6 - Equity Finance

Question 1

What is capital in the context of company law?

Answer 1

Capital refers to the funds available to run a business.

In company law, ‘share capital’ specifically relates to the money raised by issuing shares.

This share capital is contributed by investors in exchange for shares, representing ownership in the company.

Question 2

Why does a company need funds?

Answer 2

A company needs funds for:
- Starting the business (e.g., buying stock or machinery).
- Maintaining daily operations, also known as ‘working capital’.
- Funding expansion and growth (e.g., acquiring new premises or other businesses).

Question 3

How does a company fund its business?

Answer 3

A company can fund its business through:
- Issuing shares (equity finance), which raises money in exchange for ownership stakes in the company.
- Borrowing money (debt finance), which must be repaid with interest.
- Retaining profits to reinvest in the business, instead of distributing them to shareholders.

Question 4

What are shares in a company?

Answer 4

A share represents a ‘bundle of rights’ attached to ownership in the company.

By purchasing shares, the investor becomes a part-owner of the company, often with voting rights at shareholder meetings.

In private companies, shareholders usually hold their investment for the long-term and may only realise their investment on:
- Sale of their stake.
- Sale of the company.
- Company flotation.
- Company winding-up (if sufficient funds are available).

The incentive for shareholders is:
- Income from dividends.
- Capital gains through growth in company value.

Neither dividends nor capital gains are guaranteed.

Different share classes may confer varying rights and entitlements, and the exact classes and rights they confer are always outlined in the company’s Articles.

Question 5

What is the share capital structure under the Companies Act 2006?

Answer 5

Under Section 542(1) CA 2006, shares must have a fixed nominal value. Section 542(2) states that shares without a fixed nominal value cannot be allotted, rendering such allotments void.

Nominal/Par Value:
- A unit of ownership in the company, which is not the actual market value of the share.
- Common nominal values are 1p, 5p, or £1.

Section 580 CA 2006 prohibits the allotment of shares below their nominal value, but shares can be issued above nominal value.

The amount above nominal value is referred to as the premium.

Question 6

What are issued shares?

Answer 6

Issued shares form a company’s issued share capital (ISC).

This includes:
- Shares acquired by the first members (subscriber shares).
- Shares issued after incorporation to new or existing shareholders.

The ISC appears in the company’s balance sheet.

Question 7

What are allotted shares?

Answer 7

Under Section 558 CA 2006, shares are considered allotted when a person has the unconditional right to be included in the company’s register of members.

Shares are often called ‘issued’ once the shareholder is registered in the company’s register of members.

However, full legal title to shares is only achieved when the shareholder’s name is entered in the register, as per Section 112(2) CA 2006.

Question 8

What are called-up/paid-up shares?

Answer 8

Paid-up share capital refers to the portion of nominal capital that has been paid by shareholders.

If a part of the nominal value is still unpaid, the company can demand the unpaid amount, which is called the ‘call’.

Called-up share capital (as defined in Section 547 CA 2006) is the total of the paid-up capital and the amounts that the company has demanded (called) from shareholders.

Question 9

What are treasury shares?

Answer 9

Treasury shares are shares that the company has repurchased from shareholders and holds in its own name.

These shares are not cancelled but are instead held by the company and can be:
- Resold to other investors.
- Transferred to an employee share scheme.
- Cancelled if the company decides to reduce its share capital.

Treasury shares, despite being held by the company, are subject to pre-emption rights under Sections 561 and 573 CA 2006, ensuring that existing shareholders have the first opportunity to purchase them.

Question 10

What are classes of shares?

Answer 10

A company can issue different classes of shares with varying rights attached.

These rights typically concern:
- Voting entitlements.
- Dividend rights.
- The return of capital upon winding-up.

The rights attached to each class of shares are specified in the company’s Articles.

Question 11

What are ordinary shares?

Answer 11

Ordinary shares are the default class of shares.

They confer rights to:
- Vote at general meetings.
- Receive dividends (if declared).
- Participate in any surplus assets upon winding-up.

Defined in Section 560(1) CA 2006 as shares with no limit on participation in dividends or capital.

Although ordinary shareholders receive dividends after preferance shareholders, one advantage of ordinary shares is that the entitlement of ordinary shares to a dividend is unresitricted.

Question 12

What are preference shares?

Answer 12

Preference shares give shareholders priority in:
- Receiving dividends before ordinary shareholders.
- Receiving capital in the event of winding-up.

Dividends are typically fixed as a percentage of nominal value (e.g., 5% £1 preference shares, which equates to 5p per share) by way of dividend each year, provided a dividend is declared.

By default, preference shares are non-voting, but the company’s Articles may grant voting rights.

Question 13

What are cumulative preference shares and how do they function?

Answer 13

• Cumulative preference shares are presumed to be ‘cumulative’ unless otherwise stated.
• This means that if a dividend is not declared for a particular year, the right to the preferred amount on the share is carried forward.
• The accumulated dividends will be paid, together with other dividends due, when there are available profits.
• If this accumulation is not desired, then the share must be expressed to be non-cumulative.

Question 14

What are participating preference shares and their characteristics?

Answer 14

Participating preference shares allow shareholders to participate, together with the holders of ordinary shares, in:
- Surplus profits available for distribution after they have received their own fixed preferred dividend.
- Surplus assets of the company on a winding up.

