The Capital Maintenance Rules

Question 1

How can a company alter its share capital? (3)

Answer 1

• S.617 CA2006 = company can alter its share capital by:

1. Allotting new shares; (increases share capital)
2. Sub-dividing shares (e.g. converting 100 £2 shares into 200 £1 shares); or
3. Consolidating shares (e.g. converting 100 £10 shares into 10 £100 shares).

None of these reduce share capital = last 2 maintain level

Question 2

What are the 2 methods how a company can reduce its share capital?
What are 2 limitations on a company reducing its share capital?
Will authorisation from the articles be needed?

Answer 2

• 2 methods:

1. Special resolution followed by court confirmation
2. Special resolution followed by a solvency statement

• S.641 CA2006 = a company can reduce its share cap in any way, subject to 2 limitations:

1. If reducing by special resolution followed by solvency statement, cannot do so if the result leaves no members holding shares other than redeemable shares
2. Cannot reduce by either method if reduction is part of a scheme where a person acquires all the shares (in the company or in one or more classes)

• No authorisation required from articles to reduce
• Articles may exclude or restrict ability to reduce share capital
• If a reduction amounts to a variation of class rights, must follow process for varying class rights

Question 3

Which companies can reduce their share capital by a special resolution followed by court confirmation?
What will the courts consider?
When will a reduction only be confirmed?
Who has the right to object and what 2 conditions must be satisfied?
What will the courts do?
If approved what must the company do?
When will the reduction take effect?

Answer 3

○ Both private and Plc can use

○ Court consider interests of the company’s creditors before granting (a reduction can adversely affect the creditors’ position)
○ Courts’ primary concern is the interests of the creditors
○ Court also consider the shareholders (Were they able to make an informed decision when voting and does reduction affect all shareholders equally?) and the public (who may want to take shares)

○ Re Ratners Group plc [1988] = reduction will only be confirmed if creditors are safeguarded and money cannot be applied in a detrimental way

○ S.646 CA2006 = every creditor has the right to object a reduction if the following 2 conditions are met:

1. the proposed reduction involves a diminution of liability of unpaid share capital, or the payment to a shareholder of any paid-up share capital; and
2. the creditor can show it’s very likely the reduction would result in the company being unable to pay his debt or claim when it fell due

○ Courts will draw up a list of such creditors and not confirm the reduction unless every creditor has:

1. Consented to the reduction
2. Had their debt or claim paid, discharged, or secured

○ If approved, company must deliver to Companies House a copy of the court order and a statement of capital
○ Reduction will take effect once these documents have been registered

Question 4

Which companies can reduce their share capital by a special resolution followed by a solvency statement?
What is a solvency statement? When is it valid?
If passed what must the company deliver to CH?
When does the reduction take effect?
Who may face liability and for what?

Answer 4

○ Only for private companies

○ Solvency statement = shows each director has the opinion that the company can pay its debts:
1. At the date of the statement and there are no grounds to find otherwise
2. As they fall due during the year immediately following the statement
○ Statement only valid if made by all directors

○ If passed, must deliver to Companies House a statement of capital, copies of resolutions, and the solvency statement within 15 days

○ Reduction will take effect once these documents have been registered

○ S.643 CA2006 = if statement is made without reasonable grounds for the opinions expressed in it and is delivered to the register = every director in default commits an offence, and reduction is void

Question 5

What is the general rule regarding a company purchasing its own shares and why? (3)
What are 3 exceptions under s.659 CA2006?
What are 2 further exceptions?

Answer 5

• S.658 CA2006 = general rule = a company cannot acquire its own shares because:
1. Would return capital to the shareholders (generally prohibited under capital maintenance rules)
2. Company could attempt to manipulate its own share price
3. Would reduce company’s share capital and allow company to avoid the procedures for reducing share capital
• Contravention is a criminal offence

• S.659 CA2006 = exceptions:

1. Limited companies may acquire own fully-paid shares otherwise than for valuable consideration;
2. Companies may acquire own shares as part of a valid reduction of capital; and
3. Court may order company to purchase its own shares from a member if member’s interests have been unfairly prejudiced under s. 994 of the CA2006

• 2 further exceptions:

1. Redemption of redeemable shares in accordance with CA 2006
2. A company limited by shares…. may if its articles of association permit purchase its own shares.

