CP/79/2009 of M/s Aurobindo Pharma Limited Vs - on 31 December 2009

ORDER:

This petition under Sections 391 to 393 read with Sections 100 to 103 ofthe Companies Act, 1956, and rule 79 of Companies (Court) Rules, 1959 (theRules, for brevity) is filed by M/s.Aurobindo Pharma Limited (hereafter,Aurobindo) praying for sanction of Scheme of Arrangement between companyand its shareholders. The Scheme of Arrangement concerns with two aspects,namely, (i) utilizing an amount of Rs.91 crores standing to the credit of ‘CapitalRedemption Reserve’ (CRR) towards adjusting the expenses enumerated inclause 1.5 of the Scheme; and (ii) creation of ‘Reconstruction ReserveAccount’ (RRA) by transferring/crediting an amount of Rs.90.30 million standing to the credit of ‘Capital Reserve’ and the benefits accruing from buyback 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 asunder.

1.5 “Expenses” means and without limiting the generality of theforegoing, includes inter alia the following items accounted for in thefinancial statements of Aurobindo:

1.5.1 Amount to be written off towards obsolete or unrealizableassets, whether tangible or intangible or fixed or current; 1.5.2 Any unrealizable loans and/or advances, whether recoverable incash or in kind, whether belonging to Aurobindo or its Subsidiaries andarising on preparation of stand alone and/or Consolidated FinancialStatements of Aurobindo; 1.5.3 Interest and other financial charges receivable and outstandingfor such period as may be determined by the Board onloans/advances made to subsidiaries; 1.5.4 Impairment, amortization and/or write off of goodwill; 1.5.5 Diminution in the value of investments in subsidiary companiesand/or Joint Ventures of Aurobindo and/or any of its subsidiaries andconsequent impairment of goodwill and accumulated losses of suchsubsidiaries on consolidation, in the financial Statements ofAurobindo; 1.5.6 Impairment/diminution/realisation losses, if any on investmentsother than as mentioned in clause 1.5.5 above, whether current orlong term or quoted or unquoted, or trade or non-trade; 1.5.7 Such other expenses, cost, impairments, write off’s anddiminution, as considered necessary by the Board from time to time; 1.5.8 For the purposes of this clause, if any issue/question arises withrespect to identification and/or qualification of the nature and amountof the expenses, the decision/clarification of the Board shall be final.

Background of the Scheme

Aurobindo is a company registered under the Companies Act. Itsauthorized share capital is Rs.500 million consisting of 100 million equityshares 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 andpaid up amounting to Rs.268.80 million. These shares are listed on NationalStock Exchange Limited and Bombay Stock Exchange Limited. Aurobindo isin the business of manufacturing, marketing, chemicals, intermediaries, drugs,formulations, dyestuffs etc. The Board of Directors in their meeting held on31.03.2009 allegedly passed resolution approving the Scheme ofArrangement between the company and its shareholders to utilise theamounts standing in the credit of CRR as on 31.03.2008 towards expenses ofthe company especially those expenses as enumerated in clause 1.5 of theScheme and/or transferring the said amount as well as the benefits accruingfrom buyback of FCCBs to RRA towards adjusting expenses as referred tohereinabove. The details of these two aspects of the Scheme are as below.

Aurobindo issued 12.5% redeemable non-convertible preference sharesto an extent of Rs.50 lakhs (50,000 shares of Rs.100/- each) during thefinancial year 1997-1998 to Canara Bank. For the financial year 1998-1999,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 CapitalMarkets Limited, Mumbai; and preference shares to an extent ofRs.4,00,00,000 (4,00,000 preference shares of Rs.100/- each) to Global TrustBank Limited, Mumbai on 24.11.1998. These are redeemable on 17.05.2000and on 24.05.2000 respectively. The company purporting to comply withSection 80(1)(d) of the Companies Act credited out of its profit to CRR duringthe period commencing from financial years 1997-1998 to 2000-2001. Thedetails of amounts credited to CRR from out of Profits is as follows.

After transferring amounts to CRR in four financial years, Aurobindoredeemed preference shares allotted to Canara Bank on 20.12.2000. Theshares allotted to SBI Capital Markets and Global Trust Bank were redeemedon 17.05.2000 and 25.05.2000 respectively. To that effect, the company alsofiled Form No.5 in accordance with Sections 95, 97, 97A(2) and 81(4) of theCompanies Act with the Registrar of Companies (RoC).

To meet financial requirements, Aurobindo issued FCCBs twice in2005-2006 and 2006-2007. The first of these two issues is for 60 million US$due on 2010 convertible into ordinary shares of Aurobindo. The second onewas in two tranches. Tranch A is for US$ 150 million and tranch B isRs.50,000,000/-. The first issue is redeemable on 11[th] August, 2010 and thesecond issue is redeemable on 11[th] August, 2010 and on 17[th] May 2011.Reserve Bank of India (RBI) issued policy directions vide A.P (Dir Series)Circular No.39, dated 08.12.2008 under Sections 10(4) and 11(1) of theForeign Exchange Management Act, 1999 (FEMA) for buy back/pre paymentsof FCCBs at a discount of 15% or 25% as the case may be. The Companieswere required to complete the buyback by 31[st] March, 2009. By yet anothercircular No.58, dated 13.03.2009, the time has been extended up to31.12.2009 for the purpose of buyback at a discounted price. Statedly, RBIallowed buyback at a discounted price as market value of Indian Companieswere downgraded due to global economic situation. Aurobindo availedopportunity and bought back FCCBs at a discount to face value in the openmarket and appears to have reaped considerable benefit by such buyback ofFCCBs. As a part of Financial Restructuring Exercise (FRE), Aurobindoproposed to utilize capital reserve of Rs.90 million allegedly outstanding as on31.03.2008 as well as the benefit arising from buyback of FCCBs on discountfor the purpose of meeting expenses at the discretion of Board.

Aurobindo moved an application before the High Court under Sections391 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 thepurpose of considering the scheme. The application being CompanyApplication No.340 of 2009 was ordered and an advocate was appointed asChairperson to convene the meeting of shareholders. Accordingly, meetingwas convened on 21.05.2009 at the place designated by the Court. Afterdoing 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 themeeting held by chairperson, members representing 3,49,87,258 number ofshares of Rs.5/- each, 94.50% (103 members) with Rs.3.28,68,148 (93.92%)voted in favour of resolutions which were considered.

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 themaccorded consent for creation of RRA. Insofar as unsecured creditors areconcerned, Aurobindo perceives that they will not be affected adversely withthe proposed Scheme because post scheme assets will be sufficient todischarge the liabilities. Aurobindo also obtained no objection letters to theproposed Scheme from Bombay Stock Exchange and National StockExchange. Therefore, this application is filed under Sections 391 to 393 readwith Sections 100 to 103 of the Companies Act. This Court ordered notice toCentral Government while directing publication of notice of hearing in twonewspapers. Aurobindo’s counsel took out notice and also served papers onCentral Government i.e., Regional Director, Department of Company Affairs,Chennai. No objections have been received by the Court nor any personappeared when the matter was heard. The Registrar of Companies (RoC)purporting to act under authorization issued by Regional Director ofDepartment of Corporate Affairs filed an affidavit stating that CentralGovernment decided not to make any objection to the proposed Scheme.

