ANDHRA

PRADESH HIGH COURT

COMPANIES ACT

[2011] 105 SCL 717 (AP)

HIGH COURT OF ANDHRA PRADESH
Aurobindo Pharma Ltd., In re

V.V.S. RAO, J.
COMPANY PETITION NO. 79 OF 2009 AND COMPANY APPLICATION NO. 340 OF 2009
DECEMBER 31, 2009

Section 391, read with sections 80, 100 to 103, of the Companies Act, 1956 and
rule 79 of the Companies (Court) Rules, 1959 - Compromise and arrangement -
Whether unless and until resolution of company to create Capital Redemption
Reserve and use same for redemption of fully paid preference shares is
sanctioned and approved by Court, no such redemption can be resorted to - Held,
yes - Whether Capital Redemption Reserve can be applied only for redeeming
fully paid preference shares and/or issuing bonus shares to members; same
cannot be used for any other purpose - Held, yes - Petitioner-company sought for
sanction of scheme of arrangement - Under aforesaid scheme, amount standing
to credit of Capital Redemption Reserve (‘CRR’), was to be utilised towards
expenses of company especially those expenses as specified in clause 1.5 of
proposed scheme and, a Reconstruction Reserve Account (‘RRA’) was to be
created by transferring to it amount standing to credit of Capital Reserve
Account (‘CRA’), and crediting to it benefits accrued from buy-back of Foreign
Currency Convertible Bonds (‘FCCBs’) - Amount standing to credit of CRR had
been utilised by company for redemption of preference shares - Whether since
petitioner had redeemed preference shares from out of CRR without obtaining
permission of Court under sections 100 to 103, petitioner committed illegality -
Held, yes - Whether since total amount in CRR was utilized for redeeming
preference shares and, in balance sheet for financial year 2001-02 CRR was
shown as ‘NIL’, there was no question of again utilizing CRR towards adjusting
expenses - Held, yes - Whether since petition did not disclose as to whether
payment under buy back had been completed, and whether resources had been
created by opening escrow account for such purpose, mandatory condition of
RBI that FCCBs were to be bought back only by opening an escrow account with
specified banks, was not complied with by petitioner - Whether since in
shareholders’ meeting convened pursuant to order of Court, a special resolution
was passed to adjust amount standing of credit of CRR against planned expenses
but no special resolution was passed in relation to creation of RRA and transfer
to it, capital reserve and benefit accruing from buy-back of FCCBs, compliance
with section 391 could not be infered with - Held, yes - Whether in view of above
reasons, scheme of arrangement could not be approved and, thus, petition was to
be dismissed - Held, yes
 FACTS
The petitioner-company had filed the instant petition under sections 391 to 393, read
with sections 100 to 103, and rule 79 praying for sanction of scheme of arrangement with
its shareholders. The scheme of arrangement consisted of two aspects, firstly, utilization
of an amount of Rs. 9 crores standing to the credit of ‘Capital Redemption Reserve’ (CRR)
towards adjusting the expenses enumerated in clause 1.5 of the scheme and, secondly,
creation of ‘Reconstruction Reserve Account’ (RRA) by transferring/crediting an amount
of Rs. 9.3 crores standing to the credit of ‘Capital Reserve’ and the benefit accruing from
buy-back of ‘Foreign Currency Convertible Bonds’ (FCCBs). Said clause 1.5 enumerated
expenses towards writing off of obsolete or unrealizable assets, unrealizable loans and
advances, outstanding interest and other financial charges, amortization and/or write off
of goodwill, etc. The petitioner had issued redeemable non-convertible preference shares
to three entities, to the tune of Rs. 9 crores (9,00,000 preference shares of Rs. 100). The
said preference shares were redeemable on different dates, i.e., 17-5-2000 to 24-5-2000
and 20-10-2000. The petitioner purporting to comply with section 80(1)(d) credited out of
its profit an amount of Rs. 9 crores to CRR from the financial years 1997-98 to 2000-01.
After transferring amount to CRR, the petitioner redeemed preference shares allotted to
all the three entities on the respective due dates. To meet the financial requirements, the
petitioner had issued FCCBs on different occasions. The RBI had issued a circular
whereby it had permitted authorized dealer category-I banks to allow Indian companies
to prematurely buy-back FCCBs at a discounted price. The petitioner availed the
opportunity and bought back FCCBs at a discount to face value in the open market, and it
had reaped considerable benefits by such buy-back of FCCBs. As a part of Financial
Restructuring Exercise (FRE), the petitioner proposed to utilize capital reserve of Rs. 9.3
crores outstanding as on 31-3-2008 as well as benefit arising from buy-back of FCCBs on
discount for the purpose of meeting expenses as specified in clause 1.5 of the scheme at
the discretion of Board. The petitioner, thereafter, moved an application before the High
Court praying the Court to pass an order to convene the meeting of equity shareholders
for the purpose of consideration of the scheme. The said application was admitted and
meeting of the shareholders was convened. In the said meeting, 93.92 per cent of
shareholders voted in favour of resolution. The Board of Directors, (BODs) in their
meeting, had passed resolution wherein above-said scheme of arrangement was
approved. All of the secured creditors had accorded consent for creation of RRA. Insofar
as unsecured creditors were concerned, the petitioner perceived that they would not be
adversely affected with the proposed scheme because post-scheme assets would be
sufficient to discharge the liabilities. The petitioner had also obtained no objection letters
to the proposed scheme from the concerned stock exchanges.
Notice of hearing was published in two newspapers. No objection was received by the
Court nor any person appeared when the matter was heard. The RoC filed an affidavit
stating that the Central Government had no objection to the proposed scheme.
HELD
Court’s power to sanction scheme
It is settled that in all such cases as the instant one, the Court does not exercise its
appellate powers or review powers. It cannot sit in appeal over scheme of arrangement
between the company, its members and creditors. Court in a way acts as a ‘Corporate
Ombudsman’ to ensure that the scheme of arrangement/compromise among the
company, its members and creditors is fair and just and does not subvert public interest
or breach law. [Para 9]
The question that often confronts the Court is whether it can decline approval/sanction to
a scheme of arrangement, even when the majority of members approved the scheme in
the meeting convened pursuant to order of Court and all the creditors gave their consent
for the scheme. There cannot be any doubt that even in such a case, the Court can refuse
its approval if such scheme is found to contravene the law. The Court can reject sanction
if the scheme is found to have been conceived with ulterior motive of playing fraud on
public authorities. The Court can also withhold its imprimatur if it is found that in the
long run, such scheme is not in the interest of its members, creditors, employees and
subverts public interest. The Court can always throw out the scheme if it is intended to
legitimize the lapses and illegalities that crept into the corporate governance for which
persons at the helm of affairs of the company are alone responsible. Lastly, if the scheme
of arrangement is an inchoate transaction affecting future, the Court can always refuse
sanction. [Para 10]
Thus, the law providing for Court sanction for scheme is a safeguard against ultra vires
corporate excesses and is intended to subserve public interest. Of late, the corporate
world derives abundant sustained strength by State support which comes by way of
direct/indirect financial participation, subsidized infrastructural facilities, continuous
flow of supplies of human resources and sovereign guarantees where international
finances are involved. Therefore, even though the Court ought to view the scheme of
arrangement submitted for approval with deference to the wishes of proposers and
members, nevertheless the Court should be cautious not to be swayed by approval of
imposing majority. All decisions of majority at all times cannot be presumed to be legal or
legitimate, and corporate leadership cannot always be presumed to be correct in absolute
terms. The Court when called upon to examine a scheme for the purpose of according
sanction, must therefore keep in view not only the subject matter before it but also look
to effect of its decision on the future corporate arrangements. [Para 12]
Reduction of Share Capital vis-a-vis Capital Redemption Reserve
Capital includes ‘share capital’ which may again comprise equity share capital and
preference share capital. In addition to this, the reserve account created by the company
from out of its profits earned also forms a part of capital. A perusal of the provisions in
Part IV Schedule I and Schedule VI would show that the capital of the company consists
of mainly shareholders’ funds which include capital, reserves and surplus. When the
share capital together with reserves/surplus is found to be in excess of requirements of
the company, it would certainly be an unwise business proposition to carry on business
with such surplus capital. Therefore, the company, if its memorandum and articles so
authorize, can reduce its share capital. [Para 13]
The Companies Act primarily recognises three modes of reduction of share capital.
Regulation 46 of the Regulations for management of a company limited by shares (Table
A Schedule I) provides that a company may by special resolution reduce in any manner (i)
its share capital; (ii) any capital redemption reserve account; or (iii) any share premium
account. Section 100(1) indicates three ways of reducing its share capital. These are (i)
by extinguishing or reducing liability in respect of unpaid share capital; (ii) by cancelling
paid-up share capital which is lost or unrepresented by available assets; or (iii) by paying
off any paid-up share capital which is in excess of wants of the company. Any resolution
of the company to reduce share capital in any of the three ways needs confirmation of the
Court which is required to follow the procedure contemplated in sections 100 to 104 and
rules 46 to 65 of the Companies (Court) Rules. [Para 14]
In addition to the reduction of share capital as contemplated by section 100, the company
can also reduce its share capital in other two ways. Until recently, law barred a company
from purchasing its own shares. Section 77 prohibits a company to buy its own shares
unless consequent reduction of capital is effected and sanctioned in pursuance of
sections 100 to 104. By the Companies (Amendment) Act, 1999, with effect from 31-10-
1998, Parliament inserted sections 77A, 77AA, and 77B. Under section 77A, which is an
exception to section 77, a company may purchase or buy-back its own shares out of its
free reserves or securities premium account or proceeds of any shares or any other
specified securities not exceeding 25 per cent of total paid-up equity capital in a financial
year. It is now well-accepted that the companies’ decision to purchase or buy-back its
own shares from out of free reserves or share premium account is ‘an indirect method of
reducing capital of the company’. [Para 15]
In addition to reduction of capital by buy-back of shares, law also contemplates yet
another method of reduction of share capital. This is by way of a deemed provision, which
creates a fiction as if it amounts to reduction of share capital. Here, it was necessary to
refer to power of the company to issue redeemable preference shares and method of
redeeming such preference shares. [Para 16]
Section 80 deals with power of a company to issue and redeem preferential shares.
Unless and until the articles of association of a company permit to do so, preferential
shares cannot be issued. Even if the preferential shares are issued, they have to be
redeemed within a stipulated period. There cannot be any doubt that the amount, which
the company gets by issue of preferential shares forms part of the capital of a company. It
is very interesting as to how the law enables redemption of preference shares. The
proviso to sub-section (1) of section 80 contemplates the redemption of fully paid
preference shares in two ways, namely, (i) from out of the proceeds of fresh issue of
shares made for the purpose of redemption; and (ii ) from out of distributable profits.
Sub-section (3) of section 80 is to the effect that redemption of preference shares shall
not amount to reducing the amount of its authorized share capital. So to say, if fresh
issue of shares is made and if such proceeds of fresh issue of shares are utilized for
redemption of preference shares, it shall not be treated as reducing the authorized share
capital. However, if the company redeems fully paid-up preference shares from out of the
profits, it is required to follow the procedure applicable for reduction of share capital.
[Para 17]
Section 80(1) read with its proviso, especially clauses (a) and (d ) thereof is to the effect
that when shares are redeemed out of distributable profits, the company is required to
follow two things, namely, (i) to create and transfer to (from out of profits) CRR, and (ii)
to do so, follow the provisions of the Companies Act relating to reduction of share capital.
It may look little odd that when the proceeds of fresh issue of shares are utilized for
redemption of preference shares, provisions relating to reduction of share capital are not
applied but when distributable profits are utilized for reduction of the preference shares,
the provisions relating to reduction of share capital are applied. The intention of the
Legislature appeared to be the following. When the preference shares are to be
redeemed from out of the fresh issue of share capital, the company is required to issue
such fresh issue of shares specifically mentioning the purpose of such fresh issue,
namely, redemption of preference share capital. However, when the profits are earned
and for the purpose of compliance with the statute, portion of the profits are transferred
to general reserve or statutory reserve, as the case may be, no reduction of capital is
involved. The profits are ordinarily intended for various appropriations including
distribution of dividends. When once a portion of the profits are intended to be used for
redemption of preference shares, it results in reducing the profits available for
distribution and transfer to other reserve and thereby there is reduction of capital. There
cannot be any doubt that undistributed profits available to the company and its
shareholders form part of balance sheet but when once funds are transferred to CRR as
per proviso (d) to section 80(1), there is reduction of capital. [Para 18]
What is the stage at which a company is required to obtain sanction? Is it at the stage of
transferring from out of the profits to CRR or at the time of redemption of preference
shares utilizing the funds available in CRR? A plain reading of section 80(1)(d) would
