Chapter 19 Company Law: share and loan capital Flashcards
19.2 Share capital
Definition of a share and types of share capital – an incorporated with share capital means its members hold shares. They undertake to contribute an agreed amount of money to the company. A share is therefore the interest of a shareholder in a company measured by a sum of money. The share capital of a company can be described in a variety of ways:
• Authorised share capital – companies incorporated under older legislation have a maximum amount of authorised share capital. The companies Act 2006 abolished this requirement but the concept still continues where it is included in the articles of older companies
• Nominal share capital – each share has a nominal value; the nominal share capital of a company is the total nominal value of the shares in issue. The nominal value rarely matches the market value of the share.
• Issued share capital – nominal value of the shares that actually been issued. A company is not obliged to issue its shares in return for the nominal value, it can be higher. The additional money paid is called the share premium. A company cannot issue shares for less than the nominal value however
• Paid up share capital – a shareholder is liable for the debts of the company up to the nominal value of each share they own. However, they may only pay a proportion of what they owe, the companies paid up share capital is the amount actually contributed to the assets of the company. The shares are said to be partly paid and the shareholders are liable to pay the reminder at a future time
• Uncalled share capital – amount of issued share capital that shareholders have not yet been called upon by the company to pay
• Called up share capital – a company may call for any unpaid share capital to be paid in whole or part
19.2 Share capital
Classes of share and class rights – the rights enjoyed by virtue of their owning a particular class of shares are said to be the class rights of that class of share. The types of classes can be:
• Ordinary shares – these are standard shares and usually offer one vote per share on the shareholder. They are entitled to dividends from distributable profits once preferential shares have been paid. They also confer on a shareholder an entitlement to a distribution of assets on winding up of the company in proportion to the nominal value of their shares
• Preference shares – entitled to dividends before ordinary shares and priority of repayment on winding up. They are held to a dividend at a fixed rate. Where a preference share is cumulative, if a dividend is not paid in one year, the holder is entitled to double the dividend next year. A non-cumulative share will not be paid double if a dividend is not paid in one year. Participating preference shares means the holders received dividends at the fixed rate and additionally participate equally with other classes of shareholders in further dividends
• Deferred shares – issues on the basis that the rights attaching to them will take effect at a later date or on the happening of a future event
• Convertible shares – carry the right at a future time to be changed into another type of share
• Redeemable shares – there are shares that are issued with a provision that they may be nought back by the company at a later date
• Non-voting shares – they do not carry voting rights
A tax perspective – for tax purposes different classes of shares are important to distinguish. Each class of share is regarded as a different asset for CGT purposes. The corporation tax regime defines ordinary share capital as all the issued share capital of a company other than the capital the holders have a fixed rate of dividends but no rights to other profits. Participating preference shares would not be excluded by this.
19.3 Allotment and issue of shares
Getting shares into the ownership of a shareholder requires a company to allot and issue its shares using a formal process. In essence it entails the making and completion of a contract:
• Persons who wish to subscribe for the shares of a company make an offer to the company to that effect. If the company accepts that offer, the contract becomes binding and the company is under duty to issue shares
• The company’s acceptance of the offer amounts to the allotment of the shares to the shareholder concerned but at that stage the shares cannot be regarded as having been issued
• A further step is required – namely the completion of a contract and that only occurs when the shareholder’s name is entered into the company’s register of members
Further rules on allotment and issue of shares are as follows:
• Directors must have authority under the company’s articles or from an ordinary resolution of the shareholders to enter into a contract for the allotment of shares
• A public company and a private company with more than one class of share, cannot give authority to its directors to allot shares for more than five years at a time
• Shares may be issued for cash or for other forms of property
• Normally existing shareholders have the right to be given the opportunity of subscribing for additional shares before shares are issued to new shareholders
• Only if a public company may invite the public to make an offer for the issue of its shares
An issue of shares does not result in any stamp tax consequences, however the sale of shares would.