Question 6

What are redeemable shares?
What are the 4 conditions?
What happens once the shares are redeemed?

Answer 6

• S.684 CA2006 = redeemable shares = shares issued by the company on the condition that they will be bought back by the company if the company so requires

• Conditions:
1. Public company may only issue redeemable shares if articles allow
• Private company can without article authorisation
2. Only fully paid up shares can be redeemed
3. Company must pay for the shares upon redemption (Unless company and shareholder agree to payment being made later)
4. Payment must come from:
a. Company’s distributable profits; or
b. Proceeds of a fresh issue of shares made for the purpose of the redemption
• S.710 CA2006 = a private company can pay for redeemable shares using capital (so as long as use the 2 above first)

• S.688 CA2006 = once redeemed, shares are cancelled and company’s share capital is reduced by the nominal value of the shares redeemed
• Must notify CH within 1 month of the redemption, specify the shares redeemed, and provide a statement of capital

Question 7

What are the 3 limitations on a company limited by shares purchasing its own shares?
What is a market purchase and what authorisation is required?
What is an off-market purchase and what authorisation is required?
When must payment be made and what must it be paid out of?
What happens once the shares are purchased?

Answer 7

• S.690 CA2006 = companies limited by shares can purchase their own shares
• Subject to limitations:
1. The company’s articles may exclude or restrict this ability
2. Cannot purchase own shares if only redeemable shares or treasury shares would remain
3. Only fully paid shares can be purchased

Authorisation For a Market Purchase
• A market purchase = a purchase that takes place on a recognised investment exchange and is subject to a marketing arrangement
• s. 701 CA2006 = must be authorised by a resolution of the company before contract can be entered into

Authorisation For an Off Market Purchase
• An off-market purchase:
• (i) Doesn’t take place on a recognised investment exchange; or
• (ii) Does but is not subject to a marketing arrangement
• Share purchase terms must be first authorised by a resolution of the company before contract is entered into, or the contract must provide that no shares may be purchased until its terms have been authorised by a resolution of the company

Payment and Cancellation
• s.691 CA2006 = shares must be paid for on purchase
• Payment must be paid out of distributable profits or the proceeds of a fresh issue of shares made purposely for financing the purchase
• Private companies can purchase out of capital

• s.706 CA2006 = once purchased, shares are cancelled and company’s share capital is reduced by the nominal value of the shares redeemed
• Must deliver to CH within 28 days: Form SH03, specifying the number and nominal value of shares purchased, and date delivered to the company

Question 8

What is the procedure for a private limited company to acquire its own shares our of capital?

Answer 8

1. Directors’ statement = s.714(1)-(5) CA2006 = specify how much capital will be required to pay for the shares and include a statement of solvency
   ○ Must be available for inspection and a copy available to members
   ○ Accompanied by auditor’s report
2. Auditor’s report = s.714(6) CA2006 = states the permissible capital payment is properly determined and opinions expressed in solvency statement are reasonable
   ○ Must be available for inspection and a copy available to members
3. Special resolution = s.716 CA2006 = within 1 week of directors’ statement, payment out of capital must be approved
4. Public notice = S.719 CA2006 = within 1 week of special resolution, company publishes notice in the Gazette
5. Payment = s.723 CA2006 = must be made 5 weeks after but within 7 weeks of the special resolution

• S.721(1) and (2) CA2006 = any member or creditor may, within five weeks of the special resolution, apply to the court for an order cancelling the resolution
• The court will then make an order either cancelling or confirming the resolution, and it may do so on such terms and conditions as it thinks fit (s. 721(4))

Question 9

What is financial assistance?

What are 3 examples?

Answer 9

• S.677 CA2006 = ‘financial assistance’ = gifts, guarantees, security, indemnity, release or waiver, loans, and any other financial assistance given by a company

• Examples = where:
1. Company lends money to a person who uses that money to buy shares in the company;
2. Company guarantees a loan made by a bank to another person who uses that money to buy shares in the company; and
3. Person (X) borrows money from a bank and uses it to buy enough shares to control a company. X then uses the resources of the company to repay the money loaned by the bank
• Courts will examine the commercial realities of the transaction to decide if company has financial assistance

Question 10

Why was prohibited financial assistance introduced? (2)

What are the 4 scenarios of prohibited financial assistance?

