Internal Reconstruction: Introduction
A company might have suffered huge losses in the past or might have the problem of over capitalization or might have over valued its fixed assets because of inadequate provision for depreciation. Such a company faces the danger of going onto liquidation either voluntarily or because of a petition by any of its creditors or Debenture holders. In these circumstances companies have three options:
a) To Liquidate the company (Liquidation)
b) To Reconstruct Externally ( External Reconstruction)
c) To Reconstruct Internally ( Internal Reconstruction)
Meaning of Internal Reconstruction
Internal Reconstruction is an arrangement made by companies whereby the claims of shareholders, Debenture holders, creditors and other liabilities are altered/reduced, so that the accumulated losses are written off, assets are valued at its fair value and the balance sheet shows the true and fair view of the financial position.
Forms of Internal Reconstruction
Internal Reconstruction may take any of the following two forms:
a) Re-organization or Alteration of Share Capital
b) Reduction of Share Capital and other Liabilities
a) Re-organization or Alteration of Share Capital: Re-organization or alteration of share capital refers to the arrangement of the capital of the company and include the following:
a. Increase the share capital by making fresh issue of shares
b. Decreasing the share capital by cancelling the unissued shares.
c. Conversion of shares into stock and vice versa
d. Consolidation of shares of smaller amounts into shares of larger amounts
e. Sub-division of shares of larger amounts into share of smaller amounts. A company can alter its share capital if it is authorized by its Articles of Association.
b) Reduction of Share Capital and other Liabilities: Reduction of Share Capital is an arrangement under which the capital of the shareholder and sometimes even the claims of debenture holders and the creditors are reduced. The amount made available by capital reduction is utilized in writing off the accumulated losses, fictitious assets and the overvalued portion of the other assets. A company can reduce its paid-up capital if
a. It is authorized by its articles
b. A special resolution is passed and
c. A sanction of the court is obtained
Differences between Internal Reconstruction and External Reconstruction
a. No new company is formed in case of Internal Reconstruction. A new company is formed in case of External Reconstruction.
b. In case of Internal Reconstruction, no company is liquidated. In case of External Reconstruction one company is liquidated
c. Internal Reconstruction requires court’s confirmation. But External Reconstruction can be affected without court’s confirmation
d. Internal Reconstruction is a slow and tedious process. But External Reconstruction can be carried out easily
e. In the case of Internal Reconstruction, the company is able to set off its past losses against future profits. Whereas, in the case of External Reconstruction, the past losses of the old company can’t be set off against the future profits of the new company.