What is internal reconstruction?

Introduction

Internal reconstruction refers to the process of restructuring a sick company’s balance sheet by certain methods to turn it financially healthy, thus saving it from potential liquidation.

Explanation

When a company has been making losses for many years, it has a huge amount of accumulated losses due to which the reserve and surplus appear at a very low or negative amount in the balance sheet.

Also, such a company is said to be overcapitalised as it is not able to generate enough returns to its capital.

As the company is overcapitalised, the assets are also overvalued. The balance sheet also contains many fictitious assets and unrepresented intangible assets.

The balance sheet of such a ‘sick’ company looks like the following:

Hence, to save the company from liquidation,

• its assets and liabilities are revalued and reassessed,
• its capital is reduced by paying off part of paid-up capital to shareholders or cancelling the paid-up capital.
• the right of shareholders related to preference dividends is altered,
• agreements are made with creditors to reduce their claims and
• fictitious assets and accumulated losses are written off.

In this way, its balance sheet gets rid of all undesirable elements and the company gets a new life without being liquidated.  This process is known as internal reconstruction.

Legal compliance

The internal reconstruction of a company is governed by the provisions of the Companies Act, 2013.