or against
the transferee company of any legal proceeding pending by or against any transferor company;
d. the dissolution of any
transferor company but without winding it up;
e. the provision to be made for
any person, who, within such time and in such manner as the Court directs, dissent from the
compromise or arrangement; and
f. such incidental, consequential
or supplemental matters as are necessary to secure the reconstruction or amalgamation.

4.RECONSTRUCTION AND AMALGAMATION BY VOLUNTARY WINDING UP

A compromise involves a settlement of a dispute. An arrangement, in contrast, is broader and has been
held to be of wide import. It can cover any lawful arrangement that touches or concerns the rights and
obligations of the company and its shareholders or creditors, The Companies Act, 1994 6 givers power a
company to reconstruct or amalgamate by means of voluntary liquidation wherein the liquidator
transfers the assets of the company in exchange for shares or other shares of the transferee company.

a. Effect on Shareholders

The effect on shareholders is that the resolution is valid and the arrangement is binding upon
them. Nevertheless, any shareholder may, in specific circumstances, dissent from the sale or
arrangement.
The dissenting shareholder is required to give notice of his dissent to the liquidator in writing
within seven days after passing of the special resolution. A legal representative of deceased
shareholder is also entitled to dissent. However, it is open for the liquidator to waive such notice.
The share holder who neither agrees to the scheme nor challenges it but refuses to accept shares
in transferee company (especially if they are not fully paid) to avoid further liability , on these

6 https://shodhganga.inflibnet.ac.in/bitstream/10603/166944/10/10_chapter%206.pdf
 shares , shall be deemed to have permitted the liquidator to sell the new shares and pay him the
net proceeds. The liquidator shall recover the expenses incurred on such sale from the proceeds
of that sale. If there is more than one such shareholder, net proceeds shall be distributed
proportionately.

B. Effect on Creditors

The scheme does not expressly state that any arrangement binding on the creditors yet it can be
deducted from that the arrangement is binding on creditors as well unless they move the Court
within one year after passing of resolution of winding up and challenge the arrangement.

Nevertheless, an arrangement sanctioned by the special resolution does not relieve the liquidator
of the old company is dissolved. To leave everything to the new company is a “gross dereliction”
of duty by the liquidator.
Consent of the Shareholders

The Companies Act, 1994, prescribes varying requirements for decisions to attain binding force on the
company and with sound and profound reasons 7. As is evident some decisions are efficacious on
receiving the assent of a simple majority whilst others require that there must be not less than three times
the number of votes cast in favour of a Resolution than those opposed to it. Section 229 of the Act,
which deals with compromises and arrangements, contemplates the consent of three-fourths in value of
the affected persons for the decision to be binding on the remainder. Section 233 of the Act, protects the
rights of persons constituting a minority, holding not less than ten per cent of the members. The Act is
logically at the end of this spectrum, and envisages and permits, within a defined arena, the drastic
dilution of the rights of a class consisting of members constituting less than ten per cent. Although this
dilution has been seen and termed even as an ‘expropriation’, jural interference was nonetheless found to
be unnecessary only on this ground. The question that arises is whether there is any rationale in the
prescribed percentages, dependent upon the gravity of theme assures to be effected. In my opinion, it is
not legally odious to expect a minuscule group to fall in line with the dictates of an overwhelming
majority comprising ninety per cent of the group. Usually, there is wisdom in the strength of members.
There is every possibility that where nine persons are willing to accept a particular offer, the remaining
single person may be standing a part from the others for motives which are not mercantile or
commercial.

7 https://www.lawinsider.com/dictionary/shareholder-consent
The two companies may join to form a new Company but there may be absorption or blending of one by
the other, both amounts to amalgamation. When the two companies are merged and are so joined as to
form a third Company or one is dissolved into one or blended with another; the amalgamated Company
loses its identity.

Situations which Call for Internal Reconstruction of a Company

The following situations are generally responsible for the internal reconstruction of a company8:

a. When the capital structure of a company is complex and it is required to make it simple.

