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Legal Capital Rules Flashcards

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1
Q

What are Legal Capital Rules?

A

The rules constraining what a firm may do with a shareholder equity.

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2
Q

What is the Purpose of Legal Capital Rules?

A

To resolve the conflicting interests of creditors and shareholders regarding capital allocation.

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3
Q

What Documentary Requirements are there under the Legal Capital Rules upon Registration?

A

A Statement of Capital and Initial Shareholdings.

CA 2006 – §9-§10.

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4
Q

Broadly, what are the Two Categories of Legal Capital Rules?

A

The Raising and Maintenance of Capital Rules.

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5
Q

Why do the interests of Creditors and Shareholders conflict?

A

Shareholders, as residual claimants, wish to profit-maximize at all costs whereas creditors, as secured claimants, only seek repayment and thus the mitigation of unnecessary risk.

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6
Q

Structurally, how is Creditors’ and Shareholders’ conflict of interest exacerbated?

A

Shareholders hold great influence over the Board, which enables them to profit excessively at the expense of Credtiors.

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7
Q

How may Shareholders go about profiting excessively at the expense of Creditors? (A-RUC)

A
  • Asset Diversion, i.e. withdrawing assets from the firm’s cushion.
  • Risk shifting, i.e. increasing the firm’s risk profile.
  • Underinvestment, i.e. quitting projects that don’t profit-maximize.
  • Claim dilution, i.e. taking on divergently unproductive debt.
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8
Q

Are Creditors capable of benefiting themselves at the expense of Shareholders?

A

Yes, but to a comparatively lesser degree. E.g.:

  • Loan acceleration.
  • Covenants against dividends.
  • Risk-shifting.
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9
Q

What are the Two Sub-categories of the rules regulating the Raising of Capital?

A
  1. Minimum Capital Rules.
  2. Payment for Shares Rules.
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10
Q

Broadly, what do the Minimum Capital Rules pertain to?

A

The amount of capital which must be invested into a public company by its shareholders before trading.

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11
Q

What is the Par Value of a Share?

A

The nominal value at which a share is allotted.

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12
Q

What is Nominal Share Capital?

A

The amount of capital belonging to a company upon registration.

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13
Q

What is Share Capital?

A

The aggregate par value of a company’s outstanding shares.

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14
Q

What is Paid-Up Share Capital?

A

The amount already paid by shareholders to a company in exchange for shares.

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15
Q

What is Called-Up Share Capital?

A

The amount yet unpaid by shareholders to a company in exchange for shares already purchased, exceeding no more than 75% initial price.

CA 2006 – §581 & §586.

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16
Q

What is a Share Premium?

A

The amount above par at which a share is being alloted.

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17
Q

What is to be done with the Profits made on Share Premiums?

A

The aggregate value gained must be transferred to a Share Premium Account.

CA 2006 – §610.

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18
Q

How may the proceeds of a Share Premium Account be utilized?

A

To write off expenses or commissions paid on share issuances, or to give company members stock options.

CA 2006 – §610.

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19
Q

What is the Technical Difference between Share Allottment and Issuance?

A

Allottment is the portioning of shares, while issuance is the execution of said portioning.

See: Companies Act 2006 – §549-§577.

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20
Q

For a UK PLC, what is the Minimum Nominal Value of allocated share capital?

A

£50,000.

Companies Act 2006 – §763.

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21
Q

Is there a Minimum Capital Requirement for LLCs?

A

No.

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22
Q

Can Minimum Capital Requirements honestly be said to protect Creditors?

A

No. The sums they require are microscopic relative to the debts owed by PLCs, and they don’t even need to be maintained after registration.

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23
Q

How do Creditors chiefly go about protecting themselves against Insolvency?

A

By drafting contracts and clauses which afford them such protection, e.g. representations, warranties, covenants, and conditions precedent.

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24
Q

What is the Purpose of regulating Payment for Shares?

A

To guard against shareholder dilution and, to a lesser degree, to protect creditors.

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25
Q

How is Fair Consideration guaranteed in Payment for Shares?

A

By requiring that all shares must have a fixed minimum nominal value, i.e. par value.

Companies Act 2006 – §542.

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26
Q

In exchange for Shares, which forms of Consideration are acceptable?

A

Cash and Non-Cash Consideration.

CA 2006 – §582.

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27
Q

Is it possible to issue shares below par value, i.e. at a Discount?

A

No. This is known as the ‘No Discount Rule’.

