In the case of business reconstruction, a new company (hereinafter referred to as ‘transferee company’) is formed, the existing company (hereinafter referred to as transferor company’) is dissolved by passing a special resolution for members voluntary winding up and authorizing the liquidator to transfer the undertaking, business, assets and liabilities of the transferor company to the transferee company. The old company goes into liquidation and its shareholders, instead of being repaid their capital are issued and allotted equivalent shares in the new company. Consequently, the same shareholders carry on almost the same undertaking or enterprise in the name of a new company.
Halsbury’s Laws of England defines business reconstruction thus: “While an undertaking being carried on by a company is in substance transferred, not to an outsider, but to another company consisting substantially of the same shareholders with a view to its being continued by the transferee company, there is a reconstruction. It is also reconstruction, where, after the transfer of a part of the company’s undertaking, the stockholders in the new company comprise a majority in number, but less than half in value of the shareholders in the original company.”
Thus business reconstruction involves the winding up of an existing company and the transfer of its assets and liabilities to a new company formed for the purpose of taking over the business and undertaking of the existing company. Shareholders in the existing company become shareholders in the new company. The business, undertaking and shareholders of the new company are substantially the same as those of the old company. The new company may have a different capital structure from that of the old one, or have different objects, or be incorporated in a different country, but an essential feature of a reconstruction is that the new company’s, membership is substantially the same as that of the old company. A company may, if its memorandum of association permits, carry out reconstruction following the procedure laid down in Section 494 of the Companies Act, 1956 by incorporating a new company specifically for that purposes.
This is a well recognized method of reorganization and restructuring of a company. Where the shareholders of a company approve of such a method of reconstruction or reorganization of a company, it cannot be said that the directors of the company were actuated by any sinister motive in doing so. United Bank of India Ltd. v. United India Credit & Development Co. Ltd. (1977) 47 Comp. Cas. 689 (Cal.) The Supreme Court in Textile Machinery Corporation Ltd. v. CIT (1977) 107 ITR 195 (SC) held that “reconstruction” of business involves the idea of substantially the same persons carrying on substantially the same business. There, it was explained, in the context of the expression “reconstruction of business already in existence”, as used in Section 15C of the then Indian Income-tax Act, 1922, corresponding to Section 80J of the income-tax Act, 1961, that a new activity launched by an assessee by establishing a new plant and machinery by investing substantial funds may produce some commodities of the old business or it may produce some other distinct marketable produces or even commodities which may feed the old business. The products may be reconsumed by the assessee in his old business may be sold in the open market. Such an undertaking cannot be said to have been formed by the reconstruction of the old business and denied the benefit of Section 15C merely because it goes to expand the existing business of the assessee in some directions.
Simply stating, a company is reconstructed when a new company is formed, and the existing company is dissolved after the business, assets and liabilities of the dissolved company are taken over the new company under a scheme of arrangement, between the existing company and the new company (known as the reconstructed company), duly approved by all or a majority of the shareholders of both the companies and sanctioned by the court.
The reconstructed company will have substantially the same shareholders and pay the purchase price of the assets and properties of the dissolved company to the shareholders of the dissolved company by issue of its own equity shares at the agreed exchange ratio as per the approved scheme of arrangement.