Share Capital Reduction: vis-à-vis Companies Act

Meaning of Share Capital

As per Companies Act 2063 Section 2(Dha): “Share” means the divided portion of the share capital of a company. 

There is not exact defition or meaning of Authorized Capital, Issued Capital, Called Up Capital and Paid Up Capital specifically in the Act or Directive. Apart from the definition of Share Capital, no other terms has been particularly defined in this context. As “share capital” could mean (i) Authorized Capital (ii) Issued Capital (iii) Called Up Capital or (iv) Paid Up Capital. Thus the meaning of Share Capital should be understood in the contextually in interpreting Companies Act. 

Types of Share Capital

Although the Companies Act doesn’t differentiate the types of capital, in context of the references made in the Companies Act: 

  1. Authorised Capital: The Memorandum of Association of every company has to specify the amount of capital with which it wants to be registered. The capital so stated is called Registered, Authorized or Nominal Capital. The Registered Capital is the maximum amount of share capital which a company can raise by way of public subscription.
  2. Issued Capital: The company may not issue the entire authorised capital at once. It goes on raising the capital as and when the need for additional fund is felt. So, issued capital is that part of Authorised/Registered or Nominal Capital which is offered to the public for subscription in the form of shares. The balance of nominal capital remaining to be issued is called Unissued Capital.
  3. Subscribed Capital: It is that part of “issued capital” for which applications are received from the public. 
  4. Alloted Capital: The subscribed capital is allotted to the respective subscribers as per resolution passed by the directors of the company.
  5. Called up Capital: It is that part of subscribed capital which has been called up by the company. A company does not call at once the full amount on each of the shares it has allotted and therefore, calls up only such amount as it needs. It is the uncalled portion of the allotted capital and represents contingent liability of the shareholders on the shares.
  6. Paid Up Capital: It is that part of called up capital against which payment has been received from the members on their respective shares in response to the calls made by the company. 

The following pictoral summary may be better for quick reference: 

How do you get from authorized share capital to paid up share capital?

Let’s discuss step by step process how a company’s authorized capital turns into paid up capital of the company.

Step 1: Authorized Capital is the capital amount declared in the memorandum of the company at the point of registration. This is a limit on the share capital that a company may raise by the way of issuing to this potential investors by way of subscription. Authorized Share Capital can be increased by the amount as the company thinks expedient as per Section 56(1)(Ka). Comapny can also cancel the authorized capital that have not been taken or agreed to be taken by any person as per Section 56(1)(Ga). The increase or decrease in authorized share capital is called alteration of share capital. Subject to the provisions contained in its AOA, a company may, by adopting a special resolution at its general meeting, make alteration in its share capital. A submission, accompanied by the prescribed fees shall be made to the Office of Company Registrar’s (OCR) for the (i) recordal of the resolution adopted for the alteration of the share capital, and (ii) amendment to the MOA and AOA made in that regard, and the OCR shall accordingly record the alteration made in the capital of the company and the amendment made to the MOA and AOA and give information thereof to the company within 7 days after such submission.

Step 2: Issuing the share capital is the another step. Issuing of share capital can be of two types: (i) Private Placement (ii) Public Placement. The issuance is the process of offering the shares to the public for subscription and this generally includes getting the securities being registered, approved offering through the issue of prospectus. Private placement generally is simpler but in case of public placement there are a lot of compliance requirements. 

Step 3: When the company invites the potential investors for the investment in the company in form of share capital it is not ncessary that all shares are subscribed by the investors. To the extent the issued capital is sibscribed to be undertaken is called subscribed capital. There may be over and under subscription. To avoid the case of undersubscription, in which case, the projected business may not go ahead, the company might enter into an guaranteed underwriting arrangement where the unsubscribed portion are agreed to be taken by an underwriter. Company may not ask the investors to deposit the entire amount during the time of applicaiton to subscribe the shares. Typically only 10%-50% of the total value of the shares can be called up at the time of applying to subscribe the shares. However, in raising capital by a company which has been in operation since at least 3 years ago by publishing its audited fiscal statements for its last 3 years, at the time of publication of its prospectus, this provision of 50% limit of the amout at the time of applicaiton is not applicable.    

