A company may buy-back its securities out of :
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its free reserves; or
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the securities premium account; or
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the proceeds of issue of any shares or other specified securities.
Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities. [Section 77A(1)]
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Free reserves and securities premium account
While the surplus in the profit and loss account can be used for buy-back of securities, in case the profit and loss account shows a debit balance, such debit balance should first be deducted from free reserves.
Capital redemption reserve, revaluation reserve, investment allowance reserve, profit on re-issue of forfeited shares, profits earned prior to incorporation of the company and any other specific reserve are not available for distribution as dividend and hence do not form part of free reserves for the purpose of buy-back.
Even though Section 77A(1) provides that a company may buy-back its securities out of securities premium account, sub-section (2) of Section 78 does not mention buy-back of securities as one of the purposes for which the balance in the securities premium account may be utilised. However, by virtue of the non obstante clause in Section 77A, namely ‘Notwithstanding anything contained in this Act….’, Section 77A prevails over Section 78. Therefore, the securities premium account can be utilized for buy-back of securities.
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Proceeds of issue
Buy-back may be made out of the proceeds of an issue of securities other than the same kind of securities as are proposed to be bought back.
The proceeds of an earlier issue of one kind of securities may be used for the purpose of buy-back of any other kind of securities. The proceeds of an issue of preference shares may be used to buy-back equity shares and the proceeds of an issue of equity shares may be used to buy-back preference shares.
However, the proceeds of issue of preference shares carrying differential rights as to dividend, voting etc. cannot be utilized inter se for the purpose of buy-back. For instance, the proceeds of issue of 10% preference shares cannot be utilized for buy-back of 8% preference shares, as these are of the same kind, though of different classes of shares.
There should be no direct nexus between the proceeds of an issue and buy-back of securities of a company. For instance, if equity shares had been issued by a company in 1994 and the funds raised therefrom were deposited in a bank account, buy-back of equity shares by the company in 2003 will be permissible from the funds in that account, if there is evidence to prove that, over the years, the aforesaid bank account has functioned as common pool for deposit of all the funds raised and no direct nexus can be established between the proceeds of the issue in 1994 and the buy-back in 2003.
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Borrowings from banks/financial institutions
Where a company has borrowed any money from banks/financial institutions for any purpose, it should not utilize such money for buy-back of securities. [Rule 8(e)]. Further, if any approval is required to be obtained from banks/financial institutions, such approval should be obtained before passing the Board resolution for buy-back of securities.