As with preference shares, participating preference shares are also almost always issued with a fixed dividend and can be cumulative if stated as such in the articles of association.

Participating preference shares with these characteristics are generally called fixed rate participating cumulative preference shares.

Overall: These shareholders receive a fixed dividend, and a general dividend alongside ordinary shareholders.

Example: Company A has participating preference shares in issue which carry a right to receive a fixed preferential dividend of 5% of the par value of the shares per annum. Assuming that a dividend has been declared, the preference shareholders would be entitled to receive a dividend of 5p per share per annum before the ordinary shareholders receive any dividend. They would then also be entitled to a fraction of the remaining general dividend alongside the ordinary shareholders.

Question 15

What are deferred shares and their rights?

Answer 15

Deferred shares carry no voting rights and no ordinary dividend.

However, they are sometimes entitled to a share of surplus profits after other dividends have been paid, assuming there is a surplus.

More usually, deferred shares carry no rights at all and are used in specific circumstances where ‘worthless’ shares are required.

Question 16

What are redeemable shares and their purpose?

Answer 16

Redeemable shares are shares which are issued with the intention that the company will, or may wish to, buy them back and cancel them at some time in the future.

This gives companies the flexibility to manage their equity structure effectively.

Question 17

What are convertible shares and their features?

Answer 17

Convertible shares will usually carry an option to ‘convert’ into a different class of share according to stipulated criteria.

This provides shareholders with the ability to change their investment from one class to another based on the company’s terms and conditions.

Question 18

How does a variation of class rights work in relation to shares?

Answer 18

A company may issue different classes of shares, and it is essential to refer to the Articles to find the relevant rights attaching to a share, since there are no formal, universal definitions of different types of share.

If an attempt is made to alter the Articles of a company such that existing class rights are varied, the resolution in question will not be effective unless varied in accordance with provisions in the company’s Articles for the variation of those rights or, where Articles don’t contain such provisions, by consent in writing of holders of at least 75% of the issued shares of that class or by means of a special resolution passed at a separate general meeting of holders of that class (s 630 CA 2006).

Shareholders holding 15% of the relevant shares may, provided they did not vote in favour of the variation, apply to court within 21 days of the resolution to have a variation cancelled (s 633(2) CA 2006).

Following such application, the variation will not take effect unless and until it is confirmed by the court, which will not confirm the variation if it feels that the variation unfairly prejudices the shareholders of the class in question.

Question 19

What are dividends?

Answer 19

The main reason for shareholders to invest in shares in a company is generally to make money.

Shareholders may receive a return on their investment in two ways:
- By receipt of dividends (income receipts).
- An increase in the capital value of the shares.

Dividends are only payable by a company if it has sufficient distributable profits (s 830(1) CA 2006).

‘Distributable profits’ means the company’s accumulated realised profits less its accumulated realised losses (s 830(2)).

Question 20

What are the two types of dividend?

Answer 20

There are two types of dividend:

Final dividends: Recommended by the directors and declared by the company by an ordinary resolution of the shareholders following the financial year end.

Interim dividends: The articles of a company normally give the directors the power to decide to pay interim dividends if the company has sufficient distributable profits (MA 30 allows this). Interim dividends can be paid without the need for an ordinary resolution of the shareholders. They are often paid where the company has realised an investment.

Question 21

Provide a summary of the introduction to shares.

Answer 21

The term ‘share capital’ relates to the money raised by the issue of shares.

A share is a ‘bundle of rights’ in a company that often provide voting rights. Shares (and the rights attaching to them) can broadly be categorised into six groups:
- Ordinary shares;
- Preference shares;
- Participating preference shares;
- Deferred shares;
- Redeemable shares; and
- Convertible shares.

There are no statutory definitions of different types of shares. The rights attaching to shares are set out in the company’s Articles.

Question 22

What is the difference between alotting and transferring shares?

Answer 22

Allotment of shares is a contract between the company and a new or existing shareholder under which the company agrees to issue new shares in return for the purchaser paying the subscription price.

Transfer of shares is a contract to sell existing shares in the company between an existing shareholder and the purchaser, with the company not being a party to this contract (except for a sale out of treasury shares).

Question 23

What are the considerations regarding the restriction on allotment of shares under s 755 CA 2006?

Answer 23

Under s 755 CA 2006, a private company limited by shares is prohibited from offering its shares to the public, restricting it to targeted investors only.

The expression ‘offer to the public’ (defined in s 756 CA 2006) covers offers to ‘any section of the public’ but excludes offers intended only for the recipient or those considered a ‘private concern’ of the persons involved.

Offers made to existing shareholders, employees, and certain family members, as well as shares held under employee share schemes are also permitted.

This restriction must be carefully considered when a private company proposes to allot shares.

Question 24

What is the requirement for a prospectus when offering shares?

Answer 24

When a company offers shares, it is essential to determine if a prospectus must be published for would-be investors.

A prospectus is an explanatory circular providing details about the company and the investment to help investors make informed decisions. It should contain all necessary information about the company’s financial status and the rights attached to the shares (s 87A(2) FSMA).

Preparing a prospectus is usually expensive and time-consuming.

In the case of a private company offering shares, a prospectus is typically not required, but rules should be carefully considered each time.

Question 25

What are the considerations regarding financial promotions when issuing shares?

