Companies Act Section 65

Companies Act Section 65: Reserve Share Capital Requirement for Unlimited Companies Converting to Limited Companies

Introduction to Reserve Share Capital in Unlimited Companies Transitioning to Limited Status

Section 65 of the Companies Act lays out specific requirements for an unlimited company with share capital that seeks to re-register as a limited company. When an unlimited company wishes to limit the liability of its shareholders, it must comply with certain provisions to ensure a responsible transition. In particular, this section focuses on the concept of reserve share capital capital that remains uncalled except in the event of a winding-up scenario, thereby providing additional financial assurance to creditors and stakeholders during the company’s transition to limited liability.

Key Provisions Under Section 65 for Transitioning Unlimited Companies

The Act provides two key options for an unlimited company to consider when passing a resolution to convert into a limited company. These options offer flexibility in establishing a reserve share capital that can only be accessed if the company is in the process of winding up. 

Option A: Increase in Nominal Share Capital by Raising Nominal Value of Each Share

Under the first option, an unlimited company can increase the nominal (or face) value of its shares to create a reserve within its share capital. This increase in nominal share capital provides a layer of uncalled capital that can be preserved specifically for cases where the company is being wound up.

Steps to Implement Increase in Nominal Share Capital: 

The company must pass a resolution to re-register as a limited company.

The resolution must specify an increase in the nominal amount of its share capital by increasing the nominal value of each individual share. 

Restriction on Callability of Increased Share Capital: 

Importantly, this increased share capital cannot be called up or demanded from shareholders unless the company enters into a winding-up process.

This restriction means that, while the increased capital remains part of the company’s share structure, it does not impose an immediate financial obligation on shareholders.   

Purpose of Retaining Reserve Share Capital: 

By raising the nominal amount of each share without requiring payment until winding-up, the company establishes a reserve that can be accessed if the company faces liquidation. This approach safeguards creditors by ensuring that, in the event of insolvency, there will be additional funds available from shareholders to meet financial obligations.

Option B: Specify a Portion of Uncalled Share Capital as Reserve Capital

The second option for an unlimited company seeking limited status is to earmark a specific portion of its uncalled share capital as reserve capital, which will only be callable if the company undergoes liquidation.

Allocation of Uncalled Share Capital as Reserved: 

Under this approach, the company identifies a portion of its share capital that has not yet been called up, designating it as reserve share capital.

Like the first option, this reserve is protected from being called except for use in a winding-up situation, giving creditors assurance of a financial safety net in the event of liquidation.   

Winding-Up as a Condition for Callability: 

This portion of uncalled capital cannot be accessed under regular business conditions; it serves as a contingency fund accessible only if the company goes into winding-up.

This provision ensures that shareholders have a limited financial liability during regular operations but would be required to contribute additional capital if the company faces dissolution.     

Objective of Reserving Uncalled Capital for Liquidation: 

Designating a portion of uncalled share capital as reserved for winding-up provides an additional security layer for creditors. By protecting a part of the share capital as an uncalled reserve, the company demonstrates a commitment to addressing its liabilities should it become insolvent.

Purpose and Importance of Reserve Share Capital in Conversion to Limited Liability

The reserve share capital requirements under Section 65 ensure that companies converting from unlimited to limited status do so with due regard for financial accountability. This provision serves multiple essential purposes, including:

Enhancing Creditor Confidence: 

Creditors benefit from the assurance that even after re-registering as a limited company, the company retains additional capital that can be called upon in the event of a winding-up scenario.   

Limiting Shareholder Liability: 

By restricting the callable nature of reserve share capital to winding-up events, Section 65 effectively allows shareholders to limit their exposure under normal business conditions, aligning with the limited liability structure while providing a financial safeguard during liquidation.   

Facilitating Smooth Transition to Limited Liability: 

For an unlimited company with share capital, converting to limited liability involves shifting its financial structure. By establishing reserve share capital, the company can manage this transition responsibly, reassuring both shareholders and creditors.