Companies Act 2006 – §582(1); Ooregum Gold Mining Co. of India v Roper [1892] AC 125.

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28
Q

If a share’s par value is low, its stock price high, and its most recent issuance below market price but above par, are the Directors exposed to legal liability?

A

Only if they did not act bona fide in the best interests of the company when setting the price.

Shearer v Bercain [1980] 3 All ER 295; Re Sunrise Radio Ltd. [2010] 1 BCLC 367; Mutual Life Insurance Co. of New York v Rank Organization Ltd. [1985] BCLC 11.

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29
Q

For LLCs, how is the ‘No Discount Rule’ examined in cases of Non-Cash Consideration?

A

With deferrence to the Board’s commercial judgement, which goes unquestioned so long as it isn’t, “clearly colourable or illusory.”

Re Wragg Ltd. [1897] 1 Ch 796.

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30
Q

For PLCs, how is the ‘No Discount Rule’ examined in cases of Non-Cash Consideration?

A

With mandatory independent valuation of the non-cash consideration prior to allotment.

Companies Act 2006 – §593-597.

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31
Q

Is Non-Cash Consideration acceptable off-the-bat for PLCs?

A

No. §598-§604 strictly govern the use of non-cash consideration during a company’s initial period, i.e. first two years post-registration.

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32
Q

What transpires upon Breach of the Payment for Shares Rules?

A

The allottee will be liable to repay the company their discount + interest, but may also be liable to repay the shares’ entire nominal value + premium(s) + interest.

Companies Act 2006 – §593.

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33
Q

What transpires upon Transference of Illegitimately Discounted Shares?

A

Generally, all subsequent purchasers will be held jointly and severally liable for the discount + interest (or even more).

Companies Act 2006 – §588 and §605.

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34
Q

Is there a Defence against purchasing Illegitimately Discounted Shares?

A

Having demonstrably acted in good faith.

Companies Act 2006 – §588 & §605.

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35
Q

How do the Payment for Shares Rules protect Creditors or Shareholderes?

A

They practically don’t. For shareholders, share dilution is untouched. For creditors, any increase in the asset pool is good, and where shares are issued to release a debt, they are worth much less in insolvency.

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36
Q

What was the Precedent set in Centros?

A

EU firms are free to incorporate in whichever Member State they so desire, even if they don’t transact there whatsoever.

Centros Ltd. v Erhvervs-og Selskabsstyrelsen [1999] ECR I-1459

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37
Q

What was the Economic effect of Centros on the UK?

A

A large influx of relatively small, but economically significant LLCs.

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242]

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38
Q

Why were LLCs attracted to the UK after Centros?

A

The UK had the simplest and lowest-cost incorporation procedures in the Union.

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].

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39
Q

With respect to Regulation, what does the Centros corporate migration strongly imply?

A

That, if two States’ corporate law is of comparable quality, “then price considerations should dominate.”

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].

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40
Q

According to Becht et al., which Price Considerations are most relevant to prospective incorporators?

A
  • Incorporation Costs.
  • Minimum Capital Requirements.

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].

41
Q

According to Becht et al., why are Price Considerations so dominant as opposed to Non-Price Considerations?

A

The ‘penetration’ of Registration Agents has reduced and amplified the significance of non-price and price considerations due to their expertise and profit-maximizing incentive, dually respectively.

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].

42
Q

According to Becht et al., what has been the Regulatory outcome of Centros?

A

Inter-State competition for the title of lowest-cost corproate law, resultant from the clear permission of regulatory arbitrage.

Becht, Mayer, & Wagner – Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].

43
Q

What is Armour’s central point against the Threat of Regulatory Arbitrage?

A

Due to States’ inability to charge franchise taxes on Centros-style incorporated firms, they lack the profit incentive to rush to the bottom.

Armour – Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition [394].

44
Q

Why does Armour nevertheless believe that States may be motivated to relax Regulation?

A

Revenue from legal services may be an invaluable economic resource, and private legislatures, e.g. the Takeover Code, are better than public legislatures at extracting marginal revenues from firms through fees.

Armour – Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition [396].

45
Q

Why does Armour believe that Regulatory Liberalization might, in some asepcts, lead to a ‘Race to the Top’?

A

Procedural safeguards will be needed to protect affected constituencies against opportunisitic motives regarding regulatory arbitrage.

Armour – Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition [397].

46
Q

According to Armour, why might States other than UK become hotspots for incorporation?