make it clear that the company is entitled to transfer funds to CRR from out of the profits
if it resolves to redeem preference shares issued. As the statute itself permits the
company to transfer funds to CRR as and when profits accrue, no permission is required
at the stage of transfer. But having regard to the language used in clause (d) of proviso to
section 80(1), it is very clear that when once the CRR is used for redemption of
preference shares, the company has to necessarily move an application before the Court
and obtain permission for utilizing CRR for redemption, because if CRR, which is created
out of the profits, is used for redeeming preference shares, it results in diminishing of
capital. Therefore, unless and until the resolution of the company to create CRR and use
the same for redemption of fully paid preference shares is sanctioned and approved by
the Court, no such redemption can be resorted to. When once the amounts available in
CRR are utilised for redemption of preference shares, after approval of the Court, the
question of further availability of CRR does not arise. [Para 19]
The fully paid preference shares issued by a company are always redeemed at the face
value or at the issue price only. In a given case, if CRR created by the company exceeds
or far exceeds the face value of the redeemable fully paid preference shares, how this
CRR account has to be adjusted or used? Section 80(5) deals with a situation which
enables the company to apply CRR in paying up unissued shares of the company to be
issued to the members of the company as fully paid bonus shares. Section 80(5A)
contains non obstante clause and indicates that CRR can be applied only for redeeming
fully paid-up preference shares and/or for issuing bonus shares to the members. The
same cannot be used for any other purpose. [Para 20]
Thus, when a company has issued redeemable preference shares, created CRR in
accordance with proviso (d) to section 80(1) and redeemed preference shares, in
accounting practice, no amount remains as CRR. In such a case, there cannot be any
further prospect of utilising such non-existent CRR. Even if CRR which might remain in
the books of account or in the balance sheet, such account shall have to be used for
issuing bonus shares as per section 80(5A). Applying those principles, the case of the
petitioner insofar as first relief was concerned, needed to be considered. [Para 26]
Utilisation of Capital Redemption Reserve (CRR)
The instant Court had thoroughly perused the annual reports for the years 1997-98 to
2002-03, especially the balance sheet and schedules thereto, which gave the details of
the authorized and issued share capital, reserves and surplus funds. The total amount in
CRR, which was Rs. 9 crores was utilized for redeeming 9,00,000 preference shares. That
was reflected in Schedule-I to the balance sheet for the year ending 31-3-2001, and
issued, subscribed, paid-up preference share capital was shown as ‘Nil ’ because the
amount of Rs. 9 crores in CRR by the end of financial year 2000-01 was utilized for
redeeming preference shares by the end of that year. During next financial year, i.e.,
2001-02, in the balance sheet, CRR was shown as ‘Nil’ and only issued, subscribed and
paid-up equity capital was shown as share capital. That showed that by 31-3-2001, no
preference shares were required to be redeemed and ‘Nil’ amount was available in CRR.
Therefore, the question of again utilizing CRR towards adjusting expenses did not arise.
[Para 28]
The petitioner had not acted in compliance with the provisions of the law while
redeeming preference shares during 2000-01. As noticed supra , for creation and transfer
from out of the profit to CRR, the sanction of the Court is not required. But, as and when
CRR is used for redeeming preference shares, the company ought to have obtained the
sanction of the Court as if it is reduction of capital under sections 100 to 103. When
petitioner had redeemed preference shares in the year 2000-01 without obtaining
sanction of the instant Court under sections 100 to 103, the petitioner committed
illegality. After Court’s confirmation of the Minute for reduction of share capital and
publication thereof under section 102(2B), a certified copy thereof is to be produced
before the Registrar of Companies, who shall register the same and on such registration,
the Court order shall take effect. That only means that unless and until the order of the
Court confirming the Minute is registered by the Registrar of Companies, the preference
shares cannot be redeemed from out of the CRR. That procedure was not followed by the
petitioner. As could be seen from the three resolutions passed by the board of directors
that though the board of directors passed resolution for issue of redeemable non-
convertible preference shares to banks, there was no specific authorization to transfer
funds to CRR. The language of section 80(1) provisos (a ) and (d) is very clear that if the
preference shares are redeemed by issue of shares for the purpose, no permission is
required but when the preference shares are to be redeemed otherwise than from the
proceeds of the fresh issue of shares, the profits can be transferred to CRR only by the
resolution of the board of directors. Such a resolution was absent and, therefore, the
creation of CRR and transfer of profits were itself ultra vires the provisions of the Act.
[Para 29]
The petitioner had admittedly redeemed preference shares issued on two occasions. That
was done without there being compliance with section 103. Such non-compliance with
mandatory requirements of law amounted to contravention and attracted proviso (d) to
section 80(1) read with sections 100 to 103. The lapses and contravention attracted
proviso (d) to section 80(1) and were two fold. First, the petitioner redeemed preference
shares from out of CRR as seen from the balance sheets for the years 2000-01 and 2001-
02, without obtaining the permission of the Court under sections 100 to 103. Secondly,
though in the balance sheet for 2000-01, the amount of preference shares forming part of
share capital was shown as Nil and in balance sheet for 2001-02, CRR was shown as Nil,
in subsequent years from 2002-03 again, the balance available under CRR was shown as
Rs. 9 crore. When during 2001-02, CRR was shown as Nil, how the petitioner had shown
Rs. 9 crore as CRR in subsequent balance sheets. It was not their case that after
redeeming preference shares issued during 1997-98 and 1998-99, they again issued
preference shares and created another CRR. The explanation for such was not
forthcoming. Furthermore, when the preference shares were redeemed in 2000-01 from
out of the CRR created, the petitioner chose to file the instant petition long thereafter on
10-6-2009 and, therefore, the instant Court could not grant any order approving such
reduction as it would amount to approving illegal and ultra vires transaction of the
petitioner. [Para 30]
Reconstruction reserve account
The petitioner had proposed to undertake financial restructuring by creating
‘Reconstruction Reserve Account’ (RRA). It was proposed to create such RRA (i) by
transferring CRA of Rs. 9.30 crore as on 31-3-2008 to RRA; and (ii) by crediting the
amount of benefit arising from buy-back of FCCBs to RRA so that the said amounts would
be available to the board of directors for utilisation/application for the purposes
mentioned in paragraph 1.5 of the scheme of arrangement. For the sake of convenience,
above two aspects were dealt with separately. [Para 31]
Foreign Currency Convertible Bonds (FCCBs)
RBI has issued Circular bearing No. AP (DIR Series) Circular No. 39, dated 8-12-2008
permitting Authorised Dealer (AD) category-I Banks to allow Indian Companies to
prematurely buy-back FCCBs, if the buy-back value of the FCCBs is at minimum discount
of 15 per cent of the book value. The buy-back of FCCBs as was authorized by the RBI
was subjected to certain conditions. [Para 33]
The mandatory conditions stipulated in the Circular No. 39 require any company buying
back FCCBs to open an escrow account with an Indian bank or overseas bank or
International bank for buying back the FCCBs. It means that amounts in escrow account
could alone be used for buying back FCCBs. Further, the proceedings would not be in
contravention of FEMA. [Para 34]
The petitioner had not disclosed as to whether the payment under the buy-back had been
completed, and whether resources had been created by opening an escrow account for
such purpose. No details were forthcoming regarding source of funds to buy-back. There
was no mention of foreign currency internal accruals. The balance sheet for 2007-08
(provisional) and the provisional balance sheet for 2008-09 were also not clear as to the
buy-back of funds. The company petition was filed on 10-6-2009 and by that date, the
buy-back was not completed. Therefore, unless and until the actual benefit that was
accrued to the company from out of the buy-back at discounted price, and was shown in
balance sheet, it could not be assumed that benefit would accrue to the company.
Secondly, board of directors passed resolution to buy-back and cancel the FCCBs, in
which event, the alleged accruals would have been nil. It is well-settled that when a
scheme of arrangement is submitted for approval, a company is required to place all the
details to enable the Court to consider its vires before granting approval. It was not clear
as to how much benefit would accrue to the petitioner. It was also not clear whether such
accruals could be permitted to be utilized for creation of RRA authorizing the board of
directors to use the funds for the purpose enumerated in clause 1.5 of the scheme of
arrangement. In the absence of all the details, the instant Court was not inclined to
approve the scheme of arrangement with regard to creation of RRA by transferring the
benefits to be accrued from buy-back of FCCBs. [Para 37]
Capital reserve account
The scheme of arrangement was approved by board of directors of the petitioner and the
MD, CFO and company secretary were authorized to take all necessary steps in
compliance with the Act and Rules. The board of directors also had resolved for
constitution of restructuring committee to give effect to the scheme. It was not clear
from the resolution whether the board of directors had considered pointedly and
specifically the transfer of capital reserve as on 31-3-2008 to RRA for the year ended 31-
3-2009 for being utilized towards adjusting expenses as mentioned in clause 1.5 of the
scheme. Assuming that the board of directors had applied their mind to such aspect of
the matter, the question which was to be looked into was whether CRA could be
permitted to be utilized for creation of RRA to write off towards intangible assets,
towards unrealizable loans, interest financial charges, outstanding receivables, to write
off/amortization of goodwill, etc. [Para 38]
There cannot be any dispute, that the capital reserve can be utilized by the company for
the purposes authorized in law and in such a case, no permission of the Court is required.
It is a matter of good corporate practices and business prudence whether or not capital
reserve be utilized for meeting a particular contingency. But when the CRA is directly or
indirectly used in a manner that it results in reduction of share capital, the permission of
the Court is required. The purposes for which RRA was sought to be used in the instant
case were certainly not the purpose for which CRA could be utilized as noticed above.
[Para 39]
The term ‘capital reserve’ is defined in ICAI Guidance Notes as a reserve of a corporate
enterprise which is not available for distribution as dividend. It means that when once
capital reserve is created, the same cannot be utilized for any other purpose except for
the purpose for which it is intended. Capital reserve cannot be used even for distribution
for dividend. The revenue reserve unlike capital reserve is considered as free reserve
available for issue of bonus shares. Further, capital reserves are derived from non-trading
operations of the company and reserve so created out of the realization is termed as
capital reserve. As per Schedule VI, Part III of the Act, the reserve shall not include any
amount written off or retained by way of providing depreciation, renewals or diminution
in value of assets or retained by way of providing for any unknown liability, which cannot
be determined with substantial accuracy. From that, it became clear that capital reserve
cannot be used for writing off loss or for adjusting towards diminution of value of assets
etc. [Para 41]
Whether members of petitioner-company had approved the scheme under
sections 391(1) and (2)
The instant Court had appointed chairperson to convene the meeting of equity
shareholders to consider and approve the resolution to support the scheme of
arrangement proposed by the board of directors of the petitioner-company. The
chairperson convened the meeting of the shareholders. In all, 177 shareholders (either in
person or through proxies/representations) of the petitioner-company representing
3,49,88,412 equity shares of Rs. 5 each aggregating to Rs. 17,49,42,060 attended the
meeting. Out of them, 93.92 per cent of shareholders voted and approved the resolutions,
which were three in numbers. [Para 45]
Resolution 1 and resolution 3 were in general terms. Resolution 2 passed by majority
shareholders presented in the meeting authorized petitioner-company to adjust the
amount standing to the credit of CRR as on 31-3-2008 against planned expenses. There
was no such special resolution passed by equity shareholders in the meeting convened by
chairperson appointed by the instant Court in relation to creation of RRA and transfer to
it, capital reserve and/or the benefit accruing from buy-back of FCCBs. When there was
no specific resolution by equity shareholders, compliance with section 391 could not be
infered. If the intention was to obtain general approval for the scheme of arrangement,
there was no necessity for moving special resolution. When the equity shareholders
approved special resolution with regard to adjusting CRR, nothing prevented passing a
similar special resolution with regard to transfer of capital reserve and/or FCCB benefit
to RRA. When the scheme of arrangement was proposed by board of directors with
regard to three aspects, and a special resolution was passed only with reference to one
subject concurrence of majority shareholders could not be infered with reference to other
aspects. That was also one of the reasons which would disqualify the petition for
approval. [Para 46]
In annual reports and balance sheets of the petitioner for the years 2000-01 to 2007-08,
there was no indication for utilizing capital reserve for the purposes intended by
transferring to RRA. As capital is not a free reserve, it cannot be allowed for payment of
any future liability or for depreciation of assets or for bad debts. The petitioner proposed
to transfer capital reserve account to RRA to write-off capital lost and other losses. That
is not permissible under law. Therefore, the instant Court was not inclined to approve the
scheme of arrangement as proposed. [Para 47]
The company petition, therefore, was to be dismissed. [Para 48]
CASES REFERRED TO

