Article. Conversion of one class of shares into another class whether falls under scheme of arrangement? Niddhi Parmar

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1 Conversion of one class of shares into another class whether falls under Niddhi Parmar Vinod Kothari & Company Corporate Law Services Division December 19, 2015 Check at: Copyright: This write up is the property of Vinod Kothari & Company and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 Various questions arise as to whether conversion of one class of shares into any other class of shares viz. conversion of equity shares into redeemable preference shares, irredeemable preference shares into redeemable preference shares, preference share into nonconvertible debentures falls under the ambit of scheme of arrangement i.e. under sections 391 to 394 of the Companies Act, 1956 (corresponding Section 230 of the Companies Act, 2013 yet to be enforced) or should be treated as reduction of share capital under sections 100 to 104 of the Companies Act, 1956 (corresponding Section 66 of the Companies Act, 2013) or both. There is no clear legal provision as such defining the case under question, hence, one needs to rely on various judicial pronouncements interpreting the various applicable provisions of law. In this write-up, we discuss various case laws at length to attempt to have a clear understanding with respect to implication on conversion as above. Provisions of Law Reduction of share capital Sections 100 to 104 of the Companies Act, 1956 (hereinafter referred to as Act, 1956 ) deals with the procedure to be followed by the company for reduction of share capital. Subsection (1) of section 100 requires the company to pass a special resolution for reduction of share capital and prescribes the ways in which reduction of share capital shall take place; the same has been reproduced below: (1) Subject to confirmation by the Tribunal, a company limited by shares or a company limited by guarantee and having a share capital, may, if so authorised by its articles, by special resolution, reduce its share capital in any way, and in particular and without prejudice to the generality of the foregoing power, may (a) extinguish or reduce the liability on any of its shares in respect of share capital not paid-up ; (b) either with or without extinguishing or reducing liability on any of its shares, cancel any paid-up share capital which is lost, or is unrepresented by available assets ; or (c) either with or without extinguishing or reducing liability on any of its shares, pay off any paid-up share capital which is in excess of the wants of the company ;

3 and may, if and so far as is necessary, alter its memorandum by reducing the amount of its share capital and of its shares accordingly. Compromises, Arrangements and Reconstructions Clause (b) of section 390 of the Act, 1956, defines the expression arrangement to include a reorganisation of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or, by both those methods. Based on the text of law, we analyse some of the judicial pronouncements to conclude on the understanding. Conversion of securities of one class into another class: Conversion of irredeemable preference shares into redeemable preference shares In Re St. James Court Estates Ltd, 1944 Ch 6 1, the petitioner-company filed a petition for the conversion of irredeemable preference shares into redeemable preference shares under section 391 to 394 of the Act, The court held that the capital needs to be reduced by cancellation of the irredeemable preference shares and such conversion of irredeemable preference shares into redeemable preference shares could not be achieved through a medium of scheme. This was on the principle that a scheme or arrangement is intended to achieve what can be done by a private arrangement between the company and its members and/or creditors and if some of the members or creditors do not agree, the court, by sanctioning a scheme, make it binding on the dissenting members or creditors. In Pennington s Company Law 5th Edn., 1985 it is stated at page 586 et seq. under the heading Limitation of Court s Powers as follows: The court cannot sanction a scheme which can be effected under some other provision of the Companies Act, Thus, the court refused to approve a scheme which merely provided for the reduction of company s capital and in the case cited above (Re, St. James Court Estates Ltd.,) (Supra), where the court refused to approve the scheme for conversion of preference shares into redeemable preference shares, 1 Ramaiya 18 th Edition Pg no Volume I

