What is Reconstruction?
Reconstruction is an exercise of restating assets & liabilities by company / entity whose financial position as reflected by its balance sheet is not healthy but future is promising.
This exercise is done to gain the confidence of different stakeholders (creditors, lenders, customers, share holders etc) whose support is required for revival of the operations.
Objectives:
1. To generate surplus for writing off accumulated losses & writing down overstated assets.
2. To generate cash for working capital needs, replacement of assets, to add balancing equipments, modernaise plant & machinery etc.
Types of Reconstruction:
A company can be reconstructed in any of the two ways. These are:
1. External Reconstruction and
2. Internal Reconstruction.
1. External Reconstruction:
The term ‘External Reconstruction’ means the winding up of an existing company and registering itself into a new one after a rearrangement of its financial position. Thus, there are two aspects of ‘External Reconstruction’, one, winding up of an existing company and the other, rearrangement of the company’s financial position. Such arrangement shall be approved by its shareholders and creditors and shall be sanctioned by the National Company Law Tribunal (NCLT). Such a step usually involves the writing off of a debit balance on Profit and Loss Account, elimination of all fictitious assets if any from the Balance Sheet, and the consequent readjustment of share capital.
2. Internal Reconstruction:
Internal reconstruction means a recourse undertaken to make necessary changes in the capital structure of a company without liquidating the existing company. In internal reconstruction neither the existing company is liquidated, nor is a new company incorporated. It is a scheme in which efforts are made to bail out the company from losses and put it in profitable position. Internal reconstruction of a company is done through the reorganization of its share capital. It is a scheme of reorganization in which all interested parties in the capital structure volunteer to sacrifice. They are the company’s shareholders, debenture holders, creditors etc. Under internal reconstruction, the accumulated trading losses and fictitious assets are written off against the sacrifice made by these interest holders in the form of reduction of paid up value of their interest.