Miheer H. Mafatlal v. Mafatlal Industries Ltd. [1996] 10 SCL 70 (SC) (para 9), Hindustan
Lever Employee’s Union v. Hindustan Lever Ltd. [1995] 2 SCL 157 (SC) (para 9), British &
American Trustee & Finance Corpn. v. John Couper [1894] AC 399 (HL) (para 11), Traver v.
Witworth [1887] 12 AC 409 (HL) (para 15), Ramesh B. Desai v. Bipin Wadilal Mehta [2006] 69
SCL 211 (SC) (para 15), Birla Global Finance Ltd., In re [2004] 50 SCL 387 (Bom.) (para
25), CIT v. Century Spg. & Mfg. Co. AIR 1953 SC 501 (para 42), CIT v. Veeraswami Nainar [1965]
55 ITR 35 (Mad.) (para 43) and Indian Overseas Bank v. CIT AIR 1970 SC 1530 (para 44).

S. Ravi for the Petitioner. M. Anil Kumar for the Official Liquidator.
ORDER
1. This petition under sections 391 to 393, read with sections 100 to 103, of the
Companies Act, 1956, and Rule 79 of Companies (Court) Rules, 1959 (the Rules, for
brevity) is filed by M/s. Aurobindo Pharma Limited (hereinafter, Aurobindo) praying for
sanction of Scheme of Arrangement between company and its shareholders. The Scheme
of Arrangement concerns with two aspects, namely, (i) utilizing an amount of Rs. 91
crores standing to the credit of ‘Capital Redemption Reserve’ (CRR) towards adjusting
the expenses enumerated in clause 1.5 of the Scheme; and (ii) creation of ‘Reconstruction
Reserve Account’ (RRA) by transferring/crediting an amount of Rs. 90.30 million standing
to the credit of ‘Capital Reserve’ and the benefits accruing from buy-back of ‘Foreign
Currency Convertible Bonds’ (FCCBs) and for utilizing ‘RRA’ for all or any of the
expenses as enumerated in clause 1.5, which reads as under :
1.5"Expenses" means and without limiting the generality of the foregoing, includes, inter
alia, the following items accounted for in the financial statements of Aurobindo :
1.5.1Amount to be written off towards obsolete or unrealizable assets, whether
tangible or intangible or fixed or current;
1.5.2Any unrealizable loans and/or advances, whether recoverable in cash or in
kind, whether belonging to Aurobindo or its Subsidiaries and arising on
preparation of stand alone and/or Consolidated Financial Statements of
Aurobindo;
1.5.3Interest and other financial charges receivable and outstanding for such
period as may be determined by the Board on loans/advances made to
subsidiaries;
1.5.4Impairment, amortization and/or write off of goodwill;
1.5.5Diminution in the value of investments in subsidiary companies and/or Joint
Ventures of Aurobindo and/or any of its subsi-diaries and consequent
impairment of goodwill and accu- mulated losses of such subsidiaries on
consolidation, in the financial Statement of Aurobindo;
1.5.6Impairment/diminution/realisation losses, if any on investments other than as
mentioned in clause 1.5.5 above, whether current or long-term or quoted or
unquoted, or trade or non-trade;
1.5.7Such other expenses, cost, impairments, write offs and diminution, as
considered necessary by the Board from time to time;
1.5.8For the purposes of this clause, if any issue/question arises with respect to
identification and/or qualification of the nature and amount of the expenses,
the decision/clarification of the Board shall be final.
Background of the Scheme
2. Aurobindo is a company registered under the Companies Act. Its authorized share
capital is Rs. 500 million consisting of 100 million equity shares of Rs. 5 each and one
million preference shares of Rs. 100 each. 53,765,268 equity shares of Rs. 5 each have
been issued, subscribed and paid-up amounting to Rs. 268.80 million. These shares are
listed on National Stock Exchange Limited and Bombay Stock Exchange Limited.
Aurobindo is in the business of manufacturing, marketing, chemicals, intermediaries,
drugs, formulations, dyestuffs etc. The Board of Directors in their meeting held on 31-3-
2009 allegedly passed resolution approving the Scheme of Arrangement between the
company and its shareholders to utilise the amounts standing in the credit of CRR as on
31-3-2008 towards expenses of the company especially those expenses as enumerated in
clause 1.5 of the Scheme and/or transferring the said amount as well as the benefits
accruing from buy-back of FCCBs to RRA towards adjusting expenses as referred to
hereinabove. The details of these two aspects of the Scheme are as below.
3. Aurobindo issued 12.5 per cent redeemable non-convertible preference shares to an
extent of Rs. 50 lakhs (50,000 shares of Rs. 100 each) during the financial year 1997-98
to Canara Bank. For the financial year 1998-99, the company issued preference shares to
an extent of Rs. 4,50,00,000 (4,50,000 preference shares of Rs. 100 each) on 17-11-1998
to SBI Capital Marks Limited, Mumbai; and preference shares to an extent of Rs.
4,00,00,000 (4,00,000 preference shares of Rs. 100 each) to Global Trust Bank Limited,
Mumbai on 24-11-1998. These are redeemable on 17-5-2000 and on 24-5-2000
respectively. The company purporting to comply with section 80(1)(d) of the Companies
Act credited out of its profit to CRR during the period commencing from financial years
1997-98 to 2000-01. The details of amounts credited to CRR from out of profits is as
follows:

Sl. No. Financial Year ending in 31st March Amount credited

(in 000s)