Step 4: Allotment is made after the subscription. Allotment is typically guided by the allotment directive issued by the Securities Board of Nepal in case of public subscription. As per Section 28 of the Companies Act, in case of public companies, allotment can only be made where at least 50% of the shares are subscribed. 

Step 5: After the allotment is made, the other process is to call the share amount, in cases where the entire amount was not called up during the applicaiton for subscription. This is the process of calling up the amount undertaken to be paid by the attoted shareholders. In making a call pursuant for the uncalled share amount, a company shall send every shareholder a written notice, in the prescribed format, specifying (i) A time limit of at least 30 days and (ii) The installment payable by him, and (iii) The place and time for payment. In case of a public company, such notice shall also be published, for at least 2 times, in a daily newspaper with national circulation.

Step 6: It is not necessary that all the amount called up is actually paid by the shareholder. If a shareholder fails to pay the sum called and payable in respect of the share within the specified period, a notice shall be sent to the concerned shareholder giving an additonal time period. In the case of a public company, such notice shall also be published in a daily newspaper with national circulation for at least 3 times. If the installment called is not paid even within the time limit as mentioned, the company may forfeit:
(i) All shares, or
(ii) Shares remaining after retaining the number of shares as fully paid up to the extent of  (1) The amount paid up on the shares in respect of which the company has given such notice, or also (2) To the extent of the amount of dividends, if any, attached in respect of such shares

Meaning of Alteration and Reduction of Share Capital

Alteration is nominal adjustment of the share capital account. However, reduction is real adjustment of the share capital account. Alteration of the share capital account doesn’t amount to any financial transaction but is simply a restatement of how information is presented in financial statement. 

Types of Alteration of Share Capital

Increasing authorized share capital

Companies Act Section 56(1)(Ka): By increasing its authorized share capital by such amount as it thinks expedient by issuing new shares. 
Accounting Impact: No Accounting Impact
Presentation Impact: The Authorized Share Capital Figure is restated

Consolidating/dividing share capital

Companies Act Section 56(1)(Kha): By consolidating or dividing all or any of its share capital into shares of larger or smaller amount. 
Accounting Impact: No Accounting Impact
Presentation Impact: The unit value of the share is increased /decreased and the number of shares decreases /increases proportionally so this brings only the change in unit value and number of shares but there is no change in the total value of share capital. 

Cancellation of share capital by reason of forfeiture under Section 53

(a) Companies Act Section 56(1)(Ga): By canceling the shares which, at the date the adopting of the resolution in that behalf, have not been taken or agreed to be taken by any person. 
Accounting Impact: No Accounting Impact
Presentation Impact: (i) The authorized share capital of the company is restated

(b) Companies Act Section 56(1)(Ga): By canceling the shares which, at the date the adopting of the resolution in that behalf, are forfeited for the reason of non payment of call amount and diminishing the amount of its share capital by the amount of the shares so canceled. 
Accounting Impact: This is an exceptional case as there actually can be accounting impact. We will discuss this below. 
Presentation Impact: The portion of the alloted capital is reduced but it doesn’t impact the net paid up capital unless the the company foreits the entire amount of shares for the non payment on a call. 

Share forfeiture by the reason of non payment of call amount: Alteration or Reduction in share capital?

This one is a tricky part. Let’s view an example: 

A company opens up for the subscription of shares FV 100. 50% of the amount is called during the application and another 50% is called on first and final call after some time. There were 10 shareholders who applied for the subscription but one of them didn’t pay the call amount after some time. When the 2 shareholders didn’t pay the amount, their shares were subject to forfeiture. 

