Is Literal Interpretation the Right Approach for Section 66 of Companies Act, 2013? – An Analysis from the Lens of Market Efficiency

– Neha Katariya

Introduction

On 19 September 2024, the National Company Law Tribunal, Kolkata (“NCLT”) dismissed an application filed under Section 66 of the Companies Act, 2013 (“Companies Act”) in the case of Philips India Limited. The tribunal ruled that Section 66 cannot be used unless the conditions outlined in Section 66(a) of 66(b) are met. The NCLT rejected the application stating that the provision for reducing share capital is not meant to be used solely to provide liquidity or an exit option for minority shareholders or to reduce administrative expenses. It justified this view by stating that the proposed reduction in share capital was only a secondary outcome of a buy-back of shares rather than a legitimate reason for reducing share capital as per statutory provisions. However, this ruling stands in contrast to numerous decisions from both the NCLT and National Company Law Appellate Tribunal (“NCLAT”) as well as rulings from other High Courts which have consistently held that a company is entitled to reduce its share capital in any manner it chooses and judiciary plays a limited role in overseeing such capital reduction schemes.

The author in this blog analyses the decision given in Philips India Case through the lens of market efficiency. The argument is that court’s reasoning, if upheld, would limit a company’s ability to optimize its capital structure. This, in turn, could weaken capital market efficiency and exacerbates agency costs. Given these economic implications, the author suggests a more balanced approach to share capital reduction—one that enables companies to adjust their capital structure when needed—would better serve both shareholders and the broader economy.

The Philips India Case 

The shareholding structure of Philips India Limited showed that its Dutch parent company, Koninklijke Philips N.V. (“KPNV”) owned 96.13% stake of the company and the remaining shares were held by retail shareholders. Philips India had been delisted in 2004, that means its shares were no longer traded on Indian stock exchanges. As a result, minority shareholders found it difficult to sell or monetize their holdings. This created a persistent demand for an exit option. The present petition was the third attempt by Philips to buy out the minority shareholders and transfer full control to KPNV. The first attempt was in 2007 using a buyback under Section 77A of the Companies Act, 1956. The second was in 2018 when a capital reduction scheme was filed under Section 66 of the Companies Act, 2013 but later withdrawn due to opposition from non-promoter shareholders. In this latest petition, the company aimed to offer liquidity and an exit option to minority shareholders while reducing the administrative burden of servicing a large number of small public shareholders.

The NCLT ruled that a capital reduction scheme under Section 66 could only be approved if the objectives fell within the specific conditions outlined in the law. According to Section 66, a company can reduce its share capital if it either wants to cancel unpaid shares, or if the paid-up capital is no longer represented by available assets. Since the company’s objectives did not fall in with any of these provisions, the NCLT rejected the scheme. The tribunal also pointed out that, unlike Section 66(6) of the Companies Act, 2013, which excludes buybacks under Section 68 from capital reduction schemes, there was no similar exclusion under Section 100 of the Companies Act, 1956. The NCLT concluded that the company’s main objective was to execute a share buyback, with capital reduction being a secondary consideration. This made Section 66 inapplicable to the scheme. While the minority shareholders had opposed the capital reduction on the grounds of a valuation mismatch, the NCLT did not address this issue, as the petition was dismissed based on the legal grounds mentioned earlier.

Judicial Stance on the Issue

In a recent order from the Mumbai Bench of the NCLT in the case of Vanaz Engineers Limited, the NCLT allowed a capital reduction to provide an exit option to minority worker shareholders. Similar to the facts of Philips India Limited case, the capital reduction aimed to offer liquidity to minority shareholders and reduce administrative costs. The NCLT observed that Section 66 of the Companies Act grants companies the ability to reduce their share capital “in any manner” they choose, provided it is done through a Board resolution, a special resolution, and is confirmed by the NCLT.

The Andhra Pradesh High Court, in the case of IL&FS Engineer and Construction Company Limited v. Wardha Power Company Limited, supported this view, stating that share capital reduction can be carried out “in any way.” The court pointed out that the statute does not prescribe a specific method for carrying out the reduction, nor does it prohibit any particular method. This stance was reiterated in In Re: Lily Realty Private Limited where the NCLT allowed share capital reduction under Section 66 and affirmed that the provision enables a company to pay off share capital to shareholders which cannot be reclassified as a buyback.