This Court heard learned counsel for Aurobindo on 07.07.2009 and08.07.2009 and reserved the Orders. Again, the matter was directed to belisted ‘For Being Mentioned’ for certain clarifications on 20.07.2009 and27.07.2009. The counsel reiterated the principles governing the cases underthe Companies Act which require sanction/approval of the Court like schemeof compromise/ arrangement or financial reconstruction or a scheme ofamalgamation.

Court’s power to sanction Scheme

It is settled that in all such cases the Court does not exercise itsappellate powers or review powers. It cannot sit in appeal over Scheme ofArrangement between the company, its members and creditors. Court in away acts as a ‘Corporate Ombudsman’ to ensure that the Scheme ofArrangement/ compromise among the company, its members and creditors isfair and just and does not subvert public interest or breach law. In Miheer H.Mafatlal v Mafatlal Industries Limited[[1]], Supreme Court considered thescope of power vested in Court while dealing with ex parte applications andpetitions under the Companies Act and Companies rules seekingsanction/approval of the Court for the Scheme of Arrangement. Referring to Hindustan Lever Employees’ Union v Hindustan Lever Limited[[2]], thefollowing principles were laid down.

1. The sanctioning court has to see to it that all the requisite statutoryprocedure for supporting such a scheme has been complied with andthat the requisite meetings as contemplated by section 391(1)(a) havebeen held.2. That the scheme put up for sanction of the court is backed up bythe requisite majority vote as required by section 391(2).

3. That the concerned meetings of the creditors or members or anyclass of them had the relevant material to enable the voters to arriveat an informed decision for approving the scheme in question. Thatthe majority decision of the concerned class of voters is just and fairto the class as a whole so as to legitimately bind even the dissentingmembers of that class.4. That all the necessary material indicated by section 391(1)(a) isplaced before the voters at the concerned meetings as contemplatedby 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 theconcerned applicant seeking sanction for such a scheme and thecourt gets satisfied about the same.

6. That the proposed scheme of compromise and arrangement isnot found to be violative of any provision of law and is notcontrary to public policy. For ascertaining the real purposeunderlying the scheme with a veil to be satisfied on this aspect. The court, if necessary, can pierce the view of apparentcorporate purpose underlying the scheme and can judiciously X-ray the same.

7. That the company court has also to satisfy itself that members orclass of members or creditors or class of creditors, as the case maybe, were action bona fide and in good faith and were not coercing theminority in order to promote any interest adverse to that of the lattercomprising the same class whom they purported to represent.

8. That the scheme as a whole is also found to be just, fair andreasonable from the point of view of the prudent men of businesstaking a commercial decision beneficial of the class represented bythem for whom the scheme is meant.

9. Once the aforesaid broad parameters about the requirement of ascheme for getting sanction of the court are found to have been met,the court will have no further jurisdiction to sit in appeal over thecommercial wisdom of the majority of the class of persons who withtheir open eyes have given their approval to the scheme even if in theview of the court there could be a better scheme for the company andits members or creditors for whom the scheme is framed. The courtcannot refuse to sanction such a scheme on that ground as it wouldotherwise amount to the court exercising appellate jurisdiction overthe scheme rather than its supervisory jurisdiction.

The question that often confronts the Court is whether it can declineapproval/sanction to a Scheme of Arrangement, even when the majority ofmembers approved the scheme in the Court convened meeting and all thecreditors gave their consent for the scheme. There cannot be any doubt thateven 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 tohave been conceived with ulterior motive of playing fraud on publicauthorities. The Court can also withhold its imprimatur if it is found that in thelong run such scheme is not in the interest of its members, creditors,employees and subverts public interest. Needless to mention that the Courtcan always throw out the scheme if it is intended to legitimize the lapses andillegalities that crept into the corporate governance for which persons at thehelm of affairs of the company are alone responsible. Lastly if the Scheme ofArrangement is an inchoate transaction affecting future, the Court can alwaysrefuse sanction.

In British and American Trustee and Finance Corporation v John Couper[[3]], the importance and sanctity of curial sanction to a Scheme ofArrangement was explained by House of Lords in a case wherein the Schemeof Arrangement envisaged reduction of capital by paying off the shares of onegroup of members was approved observing as under.

I do not see any danger in the conclusion that the Court haspower to confirm such a scheme as that now in question, or anyreason to doubt that this was the intention of the Legislature. Theinterests of creditors are not involved, and I think it was the policy ofthe Legislature to entrust the prescribed majority of the shareholderswith the decision whether there should be a reduction of capital, and ifso, how it should be carried into effect. The interests of the dissentingminority of the shareholders (if there be such) are properlysafeguarded by this: that the decision of the majority can only prevail ifit be confirmed by the Court.

Thus, the law providing for Court sanction for Scheme is a safeguardagainst ultra vires corporate excesses and is intended to subserve publicinterest. Of late, the corporate world derives abundant sustained strength byState support which comes by way of direct/indirect financial participation,subsidized infrastructural facilities, continuous flow of supplies of humanresources and sovereign guarantees where international finances areinvolved. Therefore, even though the Court ought to view the Scheme ofArrangement submitted for approval with deference to the wishes of proposersand members, nevertheless the Court should be cautious not to be swayed byapproval of imposing majority. All decisions of majority at all times cannot bepresumed to be legal or legitimate, and corporate leadership cannot alwaysbe presumed to be correct in absolute terms. The Court when called upon toexamine a scheme for the purpose of according sanction, must therefore keepin view not only the subject matter before it but also look to effect of itsdecision on the future corporate arrangements.

Reduction of Share Capital vis-à-vis Capital Reduction Reserve

Reduction of Share Capital vis-à-vis Capital Reduction Reserve Capital includes ‘share capital’ which may again compromise equityshare capital and preference share capital (Sections 85 and 86 of CompaniesAct). In addition to this, the reserve account created by the company from outof its profits earned also forms part of capital. A perusal of the provisions inPart IV Schedule I and Schedule VI would show that the capital of thecompany consists of mainly shareholders’ funds which include capital, reserves and surplus. When the share capital together with reserves/surplus isfound to be in excess of requirements of the company, it would certainly be anunwise business proposition to carry on business with such surplus capital.Therefore, the company, if its Memorandum and Articles so authorize, canreduce its share capital.

Companies Act primarily recognises three modes of reduction of sharecapital. Regulation 46 of the Regulations for management of a companylimited by shares (Table A Schedule I) provides that a company may byspecial resolution reduce in any manner (i) its share capital; (ii) any capitalredemption reserve account; or (iii) any share premium account. Section100(1) indicates three ways of reducing its share capital. These are (i) byextinguishing or reducing liability in respect of unpaid share capital; (ii) bycancelling paid up share capital which is lost or unrepresented by availableassets; or (iii) by paying off any paid up share capital which is in excess ofwants of the company. Needless to mention that any resolution of thecompany to reduce share capital in any of the three ways needs confirmationof the Court which is required to follow the procedure contemplated inSections 100 to 104 of the Companies Act and Rules 46 to 65 of theCompanies (Court) Rules.

In addition to the reduction of share capital as contemplated by Section100 of the Companies Act, the company can also reduce its share capital inother two ways. Until recently, law barred a company from purchasing its ownshares. Section 77 of the Companies Act prohibits a company to buy its ownshares unless consequent reduction of capital is effected and sanctioned inpursuance of Sections 100 to 104 of the Companies Act. By Companies(Amendment) Act, 1999, with effect from 31.10.1998, Parliament insertedSections 77A, 77AA and 77B. Under Section 77A, which is an exception toSection 77, a company may purchase or buyback its own shares out of its freereserves or securities premium account or proceeds of any shares or anyother specified securities not exceeding 25% or total paid up equity capital ina financial year. It is now well accepted that the companies decision topurchase or buyback its own shares from out of free reserves or sharepremium account is “an indirect method of reducing capital of the company”

(See Traver v Witworth[[4]]and Ramesh B.Desai v Bipin Wadilal Mehta[[5]]).