Let’s see the accounting part: 
(a) At the time of application for subscription
Bank Account Dr. (10×100×50%) = 500
Share Application Liabillity Cr. (10×100×50%) = 500

(b) At the time of allotment of the shares
Share Application Liabillity Dr. (10×100×50%) = 500
Paid Up Share Capital Cr. (10×100×50%) = 500

(c) At the time of making a call for the rest 50% full and final call
Accountants can be divided into two parts in this one. Whether or not to book the calls in arrears as an asset item? Here it might be relevant to discuss the meaning of asset.
Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. As per Conceptual Framework for Financial Reporting. 
Here, the important distinction is the control over the asset. Asset should be within the control of the entity. The shareholders can opt not to further invest into the company have their ownership reduced to the extent of the amount actually paid up. The company will not have the right to forcibly call up the calls in arrears thus it may not be correct to book calls in arrears as an receivable item. This is the reason calls in arrears are disclosed in statement of financial position by reducing it against the paid up capital. So the approach to account for calls in arrears can be of two ways:
(1) Approach One: Not booking Calls in Arrears as receivable
Bank Account Dr. (9×100×50%)=450
Paid Up Capital Cr. (9×100×50%)=450 
(2) Approach One: Booking Calls in Arrears as receivable but presenting it by setting off against the Paid Up Capital
Bank Account Dr. (9×100×50%)=450
Calls in Arrears Account Dr. (1×100×50%)=50
Paid Up Capital Cr. (10×100×50%)=500
Even when the Calls in Arrears is booked as an asset item, it is presented by setting off against the paid up capital. So in fact, the amount of net paid up capital under approach one and approach two doesn’t differ. In the continuing blog below, we will consider the Approach One to further discuss. 

(d) At the time of making a call for the rest 50% full and final call
When the company decides to forfeit the shares: 
(i) The company may forfeit all shares
Paid Up Capital Dr. (1×100×50%)=50
Bank Cr. (1×100×50%)=50
Passing the above entry and cancelling 1 share units alloted to him during during the allotment process. 
(ii) The company may forfeit shares remaining after retaining the number of shares as fully paid up to the extent of the amount paid up 
No accounting entry is required as this doesn’t contritute financial transaction. 
Cancelling 0.5 share units alloted to him during during the allotment process and retaining only 0.5 share units in the name of the such shareholder. 

So, we have learnt that forfeiture of shares by the reason of calls in arrears: 
(i) May require adjustment in share capital account by the reason of forfeiture of all shares
(ii) May not require adjustment in share caital account by the reason of forfeiture of shares after retaining the number of shares as fully paid up to the extent of the amount paid up 

Companies Act Section 56(4): A cancellation of shares, if any, made in pursuance of non payment of call on shares within due date, shall not be deemed to have been made for purposes of the reduction of share capital of a company. 
Companies Act has clearly stated that the forefeiture (whichever form as discussed above) is not a reduction in Share Capital but is simply an alteration in share capital, even though it might require some adjustments in the paid up capital account. 
Generally, the share units are alloted to the shareholders at the time of allotment. Not all the money is paid in by the investors at the time share allotment, but the share units is already alloted to them at this point. Later, when this amount may be subjcted to fofeiture, it is only fair that the existing shareholders through a special resolution can decide to cancel the arrear shares, rather than going through the extensive compliance path of reduction of the shares. This exceptional rule is applicable only in the time of forefeiture of share the calls on which are in arrears. When the share capital is proposed to be reduced without following the procedure of share forfeiture under Section 53 or when it is decided to reduce the share capital to the extent not called, it will not be deemed as an alteration of share capital but a form of reduction in share capital. This we will discuss below in reduction of share capital as well, below. 

Types of Reduction of Share Capital

As discussed above in the alteration of share capital, the increase/decrease in the authorized capital is alteration of share capital. There is no any significance in determining whether the change in issued capital and subscribed captital and called up capital amounts to alteration or reduction of share capital as they are simply a nominal names for the issue, subscription and share call purpose. 

However, any alteration in the alloted share capital and paid up share capital (other than by the reason of forfeiture of shares in case of calls in arrears: which is also deemed to be alteration of share capital as per Companies Act 2063), is called Reduction of Share Capital. 

Here, we will try to discuss the meaning behind the types of reduction in share capital:

Reducing share capital to the extent of amount paid up

The company may decide to reduce the capital to such amount as has been paid up where calls for payment of amount on shares are not fully paid up.

This may be an investment decision when the company doesn’t not require any additional funds to further the projects of the company. In such case the company may decide not to call the uncalled call amounts. This will also include the forfeiture of shares that are not made in line with Section 53 of the Act. 

Accounting Impact
This will not require any accounting adjustment as the share capital amount that is being reduced is the alloted but uncalled share capital . Alloted but uncalled share capital are not the part of paid up capital and are not presented in the books of accounts. 

