Capital Maintenance

Question 1

What are the types of Capital Maintenance?

Answer 1

There are two types

• Financial
• Operating

Question 2

What is Financial Capital Maintenance?

Answer 2

This means the capital is maintained in monetary terms.

In times of rising prices caused by inflation the capital might be maintained in monetary terms. But may not be maintained in physical operating terms.

Due to reduced purchasing power of their money.

Question 3

What is Physical/Operating capital maintenance?

Answer 3

This means the company is able to operate at the same level.

Question 4

When talking about Capital maintenance under the Companies Act 2006

Answer 4

We are referring to financial capital maintenance

Question 5

Capital Maintenance

Governing Rules (5)

Answer 5

1) Share issue at discount
2) Capital reduction
3) Company distributions (dividend)
4) Purchase of own shares
5) Financial assistance (to anyone buying shares)

Question 6

Capital Maintenance

What is the main aim of Governing Rules

Answer 6

To protect creditors of the company (referring to Limited Liability Companies)

The rules relating to public limited companies are more restrictive than those governing private companies!

Question 7

Governing Rules

Share issue at discount

Answer 7

The company may not issue shares at discount.

The company cannot issue shares less than the nominal value.

The nominal value is the minimum amount that must be paid for the shares.

Question 8

Governing Rules

Capital Reduction

(s.641) Share capital can be reduced “in any way” … in particular:

Answer 8

1) Removing or reducing liability for any capital remaining as yet unpaid → thus, the company will not need to make any call on that unpaid capital in the future
2) Cancelling any paid up share capital which has been lost through trading and is unrepresented in the current assets of the company → thus, bringing the BS into balance at a lower level by reducing the capital liabilities in acknowledgment of the loss of assets. For example DR:Capital & CR: Returned earnings
3) Paying off any already paid up share capital that is in excess of the company’s requirement (now or in the future) → thus, giving the shareholders back some of the capital that they have invested in the company

In the case of Number 1 & 3 the creditors of the company are potentially in a much worse position before the reduction.

Question 9

Governing Rules

Capital Reduction

Public & Private Companies

Answer 9

The reduction will have to go through
- Special resolution and this must be confirmed by the court

The court can protect the interest of the creditors and minority shareholders.

It is possible that the court will require the company to add the words “and reduced” after its name → to warn the general public

General rule: all limited companies may reduce their share capital by a special resolution confirmed by the court

The Registrar of companies

• Will need a statement of capital after the reduction.
• Court order

Question 10

Governing Rules

Capital Reduction

Private Companies

Answer 10

The reduction must go through

• Special resolution
• Solvency statement from directors

Solvency statement confirms that each of the directors is of the opinion that the company is not only currently able to pay its debts, but that it will remain able to pay it debts in the coming 12 months

This is an alternative procedure. Less costly and time consuming.

Registrar of companies require

• Special resolution
• Insolvency statement
• Statement of capital

Question 11

Governing Rules

Company Distributions (dividends)

Fundamental Rule

Answer 11

• Capital must be maintained &
• Any reduction in capital is strictly controlled

Dividends may

• only be paid out of profits
• not be paid out of capital

Question 11

Governing Rules

Company Distributions (dividends)

Rules (s.830)

Answer 11

(s.830) any distribution of a company’s assets to its members must come from “profits available to that purpose”

Add: accumulated realised profits (which have not been distributed or capitalised previously)*

Less: accumulated realised losses (which have not been written off in a reduction of capital previously)

Key requirement: REALISED! (profits must be realised)

*: as by being applied in financing a bonus issue or the purchase or redemption of the company’s shares with a transfer to a capital redemption reserve

Question 12

What are capitalised shares?

Answer 12

These are bonus issue shares from the retained earnings.

Question 13

Governing Rules

Company Distributions (dividends)

Rules

Answer 13

• Unrealised profits are not distributable (eg revaluation of assets under IS 16, or a change in market value of investment properties if there is an gain then its unrealised)
• A realised capital loss following, for example, the actual sale of an asset at a loss will reduce the profit available for distribution
• “accumulated”: the position in the current year cannot be regarded in isolation. The P&L account is a continuous account! (returned earnings in SOFP)
• Undistributed profits of previous years cannot be brought forward and distributed without taking into account a revenue loss on the current year’s trading (accumulated+realised profits)
• An unrealised capital profit cannot be applied in writing off a realised revenue loss

Question 14

Profit Realisation

Answer 14

Profits will only be realised when the company decides to sell their assets.

If not then the profits will remain unrealised.

Question 15

Unrealised profits

Answer 15

Cannot be distributed to shareholders.