1. 1998 46.58

2. 1999 13,388.13

3. 2000 65,475.29

4. 2001 11,090.00

Total 90,000.00

4. After transferring amounts to CRR in four financial years, Aurobindo redeemed

preference shares allotted to Canara Bank on 20-12-2000. The shares allotted to SBI
Capital Markets and Global Trust Bank were redeemed on 17-5-2000 and 25-5-2000
respectively. To that effect, the company also filed Form No. 5 in accordance with
sections 95, 97, 97A(2) and 81(4) of the Companies Act with the Registrar of Companies
(RoC).
5. To meet financial requirements, Aurobindo issued FCCBs twice in 2005-06 and 2006-
07. The first of these two issues is for 60 million US$ due on 2010 convertible into
ordinary shares of Aurobindo. The second one was in two tranches. Tranch A is for US$
150 million and tranch B is Rs. 50,000,000. The first issue is redeemable on 11-8-2010
and the second issue is redeemable on 11-8-2010 and on 17-5-2011. Reserve Bank of
India (RBI) issued policy directions vide A.P. (DIR Series) Circular No. 39, dated 8-12-
2008 under sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999
(FEMA) for buy-back/per payments of FCCBs at a discount of 15 per cent or 25 per cent
as the case may be. The Companies were required to complete the buy-back by 31-3-
2009. By yet another Circular No. 58, dated 13-3-2009, the time has been extended up to
31-12-2009 for the purpose of buy-back at a discounted price. Statedly, RBI allowed buy-
back at a discounted price as market value of Indian Companies were downgraded due to
global economic situation. Aurobindo availed opportunity and bought back FCCBs at a
discount to face value in the open market and appears to have reaped considerable
benefit by such buy-back of FCCBs. As a part of Financial Restructuring Exercise (FRE),
Aurobindo proposed to utilize capital reserve of Rs. 90 million allegedly outstanding as on
31-3-2008 as well as the benefit arising from buy-back of FCCBs on discount for the
purpose of meeting expenses at the discretion of Board.
6. Aurobindo moved an application before the High Court under sections 391 to 393,
read with sections 100 to 103, of the Companies Act praying this Court to pass an order
to convene the meeting of equity shareholders for the purpose of considering the scheme.
The application being Company Application No. 340 of 2009 was ordered and an
advocate was appointed as Chairperson to convene the meeting of shareholders.
Accordingly, meeting was convened on 21-5-2009 at the place designated by the Court.
After doing so, Chairperson filed a report. The meeting was attended (out of 45,300) by
109 members (76 persons, 27 proxies and 6 corporate members). In the meeting held by
chairperson, members representing 3,49,87,258 number of shares of Rs. 5 each, 94.50
per cent (103 members) with Rs. 3,28,68,148 (93.92 per cent) voted in favour of
resolutions which were considered.
7. Aurobindo statedly has eight secured creditors, namely, Andhra Bank, Canara Bank,
ICICI Bank, IDBI Bank, HDFC Bank, State Bank of Hyderabad, State Bank of India and
Standard Chartered Bank. It appears all of them accorded consent for creation of RRA.
Insofar as unsecured creditors are concerned, Aurobindo perceives that they will not be
affected adversely with the proposed Scheme because post-Scheme assets will be
sufficient to discharge the liabilities. Aurobindo also obtained no objection letters to the
proposed Scheme from Bombay Stock Exchange and National Stock Exchange.
Therefore, this application is filed under sections 391 to 393, read with sections 100 to
103, of the Companies Act. This Court ordered notice to Central Government while
directing publication of notice of hearing in two newspapers. Aurobindo’s counsel took
out notice and also served papers on Central Government i.e., Regional Director,
Department of Company Affairs, Chennai. No objections have been received by the Court
nor any person appeared when the matter was heard. The Registrar of Companies (RoC)
purporting to act under authorization issued by Regional Director of Department of
Corporate Affairs filed an affidavit stating that Central Government decided not to make
any objection to the proposed Scheme.
8. This Court heard learned counsel for Aurobindo on 7-7-2009 and 8-7-2009 and
reserved the Orders. Again, the matter was directed to be listed ‘For Being Mentioned’
for certain clarifications on 20-7-2009 and 27-7-2009. The counsel reiterated the
principles governing the cases under the Companies Act which require sanction/approval
of the Court like scheme of compromise/arrangement or financial reconstruction or a
scheme of amalgamation.
Court’s power to sanction Scheme
9. It is settled that in all such cases the Court does not exercise its appellate powers or
review powers. It cannot sit in appeal over Scheme of Arrange-ment between the
company, its members and creditors. Court in a way acts as a ‘Corporate Ombudsman’ to
ensure that the Scheme of Arrange-ment/compromise among the company, its members
and creditors is fair and just and does not subvert public interest or breach law. In
Miheer H. Mafatlal v. Mafatlal Industries Ltd. [1996] 87 Comp. Cas. 7911, Supreme Court
considered the scope of power vested in Court while dealing with ex parte applications
and petitions under the Companies Act and Companies Rules seeking sanction/approval
of the Court for the Scheme of Arrangement. Referring to Hindustan Lever Employee’s
Union v. Hindustan Lever Ltd. [1995] 2 SCL 157 (SC), the following principles were
laid down :
"1.The sanctioning Court has to see to it that all the requisite statutory procedure for
supporting such a scheme has been complied with and that the requisite meetings as
contemplated by section 391(1)(a) have been held.

2.That the scheme put up for sanction of the Court is backed up by the requisite majority
 vote as required by section 391(2).
3.That the concerned meetings of the creditors or members or any class of them had the
relevant material to enable the voters to arrive at an informed decision for approving
the scheme in question. That the majority decision of the concerned class of voters is
just and fair to the class as a whole so as to legitimately bind even the dissenting
members of that class.

4.That all the necessary material indicated by section 391(1)(a) is placed before the voters at
the concerned meetings as contemplated by section 391(1).

5.That all the requisite material contemplated by the proviso to sub-section (2) of section 391
of the Act is placed before the Court by the concerned applicant seeking sanction for
such a scheme and the Court gets satisfied about the same.

6. That the proposed scheme of compromise and arrangement is not found to be violative of
any provisions of law and is not contrary to public policy. For ascertaining the real
purpose underlying the scheme with a veil to be satisfied on this aspect. The Court, if
necessary, can pierce the view of apparent corporate purpose underlying the scheme
and can judiciously X-ray the same.

7.That the company Court has also to satisfy itself that members or class of members or
creditors or class of creditors, as the case may be, were action bona fide and in good
faith and were not coercing the minority in order to promote any interest adverse to
that of the latter comprising the same class whom they purported to represent.

8.That the scheme as a whole is also found to be just, fair and reasonable from the point of
view of the prudent men of business taking a commercial decision beneficial of the
class represented by them for whom the scheme is meant.

9.Once the aforesaid broad parameters about the requirement of a scheme for getting
sanction of the Court are found to have been met, the Court will have no further
jurisdiction to sit in appeal over the commercial wisdom of the majority of the class of
persons who with their open eyes have given their approval to the scheme even if in the
view of the Court there could be a better scheme for the company and its members or
creditors for whom the scheme is framed. The Court cannot refuse to sanction such a
scheme on that ground as it would otherwise amount to the Court exercising appellate
jurisdiction over the scheme rather than its supervisory jurisdiction." [Emphasis
supplied]

10. The question that often confronts the Court is whether it can decline
approval/sanction to a Scheme of Arrangement, even when the majority of members
approved the scheme in the Court convened meeting and all the creditors gave their
consent for the scheme. There cannot be any doubt that even in such a case, the Court
can refuse its approval if such scheme is found to contravene the law. The Court can
reject sanction if the scheme is found to have been conceived with ulterior motive of
playing fraud on public authorities. The Court can also withhold its imprimatur if it is
found that in the long run such scheme is not in the interest of its members, creditors,
employees and subverts public interest. Needless to mention that the Court can always
throw out the scheme if it is intended to legitimize the lapses and illegalities that crept
into the corporate governance for which persons at the helm of affairs of the company
are alone responsible. Lastly if the Scheme of Arrangement is an inchoate transaction
affecting future, the Court can always refuse sanction.
11. In British & American Trustee & Finance Corpn. v. John Couper [1894] AC 399 (HL),
the importance and sanctity of curial sanction to a Scheme of Arrangement was
explained by House of Lords in a case wherein the Scheme of Arrangement envisaged
reduction of capital by paying off the shares of one group of members was approved
observing as under :
I do not see any danger in the conclusion that the Court has power to confirm such a
scheme as that now in question, or any reason to doubt that this was the intention of the
Legislature. The interests of creditors are not involved, and I think it was the policy of the
Legislature to entrust the prescribed majority of the shareholders with the decision
whether there should be a reduction of capital, and if so, how it should be carried into
effect. The interests of the dissenting minority of the shareholders (if there be such) are
properly safeguarded by this: that the decision of the majority can only prevail if it be
confirmed by the Court.
12. Thus, the law providing for Court sanction for scheme is a safeguard against ultra
vires corporate excesses and is intended to subserve public interest. Of late, the
corporate world derives abundant sustained strength by State support which comes by
way of direct/indirect financial partici-pation, subsidized infrastructural facilities,
continuous flow of supplies of human resources and sovereign guarantees where
international finances are involved. Therefore, even though the Court ought to view the
Scheme of Arrangement submitted for approval with deference to the wishes of
proposers and members, nevertheless the Court should be cautious not to be swayed by
approval of imposing majority. All decisions of majority at all times cannot be presumed
to be legal or legitimate, and corporate leadership cannot always be presumed to be
correct in absolute terms. The Court when called upon to examine a scheme for the
purpose of according sanction, must therefore keep in view not only the subject matter
before it but also look to effect of its decision on the future corporate arrangements.
Reduction of Share Capital vis-a-vis Capital Redemption Reserve
13. Capital includes ‘share capital’ which may again comprise equity share capital and
preference share capital (Sections 85 and 86 of Companies Act). In addition to this, the
reserve account created by the company from out of its profits earned also forms part of
capital. A perusal of the provisions in Part IV Schedule I and Schedule VI would show that
the capital of the company consists of mainly shareholders’ funds which include capital,
reserves and surplus. When the share capital together with reserves/surplus is found to
be in excess of requirements of the company, it would certainly be an unwise business
proposition to carry on business with such surplus capital. Therefore, the company, if its
Memorandum and Articles so authorize, can reduce its share capital.
14. Companies Act primarily recognises three modes of reduction of share capital.
Regulation 46 of the Regulations for management of a company limited by shares (Table
A Schedule I) provides that a company may by special resolution reduce in any manner (i)
its share capital; (ii) any capital redemption reserve account; or (iii) any share premium
account. Section 100(1) indicates three ways of reducing its share capital. These are (i)
by extinguishing or reducing liability in respect of unpaid share capital; (ii) by cancelling
paid-up share capital which is lost or unrepresented by available assets; or (iii) by paying
off any paid-up share capital which is in excess of wants of the company. Needless to
mention that any resolution of the company to reduce share capital in any of the three
ways needs confirmation of the Court which is required to follow the procedure
contemplated in sections 100 to 104 the Companies Act and Rules 46 to 65 of the
Companies (Court) Rules.
15. In addition to the reduction of share capital as contemplated by section 100 of the
Companies Act, the company can also reduce its share capital in other two ways. Until
recently, law barred a company from purchasing its own shares. Section 77 of the
Companies Act prohibits a company to buy its own shares unless consequent reduction of
capital is effected and sanctioned in pursuance of sections 100 to 104 of the Companies
Act. By Companies (Amendment) Act, 1999, with effect from 31-10-1998, Parliament
inserted sections 77A, 77AA, and 77B. Under section 77A, which is an exception to
section 77, a company may purchase or buy-back its own shares out of its free reserves
or securities premium account or proceeds of any shares or any other specified securities
not exceeding 25 per cent or total paid-up equity capital in a financial year. It is now well
accepted that the companies decision to purchase or buy-back its own shares from out of
free reserves or share premium account is "an indirect method of reducing capital of the
company" (See Traver v. Witworth [1887] 12 AC 409 (HL) and Ramesh B. Desai v. Bipin
Wadilal Mehta [2006] 69 SCL 211 (SC).
16. In addition to reduction of capital by buy-back of shares, law also contemplates yet
another method of reduction of share capital. This is by way of a deemed provision, which
creates a fiction as if it amounts to reduction of share capital. Here it is necessary to
refer to power of the company to issue redeemable preference shares and method of
redeeming such preference shares. For ready reference, section 80 of the Companies Act
to the extent relevant [comitting sub-sections (2), (4), (5A) and (6)], is extracted below :
"80. Power to issue redeemable Preference Shares.—(1) Subject to the provisions of this
section, a company limited by shares may, if so authorized by its articles, issue preference
shares which are, or at the option of the company are to be liable, to be redeemed :

Provided that—

(a )no such shares shall be redeemed except out of profits of the company which would
otherwise be available for dividend or out of the proceeds of a fresh issue of shares
made for the purposes of the redemption;

(b )no such shares shall be redeemed unless they are fully paid;

(c )the premium, if any, payable on redemption shall have been provided for out of the profits
of the company or out of the company’s security premium account, before the shares
are redeemed;

(d )where any such shares are redeemed otherwise than out of the proceeds of a fresh issue,
there shall, out of profits which would otherwise have been available for dividend, be
transferred to a reserve fund, to be called the capital redemption reserve account, a
sum equal to the nominal amount of the shares redeemed; and the provisions of this Act
relating to the reduction of the share capital of a company shall, except as provided in
this section, apply as if the capital redemption reserve account were paid-up share
capital of the company.

