12. The capital maintenance rules

Question 1

How can a company alter its share capital?

Answer 1

• By increasing capital by allotting new shares
  (for acceptable reason, e.g. not to fight a takeover bid Re Hogg case)
• By sub-dividing shares
• By consolidating shares

These do not adversely affect creditors, as they either increase capital or maintain the same level of share capital

IN general, a co cannot alter its share capital save as provided by the CA2006/

Question 2

What are the two methods by which a company can reduce its share capital?

Answer 2

Reduction of share capital can adversely affect the creditors and may only be done in a manner permitted by the Companies Act by:

• Special resolution followed by COURT confirmation
• Special resolution followed by SOLVENCY statement

Question 3

What two limitations are placed on a company’s ability to reduce its share capital?

Answer 3

The two limitations on a company ability to reduce share capital is:

Reducing capital by special resolution and solvency statement leaves only redeemable shares after reduction (s641 (2))

A company cannot reduce share capital in either way if it is part of a scheme which leaves one member with one class of shares (s 641 (2A))

Question 4

When deciding whether to confirm a reduction, what is the court’s main concern?

Answer 4

Interest of company’s creditors

Question 5

What does a solvency statement state?

Answer 5

It’s a statement, where each of the directors has formed an opinion that

• as regards the company’s situation at the date of the statement, there is no ground on which the company could then be found to be unable to pay its debts;
• the company will be able to pay its debts as they fall due during the year immediately following the date of the statement

Question 6

Why companies are generally prohibited from acquiring own shares?

Answer 6

Due to:
- such an acquisition would return capital to the shareholders, which is generally prohibited under the capital maintenance rules

• a company could purchase its own shares in an attempt to manipulate its own share price
• it would reduce the co’s share capital, and could therefore allow a company to avoid the procedures for reducing share capital.

Question 7

What are redeemable shares?

Answer 7

Shares issued by the company on the condition that they will be redeemed (bought back) by the company if so required.

The Co may issue redeemable shares under s684. There must be an authority in AA and they can only be issued if there are other share types, which cannot be redeemed.

When the shares are redeemed the Act sets out to preserve the issued capital, thus:

• Payment for redeemed shares is from profit or a fresh issue of shares.
• On redemption the shares are treated as cancelled and the issued share capital is reduced by that amount.
• An amount equivalent to redemption must be transferred out of profits to a CAPITAL REDEMPTION RESERVE FUND

DETAILS TO BE SENT TO REGISTRAR WITHIN 28 DAYS, with the statement of capital.

Question 8

Does a company require authorisation in its articles in order to issue redeemable shares?

Answer 8

Plc - may issue if authorised by A.

Private co - may not need authorisation, but may be prevented by AA

Question 9

If a company wishes to redeem or purchase its own shares, where must the payment come from?

Answer 9

Distributable profits or

Proceeds of fresh issue of shares made for the purpose of the redemption

Question 10

What happens to company’s shares when it redeems or purchases them?

Answer 10

They are cancelled and the company’s share capital must be reduced by the nominal value of the shares redeemed.

Question 11

Why was the prohibition on providing no financial assistance introduced?

Answer 11

The prohibition on acquisition of own shares was introduced to:

1. To prevent a company from being able to manipulate its share prices
2. To prevent a company from providing fin assistance to another company (B), then B using the money to purchase shares in A and take it over.

Question 12

What types of co are prohibited from providing fin assistance?

Answer 12

Only PLC

Question 13

What is financial assistance?

Answer 13

s.677 - fin assistance given by way of gift, guarantee, security, indemnity, release of waiver, loan and any other fin assistance to company where the net assets of the co are reduced to a material extent by the giving of assistance or the co has no assets.
Examples of fin assistance:
1. Co lends money to a person and that person uses that money to buy shares in the co
2. where a Co guarantees a loan made by the bank to another person and that person uses that money to buy shares
3. where a person X borrows money from the bank and uses it to buy enough shares to control the company. X then uses the resources of the company to repay the money loaned by the bank.

Question 14

What is “principal purpose” and “incidental part” exceptions

Answer 14

Fin assistance will not be prohibited where:

• the assistance is given in good faith in the interests of the company
• the company’s principal purpose in giving the assistance is not for the purpose of acquiring shares, or the giving of assistance is for the purpose of acquiring the shares but this is only an incidental part of some larger purpose of the company

Question 15

What are the consequences of a company giving assistance?