Question 16

Distributed profits calculation

Answer 16

Accumulated realised profit

LESS: Accumulated losses

Question 17

Company distributions (dividend)

Rules (s.831) (must cover for net unrealised losses too)

Public Companies

Answer 17

(s.831) Additional requirements for public companies (BS approach)

NET ASSETS at the time of distribution (must be higher than..)

The total of called up capital + undistributable reserves*

*: share premium account, capital redemption reserve fund, excess of accumulated unrealised profit

AND

The distribution must not reduce the value of the net assets below the aggregated amount of the total called up capital plus undistributable reserves

Question 18

The share premium account

Answer 18

Is undistributable

Question 19

Private Company distribution of profits

Answer 19

Only rule we need to follow is that we need to check on the Accumulated profits - Accumulated losses

Question 20

Public Company distribution of profits

Answer 20

We need to check two additional requirements.

• Must cover for net unrealised losses (this must be deducted from the unrealised loss)
• The share capital & undistriutable reserves (net assets) must not be less than the original share capital

The distribution cannot reduce the value of the net assets

Question 21

Public companies distributions calculation

Answer 21

Accumulated realised profits - Accumulated realised losses

Less: Net Unrealised losses

After this we must check that after the distribution the Net Assets aren’t less than the share capital. As we cannot reduce the value of the net assets

Question 22

Company Distributions (dividend)

Common Law Rule

Answer 22

Directors who knowingly paid dividends out of capital were liable to the company to replace any money so paid out, although they could seek to be indemnified by shareholders who knowingly received the payments.

Directors responsibility to make a decision of the dividends. If they pay dividends out of the capital then they become liable to the company for the amount.

Question 23

Company Distributions (dividend)

s.847) (From Companies Act 2006

Answer 23

The companies act 2006 additionally provides that shareholders who receive payments, with reasonable grounds to know that they are made in breach of the rules, shall be liable to repay the amount received to the company

Question 24

Purchase of own shares

Why would a company purchase their own shares?

Answer 24

• Gives the shares some marketability
• In family companies when shareholders die, resign, retire (cannot decide what to do with the shares)
• In the case of shareholder disputes
• In the case of executive directors who have taken shares in the company

Question 25

Purchase of own shares

History

(Trevor v Whitworth (1887)

Answer 25

Strict rule that companies were not allowed to buy their own shares → such purchase was treated as a major contravention of the capital maintenance rule (Trevor v Whitworth (1887)

Question 26

Purchase of own shares

History

(s.658) (common law rule)

Answer 26

Prohibits a company (public & private) from acquiring its own shares (criminal offence!!!)

… except ….

companies allowed to issue redeemable shares … BUT … strict controls over how any such redemption has to be financed

In the case of redeemable shares the company can only buy back the shares from the profits available (eg issue of new shares).

Question 27

Purchase of own shares

History

(ss.690-736) Ways in which a company can buy its own shares

Answer 27

(ss. 690-736) way in which companies can buy their own shares (other than redeemable; subject to safeguards): through e.g.
- market purchase (purchase on a recognised purchase exchange. Must be authorised by a ordinary resolution)

-off-market purchase (special resolution)

Question 28

Purchase of own shares

Rules (these are the exact same as the redemption of redeemable shares)

Answer 28

The rules for financing the purchase by a company of its own shares are the same as those that apply to the redemption of redeemable shares … the most important ones
- No purchase or redemption is to be financed from the company’s capital

Can only be paid from

• profits available for distribution to the company’s members or
• the product of a fresh issue of shares

Question 29

Purchase of own shares

Redemption of redeemable shares

Answer 29

If you try to purchase these shares then they must be cancelled.

Must inform the Registrar of companies as this has an effect on the companies capital.

Question 30

Purchase of own shares

Answer 30

If you try to purchase the own shares of the company then

Shares must be cancelled
OR
held by the company in treasury (based on the reason)

Must inform the Registrar of companies as this has an effect on the companies capital.

Question 31

Purchase of own shares

Relaxation of rules for Private limited companies

Answer 31

Relaxations of the rules for private limited companies → private companies are permitted to use the company’s capital to finance the purchase of their own shares. However this must be done by

• special resolution (75% majority)
• solvency statement (companies directors must made a statutory declaration that they believe the company is solvent and will remain solvent for the foreseeable future)
• auditor’s support

Question 32

Prohibition against financial assistance (public companies)

Additional rules

Answer 32

A public company is prohibited from providing financial assistance (transfer of cash, property ect ) to a third party to enable that third party to purchase the company’s shares.