8 https://www.quora.com/What-causes-an-internal-reconstruction-of-a-company
b. When there are huge accumulated losses and it is required to write off these losses to depict a
better position of the company.
c. When a part of the capital is not represented by available tangible assets.
d. When change is required in the face value of shares of the company so that they can become
attractive for future investors.
5.FORMS OF INTERNAL RECONSTRUCTION

Internal reconstruction of a company can be carried out in the following different ways. These are as
under:

a. Alteration of Share Capital; and

b. Reduction in Share Capital

Reduction in capital may be either involving sacrifice of shareholders only or involving sacrifice from
Shareholders and other stakeholders, viz., debenture holders and creditors. The sacrifice is made either
by the shareholders only or by the shareholders and other stakeholders jointly. It never happens that
sacrifice is made by the creditors and debenture holders only.

Alteration of Share Capital

Memorandum of Association contains capital clause of a company. Under Section 53 of the Companies
Act, 1994,9 a company, limited by shares, can alter this capital clause, if is permitted by:

(i) the Articles of Association of the company; and

(ii) if a resolution to this effect is passed by the company in the general meeting.

A company can alter share capital in any of the following ways:

a. The company may increase its capital by issuing new shares.

b. It may consolidate the whole or any part of its share capital into shares of larger amount.
c. It may convert shares into stock or vice versa.

9 https://www.cmatutors.com/2013/03/internal-reconstruction.html
 d. It may sub-divide the whole or any part of it’s share capital into shares of smaller amount.
e. It may cancel those shares which have not been taken up and reduce its capital accordingly.

To alter capital by any of the above modes require a resolution at a general meeting, but does not require
confirmation by the Court. The company is required to give a notice to the Registrar within thirty days
of alteration.

The accounting treatment of the above five types of capital alteration is discussed below. Accounting
Entries on Capital Alteration:

a. If the company has issued all of its authorized 10capital, then, for the purpose of raising fund by
the issue of fresh shares, it will have to increase its authorized capital first. For increasing the
authorized capital, the Capital clause of Memorandum of Association of the company is required
to be altered and permission of RJSC&F is also required to be obtained. No accounting entry is

10 http://baf.co.in/methods-of-internal-reconstruction-reduction-of-share-capital-compromisearrangements-surrender-of-
shares/
 necessary for increasing authorized share capital. The company will have to observe the
formalities prescribed under the Companies Act, 1994. After the increase in authorized capital, if
the company issues fresh shares to the public, necessary entries for the issue of shares shall have
to be passed.

b. The company may decide to change the shares of smaller denomination into larger
denomination. This process is called consolidation of shares. On account of consolidation, the
total amount of capital of the company will not change but the number of shares will decrease.

c. A company, in order to alter its share capital, may convert all or any of its fully paid up shares
into Stock or Stock into fully paid up shares. In case, shares are converted into Stock, the
 members get a part of Stock Capital in place of shares. By converting Shares into Stock, any
amount of Stock Capital can be transferred to any other person.

d. When the shares of a company are sub-divided in shares of small value, it is known as sub-
division of shares. In sub-division of shares, the face value of a share is converted into smaller
denomination from larger denomination. The total capital of the company remains unaffected by
sub-division but the total number of shares increase.

e. Cancellation of capital may take the following form:

 i. Cancellation of unissued capital; and
ii. Cancellation of uncalled capital.

(i) Cancellation of unissued capital: Cancellation of unissued capital means cancellation

of unissued shares by a company. It means that the part of the authorized 11 capital which
has not yet been issued to the public may be cancelled by the company. This cancellation
does not have any impact on the accounts of the company and hence no entry is required
to be passed for such cancellation. Only the capital clause in the memorandum of
association of the company is required to be altered and the altered (reduced) authorized
capital is shown in the balance sheet of the company prepared subsequent to the
alteration. The alteration is required to be registered with the Registrar of companies.

11 https://www.companieshouse.gi/publications/FSC22.pdf
 (ii) Cancellation of uncalled capital: Cancellation of uncalled capital means
cancellation of that part of the face value of the share which has not yet been called by
the company.

Reduction of Share Capital

Sometimes there may be a genuine necessity for the reduction of capital. This power is, given by Section
59 of the Companies Act, 1994 subject to the compliance of conditions. According to this, a company
may12:

12 https://www.investopedia.com/terms/c/capitalreduction.asp
 i. extinguish or reduce the liability on any of its shares in respect of share capital not paid up;
ii. cancel any paid-up share capital which is lost or is unrepresented by any available assets;
iii. pay off any paid-up share capital which is in excess of what is required by the company.