In addition to reduction of capital by buyback of shares, law alsocontemplates yet another method of reduction of share capital. This is by wayof a deemed provision, which creates a fiction as if it amounts to reduction ofshare capital. Here it is necessary to refer to power of the company to issueredeemable preference shares and method of redeeming such preferenceshares. For ready reference, Section 80 of the Companies Act to the extentrelevant (omitting sub-section (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 byshares may, if so authorized by its articles, issue preference shareswhich are, or at the option of the company are to be liable, to beredeemed:Provided that-shares may, if so authorized by its articles, issue preference shareswhich are, or at the option of the company are to be liable, to beredeemed:Provided that- (a)no such shares shall be redeemed except out of profits of

the company which would otherwise be available fordividend or out of the proceeds of a fresh issue of sharesmade for the purposes of the redemption;(b)no such shares shall be redeemed unless they are fullypaid;

(c) the premium, if any, payable on redemption shall have beenprovided for out of the profits of the company or out of thecompany’s security premium account, before the sharesare redeemed;provided for out of the profits of the company or out of thecompany’s security premium account, before the sharesare redeemed; (d)where any such shares are redeemed otherwise than out ofthe proceeds of a fresh issue, there shall, out of profitswhich would otherwise have been available for dividend,be transferred to a reserve fund, to be called the capitalredemption reserve account, a sum equal to the nominalamount of the shares redeemed; and the provisions of thisAct relating to the reduction of the share capital of acompany shall, except as provided in this section, applyas if the capital redemption reserve account were paid-upshare capital of the company.the proceeds of a fresh issue, there shall, out of profitswhich would otherwise have been available for dividend,be transferred to a reserve fund, to be called the capitalredemption reserve account, a sum equal to the nominalamount of the shares redeemed; and the provisions of thisAct relating to the reduction of the share capital of acompany shall, except as provided in this section, applyas if the capital redemption reserve account were paid-upshare capital of the company.

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

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

The provision deals with power of a company to issue and redeempreferential shares. Unless and until the Articles of Association of a companypermit to do so, preferential shares cannot be issued. Even if the preferentialshares are issued, they have to be redeemed within a stipulated period. Therecannot be any doubt that the amount, which the company gets by issue ofpreferential shares forms part of the capital of a company. It is very interestingas to how the law enables redemption of preference shares. The proviso tosub-section (1) of Section 80 of the Companies Act contemplates theredemption of fully paid preference shares in two ways, namely, (i) from out ofthe 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 theCompanies Act is to the effect that redemption of preference shares shall notamount to reducing the amount of its authorized share capital. So to say, iffresh issue of shares is made even if such proceeds of fresh issue of sharesare utilized for redemption of preference shares, it shall not be treated asreducing the authorized share capital. However, if the company redeems fullypaid up preference shares from out of the profits, it is required to follow theprocedure applicable for reduction of share capital.

Section 80(1) read with its proviso, especially clauses (a) and (d) thereofis to the effect that when shares are redeemed out of distributable profits, thecompany 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, followthe provisions of the Companies Act relating to reduction of share capital. Itmay look little odd that when the proceeds of fresh issue of shares are utilized for redemption of preference shares, provisions relating to reduction of sharecapital are not applied but when distributable profits are utilized for reductionof the preference shares, the provisions relating to reduction of share capitalare applied. The intention of legislature appears to be the following. When thepreference shares are to be redeemed from out of the fresh issue of sharecapital, the company is required to issue such fresh issue of sharesspecifically mentioning the purpose of such fresh issue, namely, redemption ofpreference share capital. However, when the profits are earned and for thepurpose of compliance with the statute, portion of the profits are transferred togeneral reserve or statutory reserve, as the case may be, no reduction ofcapital is involved. The profits are ordinarily intended for variousappropriations including distribution of dividends. When once a portion of theprofits are intended to be used for redemption of preference shares, it resultsin reducing the profits available for distribution and transfer to other reserveand thereby there is reduction of capital. There cannot be any doubt thatundistributed profits available to the company and its shareholders form part ofbalance sheet but when once funds are transferred to CRR as per Section80(1) proviso (d) of the Companies Act, there is reduction of capital.

What is the stage at which a company is required to obtain sanction? Isit at the stage of transferring from out of the profits to CRR or at the time ofredemption of preference shares utilizing the funds available in CRR? A plainreading of Section 80(1)(d) of the Companies Act would make it clear that thecompany is entitled to transfer funds to CRR from out of the profits if it resolvesto redeem preference shares issued. As the statute itself permits the companyto transfer funds to CRR as and when profits accrue, no permission is requiredat 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 veryclear that when once the CRR is used for redemption of preference shares,the company has to necessarily move an application before the Court andobtain permission for utilizing CRR for redemption, because if CRR, which iscreated out of the profits, is used for redeeming preference shares, it results indiminishing of capital. Therefore, unless and until the resolution of thecompany to create CRR and use the same for redemption of fully paidpreference shares is sanctioned and approved by the Court, no suchredemption can be resorted to. When once the amounts available in CRR areutilized for redemption of preference shares, after approval of the Court, thequestion of further availability of CRR does not arise.

The fully paid preference shares issued by a company are alwaysredeemed at the face value or at the issue price only. In a given case, if CRRcreated by the company exceed or far exceeds the face value of theredeemable fully paid preference shares, how this CRR Account has to beadjusted or used? Section 80(5) of the Companies Act deals with a situationwhich enables the company to apply CRR in paying up unissued shares ofthe company to be issued to the members of the company as fully paid bonusshares. Section 80(5A) of the Companies Act contains non-abstante clauseand indicates that CRR can be applied only for redeeming fully paid uppreference shares and/or for issuing bonus shares to the members. The same cannot be used for any other purpose.

The above view is also supported by the ‘Textbook Writers’, C.R.Datta,the learned Author “the Company Law” (sixth edition, 2008) elucidated thelegal position as under.

Redemption (sub-section (1), proviso). – Redeemable preferenceshares can be redeemed only on the following conditions:shares can be redeemed only on the following conditions:

(a) Such shares can be redeemed out of distributable profits (profitswhich would otherwise have been available for dividend) or out of theproceeds 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 havebeen provided for out of profits or out of the securities premiumaccount.

(d) If the redemption is out of distributable profits, profits equivalent tonominal amount of preference shares redeemed must be transferredto the Capital Redemption Reserve Account. The Capital RedemptionReserve Account will be treated as share capital and the provisionsas regards reduction of the share capital shall apply. But, Capitalredemption Reserve Account may be utilised in issuing fully paidBonus Shares; this will not be treated as reduction of capital (sub-section (5)).