19.4 Reorganisation of share capital
The share capital of a company can be altered, a change is called reorganisation of share capital. Share capital for the purposes of capital gains tax may be reorganised where:
• Class rights are varied
• There is a reduction in the company’s share capital
• The nominal value of shares is altered
• There is an increased of allotted or issued share capital
Existing shareholders may receive additional shares in the company for no payment (bonus issue) or given the right to buy more shares (rights issue)
Bonus issues – this reduces the share price in the company to encourage more people to buy shares. Shareholders do not pay for bonus shares, as distributable profits or the share premium account are transferred to the share capital account to ensure the shares have not been issued at a discount.
Rights issues – shares offered to existing shareholders to purchase additional shares. Companies do this to raise funds. Shareholders do not have to take up the right and might be able to sell their right.
Consolidation of share capital occurs where the nominal value of shares is low and the company coverts them into shares with a higher nominal value.
Sub-division of share capital occurs where the nominal value of shares is high and the company coverts them into shares with a lower nominal value.
Such alterations do not increase or decrease the total amount of share capital but merely alter the denomination of individual shares. This requires authority of the shareholders and a power in the Articles to effect the change.
19.5 Capital maintenance
As the share capital is the only liability that the shareholder has, a company cannot return share capital to the shareholder until all other debts have been settled. A creditor looks at the share capital to decide if they will get their money back if the company went insolvent. Creditors enjoy a creditors buffer, as the share capital means they have security. Companies can spend the share capital but it cannot return to the shareholders, that is capital maintenance
The concept arises in the context of the following:
• Payment of dividends only out of distributable profits
• Reduction of share capital]
• Financial assistance for purchase of shares
• Not issuing shares at a discount to their nominal value
19.6 Payment of dividends
A dividend is a payment out of a company’s profits for a period in respect of a share in the company. Dividends cab be paid in cash or in a non-cash form, the latter being a dividend in specie or where additional shares are issued in satisfaction of the dividend, a stock dividend.
Declaration and payment of dividends – a shareholder is entitled to a dividend unless it is declared in accordance with the procedures in the articles of association. Payment of a dividend is a distinct and separate operation entailing an actual transfer of the assets of a company. The company may only pay dividends out of distributable profits (not profits from share capital or share premium).
A public company can only make a distribution if its net assets are not less than the aggregate of its share capital and undistributable reverses. A company must follow proper procedure to pay out dividends, otherwise this is an unlawful dividend. The directors are responsible as they either recommend that a dividend should be declared or they declare interim dividends. They are liable under common law if:
• They recommend or declare a dividend which they know is paid out of capital
• Without preparing accounts they declare a dividend who proves to be paid out of capital
• They mistake the law or interpretation of the company’s constitution which leads to an unlawful dividend
The directors may honestly rely on proper accounts which disclose an apparent distributable profit. They are not liable if this later transpires that the assumptions or estimates, although reasonable at the time were in fact unsound. The position of members is:
• A member can obtain an injunction to restrain a company from paying an unlawful dividend
• The company can recover from members an unlawful dividend if the members knew it was unlawful
• If the directors have to make good to the company an unlawful dividend, they may claim indemnity from members who knew of the irregularity
19.6 Payment of dividends (2)
Types of dividends payable – directors may declare interim dividends if they believe there are sufficient distributable profits. No debt between the shareholders and company is created by the declaration so directors can change their minds and rescind the declaration.
Final dividends are declared by ordinary resolution of the shareholders and this creates a debt between shareholders and company, the debt is enforceable either immediately or in the future. The shareholders have a right to sue for payment if the company does not do so.
Tax treatment of dividends – there are two levels on taxation during the distribution of company profits. The first is corporation tax on the company and the second is income tax on the shareholders. This leads to economic double taxation. There are a number of approaches to corporate taxation which mitigate the impact of double taxation:
• Classical system – company treated wholly distinct from its shareholders. Company taxed on all its profits and so much of its profits are distributed is regarded as the income of shareholders and taxed as such. This does not mitigate double taxation
• Fiscal transparency regards the company as a mere intermediary recipient of income on behalf of its shareholders and apportions that income among them regardless of whether it is actually paid to them. This avoids double taxation entirely
• Exemption chooses to exempt the dividend from tax at shareholder level, a shareholder company will generally not be charged to corporation tax on the dividends it receives. This avoids double taxation entirely.