(3) The redemption of preference shares under this section by a company shall not be taken
as reducing the amount of its authorized share capital.

(5) The capital redemption reserve account may, notwithstanding anything in this section, be
applied by the company, in paying up unissued shares of the company to be issued to
 members of the company as fully paid bonus shares."

17. The provision deals with power of a company to issue and redeem preferential
shares. Unless and until the Articles of Association, of a company permit to do so,
preferential shares cannot be issued. Even if the preferential shares are issued, they have
to be redeemed within a stipulated period. There cannot be any doubt that the amount,
which the company gets by issue of preferential shares forms part of the capital of a
company. It is very interesting as to how the law enables redemption of preference
shares. The proviso to sub-section (1) of section 80 of the Companies Act contemplates
the redemption of fully paid preference shares in two ways, namely, (i) from out of the
proceeds of fresh issue of shares made for the purpose of redemption; and (ii) from out of
distributable profits. Sub-section (3) of section 80 of the Companies Act is to the effect
that redemption of preference shares shall not amount to reducing the amount of its
authorized share capital. So to say, if fresh issue of shares is made even if such proceeds
of fresh issue of shares are utilized for redemption of preference shares, it shall not be
treated as reducing the authorized share capital. However, if the company redeems fully
paid-up preference shares from out of the profits, it is required to follow the procedure
applicable for reduction of share capital.
18. Section 80(1) read with its proviso, especially clauses (a) and (d) thereof is to the
effect that when shares are redeemed out of distributable profits, the company is
required to follow two things, namely, (i) to create and transfer to (from out of profits)
Capital Redemption Reserve (CRR) and (ii) to do so, follow the provisions of the
Companies Act relating to reduction of share capital. It may look little odd that when the
proceeds of fresh issue of shares are utilized for redemption of preference shares,
provisions relating to reduction of share capital are not applied but when distributable
profits are utilized for reduction of the preference shares, the provisions relating to
reduction of share capital are applied. The intention of Legislature appears to be the
following. When the preference shares are to be redeemed from out of the fresh issue of
share capital, the company is required to issue such fresh issue of shares specifically
mentioning the purpose of such fresh issue, namely, redemption of preference share
capital. However, when the profits are earned and for the purpose of compliance with the
statute, portion of the profits are transferred to general reserve or statutory reserve, as
the case may be, no reduction of capital is involved. The profits are ordinarily intended
for various appropriations including distribution of dividends. When once a portion of the
profits are intended to be used for redemption of preference shares, it results in reducing
the profits available for distribution and transfer to other reserve and thereby there is
reduction of capital. There cannot be any doubt that undistributed profits available to the
company and its shareholders form part of balance sheet but when once funds are
transferred to CRR as per section 80(1) proviso (d) of the Companies Act, there is
reduction of capital.
19. What is the stage at which a company is required to obtain sanction? Is it at the stage
of transferring from out of the profits to CRR or at the time of redemption of preference
shares utilizing the funds available in CRR? A plain reading of section 80(1)(d) of the
Companies Act would make it clear that the company is entitled to transfer funds to CRR
from out of the profits if it resolves to redeem preference shares issued. As the statute
itself permits the company to transfer funds to CRR as and when profits accrue, no
permission is required at the stage of transfer. But, having regard to the language used in
clause (d) of proviso to sub-section (1) of section 80 of the Companies Act, it is very clear
that when once the CRR is used for redemption of preference shares, the company has to
necessarily move an application before the Court and obtain permission for utilizing CRR
for redemption, because if CRR, which is created out of the profits, is used for redeeming
preference shares, it results in diminishing of capital. Therefore, unless and until the
resolution of the company to create CRR and use the same for redemption of fully paid
preference shares is sanctioned and approved by the Court, no such redemption can be
resorted to. When once the amounts available in CRR are utilized for redemption of
preference shares, after approval of the Court, the question of further availability of CRR
does not arise.
20. The fully paid preference shares issued by a company are always redeemed at the
face value or at the issue price only. In a given case, if CRR created by the company
exceed or far exceeds the face value of the redeemable fully paid preference shares, how
this CRR Account has to be adjusted or used? Section 80(5) of the Companies Act deals
with a situation which enables the company to apply CRR in paying up unissued shares of
the company to be issued to the members of the company as fully paid bonus shares.
Section 80(5A) of the Companies Act contains non obstante clause and indicates that
CRR can be applied only for redeeming fully paid-up preference shares and/or for issuing
bonus shares to the members. The same cannot be used for any other purpose.
21. The above view is also supported by the ‘Textbook Writers’, C.R. Datta, the learned
Author "the Company Law" (sixth edition, 2008) elucidated the legal position as under :
"Redemption [sub-section (1), proviso].—Redeemable preference shares can be redeemed
only on the following conditions :

(a)Such shares can be redeemed out of distributable profits (profits which would otherwise
have been available for dividend) or out of the proceeds of a fresh issue of shares for
this purpose.

(b )Such shares must be fully paid-up.

(c )Any premium to be paid on redemption of such shares must have been provided for out of
profits or out of the securities premium account.

(d )If the redemption is out of distributable profits, profits equivalent to nominal amount of
preference shares redeemed must be transferred to the Capital Redemption Reserve
Account. The Capital Redemption Reserve Account will be treated as share capital and
the provisions as regards reduction of the share capital shall apply. But, Capital
Redemption Reserve Account may be utilised in issuing fully paid Bonus Shares; this
will not be treated as reduction of capital [sub-section (5)]."

22. Dealing with interplay between section 80(1) and section 100(1) of the Companies
Act, the learned Author comments as follows :
Section 100 may be invoked for reduction of any capital including the Preference Shares,
subject to approval of the Court with the object that the company may pay back to the
shareholders any paid-up share capital which is in excess of its wants. The redemption of
preference shares is nothing but repayment of the preference capital and amounts to
reducation of share capital. The three methods mentioned in clauses (a), (b) and (c ) of
sub-section (1) of section 100 of the Companies Act, 1956, are only illustrative and are
not exhaustive. A company may seek to redeem the share capital in any way and even in
a manner not covered by clauses (a), (b ) and (c) of sub-section (1) of section 100. The
words ‘Pay off any paid-up capital’ appearing in clause (c) indicate that even the
preference share capital can be paid off subject to the conditions laid down in section
100 of the Act. Section 100 makes no distinction between preference share capital and
equity share capital. Thus, the equity share capital as well as the preference share capital
of a company can be reduced in any way, if authorised by the Articles, by a Special
Resolution of the company subject to sanction of the Court. The preference shares could
be redeemed by the directors or the shareholders.
23. K.M. Ghosh and Dr. K.R. Chandratre in their ‘Company Law’ (thirteenth edition,
2006-07, p. 1472) also commented in a similar manner, as extracted herein.
According to sub-section (1)(a ), redemption can be done only: (a) out of profits which
could otherwise have been available for dividend, or (b) out of the proceeds of a fresh
issue of shares made for the purpose of redemption. It should be noted that, balance of
profits as appearing in the balance sheet cannot, strictly speaking, be called a source of
funds to meet the requirement of funds (cash) for redemption of shares. If a company
intends to redeem its preference shares out of profits, it must have not only profits
sufficient to be reduced by a sum of the face value and of the premium payable on the
redemption but also liquid cash sufficient to meet its obligation of payment to the
shareholders whose securities are bought. Thus, free reserves or securities premium are
not the sources of funds for buying back securities. A company intending to buy its
shares/other securities must have at the time of buy-back, balance in any one or more of
these accounts which is sufficient to accommodate the total value of the buy-back.
The sanction of the Court under section 100 of the Act would be necessary even where
preference shares are to be redeemed out of capital redemption reserve account created
out of the profits of the company. Again the principle of maintenance of the capital is
preserved for the protection of the creditors of the company and sanction of the Court is
necessary for reduction of the capital even for redemption of preference shares out of
capital redemption reserve account. [Emphasis supplied]
24. The learned author also dealt with the interplay between sections 80(1) and 100(1) of
the Companies Act in the following manner :
"Under clause (c) of sub-section (1) of section 100, a company can pay back to the
shareholder any paid-up share capital which is in excess of wants of the company.
Redemption of the preference shares is nothing but paying back to the shareholders their
preference share capital. This can be done subject to confirmation by the Court if the capital
is in excess of the wants of the company and the company is so authorised by its articles and
the company passes a special resolution to that effect. Therefore, preference shares can be
redeemed not only in accordance with section 80 but, also in accordance with the provisions
of section 100 of the Act. If the shares are to be redeemed not out of the fresh issue of shares
made for that purpose nor out of the profits which would otherwise be available for dividend
as required under section 80, provisions of section 100 of the Act would have to be complied.
Two independent procedures are available to a company for redemption of preference shares.
It may redeem the shares by following the procedure laid down under section 80 of the Act
which is a special provision meant for redemption of preference shares or if any take
recourse to the general provision under section 100 of the Act which is applicable for
reduction of any capital including preference capital, in any manner." [Emphasis supplied]
25. In Birla Global Finance Ltd., In re [2005] 126 Comp. Cas. 647 1 Bombay High
Court dealt with the issue of redemption of preference shares by creation of CRR. It is
observed therein as follows :
"Money required for redemption of preference shares can be obtained out of two sources
under section 80. The first source is out of the proceeds of a fresh issue of shares made for
the purpose of redemption and the second source is out of profits of the company which
would otherwise be available for dividend. In the former case, where preference shares are to
be redeemed out of the proceeds of a fresh issue of shares made for the purpose of
redemption, there is no reduction in the capital of the company for an amount equivalent to
or more than the amount to be utilised for the purpose of redemption is raised by the
company out of fresh issue of shares. Thus, the capital of the company is maintained and the
creditors are not affected. In the latter case, where shares are to be redeemed out of profits
of the company which would otherwise be available for dividend, the creditors can be
affected because existing money goes out of the company. It is for this reason that proviso (d)
to sub-section (1) of section 80 of the Act requires the company to create a capital
redemption reserve account and transfer thereto a sum equivalent to the nominal amount of
the shares to be redeemed. The proviso further provides that the provisions of the Act
relating to the reduction of the share capital of the company shall except as provided in the
section, apply as if the capital redemption reserve account were the paid-up capital of the
company. Thus, the sanction of the Court under section 100 of the Act would be necessary
even where preference shares are to be redeemed out of capital redemption reserve account
created out of the profits of the company. Again the principle of maintenance of the capital is
preserved for the protection of the creditors of the company and sanction of the Court is
necessary for reduction of the capital even for redemption of preference shares out of capital
redemption reserve account. . . . In my opinion, section 80 of the Act operates in a limited
field. It covers only the case of reduction of share capital arising out of redemption of
preference shares. Preference shares can be redeemed either out of proceeds of a fresh issue
of capital or out of the profits of a company which would otherwise be available for payment
of dividend. In the former case, as the capital of the company is maintained, no permission of
the Court is necessary. In the latter case provisions as to the reduction of the shares capital
are made applicable by virtue of proviso (d) to sub-section (1) of section 80."

