Capital reserve and redemption reserve misuse barred where shareholder approval and lawful reserve application were incomplete.

Capital redemption reserve, once used for redemption of preference shares, cannot be redeployed for further scheme expenses because it is exhausted and subject to the statutory regime for reduction of share capital. The proposed transfer of capital reserve and the claimed benefit from buy-back of foreign currency convertible bonds to a reconstruction reserve account for writing off losses and expenses was also impermissible, as capital reserve is not a free reserve and the record did not show a lawful crystallised basis for the proposed use. Shareholder approval was incomplete because the special resolution covered only the capital redemption reserve adjustment and did not extend to the additional reserve transfers. The scheme therefore could not be sanctioned.

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Issues: (i) Whether the capital redemption reserve, having already been used for redemption of preference shares, could again be applied towards the proposed expenses under the scheme of arrangement; (ii) Whether transfer of capital reserve and the benefit of buy-back of foreign currency convertible bonds to a reconstruction reserve account for writing off losses and expenses was permissible; (iii) Whether the shareholders had validly approved the scheme in respect of all its proposed components.

Issue (i): Whether the capital redemption reserve, having already been used for redemption of preference shares, could again be applied towards the proposed expenses under the scheme of arrangement?

Analysis: Amounts transferred to capital redemption reserve from distributable profits are part of capital and, when used for redemption of preference shares, attract the statutory procedure for reduction of share capital. Once that reserve has been exhausted in redeeming preference shares, it ceases to be available for any further application. In the present case, the reserve stood utilised for redemption and there was no subsisting balance to be redeployed.

Conclusion: The proposed second utilisation of capital redemption reserve was impermissible and the issue is answered against the petitioner.

Issue (ii): Whether transfer of capital reserve and the benefit of buy-back of foreign currency convertible bonds to a reconstruction reserve account for writing off losses and expenses was permissible?

Analysis: Capital reserve is not a free reserve and cannot be used to write off losses, diminution in assets, goodwill, unrealizable loans, or similar items unless the proposed application is legally permissible. The proposed use of the reconstruction reserve account was not supported by sufficient disclosure, the claimed benefit from buy-back had not crystallised on the record, and the intended deployment would amount to an impermissible reduction of capital or use of funds beyond the lawful purpose of the reserve.

Conclusion: The proposed creation and use of the reconstruction reserve account was not permissible and the issue is answered against the petitioner.

Issue (iii): Whether the shareholders had validly approved the scheme in respect of all its proposed components?

Analysis: The special resolution passed at the convened meeting specifically covered adjustment of the capital redemption reserve, but there was no corresponding special resolution covering transfer of capital reserve or the foreign currency convertible bond benefit to the reconstruction reserve account. Approval for one component could not be inferred as approval for distinct additional components proposed in the same scheme.

Conclusion: The shareholders had not validly approved the scheme in respect of all its proposed components and the issue is answered against the petitioner.

Final Conclusion: The scheme could not be sanctioned, as the proposed applications of the reserves were contrary to law and the requisite shareholder approval was incomplete.

Ratio Decidendi: A reserve created from profits for redemption of preference shares cannot be reused after its lawful exhaustion, and capital reserve cannot be applied to write off losses or similar items in a manner that bypasses the statutory regime for reduction of share capital.

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