Following conditions are required to be fulfilled by a company to reduce its share capital:

a. The Articles of Association13 of the company must permit it to reduce its capital;

13 http://huconsultancy.com/reduction-of-capital/
 b. The company in general meeting shall pass a special resolution to reduce its capital; and
c. The approval of National Company Law Tribunal (previously Court) shall be obtained for the
scheme of reduction in share capital.

There are three ways to give effect to the scheme of Reduction in Share Capital. These are
as follows

a. By extinguishing or reducing the liability on any of its shares.

b. By paying off any paid-up share capital which is in excess of what is
required by the company.
c. By cancelling any paid- up capital which is lost or is unrepresented by
any available assets.
Accounting of reduction in Share Capital by company in case of the above three methods is shown
below:

1. Journal entry for reduction of liability in respect of the uncalled amount on Shares.
2. Journal entry for reduction by refund of excess capital to shareholders.

There may be two situations14:

14 https://taxguru.in/company-law/reduction-share-capital.html
i. When denomination of shares is changed i.e. reduction by way of refund with change in the
face value.

a. To record the change.

b. To record Payment to Shareholders.
c. To transfer to General Reserve.

i. When denomination of shares is not changed i.e. reduction by way of refund without change
in the face value.

a. To record the transfer of the returnable amount.

b. To record Payment to Shareholders.
 c. To transfer to General Reserve.

1. Journal entries for Cancellation of any paid up capital which is lost or is unrepresented by any
available assets i.e. Reduction in Capital. In case of heavy losses incurred over the years, the
capital base and the financial strength of company may become weak. In such cases it becomes
necessary for such a company to undertake some financial reconstruction measures. Such
financial reconstruction measures are given effect through schemes of capital reduction.
Generally, shareholders have to bear the loss. If the loss is heavy, then creditors and debentures
holders are also required to bear a portion of such financial loss.
 This is the third way through which internal reconstruction of a company can be carried out, the
accounting entries of which are shown below. For this a ‘Capital Reduction Account’ 15, which is
also called ‘‘Reconstruction’’ account or ‘‘Re-organization’’ account, is opened. In examination
problems where there are no specific directions, you may use any of the terms viz. ‘Capital
Reduction Account’ or ‘Reorganization Account’ or ‘Reconstruction Account’. Journal Entries
for giving effect to the Capital Reduction Scheme:

a. When denomination of Shares is not reduced; only paid up value is reduced.

b. For sacrifice made by Debenture holders, if any.
c. For sacrifice made by Creditors, if any.
d. For recording any increase in the value of Assets (on Revaluation).
e. For recording decrease in the value of liability.
f. For making any Provision for Contingent Liability.
g. Capital Reduction Account is used for writing off various accumulated losses, fictitious
assets and loss on assets and liabilities.

15 https://www.linkedin.com/pulse/reduction-share-capital-procedure-before-nclt-under-act-peer-mehboob
The amount to be written off cannot exceed the amount credited to Capital Reduction Account. But if
there is any reserve in the liabilities side of the balance sheet, the same may be utilized in writing off
accumulated losses and fictitious assets. After writing off various assets, if any balance is left in the
Capital Reduction Account, the same will be transferred to Capital Reserve Account.

a. The words ‘‘And Reduced’’ should be added to the name of the company, if the Court so
directs.
b. The amount written off in respect of fixed assets under a scheme of reconstruction must be
shown in the Balance Sheet for five years after the date of reduction.

6.COMPARISON OF LAW OF RECONSTRUCTION OF COMPANIES IN

VARIOUS COUNTRIES

A scheme of arrangement (or a "scheme of reconstruction") is a court-approved agreement between a

company and its shareholders or creditors (e.g. lenders or debenture holders). It may effect mergers and
amalgamations and may alter shareholder or creditor rights.
Schemes of arrangement are used to execute arbitrary changes in the structure of a business and thus are
used when reorganization16 cannot be achieved by other means. They may be used for rescheduling debt,
for takeovers, and for returns of capital, among other purposes.