A

Certain States may seek to optimize their jurisdiction with regard to a particular firm structre, e.g. blockholding, thus appealing to that type of firm above and beyond other States.

Armour – Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition [401].

47
Q

What is Gerner-Beuerle et al.’s explanation for why Centros has had a ‘Modest Effect’?

A

The resultant arbitrage mainly centered around economic issues that primarily affected start-ups, and didn’t touch on more real-seat-based areas, e.g. labor, tort, or insolvency law.

Gerner-Beuerle et al. – The Illusion of Motion Corporate (Im)Mobility and the Failed Promise of Centros.

48
Q

What are the Maintenance of Capital Rules?

A

The rules governing the utilization of shareholder equity.

49
Q

What is the Purpose of the Maintenance of Capital Rules?

A

To guard against the return of share capital to shareholders, except as perscribed by law.

  • Flitcroft’s Case* (1882) 21 Ch. D. 519; Trevor v Whitworth (1887) 12 App Cas 409 (HL).
  • “A limited company cannot in any other way make a return of capital.”*
  • “A company cannot make payments out of share capital.”*
50
Q

Foremost, what do the Maintenance of Capital Rules guard against?

A

Asset Diversion.

51
Q

What are the Exceptions under the Maintenance of Capital Rules? (DBRRF*)

A
  • Dividends.
  • Share Buybacks.
  • Share Redemptions.
  • Reductions of Capital.
  • Financial Assistance.*
52
Q

What are the Arguments in favor of the Maintenance of Capital Regime?

A

It protects all creditors by acting as a collective covenant on all firms and increases efficiency by minimizing transaction costs.

53
Q

What are the Arguments against the Maintenance of Capital Regime?

A
  • Grounds of efficiency only justify it as an optional regime.
  • It mimics what creditors can otherwise acheive through contract.
  • It’s likely inefficient à la no such thing as one-size-fits-all.
54
Q

What is the definition of a Dividend, i.e. ‘Distribution’?

A

Any disbursement of assets, whether in cash or otherwise, to a firm’s shareholders that is not:

  • An issuance of bonus shares;
  • A reduction of share capital;
  • A share buyback; or
  • An asset diversion during insolvency.

Companies Act 2006 – §829.

55
Q

What are the Two Types of Dividends?

A

Annual and Interim.

56
Q

What are SCRIP and DRIP Dividends?

A

SCRIPs describe the option to receive stocks alongside cash in one’s dividend package, whereas DRIPs describe the reinvestment of one’s capital into the firm through the purchase of outsanding shares.

57
Q

Between SCRIPs and DRIPs, which is typically Perferred?

A

DRIPs, since unlike SCRIPs, which comprise new shares on the mraket, they aren’t dilutive. Nevertheless, SCRIPs increase a stock’s liquidity.

58
Q

With whom does the Discretion to issue Dividends lie with?

A

The Board, who can either make a recommendation at the AGM or issue interim dividends on an ad hoc basis.

59
Q

Where is the Procedure for the Declaration and Payment of Dividends set out?

A

In the Articles of Association.

60
Q

Why would a Board choose to issue Dividends? (SASA)

A
  • Satisfy shareholders, especially those who are reliant upon them.
  • Increase the firm’s Attractiveness as an investment.
  • Signal the firm’s financial health, given the costliness of issuing dividends.
  • Mitigate Agency Costs.
61
Q

What is Easterbrook’s criticism of the Signalling Hypothesis?

A

Firms’ financial health is easily verifiable given the wealth of reporting they are legally obligated to publish, especially given independent auditors’ role to play therein.

Easterbrook – Two Agency-Cost Explanations for Dividends [651].

62
Q

According to Easterbrook, what are the Two Problems that Dividends seek to address?

A

Agency costs in the form of monitoring and risk aversion.

Easterbrook – Two Agency-Cost Explanations for Dividends [652-654].

63
Q

According to Easterbrook, what is the priamry benefit of keeping firms in the capital markets from an agency costs perspective?

A

Firms which regularly rely upon external financing will be beholden to the lenders’ and investors’ interests, and will be more likely to act in accordance with those interests, thus decreasing agency costs.

Easterbrook – Two Agency-Cost Explanations for Dividends [654].

64
Q

According to Easterbrook, how do Dividends act to keep firms in Capital Markets?

A

They can act to recalibrate capital structure, efficiently lowering equity and creating space for more debt, thus compelling firms to maintain proximity to capital markets.