Section 66(6) of the Companies Act, 2013, which states that “nothing in this section shall apply to buy-back of its own securities by a company under Section 68,” is simply a clarifying provision. It makes clear that the rules for capital reduction under Section 66 do not apply to share buybacks.  Buyback of shares are separately governed by Section 68 of the Companies Act, 2013. Section 68 allows companies to repurchase their own securities up to a specified limit with the approval of the Board and shareholders without the need for NCLT approval. The NCLT in In Re: L&T Investment Management Limited explained that in a buyback under Section 68, shares are first tendered by shareholders and then cancelled, whereas in a capital reduction under Section 66, the shares are automatically cancelled upon NCLT approval. Companies can choose to undertake corporate actions either under Section 66 or Section 68, with each provision having distinct processes, approvals, and mechanisms that are mutually exclusive. In Max India Limited, Supreme Petrochemical Limited, Fairfield Atlas Limited, and Sai Service Private Limited, the NCLT had approved the reduction of share capital under Section 66 of the Companies Act. The tribunal held that capital reduction under Section 66 did not bypass the provisions of Section 68 of the Companies Act. Additionally, providing fair value to shareholders for an exit was not considered a share buyback, as noted in SM Dyechem Limited. Therefore, when the procedures outlined in Section 66 were properly followed by obtaining shareholder approval and NCLT sanction, the issue of circumventing Section 68 did not arise.

In Jadcherla Expressways Pvt Ltd., the NCLT observed that the Companies Act does not require a company to choose the buy-back route over the capital reduction route. A company is free to follow either the procedure under Section 66 or Section 68 of the Companies Act, as these provisions are independent of each other. The Madras High Court’s judgment in Re. Panruti Industrial Company (Private) Ltd. set a clear precedent by stating that share capital reduction is an internal matter for the company, decided by the majority of shareholders. In line with this, the Delhi High Court in Reckitt Benckiser (India) Ltd. v. Unknown emphasized that once share capital reduction is approved by the majority of shareholders, the court will generally confirm it, unless the transaction is found to be unfair, inequitable, or objected to by creditors.

Cost of Literalism: Implications on Corporate Governance

Principal-Agent Theory looks at the relationship between the shareholders (the principals) and the company management (the agents). Often, the agents (management) make decisions that benefit them rather than the shareholders and that creates a mismatch of interests. It leads to inefficiencies as the company might not be operating in the best interest of the shareholders. In Philips India Case, the minority shareholders were asking for an exit option because they could not sell their shares (since the company was delisted). The company’s proposed capital reduction could have been the solution that offered liquidity to these shareholders and resolve the conflict between them and the majority shareholder (the parent company). However, by rejecting the capital reduction, the NCLT created a situation where these minority shareholders were stuck with no way to exit, making the problem worse.

The Coase Theorem suggests that in the absence of transaction costs and when property rights are well-defined, private parties can negotiate solutions to disputes or inefficiencies without requiring government intervention. The theorem assumes that parties, when allowed to bargain freely, will arrive at the most economically efficient outcome regardless of who holds the initial entitlement, as long as transaction costs remain negligible. The essence of the theorem is that legal rules should minimize transaction costs and allow market participants to achieve optimal solutions through voluntary exchange. In the Philips India case, proposal for capital reduction was a mutually beneficial arrangement that would have allowed minority shareholders to liquidate their holdings while enabling the company to simplify its ownership structure. The majority and minority shareholders had clearly defined rights over their shares, and the proposed capital reduction was a voluntary arrangement. However, by imposing a rigid statutory interpretation, the NCLT disrupted this bargaining process and introduced unnecessary transaction costs. This contradicts Coase’s principle that the role of legal institutions should be to reduce, not introduce, transaction costs in private bargaining situations.

The ruling can also be viewed through the lens of externalities. Externalities are the costs or benefits that affect parties who did not choose to be involved in the situation. In this case, the minority shareholders, by being trapped in illiquid shares, incur an externality in the form of reduced liquidity. The broader market also feels the impact, as a company with a significant minority shareholding that cannot be monetized is not operating at its full potential in terms of capital allocation. This creates a less efficient market for Philips India’s shares, as the company’s equity is not reflecting the current value and utility it could have if all shareholders had an equal opportunity to realize the value of their investments. The NCLT’s decision, thus, prevents the company from effectively addressing these externalities by allowing minority shareholders to exit, which could have led to a more efficient and optimal capital structure. This also points to a negative externality where the lack of liquidity harms the broader market by creating inefficiency.

Conclusion

As seen in the cases mentioned earlier, the reduction of share capital is largely an internal matter for the company. Courts and tribunals play a limited role. Therefore, the NCLT’s interference in this instance exceeds the powers it holds when approving a capital reduction scheme. Additionally, the NCLT’s conclusion that Section 66 cannot be used for capital reduction unless the conditions in Section 66(a) or 66(b) are met disregards the plain wording of the provision which states that share capital may be reduced “in any manner.” The NCLT focused too narrowly on the specific conditions in Section 66(a) and 66(b) and overlooked the fact that the law allows for a more flexible approach to capital reduction. The order given by NCLT can be considered per incuriam as it contradicts established legal precedents that interpret “in any manner” in a broad and flexible way. The NCLT took an overly literal approach and ignored the consistent views expressed by other judicial bodies. It is important that the order be overturned on appeal to bring back clarity and consistency in the law on this issue.

The author is student of Gujarat National law University.