Reducing share capital to cut out misrepresentative assets

Company may decide to devaluate the face value of shares where the company has sustained a big loss or suffered a natural calamity. 

When the books of the company has huge figure of the misrepresentative assets or accumulated losses in the books of the company, the books of the comoany do not present in fact the real state of affairs of the company. It will depict that the investment injected into the company has funded the misrepresentative asset rather than actual state / position of the company. In such case it might be relevant to set off the misresentative assets against the paid up share capital. 

Accounting Impact
Paid Up Share Capital Account Dr. = CU XXX
Accumulated Losses Account Dr. = CU XXX

Reducing share capital on the direction of regulatory

Regulatories like Nepal Rastra Bank and Securities Board of Nepal may instruct the baking institutions or securities businesses to reduce its issued or paid up share capital.

Reducing share capital through repurchase

Repurchase is the process of reduction of share capital by paying back any paid up share capital. Normally, as per Section 61(1) of the Companies Act 2063 no company can (i) Purchase its own shares (buyback), or (ii) Lend money against security of its own shares.

However, buyback of share is possible by fulfilling the following procedures: 

  1. Obtaining approval: Obtaining approval from regulatory as applicable. 
  2. Reserves for buyback: Buyback should be made out of the free reserves available for being distributed as dividends.  
  3. Notifying: By giving information to the Office of Company Registrar’s
  4. Shares issued are paid up: Before the buyback the shares issued by the company should be fully paid up. 
  5. Shares issued are listed in Securities Board: Before the buyback the shares issued by a public company should have been listed in the Securities Board. 
  6. Authorized by AOA: The buyback of shares should be authorized by the AOA of the concerned company. 
  7. Adoption of Special Resolution: Special resolution should be adopted at the general meeting of the concerned company authorizing the buyback. The resolution to be presented at the general meeting for this purpose shall state the following matters: (a) The reason and necessity for the buyback of shares; (b) A statement of the evaluation of possible impacts of the financial situation of the concerned as a result of the buyback of shares, (c) The class and number of shares intended to be bought back; (d) The maximum or minimum amount required to buy back shares as referred to in Section 61(3)(c) and financial source of such amount; (e) The time limit for the buyback of shares; (f) The mode of the buyback of shares; (g) Such other necessary matters as specified by the Office and as required to be disclosed under the prevailing law, in respect of the buyback of shares.
  8. Limit of Buyback:
    1. Gearing Limit: The buyback should be strucutred such that the ratio of the debt owed by the company is not more than twice the capital and general reserve fund after buyback of shares.
    2. Reserve Limit: The buyback should be strucutred such that the value of shares to be bought back by a company is not more than 20% of the total paid up capital and general reserve fund of that company.
    3. Minimum Capital and Minimum Shareholders Limit: No public company shall buy back its shares in a manner that such minimum number of shareholders or minimum paid up capital as required to be maintained by that company becomes less or lower.
  9. Manner of Buyback: Where a special resolution is adopted by the general meeting for the buyback, the concerned company may buy back its shares in any of the following manners within a period of 12 months of the adoption of that resolution: (a) Purchasing from the stock exchange; (b) Purchasing from the concerned employee of the company the shares allotted to him, (c) Purchasing from the existing shareholders on a proportionate basis. 
  10. Compliances after the buyback is made
    1. Return of buyback: Company shall file with the OCR a return containing the number of shares bought back, amount paid for the same and other necessary details within 30 days of the date of such buyback.
    2. Capital redemption reserve: The company shall establish a separate capital redemption reserve fund, to which a sum equal to the nominal value of the shares bought back shall be transferred; and the amount of such fund shall be maintained as if it were the paid up capital. 
    3. Cancellation of Shares: The company shall company after it buys back its shares, shall cancel the shares so bought back within 120 days of the date of such buyback. 
    4. Reissue of shares: Once a company buys back any class of shares, the company shall not reissue the shares of that class, except for the issue of bonus shares or payment of its liability, prior to the expiration of 2 years after such buyback.