Easterbrook – Two Agency-Cost Explanations for Dividends [655].

65
Q

What is an Anciliary Benefit of Dividends’ recalibratory effect?

A

It works to roughly equate shareholders’ and creditors’ interests in the firm, thus lowering the potential for unilateral opportunism.

Easterbrook – Two Agency-Cost Explanations for Dividends [655].

66
Q

Why would a Board choose not to issue Dividends?

A

At large enough sizes, they might advantage shareholders at creditors’ expense. Likewise, they are quite costly and incur additional transaction and tax costs.

Easterbrook – Two Agency-Cost Explanations for Dividends [650].

67
Q

From what source can Dividends be issued?

A

Distributable profits, which are a firm’s, “accumulated, realised profits… [subtracted by] its accumulated, realised losses.”

Companies Act 2006 – §830.

68
Q

For PLCs, what is the Net Asset Restriction on Dividend Distributions?

A

A prohibition on issuing dividends where a firm’s net assets are lower than its called-up share capital + undistributable reserves + (AUP - AUL), or where a distribution would put its net assets below that threshold.

Companies Act 2006 – §831.

69
Q

What does the term ‘Undistributable Reserves’ describe? (SCNR)

A

A company’s:

  • Share premium account;
  • Capital redemption reserve;
  • Net accumulated unrealized profits; and
  • Reserves so prohibited by the Articles.

Companies Act 2006 – §831.

70
Q

What form must Dividend Distributions take?

A

Cash, unless otherwise authorized by the firm’s Articles.

Wood v Odessa Waterworks Co. (1889) 42 Ch D 636.

71
Q

How is a Company determined to be Capable of issuing dividends?

A

With reference, most usually, to its previous annual accounts.

Comapnies Act 2006 – §836.

72
Q

What is the Penalty for unlawfully paying out a Dividend?

A

The receipient will be personally liable to repay the funds, unless they are bona fide. The authorizing directors will be liable to the company for the sum.

Companies Act 2006 – §847; Flitcroft’s Case (1882) LR 21 Ch D 519.

73
Q

What’s the point of issuing Interim Dividends?

A

As before, to signal financial health and satisfy shareholders by delivering a steadier stream of income.

74
Q

Why is the M&M Irrelevance Hypothesis incorrect?

A

Because its core assumptions, namely perfect markets, perfect rationality, perfect information, and zero transaction costs are fallcious.

75
Q

What are the Problems with our current approach to Determining dividends?

A

It’s backwards looking and is thus vulnerable to discrepancies between historical and real-time performance and conditions. It’s also inflexible.

76
Q

Is Directors’ Liability for Unlawful Distributions Strict or Fault-based?

A

With the case law split, the matter is ultimately fact-specific.

See: Re Paycheck Services 3 Ltd. [2010] UKSC 51 (Strict) – cf – Burnden Holdings (UK) Ltd v Fielding [2019] EWHC 1566 (Ch) (Fault-Based) & Companies Act 2006 – §1157.

77
Q

What Factors are considered when determining Directors’ Liability in issuing dividends Unlawfully?

A

The director’s constructive knolwedge, intentions, and the facts at the material time.

Holland v Commissioners for Her Majesty’s Revenue [2010] UKSC 51; Dovey v Cory [1901] AC 477; Ferran – Directors’ Liability for Unlawful Dividends [321-326]

78
Q

Generally speaking, are Firms permitted to Acquire their own shares?

A

No.

Companies Act 2006 – §658(1); Trevor v Whitworth (1887) LR 12 App Cas 409.

79
Q

Are there exceptions to the General Rule against Share Repurchase and Redemption?

A

Yes.

See: Companies Act 2006 – §659; §684-§689; and §690-§708.

80
Q

What are the Potential Advantages of Share Repurchases and Redemptions?

A

They may be used to:

  • Provide an exit route for shareholders, thus facilitating intital investment.
  • Increase stock liquidity for private companies.
  • Generate value for shareholders without altering their normative expectations.
  • Signal the company’s financial health and future prospects.
  • Optimize tax obligations.
  • Reorganize capital structure.
  • Facilitate employee share schemes.
  • Productively enrich cash-flush endgame firms.

R. Moore et al, Returning Value to Shareholders: Giving Something Back (2012) 23(8) PLC 23.

81
Q

What are the Potential Disadvantages of Share Repurchases and Redemptions?