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 thePreference Shares, subject to approval of the Court with the objectthat the company may pay back to the shareholders any paid-upshare capital which is in excess of its wants. The redemption ofpreference shares is nothing but repayment of the preference capitaland amounts to reduction of share capital. The three methodsmentioned in clauses (a), (b) and (c) of sub-section (1) of Section 100of the Companies Act, 1956, are only illustrative and are notexhaustive. A company may seek to redeem the share capital in anyway and even in a manner not covered by clauses (a), (b) and (c) ofsub-section (1) of Section 100. The words ‘pay off any paid up capital’appearing in clause (c) indicate that even the preference share capitalcan be paid off subject to the conditions laid down in Section 100 ofthe Act. Section 100 makes no distinction between preference sharecapital and equity share capital. Thus, the equity share capital as wellas the preference share capital of a company can be reduced in anyway, if authorised by the Articles, by a Special Resolution of thecompany subject to sanction of the Court. The preference sharescould be redeemed by the directors or the shareholders.

K.M.Ghosh & Dr.K.R.Chandratre in their ‘Company Law’ (thirteenthedition, 2006-2007, p.1472) also commented in a similar manner, as extractedherein.

According to sub-section (1)(a), redemption can be done only: (a) outof profits which would otherwise have been available for dividend, or(b) out of the proceeds of a fresh issue of shares made for thepurpose of redemption. It should be noted that, balance of profits asappearing in the balance sheet cannot, strictly speaking, be called asource of funds to meet the requirement of funds (cash) forredemption of shares. If a company intends to redeem its preference

shares out of profits, it must have not only profits sufficient to bereduced by a sum of the face value and of the premium payable onthe redemption but also liquid cash sufficient to meet its obligation ofpayment to the shareholders whose securities are bought. Thus, freereserves or securities premium are not the sources of funds forbuying back securities. A company intending to buy its shares/othersecurities must have at the time of buyback, balance in any one ormore of these accounts which is sufficient to accommodate the totalvalue of the buyback.

The sanction of the court under Section 100 of the Act would benecessary even where preference shares are to be redeemed outof capital redemption reserve account created out of the profitsof the company. Again the principle of maintenance of the capital ispreserved for the protection of the creditors of the company andsanction of the court is necessary for reduction of the capital even forredemption of preference shares out of capital redemption reserveaccount.

The learned author also dealt with the interplay between Section 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 canpay back to the shareholder any paid-up share capital which is inexcess of wants of the company. Redemption of the preferenceshares is nothing but paying back to the shareholders their preferenceshare capital. This can be done subject to confirmation by the court ifthe capital is in excess of the wants of the company and the companyis so authorised by its articles and the company passes a specialresolution to that effect. Therefore, preference shares can beredeemed not only in accordance with section 80 but, also inaccordance with the provisions of section 100 of the Act. If theshares are to be redeemed not out of the fresh issue of sharesmade for that purpose nor out of the profits which wouldotherwise 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 forredemption of preference shares. It may redeem the shares byfollowing the procedure laid down under section 80 of the Act which isa special provision meant for redemption of preference shares or itany take recourse to the general provision under section 100 of theAct which is applicable for reduction of any capital includingpreference capital, in any manner.

In Birla Global Finance Limited, In Re[[6]], Bombay High Court dealtwith the issue of redemption of preference shares by creation of CRR. It isobserved therein as follows.

Money required for redemption of preference shares can be obtainedout of two sources under Section 80. The first source is out of theproceeds of a fresh issue of shares made for the purpose ofredemption and the second source is out of profits of the companywhich would otherwise be available for dividend. In the former case,where preference shares are to be redeemed out of the proceeds of afresh issue of shares made for the purpose of redemption, there is noreduction in the capital of the company for an amount equivalent to or

more than the amount to be utilised for the purpose of redemption israised by the company out of fresh issue of shares. Thus, the capitalof the company is maintained and the creditors are not affected. In thelatter case, where shares are to be redeemed out of profits of thecompany which would otherwise be available for dividend, thecreditors can be affected because existing money goes out of thecompany. It is for this reason that proviso (d) to Sub-section (1) ofSection 80 of the Act requires the company to create a capitalredemption reserve account and transfer thereto a sum equivalent tothe nominal amount of the shares to be redeemed. The proviso furtherprovides that the provisions of the Act relating to the reduction of theshare capital of the company shall except as provided in the section,apply as if the capital redemption reserve account were the paid-upcapital of the company. Thus, the sanction of the Court under Section100 of the Act would be necessary even where preference shares areto be redeemed out of capital redemption reserve account created outof the profits of the company. Again the principal of maintenance ofthe capital is preserved for the protection of the creditors of thecompany and sanction of the Court is necessary for reduction of thecapital even for redemption of preference shares out of capitalredemption reserve account. … In my opinion, Section 80 of the Actoperates in a limited field. It covers only the case of reduction of sharecapital arising out of redemption of preference shares. Preferenceshares can be redeemed either out of proceeds of a fresh issue ofcapital or out of the profits of a company which would otherwise beavailable for payment of dividend. In the former case, as the capital ofthe company is maintained, no permission of the court is necessary.In the latter case provisions as to the reduction of the shares capitalare made applicable by virtue of proviso (d) to Sub-section (1) ofSection 80.

Thus, when a company has issued redeemable preference shares,created CRR in accordance with Section 80(1) proviso (d) and redeemedpreference shares, in accounting practice, no amount remains as CRR. Insuch a case, there cannot be any further prospect of utilising such non-existent CRR. Even if CRR which might remain in the books of accounts or inthe Balance Sheet, such account shall have to be used for issuing bonusshares as per Section 80(5A) of the Companies Act. Applying theseprinciples, the case of the petitioner company insofar as first relief isconcerned needs to be considered.

Utilisation of Capital Redemption Reserve It is the case of the Aurobindo that during the year 1997-1998, 50,000,12.5% redeemable non-convertible preference shares of Rs.100/- each wereissued to Canara Bank for value of Rs.50,00,000/- (Fifty lakhs only) andduring 1998-1999, 8,50,000, 12% redeemable non-convertible preferenceshares of Rs.100/- each were issued to Global Trust Bank and SBI CapitalMarkets Limited for a total value of Rs.8,50,00,000/-. Thus, out of authorisedpreference share capital of 10,00,000/- preference shares of Rs.100/- each,Rs.9,00,000/- preference shares were issued by 31.03.1999. The first issueduring 1997-1998 was authorised by resolution of Board of Directors, dated26.12.1997. The same reads as under.

MINUTES OF THE MEETING OF THE BOARD OF DIRECTORS

OF AUROBINDO PHARMA LIMITED HELD AT 12.30 PM ONFRIDAY THE 26[TH] DECEMBER, 1997 AT THE REGISTEREDOFFICE OF THE COMPANY AT PLOT NO.2, MAITHRIVIHAR,BEHIND MAITHRIVANAM, AMEERPET, HYDERABAD – 500 038.

ALLOTMENT OF REDEEMABLE NON CONVERTIBLEPREFERENCE SHARES OF RS.50.00 LAKHS IN FAVOUR OFCANARA BANK

The Board was informed that the Company had received Rs.50.00Lakhs from Canara Bank towards Preference Share ApplicationMoney for allotment of 50,000 (Dividend 12.50% p.a. payableannually) Redeemable Non Convertible Preference shares ofRs.100/- each per share.

The Board was approved for allotting 50,000 Redeemable NonConvertible Preference Shares of Rs.100/- each per share to CanaraBank and passed the following resolution.

“RESOLVED THAT 50,000 (Dividend 12.50% p.a.) Redeemable NonConvertible Preference Shares of Rs.100/- each per shareaggregating to Rs.50.00 Lakhs be and are hereby allotted in thePreference 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 besigned by Sri P.V.Ramaprasad Reddy, Managing Director and SriA.J.Kamath, Director of the Company and be counter signed by SriA.N.Sarma, Company Secretary of the Company.”

