Companies! How to Distribute your excess profits prudently – Know the Secret!

This article is based on the citation: 2007(6) AIR Kar R 151 – judgement delivered by Hon’ble Justice N.Kumar of High Court of Karnataka wherein the Hon’ble Justice has threadbare the points with regard to distribution of excess profits by the Companies. For further detailed study , kindly refer the above citation. profits and losses
When a Company prospers and earns profits it may do one of two things with the profits. It may either distribute the profits by way of dividend among the shareholders or accumulate them. Ordinarily, these undistributed profits are employed in the business either in acquisition of fixed assets or as working capital and really represent an increase in the capital employed in the business. When these increase to a considerable extent, the issued capital of the company ceases to bear a true relation to the real capital employed in the business. The company may, in such a case, decide to bring its issued capital into a true relationship with the capital actually employed in the business and may for that purpose capitalize its accumulated profits and issue fully paid up shares or debentures of a nominal value equal to the amount capitalize to its shareholders. These new shares or debentures are called as Bonus Shares or Bonus Debentures. They are not a gift from the company. They are not issued gratuitously. Their nominal value is paid in full by the capitalized profits or reserves of the company, which could otherwise have been distributed to the shareholders.
The Company may instead of issuing bonus shares, issue bonus debentures by capitalizing its accumulated profits. The accumulated profits which are capitalized remain in the coffers of the Company and no part of them actually goes into the pockets of the shareholders; the only change that takes place is that the accumulated profits which prior to capitalization were employed in the business as accumulated profits are thenceforth employed as part of the issued or loan capital of the Company according as the issue is of bonus shares or bonus debentures. The accumulated profits which might have been divided among the shareholders as dividend are impounded to increase the capital of Company and what the shareholders get is not any payment out of the accumulated profits but bonus shares or bonus debentures credited as fully paid-up. When such bonus shares or bonus debentures are issued, admittedly no money is paid by the shareholders for the bonus shares or bonus debentures issued to them. There is no payment of the accumulated profits to the shareholders since no part of the accumulated profits is liberated to them. The Company does not part with any of the accumulated profits nor do the shareholders receive any part of them. But the accumulated profits are applied in paying up the capital sums which the shareholders would otherwise have had to contribute for the purchase of new shares or new debentures.

In the instant case a Company incorporated as ASTRA IDL Ltd., on 11/07/1979 under the provisions of the Companies Act, 1956 in the State of Karnataka, subsequently with effect from 31/5/2001 the name was changed to Astra Zeneca Pharma India Limited and the registered office of petitioner is situated at Hebbal, Bangalore has preferred this Company Petition under Section 391 to 393 of the Companies Act 1956 seeking the sanction for scheme of arrangement.
The Authorised Share Capital of the Company is Rs.5 crores divided into Rs.2,50,00,000/- equity shares of Rs.2/-. The issued, subscribed and the paid up share capital is Rs.5 crores. The main object of the Company was to manufacture, produce, formulate, prepare, buy market, distribute, exchange, supply, sell or otherwise and generally to deal in pharmaceutical and other kinds of chemicals and their intermediaries which is set out in the Memorandum of Association.
Clause 172 of the Articles of Association of the Company provides for capitalization. By a Special Resolution in General Meeting the Company may resolve that any money, investments or other assets forming part of the undivided profits of the Company standing to the credit of the Reserve Fund, or any Capital Redemption Reserve Account, or in the hands of the Company and available for dividend be capitalized and distributed among such of the shareholders as would be entitled to receive the same if distributed by way of dividend and in the same proportions on the footing that they become entitled thereto as capital and that all or any part of such capitalized fund be applied on behalf of such shareholders in paying up in full either at par or at such premium as the resolution may provide, any un-issued shares or debentures or debenture-stock holders in full satisfaction of their interest in the said capitalized sum. The Court observed that
It is in pursuance of this specific article in the Articles of Association, the Board of Directors of the Company have approved and adopted the scheme of arrangement with its share holders for issue of secured fully paid redeemable non-convertible bonus debentures from General Reserve.
In the meeting held in pursuance of the permission granted by this Court, all the shareholders and the creditors of the Company to consider and approve the aforesaid scheme of arrangement, unanimously the scheme is approved. And the Court did not find any substance in the objections raised by the Regional Director, Registrar of Companies and further observed:

The Company since 2000 is a zero debt Company. It has no borrowings from Banks or other financial institutions for working capital or other financial institutions for working capital or other requirements for carrying on its business efficiently. The Company has been by and large following a prudent dividend policy and has consequently transferred a significant part of its retained profits to General Reserve. The Company also has significant amounts to the credit of its Profit and Loss Account Balance. The capital represented in the form of General Reserve is in excess of its wants.

It has significant cash resources and capital, surplus to its sustainable long term operational needs. The Company has thus come to the conclusion that it should return the General Reserve in excess of its wants to its shareholders by restructuring its General reserve. The issue of debentures with a 12 months tenure under the said Scheme is designed to achieve this object.The Hon’ble High Court held:
The mechanism of issue of bonus shares or debentures is, apart from the abundance of authority to support it, clearly based on sound principle. There is no legal impediment. This is a well accepted practice. However, the scheme is conditional and subject to the requisite sanction or approval from other concerned authorities being obtained and granted in the matter in respect of which sanctions or approvals shall be required. The sanction accorded by this Court to the “Scheme of Arrangement” is always subject to such sanctions or approval that is required from the concerned authorities.

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