Answer 25

Under s 21 FSMA (amended by FSMA 2023), a financial promotion is any invitation or inducement (in the course of business) to engage in investment activity, including buying shares. Financial promotions are prohibited unless specific requirements in the FSMA are met, which is crucial when a company considers issuing shares. Communications by a company when issuing shares must either fall within an exemption from the s 21 FSMA prohibition or be approved by an authorised person appointed by the FCA.

Question 26

What is the process for the transfer and transmission of shares?

Answer 26

**Transmission of shares** occurs automatically upon the death or bankruptcy of a shareholder: - If a shareholder dies, their shares automatically pass to their personal representatives. - If a shareholder is made bankrupt, their shares automatically vest in their trustee in bankruptcy. **Transfer of shares** can occur from an existing shareholder to a new shareholder through sale or gift, subject to any restrictions in the Articles (s 544(1) CA 2006).

Question 27

What are the common restrictions on the transfer of shares as per Article 26(5) MA?

Answer 27

Two common forms of restriction on share transfers are: **Directors’ power to refuse to register**: Article 26(5) MA states that directors may refuse to register a share transfer, returning the instrument of transfer with a notice of refusal unless they suspect fraud. A company must give reasons if it refuses to register a transfer. **Pre-emption clauses (rights of first refusal)**: Pre-emption rights on transfer require that a shareholder wishing to sell must offer their shares to existing shareholders before offering them to outsiders. These rights must be specifically included in the Articles, as CA 2006 and MA do not contain automatic pre-emption rights on transfer.

Question 28

What methods are used for the transfer of shares?

Answer 28

A **transfer of shares** is made using a stock transfer form, which must be signed by the transferor and submitted, along with the share certificate, to the new shareholder (s 770 CA 2006). **Legal and equitable ownership**: - Beneficial title to the shares passes upon execution of the stock transfer form. - Legal title passes upon registration of the member as the owner of those shares in the register of members by the company (s 112 CA 2006). - The company must send the new shareholder a share certificate within two months (s 776 CA 2006). **Stamp duty**: The stock transfer form must be stamped before registration, with stamp duty payable by the buyer at 0.5% of the consideration rounded up to the nearest £5. No stamp duty is payable if consideration is £1,000 or less; a minimum fee of £5 applies if more than £1,000.

Question 29

Provide a summary of the allotment, transfer, and transmission of shares.

Answer 29

* It is possible for a company to allot new shares or for existing shares to be transferred between shareholders by way of sale or gift. * Private limited companies are prohibited from offering shares to the public. * When a shareholder is seeking to transfer shares, the Articles must always be checked to ensure there are no restrictions on transfer or pre-emption rights. * Transfer of shares is effected by the transferor signing a stock transfer form and giving this to the transferee together with the share certificate. * Stamp duty is payable on transfer of shares at 0.5% (subject to a minimum payment of £5) where the sale price exceeds £1,000. * Transmission of shares is an automatic process in the event of death or bankruptcy of a shareholder.

Question 30

When issuing shares, what is the five step procedure that companies must follow?

Answer 30

* Step 1 – check whether there is a cap on the amount of shares that can be issued by the company. * Step 2 – check whether company directors need authority to allot the shares. * Step 3 – are the shares equity securities? You will be able to work this out by looking at the dividend and capital payout on the shares. If both are capped, the share is not an equity security and therefore pre-emption rights are not relevant. If the shares are equity securities, consider whether the company needs to disapply pre-emption rights. * Step 4 – is the company creating a new class of share? If so, the Articles will need to be amended to incorporate the new class rights. * Step 5 – Board will resolve to allot the shares. This step will always be required, regardless of the other steps.

Question 31

Following step 1, what is the significance of checking for a cap on the number of shares that may be issued before issuing new shares?

Answer 31

Before issuing new shares, you must check the company’s Articles for any cap or limit on the number of shares that may be issued. If this is to be exceeded, the cap must be removed, or the limit increased. **CA 1985** - Will originally have had an authorised share capital ('ASC') which acted as a ceiling on the number of shares it could issue. These companies will continue to have an ASC unless such cap is removed from their Articles. **CA 2006** - The requirement to have an ASC no longer exists under CA 2006. Shareholders wishing to impose a cap and restrict the number of shares that such a company can issue will need to amend the Articles by special resolution to include suitable provisions.

Question 32

Following step 1, how can the cap on the number of shares be removed for companies incorporated under CA 1985 and CA 2006?

Answer 32

**CA 1985** - Shareholders wishing to remove or amend the deemed restriction in a company’s Articles may do so by ordinary resolution, despite the fact that removing such a deemed restriction involves changing the Articles, which would normally require a special resolution under s 21(1) CA 2006. Any such deemed restriction will also fall away as a consequence of the company adopting, wholesale, new Articles (such as MA) which do not include provision for any cap (applying s 21(1) CA 2006). **CA 2006** - Will not have an authorised share capital, meaning there will be no bar to issuing shares under step 1 unless a specific restriction exists in the Articles. If such a restriction exists, it can be removed, or the limit increased, by special resolution under s 21(1) CA 2006. Under s 617(2)(a) CA 2006, each time a company issues shares, its share capital increases automatically.

Question 33

What are the key points to summarise for Step 1 in the share issuance process?