“FURTHER RESOLVED THAT the following Directors of theCompany Sri P.V.Ramaprasad Reddy and Sri A.J.Kamath, be andare hereby jointly and severally authorised to do take such steps andto do all such acts, deeds, matters and things and accept anyalterations or modifications as they may deem fit and proper and givesuch directions that may arise in regard to the issue and allotment ofthe said Preference Shares including the power to allot unsubscribedPreference Shares if any in such manner as may appear to the Boardof Directors to be most beneficial to the Company and to fix theCommon Seal of the company wherever necessary in terms ofArticles of Association of the Company”.

The issue of 4,50,000 preference shares to SBI Capital Markets wasauthorised by resolution dated 17.11.1998 of the Board of Directors, whichreads as under.

MINUTES OF THE MEETING OF THE BOARD OF DIRECTORSOF THE COMPANY HELD AT 3.00 PM ON 17[TH] NOVEMBER,1998 AT THE REGISTERED OFFICE OF THE COMPANY ATPLOT NO.2, MAITHRIVIHAR, BEHIND MAITHRIVANAM,AMEERPET, HYDERABAD – 500 038.

ALLOTMENT OF REDEEMABLE CONVERTIBLE PREFERENCESHARES OF RS.450.00 LAKHS IN FAVOUR OF SBI CAPITALMARKETS LIMITED, MUMBAI:

The Board was informed that the Company has received a sum ofRs.450.00 Lakhs from SBI Capital Markets Limited as ShareApplication Money for allotment of 4,50,000 Redeemable CumulativePreference Shares of Rs.100/- each per Share carrying dividend @12.00% p.a. payable annually. After discussion, the Board hasapproved for allotment of 4,50,000 Redeemable convertiblePreference Shares of Rs.100/- each per share to SBI Capital MarketsLimited and passed the following resolution.

“RESOLVED THAT 4,50,000 Redeemable Convertible PreferenceShares of Rs.100/- each per share carrying dividend @ 12.00% p.a.payable annually, aggregating to Rs.450.00 Lakhs be and are herebyallotted in the Preference Share Capital of the Company to SBI CapitalMarkets Limited.

“FURTHER RESOLVED THAT the Preference Shares Certificate(s)be signed, the Common Seal be affixed by/in the presence of SriP.V.Ramaprasad Reddy, Managing Director and SriK.A.Venkatachalam, Director of the Company and be counter signedby Sri A.N.Sarma, Company Secretary on behalf of the Company”.

The issue of 4,00,000 preference shares to Global Trust Bank wasauthorised by resolution, dated 24.11.1998.

MINUTES OF THE MEETING OF THE BOARD OF DIRECTORSOF THE COMPANY HELD AT 11.00 AM ON 24[TH] NOVEMBER,1998 AT THE REGISTERED OFFICE OF THE COMPANY ATPLOT NO.2, MAITHRIVIHAR, BEHIND MAITHRIVANAM,AMEERPET, HYDERABAD – 500 038.

ALLOTMENT OF REDEEMABLE CONVERTIBLE PREFERENCESHARES OF RS.400.00 LAKHS IN FAVOUR OF GLOBAL TRUSTBANK:

The Board was informed that the Company has received a sum ofRs.400.00 Lakhs from Global Trust Bank as Share Application Moneyfor allotment of 4,00,000 Redeemable Cumulative Preference Sharesof Rs.100/- each per Share carrying dividend @ 12.00% p.a. payableannually. After discussion, the Board has approved for allotment of4,00,000 Redeemable Convertible Preference Shares of Rs.100/-each per share to Global Trust Bank and passed the followingresolution.

“RESOLVED THAT 4,00,000 Redeemable Convertible PreferenceShares of Rs.100/- each per Share carrying dividend @ 12.00% p.a.payable annually, aggregating to Rs.400.00 Lakhs be and are herebyallotted in the Preference Share Capital of the Company to GlobalTrust Bank.

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

During 1997-1998, Aurobindo transferred Rs.46,575/- from P&LAccount to CRR. Thereafter, during the subsequent three years i.e., 1998- 1999, 1999-2000 and 2000-2001, Aurobindo transferred more thanRs.1,00,00,000/- each per year to CRR and by 31.03.2001, an amount ofRs.9,00,00,000/- accrued in CRR, which was the amount transferred from P&LAccount. The preference shares were redeemed on 17.05.2000, 25.05.2000and 20.12.2000. Before redemption and after redemption, entries regardingpreference share account and CRR in the Balance Sheet and respectiveschedules for the years 1997-1998 to 2007-2008 is reflected in the followingtable.

* 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 inBalance sheet and relevant schedule thereto.

This Court has thoroughly perused the Annual Reports for the aboveyears, especially the Balance Sheet and Schedules (a), (b) or (1) (2) theretowhich give the details of the authorised and issued share capital, reservesand surplus funds. During the year of issue of 50,000 preference shares, i.e.,1997-1998 itself, Aurobindo created CRR and transferred funds to CRR. In1998-1999, an amount of Rs.9,00,00,000/- was shown as issued andsubscribed preference share capital and an amount of Rs.7,89,10,000/- wasshown under CRR and during that year, an amount of Rs.6,54,75,000/- wastransferred from P&L Account. During 2000-2001, an amount ofRs.1,10,90,000/- was transferred to CRR and as noted supra, the total amountin CRR, which was Rs.9,00,00,000/- was utilised for redeeming 9,00,000preference shares. This is reflected in Schedule I to Balance Sheet for theyear ending 31.03.2001 and issued subscribed paid-up preference sharecapital was shown as Nil because the amount of Rs.9,00,00,000/- in CRR bythe end of financial year 2000-2001 was utilised for redeeming preferenceshares by that year end. During next financial year i.e., 2001-2002 in theBalance Sheet, CRR was shown as Nil and only issued, subscribed and paid-up equity capital was shown as share capital. This shows that by 31.03.2001,no preference shares were required to be redeemed and nil amount wasavailable in CRR. Therefore, the question of again utilising CRR towardsadjusting expenses does not arise.

Whether the company acted in compliance with the provisions of thelaw while redeeming preference shares during 2000-2001? The answer mustbe 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 CRRis used for redeeming preference shares, the company ought to have obtainedthe sanction of the Court as if it is reduction of capital under Sections 100 to103 of the Companies Act. When Aurobindo redeemed preference shares in2000-2001 without obtaining sanction of this Court under Sections 100 to 103,the company committed illegality. It may be noticed that after Court’sconfirmation of the Minute for reduction of share capital and publicationthereof under Section 102(2B), a certified copy thereof shall be producedbefore the Registrar of Companies, who shall register the same and on suchregistration, the Court order shall take effect. This only means that unless anduntil the order of the Court confirming the Minute is registered by the Registrarof Companies, the preference shares cannot be redeemed from out of theCRR. This procedure was not followed by Aurobindo. As seen from the threeresolutions extracted hereinabove, though the Board of Directors passedresolution for issue of redeemable non-convertible preference shares toBanks, there was no specific authorization to transfer funds to CRR. Thelanguage of Section 80(1) provisos (a) and (d) is very clear that if thepreference shares are redeemed by issue of shares for the purpose, nopermission is required but when the preference shares are to be redeemedotherwise than from the proceeds of the fresh issue of shares, the profits canbe transferred to CRR only with the resolution of the Board of Directors. Sucha resolution is absent, and therefore, the creation of CRR and transfer ofprofits itself ultra vires the provisions of the Companies Act.