26. Thus, when a company has issued redeemable preference shares, created CRR in
accordance with section 80(1) proviso (d) and redeemed preference shares, in accounting
practice, no amount remains as CRR. In such a case, there cannot be any further
prospect of utilising such non-existent CRR. Even if CRR which might remain in the books
of account or in the Balance Sheet, such account shall have to be used for issuing bonus
shares as per section 80(5A) of the Companies Act. Applying these principles, the case of
the petitioner company insofar as first relief is concerned needs to be considered.
Utilisation of Capital Redemption Reserve
27. It is the case of the Aurobindo that during the year 1997-98, 50,000, 12.5 per cent
redeemable non-convertible preference shares of Rs. 100 each were issued to Canara
Bank for value of Rs. 50,00,000 (Fifty lakhs only) and during 1998-99, 8,50,000, 12 per
cent redeemable non-convertible preference shares of Rs. 100 each were issued to Global
Trust Bank and SBI Capital Markets Limited for a total value of Rs. 8,50,00,000. Thus,
out of authorised preference share capital of 10,00,000 preference shares of Rs. 100
each, 9,00,000 preference shares were issued by 31-3-1999. The first issue during 1997-
98 was authorised by resolution of Board of Directors, dated 26-12-1997. The same reads
as under :
Minutes of the Meeting of the Board of Directors of Aurobindo Pharma Limited held at 12.30
p.m. on Friday the 26-12-1997 at the Registered Office of the Company at Plot No. 2,
Maithrivihar, behind Maithrivanam, Ameerpet, Hyderabad - 500 038.

Allotment of Redeemable Non-Convertible Preference Shares of Rs. 50.00 lakhs in favour of

Canara Bank.

The Board was informed that the Company had received Rs. 50.00 lakhs from Canara Bank
towards Preference Share Application Money for allotment of 50,000 (Dividend 12.50 per
cent p.a. payable annually) Redeemable Non-Convertible Preference Shares of Rs. 100 each
per share.

The Board was approved for allotting 50,000 Redeemable Non-Convertible Preference Shares
of Rs. 100 each per share to Canara Bank and passed the following resolution :

"RESOLVED THAT 50,000 (Dividend 12.50 per cent p.a.) Redeemable Non-Convertible
Preference Shares of Rs. 100 each per share aggregating to Rs. 50.00 lakhs be and are
hereby allotted in the Preference Share Capital of the Company to Canara Bank, Treasury &
Investments Division, Treasury & Intl., Operations Wing, HO. 112, J.C. Road, Bangalore-2.

FURTHER RESOLVED THAT the Preference Share Certificate be signed by Sri P.V.
Ramaprasad Reddy, Managing Director and Sri A.J. Kamath, Director of the Company and be
counter signed by Sri A.N. Sarma, Company Secretary of the Company.

FURTHER RESOLVED THAT the following Directors of the Company Sri P.V. Ramaprasad
Reddy and Sri A.J. Kamath, be and are hereby jointly and severally authorised to do take such
steps and to do all such acts, deeds, matters and things and accept any alterations or
modifications as they may deem fit and proper and give such directions that may arise in
regard to the issue and allotment of the said Preference Shares including the power to allot
unsubscribed Preference Shares if any in such manner as may appear to the Board of
Directors to be most beneficial to the Company and to fix the Common Seal of the company
wherever necessary in terms of Articles of Association of the Company."

The issue of 4,50,000 preference shares to SBI Capital Markets was authorised by
resolution dated 17-11-1998 of the Board of Directors, which reads as under :
Minutes of the Meeting of the Board of Directors of the Company held at 3.00 p.m. on 17th
November, 1998 at the Registered Office of the Company at Plot No. 2, Maithrivihar, behind
Maithrivanam, Ameerpet, Hyderabad-500 038.

Allotment of Redeemable Convertible Preference Shares of Rs. 450.00 lakhs in favour of SBI
Capital Markets Limited, Mumbai :

The Board was informed that the Company has received a sum of Rs. 450.00 lakhs from SBI
Capital Markets Limited as Share Application Money for allotment of 4,50,000 Redeemable
Cumulative Preference Shares of Rs. 100 each per share carrying dividend at the rate of
12.00 per cent p.a. payable annually. After discussion, the Board has approved for allotment
of 4,50,000 Redeemable Convertible Preference Shares of Rs. 100 each per share to SBI
Capital Markets Limited and passed the following resolution :

"RESOLVED THAT 4,50,000 Redeemable Convertible Preference Shares of Rs. 100 each per
share carrying dividend at the rate of 12.00 per cent p.a. payable annually, aggregating to Rs.
450.00 lakhs be and are hereby allotted in the Preference Share Capital of the Company to
 SBI Capital Markets Limited.
FURTHER RESOLVED THAT the Preference Shares Certificate(s) be signed, the Common
Seal be affixed by/in the presence of Sri P.V. Ramaprasad Reddy, Managing Director and Sri
K.A. Venkatachalam, Director of the Company and be counter signed by Sri A.N. Sarma,
Company Secretary on behalf of the Company."

The issue of 4,00,000 preference shares to Global Trust Bank was authorised by
resolution, dated 24-11-1998.
Minutes of the Meeting of the Board of Directors of the Company held at 11.00 a.m. on 24th
November, 1998 at the Registered Office of the Company at plot No. 2, Maithrivihar, behind
Maithrivanam, Ameerpet, Hyderabad-500 038.

Allotment of Redeemable Convertible Preference Shares of Rs. 400.00 lakhs in favour of

Global Trust Bank :

The Board was informed that the Company has received a sum of Rs. 400.00 lakhs from
Global Trust Bank as Share Application Money for allotment of 4,00,000 Redeemable
Cumulative Preference Shares of Rs. 100 each per share carrying dividend at the rate of
12.00 per cent p.a. payable annually. After discussion, the Board has approved for allotment
of 4,00,000 Redeemable Convertible Preference Shares of Rs. 100 each per share to Global
Trust Bank and passed the following resolution :

"RESOLVED THAT 4,00,000 Redeemable Convertible Preference Shares of Rs. 100 each per
share carrying dividend at the rate of 12.00 per cent p.a. payable annually, aggregating to Rs.
400.00 lakhs be and are hereby allotted in the Preference Share Capital of the Company to
Global Trust Bank.

FURTHER RESOLVED THAT the Preference Shares Certificate(s) be signed by Sri P.V.
Ramaprasad Reddy, Managing Director and Sri A.J. Kamath, Director of the Company and be
counter signed by Sri A.N. Sarma, Company Secretary on behalf of the Company."

During 1997-98, Aurobindo transferred Rs. 46,575 from P&L Account to CRR. Thereafter,
during the subsequent three years i.e., 1998-99, 1999-2000 and 2000-01, Aurobindo
transferred more than Rs. 1,00,00,000 each per year to CRR and by 31-3-2001, an
amount of Rs. 9,00,00,000 accrued in CRR, which was the amount transferred from P&L
Account. The preference shares were redeemed on 17-5-2000, 25-5-2000 and 20-12-2000.
Before redemption and after redemption, entries regarding pre-ference share account
and CRR in the Balance Sheet and respective schedules for the years 1997-98 to 2007-08
is reflected in the following table :
Extracts from Annual Reports

Sl. Financial Issued, Amount Amount Value of Redeemed Shares
No. Year Subscribed transferred shown in
and paid-up from P&L Schedule
Redeemable A/c to CRR annexed to
Non- Balance
convertible Sheet
Preference
share capital*

Rs. Rs. Rs. Rs.

 1. 1997-98 50,00,000 46,575 46,575 —

2. 1998-99 8,50,00,000 1,33,88,127 1,34,34,702 —

3. 1999-2000 — 6,54,75,000 7,89,10,000 —

4. 2000-01 — 1,10,90,000 9,00,00,000 9,00,00,000

5. 2001-02 — Nil Nil Nil

6. 2002-03 — — 9,00,00,000** —

*Authorised Preference Share Capital is Rs. 10,00,00,000 divided into 10,00,000 shares of Rs.
100 each.

**In subsequent financial years also, an amount of Rs. 9,00,00,000 was shown in Balance Sheet
and relevant schedule thereto.

