REDUCTION OF CAPITAL

A company may lose money through bad luck or bad management. For example,
accumulated business losses. As a result, the original capital may either have become lost or a
company may find that it has more resources that it can profitably employ. In either of these
cases, the need to reduce capital may arise to adjust the relation between capital and assets.

Therefore, as an alternative to a shares buy back, a company may wish to reduce its
capital by undertaking a reduction of capital in the ways allowed by section 64 of the Companies
Act 1965. The reduction of capital can only be done if the reduction is authorised by the
companys Article of Association, is approved by a special resolution by the shareholders and is
confirmed by the court.1 It means that a company cannot simply reduce its capital. There must be
a clear provision in the Article of Association that reduction of capital is allowed under certain
circumstances. Plus, it must be approved by a special resolution of the company and the
company must seek the court's confirmation for any reduction in its share capital.

Reason for a Company to Reduce Its Capital

The most common reason that a company may seek to reduce its issued capital is to write
off capital which is no longer represented by assets. This occurs after a companys assets fall in
value or the company has suffered trading losses. Such a reduction of capital is seen as causing
no injury to shareholders and may be of some benefit in that it enables dividends to be declared.
This may be detrimental to creditors, especially if payment of dividends is resumed while their
debts remain outstanding. Therefore, the Companies Act 1965 is primarily concerned with
safeguarding the interest of creditors where a company seeks to reduce its capital.

1 Section 64(1), Companies Act 1965 (Act 125)

In other cases, a company may wish to return capital to members that is in excess of the
companys needs. This may occur if the company wishes to reduce its business or has sold a
significant part of its business. A company may also reduce its capital as a part of reconstruction.
Because such reductions involve returns to shareholders, a company may unfairly favour or
discriminate against one class of shareholders relative to another. A reduction of capital therefore
may also affect the interests of shareholders of different classes.2

Methods of Reduction of Capital

Under section 64(1) of the Companies Act 1965, a company may undertake a reduction of capital
in any way but may do all or any of the following envisaged by the section;
(a) Extinguish or reduce the liability on any of its shares in respect of share capital not paid up;3
In Re Doloswella Rubber & Tea Estates Ltd4, for example, the company was incorporated with
the object of developing a rubber estate in Ceylon of about 8000 acres. Its issued capital was
divided into 640 share of 500 each on which 185 per share has been paid. After its
incorporation the company decided to limit the area of cultivation to 4000 acres and
consequently it did not require the whole of its issued capital. It resolved therefore to reduce its
issued capital by 200 per share.
(b) A company may cancel any paid up share capital that is lost or is not represented by available
assets;5
In Re Rhodesian Manufacturing Co Ltd 6, the companys issued share capital comprised 44,360
A shares of 1 each and 19,000 B shares also 1 each. All issued shares were fully paid. The
2 Rachagan S., Pascoe J., Joshi A., Principles of Company Law in Malaysia, Malayan
Law Journal Sdn Bhd, Malaysia, 2002, p 224 225.
3 Section 64(1)(a), Companies Act 1965 (Act 125)
4 [1917] 1 Ch 213
5 Section 64(1)(b), Companies Act 1965 (Act 125)

company had made large losses such that its net assets amounted to about 12,555. The company
resolved to reduce its issued capital by cancelling all B shares and reducing the nominal value of
the A shares to 6/8 each. This reduction resulted in bringing the issued capital into line with the
net value of its assets.
(c) A company may pay off any paid share capital that is in excess of its needs.7
In the Australian case of Re Fowlers Vacola Manufacturing Co Ltd 8, because of intense
competition in its food canning business, the company abandoned this activity and consequently
had capital in excess of its needs. It resolved to reduce its capital and return the excess to its
ordinary shareholders. This was done by reducing the nominal value of ordinary shares from 10s
each to 2/6 and returning 7/6 in respect of each ordinary share.

Right to Object and Confirmation by the Court

According to Section 64(2) of Companies Act 1965, in respect of the right of the creditor to
object to the reduction, creditors will have to be notified of the reduction. Before confirming the
reduction of capital, the Court shall be satisfied that the consent of the creditors to the reduction
of capital has been obtained or the creditors have been discharged or their debts or claims have
been discharged or settled or secured. The creditor for this purpose means a person who has a
debt or any claim against the company of such a nature as would have been provable in winding
up.

As per Section 64 (2) (c) of Companies Act 1965, the Court has first to be satisfied that
the creditors who had objected to the reduction of capital that either their consent has been
obtained or their debts or claims have been discharged or settled or secured. If the company does
6 [1927] SASR 310
7 Section 64(1)(c), Companies Act 1965 (Act 125)
8 [1966] VR 97

not admit or provide the full amount of debt or the amount is contingent or not ascertainable then
the Court has the right to fix the amount.9

The Courts discretion to refuse confirmation of a reduction in capital when it is opposed by a

creditor was considered in Re Convalescent Services Ltd10. In that case, the company, which
operated convalescent hospitals, resolved to reduce its capital by returning half of the paid up
capital to its shareholders. The reduction was opposed by Levy who held a mortgage over one of
the companys hospitals. The court held the Levy, as creditor, had a bona fide concern as to the
companys ability to pay the mortgage debt in the event of the reduction and there being no
attempt by it to secure the debt in some other way, thus the confirmation was refused.

When a Reduction is Fair and Reasonable to Shareholders and Creditors?

Before proceeding with the reduction, the company must be satisfied as it thinks fit that the
reduction is fair and reasonable to the shareholders as a whole. This includes the adequacy of
the payment (if any) to shareholders, the effect on shareholder rights and whether the reduction is
being used to avoid the take-over provisions or is being used in circumstances that should
properly involve a scheme of arrangement.
As for creditors concerned, Section 62 of the Companies Act 1965 has stringent
requirements where creditors are concerned. The court will not confirm the reduction unless
creditors rights are protected, either by obtaining the creditors consent or by ensuring that the
debt or claim has been discharged or secured. The court will require that the company prepares a
list of creditors and ascertain their claims. If the creditors do not consent, the court has authority
to order the company to secure the debts.

9 Section 64(2)(c)(ii), Companies Act 1965 (Act 125)

10 (1972) CLC 40047