Answer 33

Check whether any resolutions to remove, impose or change any cap, or increase the share capital, have been passed. Ensure that you have up-to-date information, particularly checking the company’s Articles. Verify whether any shares have been issued by checking the register of members or the most recent confirmation statement filed at Companies House and any subsequent forms filed on allotments of shares (using Form SH01 under s 555 CA 2006). If the company does not have a limit on its share capital or if there are sufficient unissued shares available within any cap for a proposed new issue, the company can proceed to step 2.

Question 34

In Step 2, do the company’s directors need authority to allot shares?

Answer 34

Directors are responsible for the actual allotment of shares to a shareholder and they must resolve by board resolution to make an allotment. However, they may need to have the prior authority of the shareholders to do this. Section 549 CA 2006 provides that the directors of a company must not exercise any power of the company to allot shares in the company except in accordance with: - s 550 CA 2006: For private companies with only one class of shares in existence, the directors will have automatic authority to allot new shares of the same class unless they are prohibited from doing so by the company’s Articles. This simplifies the process for many smaller companies, as no shareholder resolution is required to grant authority to directors to allot new shares. For companies incorporated under CA 1985, an ordinary resolution is required to authorise the directors to rely on s 550 CA 2006. - s 551 CA 2006: For all other companies, the directors will need to be granted authority to allot the new shares by the shareholders through an ordinary resolution.

Question 35

Following step 2, what is the procedure for obtaining authority to allot new shares under Section 551 CA 2006?

Answer 35

If s 550 CA 2006 cannot be relied upon, directors require authority under s 551(1) CA 2006, which may be granted by a provision in the company’s Articles or by shareholder ordinary resolution unless the Articles require a higher majority. Therefore, it is essential to check the latest version of the company’s Articles and any resolutions that have been passed giving the directors authority to establish whether further authority is required. Authority to allot under s 551(1) CA 2006 can only be granted subject to limits in terms of both time and number of shares (s 551(3) CA 2006).

Question 36

Why must pre-emption rights be disapplied on allotment according to Step 3?

Answer 36

A ‘pre-emption right’ means the ‘right of first refusal’; new shares should be offered pro rata to existing shareholders before any new investor. This is crucial as allotting shares to new shareholders dilutes the proportionate ownership held by existing shareholders, impacting their entitlement to dividends and voting power. Due to this potential dilution, s 561 CA 2006 contains pre-emption rights that protect existing shareholders. Typically, when pre-emption rights apply, the company requests existing shareholders to disapply these rights through a special resolution.

Question 37

What types of shares are relevant to pre-emption rights according to Section 561 CA 2006?

Answer 37

Section 561 CA 2006 states that a company must not allot equity securities to a person on any terms unless it has made an offer to each person who holds ordinary shares to allot to them on the same or more favourable terms, in proportion to their existing shareholdings. This means that any new ‘equity securities’ (defined in s 560 CA 2006) must be offered to the existing shareholders (holding ordinary shares) before being offered to anyone outside the company. Under s 560(1) CA 2006, ‘equity securities’ include (i) ‘ordinary shares’ or (ii) rights to subscribe for, or convert securities into, ordinary shares.

Question 38

How are ordinary shares defined under Section 560 CA 2006 in relation to pre-emption rights?

Answer 38

Under s 560(1), ordinary shares are defined as shares other than those that, as regards dividends and capital, carry a right to participate only up to a specified amount. This implies that if a class of shares carries capped rights to receive dividends and capital payments, these shares will not be classified as ‘equity securities’ and will not be subject to pre-emption rights. In all other cases, the shares will fall within the definition of ‘equity securities’ and be subject to pre-emption rights under s 561 CA 2006.

Question 39

Can a company disapply pre-emption rights, and if so, how?

Answer 39

Yes, a company can disapply pre-emption rights as outlined in s 562 CA 2006, although the procedure can be lengthy and complicated, especially for companies with many shareholders. It may not always be appropriate to follow the pre-emption rights procedure; for example, when all shareholders agree to bring in a new shareholder, the company would want to disapply pre-emption rights. This is permitted in CA 2006, with the permission of the company’s existing shareholders. Companies typically use one of two methods to disapply pre-emption rights, depending on the source of the directors’ authority to allot shares.

Question 40

What is the process for general disapplication of pre-emption rights according to CA 2006?

Answer 40

A company may disapply pre-emption rights where the directors are generally authorised for the purposes of s 551 CA 2006 by passing a special resolution or including the disapplication in its Articles under s 570(1) CA 2006. This disapplication is not permanent; it attaches to a particular, pre-existing s 551 authority. In practice, this is the most common method by which companies dispense with pre-emption rights on allotment.

Question 41

What provisions exist for the disapplication of pre-emption rights for private companies with one class of share?

Answer 41

Section 569 CA 2006 allows for the disapplication of pre-emption rights for private companies with only one class of share by special resolution. This presupposes that the directors’ authority to allot shares derives from s 550 CA 2006, applying for as long as the company has in issue and allots shares of only one class.

Question 42

What are the other methods available for disapplying pre-emption rights?

Answer 42

Specific disapplication of pre-emption rights is possible, although uncommon, by passing a special resolution under s 571 CA 2006 for a specific allotment of shares (e.g., shares issued to a particular person). Directors must provide shareholders with a written statement explaining the reasons for the specific disapplication and the amount to be paid to the company pursuant to the allotment, along with justification for that amount, under s 571(6) CA 2006. In practice, this is rarely done.