28. This Court has thoroughly perused the Annual Reports for the above years, especially
the Balance Sheet and Schedules (a), (b) or (1) (2) thereto which give the details of the
authorised and issued share capital, reserves and surplus funds. During the year of issue
of 50,000 preference shares, i.e., 1997-98 itself, Aurobindo created CRR and transferred
funds to CRR. In 1998-99, an amount of Rs. 9,00,00,000 was shown as issued and
subscribed preference share capital and an amount of Rs. 7,89,10,000 was shown under
CRR and during that year, an amount of Rs. 6,54,75,000 was transferred from P&L
Account. During 2000-01, an amount of Rs. 1,10,90,000 was transferred to CRR and as
noted supra, the total amount in CRR, which was Rs. 9,00,00,000 was utilised for
redeeming 9,00,000 preference shares. This is reflected in Schedule I to Balance Sheet
for the year ending 31-3-2001 and issued subscribed paid-up preference share capital
was shown as Nil because the amount of Rs. 9,00,00,000 in CRR by the end of financial
year 2000-01 was utilised for redeeming preference shares by that year end. During next
financial year i.e., 2001-02 in the Balance Sheet, CRR was shown as Nil and only issued,
subscribed and paid-up equity capital was shown as share capital. This shows that by 31-
3-2001, no preference shares were required to be redeemed and nil amount was
available in CRR. Therefore, the question of again utilising CRR towards adjusting
expenses does not arise.
29. Whether the company acted in compliance with the provisions of the law while
redeeming preference shares during 2000-01? The answer must be in the negative. As
noticed supra, for creation and transfer from out of the profit to CRR, the sanction of the
Court is not required. But, as and when CRR is used for redeeming preference shares,
the company ought to have obtained the sanction of the Court as if it is reduction of
capital under sections 100 to 103 of the Companies Act. When Aurobindo redeemed
preference shares in 2000-01 without obtaining sanction of this Court under sections 100
to 103, the company committed illegality. It may be noticed that after Court’s
confirmation of the Minute for reduction of share capital and publication thereof under
section 102(2B), a certified copy thereof shall be produced before the Registrar of
Companies, who shall register the same and on such registration, the Court order shall
take effect. This only means that unless and until the order of the Court confirming the
Minute is registered by the Registrar of Companies, the preference shares cannot be
redeemed from out of the CRR. This procedure was not followed by Aurobindo. As seen
from the three resolutions extracted hereinabove, though the Board of Directors passed
resolution for issue of redeemable non-convertible preference shards to Banks, there was
no specific authorization to transfer funds to CRR. The language of section 80(1) provisos
(a) and (d) is very clear that if the preference shares are redeemed by issue of shares for
the purpose, no permission is required but when the preference shares are to be
redeemed otherwise than from the proceeds of the fresh issue of shares, the profits can
be transferred to CRR only when the resolution of the Board of Directors. Such a
resolution is absent, and therefore, the creation of CRR and transfer of profits itself ultra
vires the provisions of the Companies Act.
30. Aurobindo admittedly redeemed preferential shares issued on two occasions in May,
2000 and December, 2000 during 2000-01. This was done without there being
compliance with section 103 of the Companies Act. Such non-compliance with mandatory
requirements of law amounts to contravention and attracts sub-section (6) of section
80(1) proviso (d) read with sections 100 to 103 of the Companies Act. The lapses and
contravene- tion attract section 80(d) and are two fold. First, Aurobindo redeemed
preference shares from out of CRR as seen from the Balance Sheets for the years 2000-
01 and 2001-02, without obtaining the permission of the Court under sections 100 to 103
of the Companies Act. Secondly, though in the Balance Sheet for 2000-01, the amount of
preference shares forming part of share capital was shown as Nil and in Balance Sheet
for 2001-02, CRR was shown as Nil, in subsequent years from 2002-03 again the balance
available under CRR was shown as Rs. 9,00,00,000. When during 2001-02, CRR was
shown as Nil, how Aurobindo has shown Rs. 9,00,00,000 as CRR in subsequent Balance
Sheets. It is not their case that after redeeming preference shares issued during 1997-98
and 1998-99, they again issued preference shares and created another CRR. The
explanation for this is not forthcoming. Furthermore, when the preference shares were
redeemed in 2000-01 from out of the CRR created, Aurobindo chose to file present
petition long thereafter on 10-6-2009, and therefore, this Court cannot grant any order
approving such reduction as it would amount to approving illegal and ultra vires
transaction of Aurobindo.
Reconstruction Reserve Account
31. Aurobindo proposes to undertake financial restructuring by creating "Reconstruction
Reserve Account" (RRA). It is proposed to create such RRA (i) by transferring Capital
Reserve Account (CRA) of Rs. 9,30,00,000 as on 31-3-2008 to RRA; and (ii) by crediting
the amount of benefit arising from buy-back of FCCBs on or after 1-4-2008 but before 31-
12-2009 to RRA, so that the said amount will be available to the Board of Directors for
utilisation/application for the purposes mentioned in paragraph 1.5 of the Scheme of
Arrangement extracted hereinabove. For the sake of convenience, these two aspects need
to be dealt with separately.
Foreign Currency Convertible Bonds (FCCBs)
32. As indicated hereinabove, during the financial year 2005-06, Aurobindo issued
FCCBs for a total sum of US$ 6,00,00,000 for 1,000 each at issue price of 100 per cent.
These bonds are convertible at any time on or after 20-9-2005 and up to 1-8-2010 into
shares of Rs. 5 each at conversion price of Rs. 522.06 with fixed rate of exchange of
conversion of Rs. 43.3925 = US1$. Similarly, during 2006-07, Aurobindo issued FCCBs in
two tranches. US$ 15,00,00,000 in US$ convertible bonds due 2011 of 100 US$ each in
tranch ‘A’ and US$ 50 million (5,00,00,000) forward convertible bonds due 2011. FCCBs
in tranch ‘B’ are convertible at any time on or after 27-6-2006 and up to 10-5-2011 into
shares of the company at a conversion price to be determined on 17-5-2007 with fixed
rate of exchange of conversion of Rs. 45.145 = US 1$.
33. RBI issued Circular bearing No. AP (DIR. Series) Circular No. 39, dated 8-12-2008
permitting Authorised Dealer (AD) Category-I Banks to allow Indian Companies to
prematurely buy-back FCCBs, if the buy-back value of the FCCBs is minimum discount of
15 per cent of the book value. The funds used for the buy-back shall be out of existing
foreign currency funds held by the company either in India or out of fresh External
Commercial Borrowings (ECBs) in conformity with ECB norms. This is under automatic
route and does not require approval of Reserve Bank of India. The buy-back of FCCBs
under approval route was also permitted. In this category, buy-back value of FCCB shall
be at a minimum discount of 25 per cent on the book value and the funds used for buy-
back shall be out of external accruals to be certified by statutory auditors and authorised
Dealer-I Banks certificate. Under this, the total amount of buy-back shall not exceed US$
50 million of the redemption value for the company. The buy-back authorised by RBI in
Circular No. 39 is subject to the following conditions.
General conditions
In addition to the conditions set out above, the following additional conditions shall be
applicable for the proposals both under the automatic and approval routes :
(i)the FCCB should have been issued in compliance with the extant guidelines.
(ii)The FCCB should have been registered with the Reserve Bank, the LRN number
obtained and ECB 2 returns submitted up to date.
(iii)No proceedings for contravention of FEMA are pending against the company.
(iv)The right for buy-back is vested with the issuer of FCCBs. However, the actual buy-
back is subject to the consent of the bond holders.
(v)The FCCBs bought back/repurchased from the holders must be cancelled and should
not be reissued or re-sold.
(vi)The buy-back will not have any effect on the bond holders not opting for the buy-back
or on the non-participating bond holders of companies opting for the buy-back.
(vii)The Indian company shall open an escrow account with the branch or subsidiary of an
Indian Bank Overseas or an International Bank for buying back the FCCBs to ensure
that the funds are used only for the buy-back.
34. Under Circular No. 39, the last date was fixed as 31-3-2009. However, by issuing A.P.
(DIR Series) Circular No. 58, dated 13-3-2009, RBI extended the date for completing the
entire procedure for buy-back of FCCBs up to 31-12-2009 without changing terms and
conditions in Circular No. 39. The mandatory conditions stipulated in Circular No. 39
require any company buying back FCCBs to open an escrow account with an Indian Bank
or Overseas Bank or international bank for buying back the FCCBs. This means the
amounts in escrow account can alone be used for buying back FCCBs. Further, the
proceedings shall not be contravention of FEMA.
35. As per Foreign Exchange Management (Transfer of Issue of any Foreign Security)
(Amendment) Regulations, 2004 (hereafter called, FEMA Regulations), FCCB means a
bond issued by an Indian company expressed in foreign currency and the principle and
interest is payable only in foreign currency. But for the Regulations, the issue of foreign
security is prohibited except with the permission of RBI. Regulation 4 permits any person
resident in India either to purchase or to sell foreign security. Part I of the Regulations
deals with direct investment outside India whereas Parts II and III deal with investments
abroad by individuals and investments in foreign securities other than by direct
investment. Regulation 21(2)(i) of the Regulations enables Indian company to issue
FCCBs not exceeding US$ 500 million and/or to issue FCCBs beyond US$ 500 million
with the approval of the Bank. That is to say, if the total value of FCCBs does not exceed
US$ 500 million, it is automatic route not requiring prior permission of RBI but subject to
the conditions stipulated in Schedule I to the Regulations. If a company issues FCCBs
either through automatic route or regulated route, within thirty (30) days after such
issue, a company has to furnish a report to RBI giving the details and documents with
regard to the total amount for which FCCBs are issued, names of the investors and
number of FCCBs and the amount repatriated to India through normal banking channels
and/or the amounts received by debit through NRE/FCNR account of investors.
36. Schedule I referred to in Regulation 21(2)(i) of FEMA Regulations provides
conditionalities for automatic route for issue of FCCBs. Conditions (vi) and ( viii) are
important. These stipulate that all in cost will be on part that those prescribed for
External Commercial Borrowing (ECB) and the proceeds from FCCBs shall be used for
the purpose for which ECB proceeds are permitted to be utilized under ECB schemes.
The regulations are silent as to how the benefit that may accrue due to buy-back of
FCCBs at discounted price can be utilized by the company. If the FCCBs are liabilities of
the company shown in the Balance Sheet, the premium on conversion of FCCBs and the
amounts realized by issue of such FCCBs shall have to be shown in the Balance Sheet.
What would happen when FCCBs are bought back from out of the Foreign Currency
Reserves parked in escrow account with a bank as mentioned in general condition (vii) of
Circular No. 39 referred to hereinabove? Whether Aurobindo has complied with all these
conditions?
37. The petition does not disclose whether the payment under the buy-back has been
completed, and whether resources have been created by opening escrow account for
such purpose. The Board of Directors of Aurobindo passed resolution on 30-7-2008 for
purchase of FCCBs from open market at a price not exceeding face value of the bonds
and for consequential cancellation up to and aggregate of US$ 100 million out of the
outstanding three FCCB series. Except these particulars, no details are forthcoming
regarding source of funds to buy-back. There is no mention of Foreign Currency internal
accruals. The Balance Sheet for 2007-08 (provisional) and the provisional Balance Sheet
for 2008-09 are also not clear as to the buy-back of funds. The company petition was filed
on 10-6-2009 and by that date the buy-back is not completed. Therefore, unless and until
the actual benefit that accrues to the company from out of the buy-back at discounted
price, and is shown in Balance Sheet, it cannot be assumed that benefit would accrue to
the company. Secondly, Board of Directors passed resolution on 30-7-2008 to buy-back
and cancel the FCCBs, in which event, the alleged accruals would be nil. It is well settled
that when a Scheme of Arrangement is submitted for approval, a company is required to
place all the details to enable the Court to consider its vires before granting approval. It
is not clear as to how much benefit would accrue to Aurobindo. It is also not clear
whether such accruals can be permitted to be utilized for creation of RRA authorizing the
Board of Directors to use the funds for the purpose enumerated in clause 1.5 of the
Scheme of Arrangement. In the absence of all the details, this Court is not inclined to
approve the Scheme of Arrangement with regard to creation of RRA by transferring the
benefits to be accrued from buy-back of FCCBs.
Capital Reserve Account
38. The Scheme was approved by Board of Directors of Aurobindo on 31-3-2009 and the
Managing Director and/or CFO and/or Company Secretary are authorized to take all
necessary steps in compliance with the Companies Act and Company Rules. The Board of
Directors also resolved for constitution of restructuring committee to give effect to the
Scheme. It is not clear from the resolution whether the Board considered pointedly the
transfer of capital reserve as on 31-3-2008 to RRA for the year ended 31-3-2009 for being
utilized towards adjusting expenses as mentioned in clause 1.5. Assuming that the Board
of Directors had applied its mind to this aspect of the matter, the question would be
whether CRA can be permitted to be utilized for creation of RRA to write off towards
intangible assets, towards unrealizable loans, interest/financial charges, outstand- ing
receivables, to write off/amortization of goodwill etc.
39. There cannot be any dispute, the capital reserve can be utilized by the company for
the purposes authorized in law and in such a case, no permission of the Court is required.
It is a matter of good corporate practices and business prudence whether or not capital
reserve be utilized for meeting a particular contingency. But when the CRA is directly or
indirectly used in a manner that it results in reduction of share capital, the permission of
the Court is required. The purposes for which RRA is sought to be used are certainly not
the purpose for which CRA can be utilized as noticed infra.
40. The terms ‘reserve’, ‘capital reserve’ and ‘reconstruction reserve’ are not defined in
the Companies Act. Section 211 of the Companies Act requires every company to prepare
the Balance Sheet containing the true and fair view of the state of affairs of the company
at the end of the financial year in the form set out in Part I of Schedule VI or as near
thereto as circumstances admit. Schedule VI contains horizontal form as well as vertical
form of Balance Sheet in Part I. Part II contains provisions to be applied to income and
expenditure account referred to in section 210(2) of the Companies Act. Part III contains
Rules 7 and 8. For our purpose, Rule 7(1) is relevant as this explains the expressions
‘reserve’ and ‘capital reserve’ :
"7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise
requires,—