Aurobindo admittedly redeemed preferential shares issued on twooccasions in May, 2000 and December, 2000 during 2000-2001. This wasdone without therebeing compliance with Section 103 of the Companies Act.Such non-compliance with mandatory requirements of law amounts tocontravention and attracts sub-section (6) of Section 80(1) proviso (d) readwith Sections 100 to 103 of the Companies Act. The lapses andcontraventions attract Section 80(d) and are two fold. First, Aurobindoredeemed preference shares from out of CRR as seen from the BalanceSheets for the year 2000-2001 and 2001-2002, without obtaining thepermission of the Court under Sections 100 to 103 of the Companies Act. Secondly, though in the Balance Sheet for 2000-2001, the amount ofpreference shares forming part of share capital was shown as Nil and inBalance Sheet for 2001-2002, CRR was shown as Nil, in subsequent yearsfrom 2002-2003 again the balance available under CRR was shown asRs.9,00,00,000/-. When during 2001-2002, CRR was shown as Nil, howArobindo 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 1997-1998 and 1998-1999, they again issued preference shares and createdanother CRR. The explanation for this is not forthcoming. Further more, whenthe preference shares were redeemed in 2000-2001 from out of the CRRcreated, Aurobindo chose to file present petition long thereafter on10.06.2009, and therefore, this Court cannot grant any order approving suchreduction as it would amount to approving illegal and ultra vires transaction ofAurobindo.

Reconstruction Reserve Account

Reconstruction Reserve Account

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 on31.03.2008 to RRA; and (ii) by crediting the amount of benefit arising frombuy-back of FCCBs on or after 01.04.2008 but before 31.12.2009 to RRA, sothat the said amount will be available to the Board of Directors forutilisation/application for the purposes mentioned in paragraph 1.5 of theScheme of Arrangement extracted hereinabove. For the sake of convenience,these two aspects need to be dealt with separately.

Foreign Currency Convertible Bonds (FCCBs)

As indicated hereinabove, during the financial year 2005-2006,Aurobindo issued FCCBs for a total sum of US $ 6,00,00,000 for 1,000/- eachat issue price of 100%. These bonds are convertible at any time on or after20.09.2005 and upto 01.08.2010 into shares of Rs.5/- each at conversionprice of Rs.522.06 with fixed rate of exchange of conversion of Rs.43.3925 =US 1$. Similarly, during 2006-2007, Aurobindo issued FCCBs in twotranches. US $ 15,00,00,000/- in US $ convertible bonds due 2011 of 100US$ each in tranch ‘A’ and US $ 50 million (5,00,00,000/-) forward convertiblebonds due 2011. FCCBs in tranch ‘B’ are convertible at any time on or after27.06.2006 and upto 10.05.2011 into shares of the company at a conversionprice to be determined on 17.05.2007 with fixed rate of exchange ofconversion of Rs.45.145 = US 1$.

RBI issued Circular bearing No.AP (Dir. Series) Circular No.39, dated08.12.2008 permitting authorised dealer (AD) category I Banks to allow IndianCompanies to prematurely buyback FCCBs, if the buyback value of theFCCBs is minimum discount of 15% of the book value. The funds used for thebuyback shall be out of existing foreign currency funds held by the companyeither in India or out of fresh External Commercial Borrowings (ECBs)inconformity with ECB norms. This is under automatic route and does notrequire approval of Reserve Bank of India. The buyback of FCCBs underapproval route was also permitted. In this category, buyback value of FCCBshall be at a minimum discount of 25% on the book value and the funds usedfor buyback shall be out of external accruals to be certified by statutoryauditors and authorised Dealer-I Banks certificate. Under this, the total amountof buyback shall not exceed US$ 50 million of the redemption value for thecompany. The buyback authorised by RBI in circular No.39 is subject to thefollowing conditions.

General conditions

In addition to the conditions set out above, the followingadditional conditions shall be applicable for the proposals both underthe automatic and approval routes:the automatic and approval routes:

(i) the FCCB should have been issued in compliance with theextant guidelines.extant guidelines.

(ii) The FCCB should have been registered with the ReserveBank, the LRN number obtained and ECB 2 returnssubmitted upto date.Bank, the LRN number obtained and ECB 2 returnssubmitted upto date.

(iii) No proceedings for contravention of FEMA are pendingagainst the company.against the company.

(iv) The right for buyback is vested with the issuer of FCCBs.However, the actual buyback is subject to the consent ofthe bond holders.However, the actual buyback is subject to the consent ofthe bond holders.

(v) The FCCBs bought back/repurchased from the holdersmust be cancelled and should not be re-issued or re-sold.must be cancelled and should not be re-issued or re-sold.(vi)The buyback will not have any effect on the bond holders notopting for the buyback or on the non-participating bondholders of companies opting for the buyback.opting for the buyback or on the non-participating bondholders of companies opting for the buyback.

(vii) The Indian company shall open an escrow account with thebranch or subsidiary of an Indian Bank Overseas or anInternational Bank for buying back the FCCBs to ensurethat the funds are used only for the buyback.branch or subsidiary of an Indian Bank Overseas or anInternational Bank for buying back the FCCBs to ensurethat the funds are used only for the buyback.

Under Circular No.39, the last date was fixed as 31.03.2009. However,by issuing A.P. (Dir series) Circular No.58, dated 13.03.2009, RBI extendedthe date for completing the entire procedure for buyback of FCCBs upto31.12.2009 without changing terms and conditions in Circular No.39. Themandatory conditions stipulated in circular No.39 require any company buyingback FCCBs to open an escrow account with an Indian Bank or overseasbank or international bank for buying back the FCCBs. This means theamounts in escrow account can alone be used for buying back FCCBs.Further, the proceedings shall not be in contravention of FEMA.

As per Foreign Exchange Management (Transfer of Issue of anyForeign Security) (Amendment) Regulation, 2004 (hereafter called, FEMARegulations), FCCB means a bond issued by an Indian company expressedin foreign currency and the principle and interest is payable only in foreigncurrency. But for the Regulations, the issue of foreign security is prohibitedexcept with the permission of RBI. Regulation 4 permits any person residentin India either to purchase or to sell foreign security. Part I of the Regulationsdeal with direct investment outside India whereas Part II and III deal withinvestments abroad by individuals and investments in foreign securities otherthan by direct investment. Regulation 21(2)(i) of the Regulations enablesIndian company to issue FCCBs not exceeding US $500 million and/or toissue FCCBs beyond US $500 million with the approval of the Bank. That isto say, if the total value of FCCBs does not exceed US $ 500 million, it isautomatic route not requiring prior permission of RBI but subject to theconditions stipulated in Schedule I to the Regulations. If a company issuesFCCBs either through automatic route or regulated route, within thirty (30)days after such issue, a company has to furnish a report to RBI giving thedetails and documents with regard to the total amount for which FCCBs areissued, names of the investors and number of FCCBs and the amountrepatriated to India through normal banking channels and/or the amountsreceived by debit through NRE/FCNR account of investors.