In the United Kingdom, the relevant provisions for affecting a scheme of arrangement are found in the
Companies Act, 2006, Part 26 (ss.895-901) and Part 27 (special rules for public companies).

In Australia, the relevant provisions for affecting a scheme of arrangement or reconstruction are located
in Part 5.1 of the Corporations Act, 2001 (Cth).

In India, the relevant provisions for affecting a scheme of arrangement are found in the Companies Act,
2006, Section 391, which empowers the court to sanction the compromise or arrangement proposed by
the companies. Section 392 further empowers the High Court to enforce a compromise or arrangement
ordered by the court under section 391 of the Companies Act. Section 393 provides supporting
provisions for compliance with the provisions or directions given by the court. Sections 395, 396 and
396A are supplementary provisions relating to amalgamation. Section 395 deals with the power to
amalgamate without going through the procedure of the court.

16
https://www.academia.edu/5351353/A_REVIEW_AND_COMPARISON_OF_LAW_OF_RECONSTRUCTION_OF_VARI
OUS_COUNTRIES
The Bangladesh law laid down similar provision like India. Section 228 of the Companies Act, 1994 can
be used whether the company is a going concern or is in the course of winding up. It will not, for
example, be necessary where it is desired to alter rights attached by the articles to a class of shares where
the articles provided the method for the variation of such rights. On the other hand, if no provision exists
enabling the company to vary the rights attached to a class of shares, it will only be possible effectively
to alter any such rights either with the consent of every holder of the shares whose rights are to be varied
are following the procedure laid down in the Section 71 of the Act 17 or by means of a Scheme of
Arrangement under Section 228. Section 10 does not prohibit an alteration of special rights by this
procedure.

The utility of Sections 228 and 229 is more evident when more creditors are concerned. Prima facie no
creditor can be bound by the agreement of the company with the other creditors or by an agreement
between the later. A compromise approved by a great majority of creditors might be rendered ineffective
if a comparatively small creditor were to object. It is one of the purpose of Section 228 to meet the
situations.

17 https://www.investopedia.com/terms/a/amalgamation.asp
7.CONCLUSION

Reconstruction in law refers typically to the transfer of a company's (or several companies') business to
a new company. The old company will get put into liquidation, and shareholders will agree to take
shares of equivalent value in the new company. The sanction of a court is not required (unlike under a
so-called "scheme of arrangement", which could or creditors). Yet if a shareholder objects, she may
require cash payment rather than shares. Creditors who object to have their debts transferred to a new
company can demand satisfactions during the old company's liquidation.

Small private companies, family companies and investment trusts often use the procedure. The purposes
can vary, from changing the objects of the business, varying share class rights, or reorganize before a
demerger takes place.
Bibliography

1.Books

1. C.R. Datta, The Company Law, V-II, 6th Edition, 2008, Wadhawa and
Company.

2. Nirmalendhu Dhar, Company Law & Partnership, 3 rd Edition, ReMiSi

Publishers.

3. Janet Dine, Company Law, 3rd Edition, 1998, Macmillan Press Ltd.

4. John H Farrar; Nigel E Feury; and Brenda M Hanningam, Farrar’s

Company Law, 3rd Edition, 1991, London.

5. L.C.B. Gower, Principles of Modern Company Law, 5 th ed., (London:

Sweet & Maxwell, 1992).

6. H.C. Johari, Commentaries on Companies Act, V-2, 2006 Edition,

Kamal Law House.

7. Graham Stedman; Janet Jones; Shareholders’ Agreement, Third

Edition, (London: Sweet & Maxwell, 1998).
 8. Dr. M Zahir, Company and Securities Law, (Revised and updated
Edition), 2005, the University Press Limited.

Statutes

1. The Companies Act, 1994 (Act No. XVIII of 1994).

2. The English Companies Act, 2006.

3. The India Companies Act, 1986.

Cases

1. Re Guardian Assurance Co. [1917] 1 Ch 431, 441.

2. Re Empire Mining Co. [1980], 44 Ch.D. 402.
3. Re Brownfeild Guild Pottery Society [1898] W.N. 80.
4. Re Stephen Walter & Sons [1926] W.N. 236.