(a )the expression "provision" shall, subject to sub-clause (2) of this clause, mean any amount
written off or retained by way of providing for depreciation renewals or diminution in
value of assets, or retained by way of providing for any known liability of which the
amount cannot be determined with substantial accuracy;

(b )the expression "reserve" shall not, subject as aforesaid, include any amount written off or
retained by way of providing for depreciation, renewals or diminution in value of assets
or retained by way of providing for any known liability;

(c )the expression "capital reserve" shall not include any amount regarded as free for
distribution through the profit and loss account; and the expression "revenue reserve"
 shall mean any reserve other than a capital reserve;
and this sub-clause the expression "liability" shall include all liabilities in respect of
expenditure contracted for and all disputed or contingent liabilities."

The Compendium of Guidance Notes (Accounting) published by Institute of Chartered

Accountants of India (ICAI) (July 2006 edn.,) defines ‘reserve’ as under :
"Reserve : The portion of earnings, receipts or other surplus of an enterprise (whether capital
or revenue) appropriated by the management for a general or a specific purpose other than a
provision for depreciation or diminution in the value of assets or for a known liability. The
reserves are primarily of two types : capital reserves and revenue reserves." [Emphasis
supplied]

41. The term ‘capital reserve’ is defined in ICAI Guidance Notes as a reserve of a
corporate enterprises which is not available for distribution as dividend. This means
when once capital reserve is created, the same cannot be utilized for any other purpose
except for the purpose for which it is intended. Capital reserve cannot be used even for
distribution for dividend. The revenue reserve unlike capital reserve is considered as free
reserve available for issue of bonus shares. Further, capital reserves are derived from
non-trading operations of the company and reserve so created out of the realization is
termed as capital reserve. As already seen, as per Schedule VI, Part III of the Companies
Act, the reserve shall not include any amount written off or retained by way of providing
depreciation, renewals or diminution in value of assets or retained by way of providing
for any unknown liability, which cannot be determined with substantial accuracy. From
this, it becomes clear that capital reserve cannot be used for writing off loss or for
adjusting towards diminution of value of assets etc.
42. In CIT v. Century Spg. & Mfg. Co. AIR 1953 SC 501, Constitution Bench of the
Supreme Court considered the term ‘reserve’. It was held that the term reserve ‘should
be given the ordinary natural meaning as understood in the common parlance and that
profits lying unutilized and not specifically set apart for any purpose would not constitute
reserves.’ It was also held that the reserve may be a general reserve or a specific reserve
but there must be clear indication to show that whether it is a reserve either of the one
or other kind. When once capital reserve is created, the company had no power to
distribute the same as dividend, but the same should be set apart for investment in the
company and not to write off the losses of a company or its subsidiaries. ‘Capital reserve’
therefore cannot be used for writing off losses and as noticed supra, a capital reserve is
not a free reserve and cannot be used for purposes not authorized under law.
43. In CIT v. Veeraswami Nainar [1965] 55 ITR 35 (Mad.), the assessee was an HUF with
bus/lorry transport business, filed Return for 1959-60 showing loss of Rs. 20,441 after
deducting development rebate of Rs. 18,965 at 25 per cent on a new lorry and a new bus
purchased subsequent to December, 1957. But, the assessee did not debit 75 per cent of
that amount to the profit and loss account and consequently rebate claimed had not been
credited to the reserve account as required under section 10(2)(vib) of the Income-tax
Act, 1922. Income-tax Authorities refused to allow development rebate on the ground
that bus and lorry cannot be regarded as plant and machinery within the meaning of said
provision. The appellate authority agreed with Income-tax Officer, but on further appeal,
the Income-tax Appellate Tribunal referred the question to the High Court as to whether
the assessee can claim allowance even though necessary reserve was not created as
required under law. Madras High Court answered reference against the assessee and it
was held :
"It will be apparent from the terms of the proviso that the object of the Legislature in
allowing a development rebate is a real one, that is, to facilitate the improvement of the
assessee’s business from out of the reserve fund. The entries in the account books required
by the proviso are not an idle formality. The assessee being obliged to credit the reserve fund
for a specific purpose, he cannot draw upon the same for purposes other than those of the
business, and if the assessee were a company for exemption that amount could not be
distributed by way of dividend. It is also clear from the terms of the proviso that the reserve
should be made at the time of making up the profit and loss account. The Tribunal was clearly
in error when it held that account by making the reserve at a later period of time. Any
account maintained by a business should reflect its financial transactions correctly. If at the
time of the closing of the accounts for a year, a particular appropriation had not been made,
but the moneys had been spent otherwise, it would indeed be futile to direct the assessee to
re-adjust the account." [Emphasis supplied]

44. The dicta in Veeraswami Nainar’s case (supra) was approved by Supreme Court in
Indian Overseas Bank v. CIT AIR 1970 SC 1530, wherein it was held :
"The reserve contemplated by that provision is a separate reserve. The amount transreferred
to that reserve cannot be utilized for business purposes. The reserve contemplated by proviso
(b) to section 10(2)(vib) of the Act is an independent reserve. The amount to be transferred to
that reserve is debited before the profit and loss account is made up. That amount is required
to be credited to a reserve account to be utilized by the assessee during a period of ten years
for the purposes of the business of the undertaking. The nature of the two reserves are
different. They are intended to serve two different purposes. As observed by the Madras High
Court in Veeraswami Nainar (supra) that the object of the Legislature in allowing a
development of the assessee’s business from out of the reserve fund is apparent from the
terms of the proviso. The entries in the account books required by the proviso are not an idle
formality. The assessee being obliged to credit the reserve fund for a specific purpose, he
cannot draw upon the same for purposes other than those of the business and that amount
cannot be distributed by way of dividend. It is also clear from the terms of the proviso that
the transfer to the reserve fund should be made at the time of making up the profit and loss
account." [Emphasis supplied]

Whether Members of Aurobindo approved the Scheme under section 391(1) and (2) of
Companies Act?
45. This Court appointed Chairperson to convene the meeting of equity shareholders to
consider and approve the resolution to support the Scheme of Arrangement proposed by
the Board of Directors of Aurobindo. The chairperson convened the meeting of the
shareholders at 3.00 p.m. on 21-5-2009 at Katriya Hotel and Towers, Hyderabad. In all
177 shareholders (either in person or through proxies/ representations) of Aurobindo
representing 3,49,88,412 equity shares of Rs. 5 each aggregating to Rs. 17,49,42,060
attended the meeting. Out of them, 93.92 per cent of shareholders voted and approved
the following resolutions :
"Resolution 1.—Resolved that the Scheme of Arrangement by and between Aurobindo Pharma
Limited and its shareholders tabled before the meeting and initiated by the Chairman for
identification purpose be and is hereby approved.
 Special Resolution 2.—Resolved that the Applicant company be and is hereby authorized to
exercise all the powers conferred under sections 100 to 103 of the Companies Act, 1956, to
adjust the amount standing to the credit of Capital Redemption Reserve Account as on March
31, 2008 against the expenses as provided for in the Scheme of Arrangement between
Aurobindo Pharma Limited and its Shareholders on March 31, 2009.

Special Resolution 3.—Resolved that the Board of Directors of the Applicant Company
(hereinafter referred to as ‘the Board’ which expression shall also include any Restructuring
Committee constituted thereof) be and is hereby authorized to do all such acts, deeds,
matters and things, which the Board considers necessary, requisite, desirable or appropriate
and to make, agree or accept such modifications/amendments/limitations and/or conditions
arising out of or by virtue of the said Scheme or as may be directed or imposed by the Stock
Exchange with whom the shares of the Company are listed and/or any other authorities
and/or by the Hon’ble High Court of Judicature of Andhra Pradesh at Hyderabad and which
the Board considers necessary to effectively implement the said Scheme."

46. Resolution 1 and Resolution 3 above are in general terms. Resolution 2 passed by
majority shareholders presented in the meeting authorized Aurobindo to adjust the
amount standing to the credit of Capital Redemption Reserve as on 31-3-2008 against
planned expenses. There is no such special resolution passed by equity shareholders in
the meeting convened by chairperson appointed by this Court in relation to creation of
Reconstruction Reserve Account and transfer to it, capital reserve and/or the benefit
accruing from buyback of FCCBs. When there is no specific resolution by equity
shareholders, compliance with section 391 of the Companies Act, cannot be inferred. If
the intention was to obtain general approval for the Scheme of Arrangement, there was
no necessity for moving special resolution. When the equity shareholders approved
special resolution with regard to adjusting CRR, nothing prevented passing a similar
special resolution with regard to transfer of capital reserve and/or FCCB benefit to RRA.
When the Scheme of Arrangement is proposed by Board of Directors with regard to three
aspects, and a special resolution is passed only with reference to one subject
concurrence of majority shareholders cannot be inferred with reference to other aspects.
This is also one of the reasons which would disqualify the petition for approval.
47. This Court has carefully perused the annual reports and Balance Sheets of Aurobindo
for the years 2000-01 to 2007-08. In none of these, there is no indication for utilizing
capital reserve for the purposes intended now by transferring to RRA. As capital is not a
free reserve, it cannot be allowed for payment of any future liability or for depreciation of
assets or for bad debts. As noticed supra, Aurobindo proposes to transfer capital reserve
account to RRA to write-off capital lost and other losses. This is not permissible under
law. Therefore, this Court is not inclined to approve the Scheme of Arrangement as
proposed.
48. The company petition is therefore dismissed.
Petition dismissed.