Schedule I referred to in Regulation 21(2)(i) of FEMA Regulationsprovides conditionalities for automatic route for issue of FCCBs. Conditions(vi) and (viii) are important. These stipulate that all in cost will be on part thatthose prescribed for External Commercial Borrowing (ECB) and the proceedsfrom FCCBs shall be used for the purpose for which ECB proceeds arepermitted 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 discountedprice can be utilized by the company. If the FCCBs are liabilities of thecompany shown in the Balance Sheet, the premium on conversion of FCCBsand the amounts realized by issue of such FCCBs shall have to be shown inthe Balance Sheet. What would happen when FCCBs are bought back fromout of the Foreign Currency Reserves parked in escrow account with a bankas mentioned in general condition (vii) of Circular No.39 referred tohereinabove? Whether Aurobindo has complied with all these conditions?

The petition does not disclose whether the payment under the buy backhas been completed, and whether resources have been created by openingescrow account for such purpose. The Board of directors of Aurobindo passedresolution on 30.07.2008 for purchase of FCCBs from open market at a pricenot exceeding face value of the bonds and for consequential cancellation upto and aggregate of US$ 100 million out of the outstanding three FCCB series.Except these particulars, no details are forthcoming regarding source of fundsto buy back. There is no mention of Foreign Currency internal accruals. TheBalance Sheet for 2007-2008 (provisional) and the provisional Balance Sheetfor 2008-2009 are also not clear as to the buy back of funds. The companypetition was filed on 10[th] June, 2009 and by that date the buy back is notcompleted. Therefore, unless and until the actual benefit that accrues to thecompany from out of the buy back at discounted price, and is shown inBalance Sheet, it cannot be assumed that benefit would accrue to thecompany. Secondly, Board of Directors passed resolution on 30.07.2008 tobuy back and cancel the FCCBs, in which event, the alleged accruals wouldbe nil. It is well settled that when a Scheme of Arrangement is submitted forapproval, a company is required to place all the details to enable the Court toconsider its vires before granting approval. It is not clear as to how muchbenefit would accrue to Aurobindo. It is also not clear whether such accrualscan be permitted to be utilized for creation of RRA authorizing the Board ofDirectors to use the funds for the purpose enumerated in clause 1.5 of theScheme of Arrangement. In the absence of all the details, this Court is notinclined to approve the Scheme of Arrangement with regard to creation ofRRA by transferring the benefits to be accrued from buy back of FCCBs.Capital Reserve Account The Scheme was approved by Board of Directors of Aurobindo on31.03.2009 and the Managing Director and/or CFO and/or CompanySecretary are authorized to take all necessary steps in compliance with theCompanies Act and Company Rules. The Board of Directors also resolved forconstitution of restructuring committee to give effect to the Scheme. It is notclear from the resolution whether the Board considered pointedly the transferof capital reserve as on 31.03.2008 to RRA for the year ended 31.03.2009 forbeing utilized towards adjusting expenses as mentioned in clause 1.5.Assuming that the Board of Directors had applied its mind to this aspect of thematter, the question would be whether CRA can be permitted to be utilized forcreation of RRA to write off towards intangible assets, towards unrealizableloans, interest/financial charges, outstanding receivables, to writeoff/amortization of goodwill etc.

There cannot be any dispute, the capital reserve can be utilized by thecompany for the purposes authorized in law and in such a case, nopermission of the Court is required. It is a matter of good corporate practicesand business prudence whether or not capital reserve be utilized for meetinga particular contingency. But when the CRA is directly or indirectly used in amanner that it results in reduction of share capital, the permission of the Courtis required. The purposes for which RRA is sought to be used are certainly notthe purpose for which CRA can be utilized as noticed infra.

The terms ‘reserve’, ‘capital reserve’ and ‘reconstruction reserve’ are notdefined in the Companies Act. Section 211 of the Companies Act requiresevery company to prepare the Balance Sheet containing the true and fair viewof the state of affairs of the company at the end of the financial year in the formset 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 Sheetin Part I. Part II contains provisions to be applied to income and expenditureaccount referred to in Section 210(2) of the Companies Act. Part III containsRules 7 and 8. For our purpose, Rule 7(1) is relevant as this explains theexpressions ‘reserve’ and ‘capital reserve’.

7(1) For the purposes of Parts I and II of this Schedule, unless thecontext otherwise requires,-context otherwise requires,- (a)the expression “provision” shall, subject to sub-clause (2) of thisclause, mean any amount written off or retained by way ofproviding for depreciation renewals or diminution in value ofassets, or retained by way of providing for any known liability ofwhich the amount cannot be determined with substantialaccuracy;clause, mean any amount written off or retained by way ofproviding for depreciation renewals or diminution in value ofassets, or retained by way of providing for any known liability ofwhich the amount cannot be determined with substantialaccuracy; (b)the expression “reserve” shall not, subject as aforesaid, includeany amount written off or retained by way of providing fordepreciation, renewals or diminution in value of assets or retainedby way of providing for any known liability;any amount written off or retained by way of providing fordepreciation, renewals or diminution in value of assets or retainedby way of providing for any known liability;

(c) the expression “capital reserve” shall not include any amountregarded as free for distribution through the profit and lossaccount; and the expression “revenue reserve” shall mean anyreserve other than a capital reserve;regarded as free for distribution through the profit and lossaccount; and the expression “revenue reserve” shall mean anyreserve other than a capital reserve; and this sub-clause the expression “liability” shall include all liabilitiesin respect of expenditure contracted for and all disputed or contingentliabilities.in respect of expenditure contracted for and all disputed or contingentliabilities.

The Compendium of Guidance Notes (Accounting) published byInstitute of Chartered Accountants of India (ICAI) (July 2006 edn.,) defines‘reserve’ as under.

Reserve: The portion of earnings, receipts or other surplus of anenterprise (whether capital or revenue) appropriated by themanagement for a general or a specific purpose other than aprovision for depreciation or diminution in the value of assets orfor a known liability. The reserves are primarily of two types:capital reserves and revenue reserves.enterprise (whether capital or revenue) appropriated by themanagement for a general or a specific purpose other than aprovision for depreciation or diminution in the value of assets orfor a known liability. The reserves are primarily of two types:capital reserves and revenue reserves.

The term ‘capital reserve’ is defined in ICAI Guidance Notes as areserve of a corporate enterprise which is not available for distribution as

dividend’. This means when once capital reserve is created, the same cannotbe utilized for any other purpose except for the purpose for which it isintended. Capital reserve cannot be used even for distribution for dividend.The revenue reserve unlike capital reserve is considered as free reserveavailable for issue of bonus shares. Further, capital reserves are derived fromnon-trading operations of the company and reserve so created out of therealization is termed as capital reserve. As already seen, as per Schedule VIPart III of the Companies Act, the reserve shall not include any amount writtenoff or retained by way of providing depreciation, renewals or diminution invalue of assets or retained by way of providing for any un-known liability,which cannot be determined with substantial accuracy. From this, it becomesclear that capital reserve cannot be used for writing off loss or for adjustingtowards diminution of value of assets etc.

I n I.T.Commissioner v Century Spinning and Manufacturing Company[[7]], Constitution Bench of the Supreme Court considered the term‘reserve’. It was held that the term reserve ‘should be given the ordinarynatural meaning as understood in the common parlance and that profits lyingunutilized and not specifically set apart for any purpose would not constitutereserves”. It was also held that the reserve may be a general reserve or aspecific reserve but there must be clear indication to show that whether it is areserve 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 sameshould be set apart for investment in the company and not to write off thelosses of a company or its subsidiaries. ‘Capital reserve’ therefore cannot beused for writing off losses and as noticed supra, a capital reserve is not a freereserve and cannot be used for purposes not authorized under law.