Question 43

How can private companies permanently exclude pre-emption rights?

Answer 43

Private companies can exclude statutory pre-emption rights entirely in their Articles by special resolution under s 567 CA 2006. This exclusion is unusual, as it offers no protection against dilution for existing shareholders, and the practice is generally not followed. It is generally only subsidiary companies adopting such provisions as a means of limiting the powers of existing shareholders.

Question 44

Following step 4, what steps must a company take when considering whether new class rights must be created for the shares being issued?

Answer 44

When issuing new shares, a company may wish to create a new class of shares, such as preference shares. To create a new class of shares, the company must insert new provisions in its Articles dealing with the rights attached to those new shares. An alteration to the Articles requires a **special resolution** of the shareholders under s 21 CA 2006 (except for a CA 1985 company if removing a cap transferred from a company’s authorised share capital in its memorandum).

Question 45

Following step 5, what is the procedure for directors to pass a board resolution to allot shares?

Answer 45

The directors will resolve by board resolution to allot new shares on behalf of the company. Any requirements for shareholder resolutions must be dealt with in a general meeting before the board meeting where the new shares are allotted. A general meeting is not needed in advance if: - There is no limit in the constitution on the number of shares that can be issued by the company. - Directors do not require authorisation because the company is a private company with only one class of shares, and there is no restriction in the company’s Articles (s 550 CA 2006), or they have already been given authority to allot shares. - Shares are issued to existing shareholders in proportion to their existing shareholdings and follow the procedure in s 562 CA 2006, or s 561 CA 2006 has already been disapplied, or the company is private and has taken advantage of s 567 CA 2006. The relevant class rights are included in its Articles.

Question 46

What are the administrative requirements on allotment after shares have been allotted?

Answer 46

**Copies of resolutions must be sent to Companies House within 15 days (s 29, s 30(1), s 26(1)):** - CA 1985 companies must file any ordinary resolution removing the cap on authorised share capital and any ordinary resolution allowing the company to use s 550 CA 2006 if passed. - Any s 551 ordinary resolution granting the directors authority to allot, if passed. - All special resolutions regarding the disapplication of pre-emption rights and/or amending articles, if passed. - Amended Articles must be sent to Companies House if a new class of shares has been created and the Articles amended. **Company forms to be sent include:** - Return of allotment (Form SH01) and statement of capital within one month. - If persons with significant control change due to allotment, the relevant forms (PSC01, PSC02, PSC04, PSC07) must be filed. **Updating registers:** - The register of members must be updated within two months of the allotment, and the PSC register updated if necessary. Share certificates must be prepared and sent to new shareholders within two months of the allotment.

Question 47

Provide a summary of the prodecure for allotment of shares.

Answer 47

* When issuing shares, a company needs to follow a 5-step procedure. * Step 1 – Check whether there is a cap on the amount of shares that can be issued by the company. * Step 2 – Check whether company directors need authority to allot the shares. * Step 3 – Are the shares equity securities? You will be able to work this out by looking at the dividend and capital payout on the shares. If both are capped, the share is not an equity security and therefore pre-emption rights are not relevant. If the shares are equity securities, consider whether the company needs to disapply pre-emption rights. * Step 4 – Is the company creating a new class of share? If so, the Articles will need to be amended to incorporate the new class rights. * Step 5 – Board will resolve to allot the shares. This step will always be required, regardless of the other steps. * Finally, there will be administrative matters to attend to.

Question 48

What are the statutory rules prohibiting financial assistance in company share acquisitions?

Answer 48

The statutory rules prohibit certain companies involved in the acquisition of shares from providing assistance for the purpose of the acquisition. These rules primarily apply to public companies and private companies in groups containing public companies. For instance, if an individual struggles to finance a share purchase, the target company’s loan to the individual may constitute illegal financial assistance under CA 2006.

Question 49

To what transactions are the rules on financial assistance applicable?

Answer 49

The rules on financial assistance are applicable to: **Acquisition or Sale of Shares**: Financial assistance is relevant when there is an acquisition (or proposed acquisition) of shares. A share sale involves an acquisition by way of a share transfer, requiring careful examination of funding arrangements to avoid falling foul of the financial assistance prohibitions. **Issue of Shares**: Financial assistance is also relevant when a company issues shares to an investor, as this amounts to an acquisition of shares by the investor.

Question 50

Which companies are prohibited from giving financial assistance?

Answer 50

For a share sale, the target company is the company which is the subject of the acquisition. For an issue of shares, the target company is the company doing the issuing of the shares. If the target company is **a public company**, the prohibition on giving financial assistance applies to the target company itself and any subsidiary of the target company, whether private or public (s 678 CA 2006). If the target company is a private company, the prohibition applies to any public company subsidiary of the target company (s 679 CA 2006).

Question 51

What does giving financial assistance mean?

Answer 51

Financial assistance is very broadly defined in s 677 CA 2006. It includes: - Financial assistance given by way of gift (s 677(1)(a) CA 2006). - Financial assistance given by way of guarantee, security or indemnity, release or waiver (s 677(1)(b) CA 2006). - Financial assistance given by way of loan or similar agreement (s 677(1)(c) CA 2006). - Any other financial assistance given by a company where the net assets of the company are reduced to a material extent (s 677(1)(d) CA 2006). Note that assistance must be financial in nature and must be intended to facilitate the acquisition. The financial assistance rules apply whether the assistance is direct (e.g., a loan given to the buyer of shares) or indirect (e.g., a guarantee given to a bank in relation to a loan made to a buyer of shares), and whether it is given before, at the same time, or after the acquisition.