4 a second reason given for its decision was that the company could carry out the scheme by issuing new redeemable preference shares for cash and using the proceeds to pay off the existing preference shares on a duly authorised reduction of capital. But there seems to be no reason why a company should not seek the court s sanction to a modification of shareholders or debenture holders rights merely because there are provisions in its or in the Debenture Trust Deed by which the modification could be effected out of court. The Companies Act makes an express provision with regard to reduction of capital and that provision cannot be circumvented by obtaining an approval of the court to a scheme or arrangement under sections 391 to 394. Conversion of equity shares into redeemable preference shares In Smartplay Technologies vs Nil on 29 November, , the petitioner company filed a petition under sections 100 to 104 of the Act, 1956, for conversion of 70, 260 equity shares of Rs.10/- each into 70, 260 redeemable preference shares of Rs.10/- each carrying a dividend of 1% and redeemable within a period of 10 years with the Karnataka High Court. The petitioner company obtained approval from its shareholders for conversion of 70, 260 equity shares into redeemable preference shares, vide a special resolution passed at an extra-ordinary general meeting of the company held on July 19, It was argued on the part of petitioner-company that the conversion of the share capital would not involve any financial outlay and would not affect the interest of their creditors. Further, adding that the court had dispensed with the procedure of settling the list of creditors, by its order dated October 23, 2013 in Company Application No.1639/2013, and had directed the petitioner company to take out notice by way of paper publication. The Court held that the petitionercompany has duly complied with the statutory requirements, therefore, the petition was allowed. Conversion of preference shares into non-convertible debentures In Re: Investment Corporation Of... vs Unknown on 19 August, , the petitioner company filed a petition under section 101 and section 391 of the Act, The petitioner company had one category of preference shares, viz. 5000, 7 ¾ % preference shares of Rs each. The preference shareholders requested the petitioner company to increasing the rate of the (1987) 61 CompCas 92 Bom -

5 dividend payable due to higher bank rates. The board of directors of the petitionercompany thereupon decided to cancel the said preference shares and issue secured nonconvertible debentures of Rs. 100 each bearing interest at the rate of 12% per annum payable half-yearly to such preference shareholders through a scheme of arrangement between the petitioner company and the shareholders. The proposed scheme inter-alia provided reduction of capital; issuance of debenture on cancellation of preference shares and the debenture would be secured by floating charge on the petitioner company s assets. The petitioner company filed an application 4 and received an order to convene separate meetings of its members holding preference shares and ordinary shares. In both the meetings the resolution for reduction was approved by the respective shareholders. The petitioner company thereafter made an application for dispensing the procedure under section 101 of the Act, 1956 and the order was passed for dispensing the same. However, the scheme of arrangement was opposed by the Registrar of Companies and/or the Company Law Board (hereinafter referred to as CLB ). The counsel appearing for CLB insisted on following the procedure under reduction of capital, however, it was negated by the judge: The said section (section 101) itself provides that the procedure may be dispensed with by the court if it thinks fit and proper. In the present case, as stated earlier, it was only after scrutinizing the fiscal health of the company and considering the ramifications of the scheme and considering the resolutions passed by the shareholders that an order was passed dispensing with the procedure under section 101. Furthermore, barring making a submission, Mr. Bulchandani has not been able to state as to who has complained of any prejudice being caused or to whom it is caused or as to who has complained of the reduction of capital being unfair or, if the Company Law Board finds it unfair, and in what manner. The contention canvassed by Mr. Bulchandani must now be negatived. Further, the counsel argued that the scheme contemplates an adjustment or modification of rights, and if this be so, then the same cannot fall within the ambit of the expression "arrangement" used in section 390, however, it was negated by the judge observing the following: 4 Company Application No. 385 of 1984

6 The word "arrangement" as set out in section 390(b) is an inclusive definition and contemplates all arrangements and not only reorganisation of the share capital. This is all the more clear, because the word used is "includes". The aforementioned points laid down by the counsel were negated by the judge and the petition was approved. Analysis The Company may divide its share capital into different classes only if so authorized by its articles or by alteration of articles through special resolution. The terms of different classes of shares can differ by virtue of rights as to dividend or votes. In Re, Chowgule & Co. (P.) Ltd., 1972 Tax LR 2163, the Judicial Commissioner of Goa discussed the case cited above (St. James Court Estates Ltd.,) (Supra) and held that in case of conversion of equity shares into redeemable preference share the procedure as laid down under sections 100 to 104 of the Act, 1956 to be adopted. In author s view, conversion of one class of shares into another class may it be conversion of irredeemable preference shares or equity shares into redeemable preference shares the same needs to be effected only through a process of reduction of capital given the observations under the various case laws discussed above. While a scheme of arrangement deals with reorganization of the share capital, however, when there is an express provision under the Act, 2013 the same should not be sidestepped by obtaining approval under some other provisions. View our recent articles on Companies Act 2013 at: financing.com/component/content/article/281.html