A quick note on the mathematics behind the buyback
Buyback should be structured such that:
♦ B≤(C+R)×20%
♦ Post buyback:D≤2(C+R)
Where, B means the face value of the share capital to be bought back, D means all amounts of secured and unsecured debts borrowed by a company, C means the paid-up share capital of the company, R means general reserve fund (distributable reserve and share premium reserve)
General note: The test under Section 61(2)(Cha) can be easily made but for the purpose of the test under Section 61(2)(Gna) these factors need to be considered:
• The face value of the shares newly issued for the purpose of facilitating buyback; discount and share premium relating to such issue
• Bonus call or bonus shares declared for the purpose of buyback; adjustment of the distributable reserves relating to such declaration
• The discount or premium amount relating the share capital to be redeemed
• Availability of the distributable reserve and share premium reserve

What is the process of Share Capital reduction?


If a company intends to reduce its share capital, it may, reduce its share capital by:
• Adopting a special resolution to that effect at its general meeting, and
• Obtaining approval of the Court, and
• Making necessary amendment to or alteration in the MOA and AOA, accordingly
However, a company which has already become insolvent in accordance with the prevailing law shall not be eligible to reduce its capital pursuant to Companies Act.

Filing petition

Once a company has adopted a special resolution for reducing its share capital, it shall make a petition to the Court for an order confirming the reduction.

Submitting te details of claimants

The director or company secretary of a company shall, as ordered by the Court, submit to the Court a real and true list of creditors of the company, if any, setting out, inter alias, their names, addresses and amount of debt repayable to each of them, at the commencement of hearing of the petition for reducing the capital of the company. If the list of creditors submitted is found to contain any false statement or omission, the director of the company who submits such list and the officer who signs such list shall be liable to punishment under this Act.

Hearing of petition

Once a a petition is made, the concerned company shall, prior to the hearing of such petition, publish a public notice in a daily newspaper of national circulation for at least 3 times, setting out the venue and date of hearing on the reduction of share capital of the company.

Court Order and Protection of Claimants Rights

Every person who is entitled to any debt or claim under the prevailing law at the time of commencement of the winding up or insolvency of a company shall be entitled to submit his claim and objection to the reduction of share capital of the company.

Irrespective of whether the creditors whose debts are yet to be discharged or determined, out of the creditors whose names are entered on the list submitted, do or do not consent to the reduction of capital in the case where the company admits the full amount of the debts or claims made by the creditors, or though not admitting it, agrees to make provision of moneys required to pay such amount and makes required provision for the same by executing a bond undertaking to pay the full amount within a certain date, then the Court may issue order confirming the reduction of the share capital. In taking action for approval on a proposed reduction of share capital which involves either the diminution of any liability in respect of unpaid share capital or the paying back to an shareholder of any amount paid for shares, the Court may, if, having regard to the circumstances and available evidence, it thinks proper so to do, direct that the, right of the person entitled to submit his claim and objection to the reduction of share capital of the company, shall not apply to any specific creditor.

If the Court is satisfied, with respect to the creditors who are entitled to object to the resolution on reduction of capital, that either their consent to the reduction has been obtained or their debts or claim have been discharged or have been determined and are at the state of discharge, or have been secured, it may make an order confirming the reduction, specifying appropriate conditions. 

Implementation of Court Order

Where the Court makes an order, it may, if it thinks proper so to do, order directing that the concerned company, of which resolution to reduce capital has been so confirmed, shall, for a specified periods, add to its names the last words thereof the words “capital reduced” and publish necessary notice with a view to giving information to the general public about the reasons and causes for such reduction and other important information in regard thereto .
The contents of the terms in an order issued by the Court, in the course of confirming a resolution for the reduction of capital shall be deemed to have ipso facto been incorporated in the MOA and AOA of the company; and the MOA and AOA shall be deemed to have been amended to that extent. Furthermore, where the share capital of a company is reduced, the director or company secretary of that company shall mention and authenticate that matter in each share certificate issued by such company.