Question 52

Are there any exceptions to the prohibition on financial assistance?

Answer 52

Yes, there are exceptions to the prohibition. **Purpose Exceptions**: Sections 678(2), 678(4), 679(2), and 679(4) CA 2006 state that giving financial assistance will not be unlawful if the principal purpose in giving it is not for the purpose of the acquisition, or if that purpose is only an incidental part of a larger purpose. **Unconditional Exceptions**: Section 681 CA 2006 lists specific transactions exempt from the ss 678 and 679 CA 2006 prohibitions, such as dividend payments (s 681(2)(a) CA 2006). **Conditional Exceptions**: Section 682 CA 2006 provides exemptions for specific types of transactions, like money lending in the ordinary course of business or assistance in respect of employee share schemes, provided certain conditions are met. The conditions are that (i)the company giving the assistance is a private company or (ii) the company giving the assistance is a public company and the net assets of that company are not reduced by the giving of the assistance or to the extent that they are reduced the assistance is provided out of distributable profits (s 682(1) CA 2006).

Question 53

What are the consequences of carrying out prohibited financial assistance?

Answer 53

Under s 680 CA 2006, breaching s 678 or s 679 CA 2006 is an offence that can lead to penalties for the company (a fine) and for the officers of the company (fine/imprisonment). Additionally, transactions amounting to prohibited financial assistance may be void, and the wider transaction (e.g., the share acquisition itself) may also be void.

Question 54

Provide a summary of the prohibitions on financial assistance by a company for the purchase of its shares.

Answer 54

* The term "financial assistance" is extremely broad and captures many different types of assistance (see s 677 CA 2006). * The prohibitions on a company providing financial assistance for the purchase of its own shares apply only to public companies (and private companies offering assistance for the purchase of shares in a public holding company) - ss 678 - 679. * There are conditional and unconditional exceptions set out in ss 681 and 682. * There are also principal purpose and incidental part of a larger purpose defences set out in s 678(2) and (3) and s 679 (2) and (3) but these will be extremely narrowly construed by the courts. * Financial assistance is a criminal offence and the company and defaulting officers are liable to a fine and/or up to 2 years' imprisonment.

Question 55

What is the principle of maintenance of share capital in company law?

Answer 55

- The principle of maintenance of share capital states that once a shareholder has decided to invest in shares in a company, that investment cannot normally be returned. - A company is not usually permitted to return capital to its shareholders; all payments should be made out of distributable profits. - The shareholders' investment is recorded in the equity account, which cannot be returned to shareholders while the company is a going concern, thereby protecting the interests of creditors.

Question 56

What are the consequences of the principle of maintenance of share capital?

Answer 56

The principle of maintenance of share capital has several significant consequences, particularly: - Dividends may only be paid out of distributable profits, not capital (s 830(1)). - Companies generally must not purchase their own shares. However, there are exceptions: - A company may buy back its own shares or redeem redeemable shares provided it follows the procedures set out in CA 2006. - A company may purchase its own shares if a court order is made following a successful shareholder petition for unfair prejudice.

Question 57

What are the two situations in which a company can effectively buy its own shares?

Answer 57

A company can effectively buy its own shares in two situations: - Redemption of redeemable shares. - Purchase of own shares (‘buyback’). A common reason for a company to buy back shares is when a shareholder in a private company wants to leave but cannot find a buyer for their shares, as private company shareholders are prohibited from offering their shares to the public.

Question 58

What is a buyback of shares?

Answer 58

A buyback of shares occurs when a company purchases its own shares from an existing shareholder. This often takes place when there is no other buyer available. In many cases, these buybacks are 'off-market' purchases, meaning they occur outside a 'recognised investment exchange.' The company must have a contract outlining the terms of the purchase, which must be approved by the shareholders through an **ordinary resolution**. When using capital to fund the buyback, strict regulations and procedures apply.

Question 59

How can a company fund a buyback of its own shares?

Answer 59

A company can fund a buyback of its own shares in three ways: - Using distributable profits. - Using proceeds from a fresh issue of shares made for the purpose of financing the buyback. - Using capital. However, the use of capital to fund a buyback is strictly regulated. Notably, only private companies can use capital to purchase their own shares, and any redemption or purchase out of capital must comply with the restrictions in ss 709 - 723 CA 2006. Companies must first use any available money in the form of distributable profits or proceeds from a fresh issue of shares before resorting to capital.

Question 60

What conditions must be met for a company to purchase its shares out of profits or proceeds of a fresh issue?

Answer 60

A company may purchase its shares out of distributable profits or the proceeds of a fresh issue of shares provided: - The purchase of own shares is not restricted or prohibited in the company’s Articles (s 690(1)(b)). - The shares being purchased are fully paid up (s 691(1)). Following the purchase, the company must continue to have issued shares other than redeemable and treasury shares. The procedure outlined in Section 694 requires a contract to purchase own shares and approval by ordinary resolution.

Question 61

What is the initial procedure for the buyback of shares out of profits or proceeds of a fresh issue?