Answer 15

The CA2006 only states one consequence - that the company and and every officer in default commits a criminal offence - s.680. However a number of civil consequences have been established by the courts:

1. director may be held in breach of duty (Flap envelope)
2. agreement is unenforceable in its entirety
3. i) recipient will be liable to account for the sum if they knew or ought to have known the impropriety of the transaction, ii)person can be held liable

Question 16

How does the CA define “distribution”?

Answer 16

“Every description of distribution of co’s assets to its members, whether in cash or otherwise

Question 17

What is a dividend?

Answer 17

It is a distribution of part of co’s profits to its members.
FINAL dividend - paid out once the co final accounts have been prepared
INTERIM - paid out before the co’s final accounts have been prepared (i.e. paid during the fin year)

Question 18

A distribution must be paid out of what assets of the company?

Answer 18

s.830 - out of profits available for the purpose, “accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or re-organisation of capital duly made.

Question 19

What is the usual three-stage process for paying final dividend?

Answer 19

1. Directors recommend dividends
2. Company declare dividends by the members passing resolution
3. Pay out, based on rights of members

Question 20

Do dividends have to paid in cash?

Answer 20

Dividends must be paid in cash, unless otherwise stipulated by AA

Question 21

If an unlawful dividend is paid, to what expent will be co’s directors be liable?

Answer 21

• A director who authorises the payment is jointly and severally liable to repay the amount for distribution
• if a member knows or has reasonable grounds for believing that it was made unlawfully, the member is liable to
  i. repay the distribution
  ii. if the distribution was not made in cash, then repay the co a sum equal to the value of distribution.

Question 22

Reduction of capital

Answer 22

This is possible if:
1. articles permit (for Cos incorporated before 01.10.2009 Table A does) for Cos incorporated after 01.10.2009, authority of the articles is not required but the company may – by its articles – prohibit the reduction of capital;
2. special resolution is passed (accompanied by a director’s statement of solvency -for private companies only);
3. consent of court is obtained for plcs.
A statement of capital must be sent to the Registrar in Form SH19.

N.B. Note the simpler provisions for private Cos.

The reduction may be for any reason, ‘though s641 (4) Companies Act 2006 envisages three situations: -

i. To extinguish or reduce the liability of members for shares not fully paid up.
ii. To cancel paid up capital no longer represented by available assets.
iii. To return paid up capital to shareholders in excess of needs of company.

Question 23

Purchase of Company’s own shares

Answer 23

Sec 690 CA 2006
A company may issues as:
1. Redeemable
2. Not redeemable.

A redeemable share is one which, by the company’s articles (as of 01.10.2009 this is no longer required for private companies) or by the terms of issue, is redeemable. Such a redemption can be out of:

a. proceeds of fresh issue of shares
b. capital redemption reserve built up out of the profits earned by the company.

N.B. Article 43 PLCs & Article 22 Private Co

Question 24

Can directors of a private co allot more shares of the same class?

Answer 24

Where the co has only one class of shares, then the directors are authorised to allot more shares of the same class on behalf of the co. S 550

Question 25

What 3 reason the capital can be reduced for?

Answer 25

• Capital is no longer represented by available assets
• Co wishes to extinguish liability of class
• Co wishes to restructure its capital funding (e.g wishes to replace some of the shares with loan capital

Question 26

What is the procedure on variation of class rights?

Answer 26

If the AA contain provision, they must be followed.

If NO provision in the constitution, the following procedures must be followed:

• Agreement in writing by 3/4 of that class holders in writing or by special resolution at a class meeting
• If no less than 15% object, then the class members can apply to court

Question 27

What are the exceptions to proving financial assistance?

Answer 27

Under s.677/8/9 CA 2006, it is a criminal offence to lend money for purchase of own shares.

However, there are 4 exceptions for PLCs:

1. Lending money is the ordinary business for the company
2. Employee share schemes
3. Loan to employees (other than directors) to enable them to buy shares in the company
4. Where the principal purpose of the financial assistance is not so much giving of the assistance but some other bona fide purpose in the interest of the company (management buyout)