Liability of the shareholders towards the reduced share capital

It should be clearly unterstood that no shareholder shall be liable to pay an amount in excess of the face value of a share at the time of the subscription of such share by him. 
However, a person who was a shareholder of a company at the date of issue by the Court of an order confirming the resolution for reducing the capital of the company shall be liable to pay an amount not exceeding the amount which he would have been liable to pay if the company had undergone insolvency and commenced insolvency proceedings on the day immediately before the said date, if: 
• The list of creditors entitled to object to the reduction of share capital submitted to the Court omits any such creditor, and
• After an order confirming the reduction of capital of the company has been made, the company is unable to pay the amount of debt of such creditor

But where the list submitted to the Court omits the name or any claim of a creditor because of a fault or negligence of his own, the shareholders shall not be bound to pay such amount. 

The term "Court" referred above is Commercial Bench

History of Commercial Bench in Nepal

In 2063 BS, the Supreme Court set up a task force in this regard. The task force reviewed several exercises together with some international practices for establishment of Commercial Bench. The Task Force studied the reports of Court Management Committee, 2055 Court Strengthening Committee, 2058 and the Five Year Strategic Planning of the Court (2061- 2066). The Ministry of Law and the Ministry of Industry had also carried out some consultation with the Supreme Court in the year 2059 for the establishment of Commercial Court.

A project carried out under the loan assistance of Asian Development Bank namely Improving Legal Enforcement Mechanism and Judicial Capacity had a component called Establishment of Commercial Bench under its package 2 activity. From Manshir 2059, this project carried out activities on establishment of Commercial Bench. This project had hired an expert Hon. C. W. Pincus QC who submitted a report recommending a number of things on establishment of commercial bench. Nepal Judicial Academy (NJA) also worked very closely with this project on the Commercial Bench component. This project had also worked with private sectors like Federation of Nepalese Chambers and Commerce and Industry (FNCCI) and others in this course.

According the report of the Task Force, Commercial Cases Baseline Survey, 2003 carried out by Nepal Law campus presents 17 different kinds of cases as commercial cases tried and tested in several courts all over the country. The 17 different kinds of cases are – Company, Secured Transaction, Contract, Insolvency, Banking and Negotiable Instruments, Arbitration, Intellectual Property, Finance, Foreign Investment, Insurance, Security Transaction, Agency, Partnership, Construction, Leasing/Rent, Transportation and any others.

Analysing the evolution of concept of Commercial Bench and a comparative study on commercial dispute settlement of some other countries like United Kingdom, United States, India and China, the Task Force has finally put forth 26 suggestions.

Establishment of Commercial Bench in Nepal

On 2065 Magh 1, the government of Nepal established a Commercial Bench in four Appellate Courts namely Biratnagar, Patan, Butwal and Nepalgunj and later added Hetauda Appellate Court also through a notification on 2067 Baisakh 1. These Commercial Benches are provided with jurisdiction to look after cases of Secured Transaction Act, 2063, Competition Promotion and Market Promotion Act, 2063, Company Act, 2063 and Insolvency Act, 2063.

Later, the government of Nepal, through a notification published on 2065 Shrawan 5, extended the jurisdiction of the Commercial Benches for the disputes under Banking Offence and Punishment Act, 2066. Most of the cases going to Commercial Bench were filed in the Commercial Bench of Patan Appellate Court. Some 99 commercial cases were filed in the Patan Appellate Court up to the fiscal year 2067, some 154 cases were filed in the fiscal year 2067/068, some 237 cases were filed in the fiscal year 2068/069 and some 263 cases were filed before the completion of the fiscal year 2069/070.

After the establishment of the Commercial Bench, a procedure for the same was supposed to be made. In fact, a procedure is also drafted. However, the procedure has not come into force. Company Act, 2063 and Competition & Market Promotion Act, 2063 have provided that lawsuits under these Acts should follow summary proceeding. The Insolvency Act provides for a procedure within itself and that procedure is being followed now generally.

No special procedure is prescribed for Secured Transaction Act and Banking Offence Act. These two Acts seem to follow general procedure. Despite the lack of a specific procedure for the Commercial Bench, Chief Judge of the Appellate Court where the Commercial Benches reside have provided for necessary procedural matters as and when required. For example, cases of Commercial Bench are heard by a division bench, other cases related to the case filed in the Commercial Bench are also heard in Commercial Bench, so on and so forth.

Extract from New Business Age article by Rudra Sharma.