Answer 61

The initial procedure for the buyback of shares out of profits or proceeds of a fresh issue includes: - Checking that there is no limit in the Articles on the power to buy back shares. - Preparing accounts to verify there are sufficient distributable profits. - Confirming that the shares are fully paid.

Question 62

What additional conditions apply to the buyback of shares out of capital?

Answer 62

For a buyback of shares out of capital, which is only permitted for private companies, the following conditions apply: - The purchase of own shares out of capital is not restricted or prohibited in the company’s Articles. - The accounts must be prepared no more than three months before the directors’ statement. - Any available distributable profits must be used before capital can be employed (s 710). - A directors’ statement of solvency and an auditors’ report must be prepared (s 714). - A special resolution approving payment out of capital must be passed within **a week** after the directors sign the written statement of solvency (s 716).

Question 63

What are the requirements for the directors' statement of solvency and auditors' report when buyback is out of capital?

Answer 63

The directors’ statement of solvency must be made no earlier than one week before the general meeting. It confirms the company’s solvency and its ability to pay debts as they fall due for the next 12 months post-buyback (s 714). Directors must ensure they have reasonable grounds for making this statement, as insolvency within a year may result in liability. An auditors’ report must be attached, affirming that the auditors are unaware of anything indicating the directors’ opinion is unreasonable. Copies of these documents must be made available to members.

Question 64

What are the notification requirements after passing the special resolution for buyback out of capital?

Answer 64

Within seven days of passing the special resolution for payment out of capital, the company must notify its creditors by: - Publishing a notice in the Gazette, stating that the company has approved a payment out of capital for purchasing its own shares, along with where to find the directors' statement and auditors’ report. - Publishing a similar notice in a national newspaper or notifying each creditor in writing. - Filing copies of the directors’ statement and auditors’ report at Companies House for creditor inspection.

Question 65

What are the timing restrictions for a buyback of shares out of capital?

Answer 65

The share purchase can take place no earlier than five weeks and no later than seven weeks after the date of the special resolution (s 723 CA 2006). This period allows shareholders and creditors to object to the payment out of capital by applying to the court for cancellation of the resolution. The seven-week longstop ensures that the directors' solvency assessment remains valid when the share purchase occurs.

Question 66

What is the procedure for the buyback of shares out of capital?

Answer 66

The procedure for the buyback of shares out of capital includes: 1. Checking Articles for limits on buyback or capital use. 2. Preparing accounts to ascertain available profits within three months before the directors prepare the statement of solvency. 3. Confirming shares are fully paid. 4. The board meeting must approve the directors’ statement of solvency and the auditors’ report. 5. The contract terms must be set out and made available for inspection before the general meeting. 6. Special and ordinary resolutions must be passed to approve the payment out of capital and the contract. 7. Notifications to creditors must be issued, followed by the contract signing and compliance with filing requirements.

Question 67

What characterises redeemable shares, and how do they differ from other shares?

Answer 67

Redeemable shares are those issued with specific provisions for redemption, which allows the holder temporary membership in the company. They are redeemed on predetermined circumstances, which can include fixed dates and prices, or at the option of the issuing company or shareholder. Unlike other shares, the redemption terms are established in the Articles or determined by the directors before issuance, meaning a contract is not required for redemption, regardless of funding source.

Question 68

Provide a summary for the buyback of shares.

Answer 68

* It is a fundamental and long-established concept of company law that the share capital of a company is seen as a permanent fund available to its creditors. * However, companies may buyback their own shares (or redeem redeemable shares) provided they meet the conditions in CA 2006. * A buyback of shares may be funded out of distributable profits, the proceeds of a fresh issue of shares or (for private companies only and only to the extent that there are no profits / proceeds of a fresh issue available), out of capital. * Where a buyback is funded out of profits / proceeds of a fresh issue, a contract is required which must be approved by an OR of the shareholders. * Where capital is used there are further procedural requirements: a DSS and an AR are required, a SR is needed to approve payment out of capital and there are detailed requirements to notify creditors. The buyback must take place within five to seven weeks following the passing of the SR.

Question 69

What are financal services?

Answer 69

Advising on, dealing in, and arranging investment products on behalf of clients. This includes shares, pensions, endowment policies, regulated mortgage contracts (a mortgage which is used to buy a property of which 40% or more is used as a residential dwelling.)

Question 70

Why are financial services regulated?

Answer 70

To ensuure that those providing financial services are approved and authorised and that consumers are adequately protected from negligent advisors.

Question 71

How is the provision of financial services regulated in the UK?

Answer 71

The key statute governing financial services is the Financial Services and Markets Act 2000 (FSMA), together with the Financial Services and Markets 2000 (Regulated Activities) Order 2001 (SI 2001/544), as amended, is known as the Regulated Activities Order (‘RAO’) and establishes the activities to be regulated by FSMA if they are carried on in the UK by an entity by way of business.

Question 72

Why is the regulation of financial services important for law firms?

Answer 72

Important from the perspective of a solicitor having to ensure that in the course of their practice the solicitor does not commit an offence, but also in terms of being aware of the statutory constraints which might be placed on a client in terms of the deal being proposed. Few law firms have obtained direct FCA authorisation because the stringent level of regulation imposed by the FCA, coupled with the relatively small proportion of work for clients which would require direct FCA authorisation

Question 73

Who are the regulators of financial services?