A

They may:

  • Mislead the market through false signalling.
  • Undermine the Capital Maintenance Rules.
  • Deplete long-term liquidity.
  • Increase leverage, if debt-funded, and thus firm fragility.
  • Incur opportunity costs, e.g. R&D or CapEx.
  • Personally enrich insiders at other stakeholders’ expense.
  • Decrease firm, and thus economic, productivity.
  • Increase wealth inequality.
  • Concentrate shareholding power.
82
Q

When is a Share Repurchase deemed Legal?

A

When all of the Legislative requirements are met, and a Shareholder Resolution is passed.

See: Companies Act 2006 – §684-§690.

83
Q

Are all Share Repurchases the same?

A

No. Legislation distinguishes between Market and Off-Market Repurchases.

Companies Act 2006 – §694.

84
Q

What Effectually is the Distinction between Market and Off-Market Share Repurchases?

A

While both require a Shareholder Resolution, the latter must pertain to a specific share, and thus contract, whereas the former must not.

Companies Act 2006 – §694.

85
Q

How must a Repurchase be Funded?

A

Either through Distributable Profits or a Fresh Share Issuance.

Companies Act 2006 – §692.

86
Q

Are Public and Private Companies equally capable of Share Repurchases?

A

Under certain circumstances, private firms may repurchase shares out of capital.

Companies Act 2006 – §692; §714-§723.

87
Q

How are Repurchased Shares held by a Company?

A

As Treasury Shares, wherein any associated rights cannot be exercised. It may later either liquidate, cancel, or distribute them to employees.

Companies Act 2006 – §724-§733.

88
Q

What are Redeemable Shares?

A

Shares which may be repurchased by the issuing company from a shareholder on or after a specific date or event at a predetermined price, i.e. the Call Price.

89
Q

Are Redeemable Shares permitted under Company Law?

A

Yes.

Companies Act 2006 – §684.

90
Q

Do Redeemable Shares require Prior Authorization by a Firm’s Articles?

A

For Public Companies, Yes.

For Private Companies, No.

Companies Act 2006 – §684.

91
Q

For Public Companies, must the Terms of Redemption be specified in the Articles?

A

No. The Board can determine the Terms, Conditions, and Manner discretionarily prior to execution.

Companies Act 2006 – §685.

92
Q

How must a Redemption be Financed?

A

Identically to a Repurchase, subject to the same exceptions.

Companies Act 2006 – §687.

93
Q

Do Redeemed Shares become Treasury Shares upon redemption?

A

No. They must be Cancelled.

Companies Act 2006 – §688.

94
Q

Although Share Repurchases and Redemptions may indirectly lead to fewer existing shares, a Reduction of Capital is distinct attempt at such a goal. What are its Advantages?

A

They may allow the Firm to:

  • Return surplus value to shareholders.
  • Reorganize capital structure.
  • Boot shareholders.
  • Transform otherwise undistributable reserves into realized profits, i.e. distributable reserves.
  • Downsize the scale of the operation.
95
Q

What Legislative or Constitutional Barriers exist for Reductions of Capital?

A

Special Resolution, followed by Court Approval and subject to Creditor Objection.

Companies Act 2006 – §641-§648.

96
Q

What are Requisite Grounds of a Creditor Objection?

A

That a reduction of capital presents a ‘Real Likelihood’ of decreasing the firm’s repayment capacities.

Companies Act 2006 – §646-§648; Re Liberty Internationl Plc. [2010] EWHC 1060; Prudential Assurance Co. Ltd. v Chatterley-Whitefield Collieries Co. Ltd. [1949] AC 512; Re Royal Scotland Assurance Plc. [2011] SLT 264; Re Vodafone Group Plc. [2014] EWHC 1357.

97
Q

Whose Interests must the Court account for regarding Reductions of Capital?

A
  1. Creditors.
  2. Shareholders.*

Companies Act 2006 – §645; Scottish Insurance Corp. v Wilsons [1949] AC 462*; Re Northern Engineering Industries Plc. [1994] BCC 618*;

98
Q

Must Private Companies also go through the Courts to legalize a Reduction of Capital?

A

No. They may instead utilize the Solvency Statement Mechanism in addition to a Special Resolution.

Companies Act 2006 – §643; BTI 2014 LLC. v Sequana SA [2016] EWHC 1686; LRH Services Ltd. v Trew EWHC 600.

Corporate Finance (9 decks)

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