19.7 Reduction of share capital
There may be certain circumstances where a company wishes to reduce its share capital and this can be done if certain procedures are followed. A private company can reduce issued share capital provide the articles allow it, the shareholders pass a special resolution and either:
• Court approval is obtained, or
• A solvency statement supports the resolution and there are still non-redeemable shares left after the reduction
The reduction of a company’s share capital for CGT purposes treated as a reorganisation of its share capital.
19.8 Acquisition of own shares
A reduction of capital might occur through a company purchasing its own shares, called a share buy-back. This is not usually allowed but there are exemptions under the 2006 Companies Act. A buy-back of shares can be funded in different ways:
• Out of distributable profits
• From the proceeds of a fresh issue of shares
• With a de minimis amount of cash (the larger of £15,000 or 5% of share capital in any financial year
• Out of capital
A public company may only buy-back its own shares using distributable profits or proceeds of a fresh issue of shares. Where a buy-back is made otherwise than out of capital, the procedure is as follows:
• The contract for the buy-back of shares must be approved by the members of ordinary resolution. Members whose shares are being bought back are not allowed to vote
• The contract must be available at the registered office at least 15 days before the meeting. This notice period is shortened if voting members are sent a copy of the contract and sign a written resolution approving it
• Within 28 days a return must be made to companies’ house stating the number of shares bought back, their nominal value and the date of purchase
• The shares bought back must be cancelled and cannot be reissued, unless held as treasury shares
• Once the shares are cancelled, an amount equal to the nominal value of the shares bought back must be transferred to a capital redemption reserve.
• The articles must permit the use of capital to buy back shares and accounts used to determine whether they are available profits
• A directors’ statement must be issued that the company will remain solvent and carry-on business as a going concern for at least a year. The statement should specify the amount of permissible capital payment, the directors commit a criminal offence if they make the statement without having reasonable grounds for the opinion expressed in it
• An auditor’s report must support the director’s statement
• A special resolution must be passed approving the payment
• A notice of the statement must be published in the London Gazette within one week so creditors can apply to the court to prevent this going through
• Payment for the shares must be made by the company not less than five nor more than seven weeks after the date the resolution passed
Where a share re-purchase happens in the 12 months before a company becomes insolvent and the company has a deficiency of assets, the shareholders concerned are liable to pay back the money received. Directors who certified solvency can be help liable to pay in certain circumstances.
19.9 Financial assistance for the purchases of shares
Generally, it is not lawful for a public company to give financial assistance directly or indirectly to a person acquiring shares in the company before or at the same time the acquisition takes place. The criminal consequences
The criminal consequences of a breach of financial assistance rules could mean up to two year’s imprisonment and a fine for officers of a public company. Exceptions include:
• Money lent by a company in the ordinary course of its business
• Lawful dividends
• Employee’s share schemes
• Loans to employees
19.10 Loan capital (debt)
The reasons a company might decide to take out a loan rather than issue shares include:
• Debt can be repaid or redeemed at any time, but strict rules govern the repayment of share capital
• Interest on debt can be paid so long as the company has sufficient cash, whereas dividends can be paid only out of distributable profits
• Debts can be more tax effective, as a corporation tax deduction is generally available for interest paid but not for dividends distributed
• Shares may not be issued as a discount to their nominal value but debt can be taken on at a discount
Debt capital of a company is usually taken to be loan stock rather than an overdraft. Loan stock is a series of loans from different lenders but on identical terms, they normally have a fixed repayment dates. They monies raised go through a legal process known as securitisation, so the original lenders are no longer regarded as lending separate and distinct amounts to the company but are treated as owning units of debt which are choses in action. Those units may be purchased or sold.
