Reclassification Of Authorised Share Capital?

Companies often need to continuously adapt their capital structures to align with evolving business strategies, funding requirements, and investor preferences. One such adaptation is the reclassification of authorised share capital, a mechanism that allows firms to convert unissued shares from one class to another without necessarily increasing the overall authorised limit. This process is governed by the Companies Act, 2013, and provides a flexible tool for corporate restructuring.

Authorised share capital represents the maximum value of shares a company is permitted to issue, as outlined in the capital clause of its Memorandum of Association (MoA). Shares are typically classified into equity shares, which carry voting rights and residual claims on assets, and preference shares, which offer fixed dividends and priority in asset distribution but limited voting rights. Reclassification involves altering this composition by canceling unissued shares of one class (e.g., equity) and simultaneously creating an equivalent number in another class (e.g., preference), effectively reshaping the authorised capital without changing its total quantum.

Rationale for Reclassification:

The primary reason for reclassifying authorised share capital stems from the need for strategic financial flexibility. Businesses may initially structure their capital predominantly as equity to foster growth through retained earnings and shareholder involvement. However, as they mature, they might require alternative funding sources, such as preference shares, to attract investors interested in steady returns rather than voting power. Some of the key factors behind reclassification include:

1. Optimizing Capital Structure: Reclassification enables companies to balance debt and equity-like instruments. For instance, issuing preference shares can provide quasi-debt financing without the obligations of traditional loans, helping maintain a healthy debt-equity ratio.
2. Attracting Diverse Investors: Preference shares appeal to risk-averse investors seeking fixed dividends, while equity suits those betting on long-term growth. This diversification can broaden the investor base and reduce funding costs.
3. Responding to Market and Business Needs: Economic shifts, expansion plans, or regulatory changes might necessitate a pivot. Reclassifying allows quick adaptation without the need to increase total authorised capital, thereby avoiding associated fees or stamp duties.
4. Cost Efficiency: Unlike outright increases in authorised capital, which may involve government fees proportional to the increment, reclassification of unissued shares incurs no such additional costs, making it an economical option for internal restructuring.
5. Strategic Alignment: It supports long-term goals, such as mergers, acquisitions, or employee stock option plans, by ensuring the capital structure aligns with operational strategies.

In essence, reclassification empowers companies to fine-tune their financial architecture, enhancing resilience and competitiveness in a volatile market environment.

Legal Framework Under the Companies Act, 2013

Reclassification is facilitated through Section 61, which empowers limited companies to alter their share capital if authorised by their Articles of Association (AoA). Specifically:

– Section 61(1)(a) allows an increase in authorised share capital and Section 61(1)(e) permits the cancellation of shares that have not been taken or agreed to be taken by any person, thereby diminishing the share capital by that amount.

Reclassification is achieved by combining these: canceling unissued shares of one class under clause (e) and increasing shares of another class under clause (a). This alteration necessitates amending the MoA under Section 13, as the capital clause must reflect the new composition.

If the AoA does not authorise such alterations, it must first be amended via a special resolution under Section 14.

Process for Reclassification:

Below is a step-by-step guide for the reclassification of capital by a private limited company:

1. Review the Articles of Association of the Company: Examine the AoA to confirm authorisation for share capital alterations. If not, AoA amendments shall be done to ensure the legality of the reclassification of capital.

2. Convene Board Meeting: Draft and circulate a notice with an agenda. At the meeting, pass resolutions to:

• Approve the cancellation of unissued shares in one class and the creation of an equivalent number in another class.
• Alter the capital clause in the MoA to reflect the reclassified structure.
• Fix the date, time, venue, and agenda for an EGM.
• Authorise a director or company secretary to issue EGM notices.

3. Issue EGM Notice: Send notices at least 21 days in advance, including an explanatory statement detailing the rationale and impact of the reclassification.

4. Hold EGM and Pass Resolutions: Secure shareholder approval through an ordinary resolution for the reclassification and MoA alteration.

5. File E-form with RoC: Within 30 days of passing the resolution, submit e-Form SH-7 attaching:

• Certified copy of the ordinary resolution and explanatory statement.
• Altered MoA

6. Obtain Certificate from RoC: Upon approval, the RoC issues a certificate confirming the reclassification of capital.

7. Post-Approval Actions: Upon RoC approval, update company records, inform stakeholders. The reclassification takes effect from the approval date.