I n Commissioner of Income Tax v Veeraswami Nainar[[8]], theassessee was an HUF with bus/lorry transport business, filed Return for 1959-1960 showing loss of Rs.20,441/- after deducting development rebate ofRs.18,965/- at 25% on a new lorry and a new bus purchased subsequent toDecember, 1957. But, the assessee did not debit 75% of that amount to theprofit and loss account and consequently rebate claimed had not beencredited to the reserve account as required under Section 10(2)(vi-b) of theIncome Tax Act, 1922. Income Tax Authorities refused to allow developmentrebate on the ground that bus and lorry cannot be regarded as plant andmachinery within the meaning of said provision. The appellate authorityagreed with Income Tax Officer, but on further appeal, the Income TaxAppellate Tribunal referred the question to the High Court as to whether theassessee can claim allowance even though necessary reserve was notcreated as required under law. Madras High Court answered referenceagainst the assessee and it was held:

It will be apparent from the terms of the proviso that the object of theLegislature in allowing a development rebate is a real one, that is, tofacilitate the improvement of the assessee’s business from out of thereserve fund. The entries in the account books required by the provisoare not an idle formality. The assessee being obliged to credit thereserve fund for a specific purpose, he cannot draw upon theLegislature in allowing a development rebate is a real one, that is, tofacilitate the improvement of the assessee’s business from out of thereserve fund. The entries in the account books required by the provisoare not an idle formality. The assessee being obliged to credit thereserve fund for a specific purpose, he cannot draw upon the same for purposes other than those of the business, and if theassessee were a company for exemption that amount could notbe distributed by way of dividend. It is also clear from the termsof the proviso that the reserve should be made at the time ofmaking up the profit and loss account. The tribunal was clearly inerror when it held that account by making the reserve at a later periodof time. Any account maintained by a business should reflect itsfinancial transactions correctly. If at the time of the closing of theaccounts for a year, a particular appropriation had not been made, butthe moneys had been spent otherwise, it would indeed be futile todirect the assessee to re-adjust the account.

The dicta in Veeraswami Nainar (supra) was approved by Supreme Court in Indian Overseas Bank v the Commissioner of Income Tax[[9]],wherein it was held.

The reserve contemplated by that provision is a separate reserve.The amount transferred to that reserve cannot be utilized forbusiness purposes. The reserve contemplated by proviso (b) toSection 10(2) (vi-b) of the Act is an independent reserve. The amountto be transferred to that reserve is debited before the profit and lossaccount is made up. That amount is required to be credited to areserve account to be utilized by the assessee during a period of tenyears for the purposes of the business of the undertaking. The natureof the two reserves are different. They are intended to serve twodifferent purposes. As observed by the Madras High Court inVeeraswami Nainar (supra) that the object of the legislature inallowing a development of the assessee’s business from out of thereserve fund is apparent from the terms of the proviso. The entries inthe account books required by the proviso are not an idle formality.The assessee being obliged to credit the reserve fund for a specificpurpose, he cannot draw upon the same for purposes other thanthose of the business and that amount cannot be distributed by way ofdividend. It is also clear from the terms of the proviso that the transferto the reserve fund should be made at the time of making up the profitand loss account.

Whether Members of Aurobindo approved the Scheme under Sections 391(1)and (2) of Companies Act?

This Court appointed Chairperson to convene the meeting of equityshareholders to consider and approve the resolution to support the Scheme ofArrangement proposed by the Board of Directors of Aurobindo. Thechairperson convened the meeting of the shareholders at 3.00 p.m., on21.05.2009 at Katriya Hotel and Towers, Hyderabad. In all 177 shareholders(either in person or through proxies/representations) of Aurobindorepresenting 3,49,88,412 equity shares of Rs.5/- each aggregating toRs.17,49,42,060/- attended the meeting. Out of them, 93.92% of shareholdersvoted and approved the following resolutions.

Resolution:1

“Resolved that the Scheme of Arrangement by and betweenAurobindo Pharma Limited and its shareholders tabled before the meting and initialed by the Chairman for identification purpose be andis hereby approved.”

Special Resolution:2

“Resolved that the Applicant company be and is herebyauthorized to exercise all the powers conferred under Sections 100 to103 of the Companies Act, 1956, to adjust the amount standing to thecredit of Capital Redemption Reserve Account as on March 31, 2008against the expenses as provided for in the Scheme of Arrangementbetween Aurobindo Pharma Limited and its Shareholders on March31, 2009.”

Special Resolution:3

“Resolved that the Board of Directors of the ApplicantCompany (hereinafter referred to as ‘the Board’ which expressionshall also include any Restructuring Committee constituted thereof)be and is hereby authorized to do all such acts, deeds, matters andthings, which the Board considers necessary, requisite, desirable orappropriate and to make, agree or accept suchmodifications/amendments/limitations and/or conditions arising out ofor by virtue of the said Scheme or as may be directed or imposed bythe Stock Exchange with whom the shares of the Company are listedand/or any other authorities and/or by the Hon’ble High Court ofJudicature of Andhra Pradesh at Hyderabad and which the Boardconsiders necessary to effectively implement the said Scheme.”

Resolution 1 and Resolution 3 above are in general terms. Resolution2 passed by majority shareholders presented in the meeting authorizedAurobindo to adjust the amount standing to the credit of Capital RedemptionReserve as on 31.03.2008 against planned expenses. There is no suchspecial resolution passed by equity shareholders in the meeting convened bychairperson appointed by this Court in relation to creation of ReconstructionReserve Account and transfer to it, capital reserve and/or the benefit accruingfrom buyback of FCCBs. When there is no specific resolution by equityshareholders, compliance with Section 391 of the Companies Act, cannot beinferred. If the intention was to obtain general approval for the Scheme ofArrangement, there was no necessity for moving second special resolution.When the equity shareholders approved special resolution with regard toadjusting CRR, nothing prevented passing a similar special resolution withregard to transfer of capital reserve and/or FCCB benefit to RRA. When theScheme of Arrangement is proposed by Board of Directors with regard tothree aspects, and a special resolution is passed only with reference to onesubject concurrence of majority shareholders cannot be inferred withreference to other aspects. This is also one of the reasons which woulddisqualify the petition for approval.

This Court has carefully perused the annual reports and BalanceSheets of Aurobindo for the years 2000-2001 to 2007-2008. In none of these,there is an indication for utilizing capital reserve for the purposes intendednow by transferring to RRA. As capital is not a free reserve, it cannot beallowed for payment of any future liability or for depreciation of assets or forbad debts. As noticed supra, Aurobindo proposes to transfer capital reserveaccount to RRA to write-off capital lost and other losses. This is notpermissible under law. Therefore, this Court is not inclined to approve the Scheme of Arrangement as proposed.

The company petition is therefore dismissed.

.12.2009plnNote: LR copy be marked. (By order) pln ______________

(V.V.S.RAO,J)

[1](1996) 87 Comp Cas 791 = AIR 1997 SC 506[2]1995 Supp (1) SCC 499 = 1994 AIR SCW 4701[3](1894) AC 399 (HL)[4](1887) 12 AC 409 : (1886-1890) All ER 46 (HL))[5](2006) 5 SCC 638[6](2005) 126 Comp Cas 647 (Bom) : (2004) 58 CLA 154 (Bom)[7]AIR 1953 SC 501[8](1965) 55 ITR 35 (Mad) : AIR 1965 Mad 533[9](1970) 2 SCC 4 : AIR 1970 SC 1530