There may be different classes of loan stock with differing rights. The rights are part of contractual terms on which the company has borrowed the money. One class of loan stock can be convertible into another class of loan stock or into shares. Companies issue certificates called debentures to owners of the stock to prove they are creditors. A debenture holder has a contractual relationship with the company, the terms are fixed except on normal contractual principles. It is common for the terms of issue to include a provision that allows a variation to be made by a 75% majority of the holders.
19.11 Security for loans and charge
Types of security – loan stock can be secured or unsecured. When unsecured the creditor has a contract and their rights stem from contract law. When secured the lender has rights over the company’s property against which the loan has been secured.
Security for company lending may be in the form of:
• A personal guarantee from a director or shareholder
• A charge over the assets of the company, if the lender’s bargaining position enables it to insist upon this
A charge is a mechanism for securing a debt against an asset, which is charged on the company if they do not repay the loan. A company can grant a fixed charge or a floating charge, the effect of each is to increase the likelihood that the creditor will receive their money.
Fixed charge – this attaches to a physical asset of a company like land, buildings etc. In essence it is a mortgage and is created by the appropriate procedure for mortgaging property as follows:
• In England by a mortgage of land by deed
• In Scotland, by a standard security
The charge against property may not be dealt in freely (sold) by the company in the ordinary course of business without reference to the charge holder. The charge grants the holder the right of enforcement against the asset so that the creditor may realise the asset to meet the debt owed. Fixed charge ranks first in order of priority in a liquidation.
If a company disposes of the charged asset it will either repay the secured debt out of the proceeds of sale, so that the charge is discharged at the time of sale or it will pass the asset to the purchaser still subject to the charge.
Floating charge – charge on a class of assets of a company, until the holders enforce the charge the company may carry on business and deal in the assets charged. Floating charges do not attach to the relevant assets until the charge crystallises and until that time the company may deal in the assets subject to the charge without consent of the creditor. The charge over the undertaking and assets of a company applies to future and current assets. Crystallisation of a floating change occurs when it is converted into a fixed charge on the assets owned by the company at the time of crystallisation. Events include the company defaulting the loan, liquidation, cessation of business or the appointment of a receiver to deal with the company’s assets. Contracts can make provision for automatic crystallisation when a specific event occurs. These clauses are accepted by the court if they state on the event occurring, the floating charge is converted into a fixed one It is not always apparent is a charge is fixed or floating, a contract may not always state this. The general rules are a charge over assets is not fixed if it is envisaged that the company will still be able to deal with the charged assets without reference to the creditor.
19.11 Security for loans and charge (2)
Registration of charges – companies are obliged to register the charge with companies’ house. Registration of charges is intended to put other creditors on notice of the existence of the charge before making a loan or giving credit to the company. Most charges should be register within 21 days of creation.
Priority of charges – this is order in which secured loans are repaid to creditors:
• Fixed charges – the earlier of the fixed charges also have priority over other fixed charges
• Floating charges
• If a floating charge is created and a fixed charge over the same property is created later, unless the fixed charger holder knew of the floating charge, the fixed charge will rank first, as it attaches to the property as cessation instead of a floating charge which attaches itself at the time of crystallisation
• A floating charge holder may seek to protect itself against losing priority by including a clause that prohibits the company from creating a fixed charge over the same property. If the company breaks this and creates a fixed charge, the fixed charge is given priority still unless then creditor with the fixed charge knew of the prohibition
Remedies for non-repayment – the remedies depend on whether the loan is unsecured or secured:
• If unsecured, any action to enforce payment of principal or interest is limited to an action for payment of the debt. This may be enforced in a number of ways, from sending in a bailiff to having the company wound up
• If secured, the holder may start an action for payment of the debt. It may enforce its security by selling the property and taking the money due from the proceeds and handing any surplus to the company or by appointing a receiver to collect income due
A receiver is appointed by the debenture holder to collect the income produced by the charged asset. In English law a receiver may be appointed only by the holders of a fixed charge over a specific asset. Appointment of a receiver by floating charge (administrative receiver) is only possible if:
• The charge was created before 15 September 2003, or
• The charge is concerned with the exceptions outlined in the Insolvency Act 1986