Answer 73

There are two regulators: the Prudential Regulation Authority (‘PRA’) and the Financial Conduct Authority (‘FCA’).

Question 74

What is the general prohibition under the FSMA?

Answer 74

s19(1) FSMA states: "No person may carry on a regulated activity in the United Kingdom, unless he is: (a) An authorised person, or (b) An exempt person. It is a criminal offence to breach this. A regulated activity = Specified Investment + Specified Activity. E.g., advising on the merits of shares. **s19 could come up in the exam so need to know statute number.**

Question 75

What are the four steps to consider to determine if the financial activity is regulated by the FSMA?

Answer 75

1) Is the investment ‘specified’ under FSMA? (see Part III RAO)? If yes 2) Is the activity a ‘specified activity’ under FSMA? (See Part II RAO) If yes 3) Is the activity excluded under FSMA? (See Part II RAO)? If no 4) Does the activity fulfil the basic conditions in s. 327 of FSMA and SRA Scope Rule 2? If yes, exemption is possible; if no, authorisation is required.

Question 76

What investments are "specified" under FSMA?

Answer 76

This includes shares (Article 76), instruments creating or acknowledging indebtedness such as bonds and other debt instruments (Article 77), and regulated mortgage contracts (Article 88), as defined in Article 61(3) RAO.

Question 77

What activities are a "specified activity" under FSMA?

Answer 77

Include dealing in investments as a principal (Article 14) or as an agent (Article 21), which covers buying, selling, subscribing for, or underwriting securities or contractually based investments; arranging deals in investments (Article 25); and managing investments (Article 37), which involves exercising discretion over investments that are securities or contractually based investments.

Question 78

Are advising on the merits of investments a specified activity?

Answer 78

Advising on the merits of investments (Article 53(1) RAO) is a common specified activity. Generic advice, e.g., how to invest in different regions or providing information, is not considered a specified activity. Advice becomes regulated under Article 53(1) if it involves a recommendation or opinion to a client who is or could be an investor, regarding actions like buying, selling, or holding investments.

Question 79

Which activities are excluded under FSMA?

Answer 79

Excluded activities fall outside FSMA's scope and don't require additional compliance under its regulations. Specific Exclusions - "Dealing in Investments as Agent" (Article 21) is excluded if the activity involves deals with or through **authorised persons** (Article 22). General Exclusions - Article 67 RAO: Regulated activities that are a **necessary part **of other services provided in a profession or non-investment business are excluded, provided they are integral to those services and not separately remunerated. Article 70 RAO: Activities related to the purchase or** sale of shares in a company are excluded if the shares represent 50% or more of the voting shares**, and the transaction is intended to acquire day-to-day control of the company.

Question 80

If the FSMA applies, what should a solicitor do?

Answer 80

Solicitors must either be directly authorised by the FCA or supervised by a Designated Professional Body like the Law Society, which is regulated by the SRA. The firm must comply with the SRA Financial Services (Scope) Rules 2019 to carry on exempt regulated activities. The Scope Rules set out the scope of the regulated financial services activities that may be undertaken by firms authorised by the SRA (but not the FCA).

Question 81

For the regulated activities to be exempt, which conditions of the FSMA must be met?

Answer 81

In order for the regulated activities to be exempt regulated activities all the conditions set out in s 327(2) – (7) FSMA must be satisfied. 1. The person must be a member of a profession (e.g., solicitor, s 325(2) FSMA). 2. No third-party commission is allowed unless accounted for to the client, with informed consent (SRA guidance). 3. The regulated activity must be incidental to the provision of professional services. 4. The person must comply with rules set by their designated professional body (e.g., SRA Scope Rules under s 332(3) FSMA).

Question 82

When is the activity incidental? (FSMA)

Answer 82

The regulated activities must not be a major part of the firm's practice. Consider: - Scale of the activity relative to other professional services. - Whether the services are presented as separate from other legal services. - How the firm advertises or promotes its regulated activities. Regulated activities are not incidental if they form a separate business. It’s incidental if the specified activity is a small part of the firm's overall work for clients.

Question 83

What must be satisfied for an activity to be exempt under s 327 FSMA and Scope Rule 2?

Answer 83

Need to satisfy s327 FSMA and Scope Rule 2. If these can be satisfied, you are carrying out an exempt activity. Scope Rule 2 Conditions: The activity must arise out of or be complementary to the provision of a particular professional service to a client (Scope Rule 2.1(b)). Arising Out Of: The activity should be directly related to the non-regulated work (e.g., advice on investments tied to a company sale). Complementary: The activity must naturally arise from the existing work (e.g., legal/tax advice, drafting documents related to investments).

Question 84

What happens if the s327 FSMA and Scope 2 Rules are not met by a firm?

Answer 84

The firm must be authorized by the PRA or FCA and comply with their Handbook for the activity, or refuse to carry out the activity. If not authorized by PRA or FCA, carrying out the activity breaches s 19(1) FSMA, which is a criminal offence.

Question 85

What happens if the s327 FSMA and Scope 2 Rules are met by a firm?

Answer 85

The activity is an exempt regulated activity. In order to be able to carry out an exempt regulated activity, the law firm must 1) ensure it complies with the Scope Rules; and 2) be authorised by the SRA in relation to this activity and comply with any relevant SRA Financial Services (Conduct of Business) Rules 2019.