Limits on buyback in new norms illusory

Jayant M Thakur

Jayant M Thakur, Chartered Accountant

A few days ago, on 23rd October 2001 to be exact, the Companies Act, 1956, has been amended by an ordinance to relax some of the buyback provisions. It may be recollected that buyback was introduced about three years back with great expectations, so much so that it was introduced almost as an emergency measure. The original provisions were also introduced in the form of an ordinance. SEBI was directed to introduce buyback regulations for listed companies within one week (notwithstanding that other regulations of similar stature often took years for even a draft to be released). And SEBI did the job. There were however no immediate takers for buyback.

What was even more important is that even those companies that did carry out buyback did not gain the main benefit perceived of buyback, ie, sustained increase in market prices. In fact, what has happened is that the prices of the shares of such companies hovered near the offered price till the buyback offer was in place and thereafter the prices went down with the company losing and the shareholders who offered shares gaining. Faced with stagnant capital markets feared to go down further post-September 11, the law ministry forgot the earlier poor show of buyback and have tried to use his tool once again. Thus, we have this new ordinance which seeks to relax some of the provisions. It is expected that SEBI will also amend its regulations to give some matching relaxations.

Before we deal with the amendments, let us quickly review the overall scheme of the provisions relating to buyback. It may be recollected that buyback is a form of reduction of capital. Normally, reduction of capital is restricted since, in the context of limited liability of the company, the protection of the creditors is in the form of the paid up share capital. Hence, return of capital is normally not permitted. Therefore, one of the conditions of buyback is that the company should be solvent and remain solvent for at least one year.
An added protection in the scheme of provisions is that that the amount of paid up capital returned should be replenished either out of a fresh issue or transfer from reserves. Then there are some restrictions over the quantum of buyback, and some qualitative restrictions of non-issue of fresh capital within 24 months. An important requirement is that a special resolution would have to be passed. This has to be read with the new requirements of postal ballot. Now, in this scheme, let us see what are the amendments made.

The first amendment makes an exception to the regular requirement that approval through a special resolution should be obtained. Buyback may now be authorised even through a board resolution passed at a meeting of the board. However, such a board resolution can enable buyback only upto 10 per cent of the total paid up share capital and free reserves. It would be interesting to analyse this amendment.

Firstly, note that the limit is 10 per cent of the paid up “equity capital” and free reserves. Compare the existing requirement of 25 per cent of the “total paid up capital” and free reserves. The other annual limit is 25 per cent of the “paid up equity capital”. The new limitation is a combination of the paid up equity capital and free reserves.

In other words, it is illusory that the 10 per cent limit will apply to the capital. If the buyback offer price is lower than the book value of the company, the company can, through the new board resolution route, buyback even upto 25 per cent of its paid-up equity share capital.

The next condition is that there should be a gap of 365 days from one buyback offer and another. Will this restriction also apply to buybacks through the special resolution route? Though with a little awkward language, it is clarified that this gap is required only for buybacks carried out through the board resolution route. The next requirement is that the buyback should be approved only through a resolution passed at a board meeting. This has to be read with another amendment to section 292. Section 292 lists down certain powers of the company that can be exercised only through meetings of the board. Thus, directors or even managing or whole time directors individually cannot exercise such powers. To this list, the power of carrying out buyback through the board resolution route has been added. It has to be noted that the approval will have to be at a board meeting and not through circular resolution. This can be actually a small hindrance and against the objective of the amendment to facilitate quick buybacks. When the amendment to section 77A clearly provides that the board approval is only through a meeting, the amendment to section 292 is not clear and hence there is an element of repetition. The other significant relaxation is that the period of 24 months for which a company carrying out buyback cannot issue further shares of the same kind has been relaxed to 6 months.

A significant aspect to be noted is that while the original announcements were that the relaxation will be only for a period of six months, the amendments made are permanent and without any limit. In other words, the relaxations made are without any time limit during which the benefit can be made use of. It has to be noted that this relaxation is for both types of buybacks, whether through the general meeting route or to the board resolution route.

Finally, an important point to note is that this relaxation is available to all companies, listed or unlisted.

In conclusion, one now awaits the SEBI regulations to see what relaxations are carried out therein. One also waits with a little skepticism whether there will be any immediate (far from long term) benefits to stock markets or shareholders in general of these amendments or whether it is found that this is merely a gimmick without substance. Perhaps the first step to watch for is whether there are many companies that see any advantage and come forward and use these provisions.