Answer 10

• Prohibition were introduced to prevent:

1. A company from being able to manipulate its share price; and
2. A company (A) from providing financial assistance to another company (B), and B then using that money to purchase shares in A and take it over

• 4 scenarios of prohibited financial assistance = where a person:
1. Is acquiring shares in a public company
• Then a company or subsidiary cannot give (direct or indirect) financial assistance for the purpose of the acquisition before or at the same time as it takes place

2. Is acquiring shares in a private company
   • Then a public company that is a subsidiary of that company cannot give financial assistance for the purpose of the acquisition before or at the same time as it takes place
3. Has acquired shares in a public company and a liability has been incurred for the purpose of the acquisition
   • Then that company or subsidiary cannot give financial assistance to reduce or discharge the liability
4. Has acquired shares in a private company and a liability has been incurred for the purpose of the acquisition
   • Then a public company that is a subsidiary of that company cannot give financial assistance to reduce or discharge the liability

Question 11

What are the principle purpose and incidental part of financial assistance that cause an exception? (3)
What is an example of a larger purpose?

Answer 11

• Each of the 4 scenarios is subject to an exception, where:

1. The assistance is given in good faith in the interests of the company; and
2. The company’s principal purpose for assistance is not for the purpose of acquiring the shares, or
3. The giving of assistance is for the purpose of acquiring shares, but only an incidental part of some larger purpose

• Example of a ‘larger purpose’ = the financial assistance was part of a scheme designed to restructure a corporate group in order to rescue a company

Question 12

Under s.681 CA2006, what transactions will not constitute prohibited financial assistance? (5)
Under s.682 CA2006, when will transactions not constitute prohibited financial assistance? (3)

Answer 12

• S.681 CA2006 = transactions that will not constitute prohibited financial assistance:

1. A distribution of a company’s assets by way of lawful dividend
2. A distribution of company assets made in the course of winding up
3. Arrangements by liquidator in insolvency
4. An allotment of bonus shares
5. By way of court order

• S.682 CA2006 = transactions that will not constitute prohibited financial assistance if:
1. The company giving the assistance is a private company, or
2. The company giving the assistance is a public company, and
○ (i) the company has net assets that are not reduced by the giving of the assistance; or
○ (ii) to the extent that the assets are so reduced, the assistance is provided out of distributable profits
3. S.682 CA2006 list includes:
a. Lending money is part of the ordinary business of the company
b. Employee share scheme
c. Bona fide employees and connected persons buying shares

Question 13

What are the consequences of providing prohibited financial assistance?
What are the 3 civil consequences?
Who can be personally liable?

Answer 13

• s.680 CA2006 = the company and every officer in default commits a criminal offence
• Civil consequences established by courts:

1. Agreement to provide unlawful financial assistance in not enforceable
2. Director may be in breach of duty, or disqualified
3. Recipient of prohibited financial assistance will be liable to account for the sum received if he knew or ought to have known of the impropriety of the transaction

A person who knowingly assists the directors to provide prohibited financial assistance can be personally liable to the company

Question 14

What is a distribution?

What 4 things do not amount to a distribution?

Answer 14

• S.829 CA2006 = distribution = any method of handing back the company’s assets to its members, whether in cash or otherwise
• Definition is wide and flexible to prevent disguising a contribution to avoid the distribution rules

• Following do not amount to a distribution:

1. An issue of party or fully paid bonus shares
2. The reduction of share capital by extinguishing the outstanding liability on partly paid shares, or by repaying paid-up share capital
3. The redemption or purchase of the company’s own shares; and
4. A distribution of assets to members on company winding up

Question 15

What is a dividend?
What are the 2 types of dividend payments?
When is each paid and what do the articles say about each?

Answer 15

• = a distribution of part or all of the company’s profits to its members
• Each member usually gets X pence for each share they own
• 2 types of dividend payments:
1. A final dividend = dividend paid out once the company’s final accounts have been prepared
○ Is paid following the end of the relevant financial year
○ Articles usually provide members must ‘declare’ a final dividend by passing an ordinary resolution
2. An interim dividend = dividend paid out before the company’s final accounts have been prepared
○ Is paid during the relevant financial year
○ Articles usually provide directors can pay out an interim dividend without obtaining member approval

Question 16

What are the profits available for distribution?

Answer 16

• s. 830 CA2006 = company can only make a distribution out of profits available for that purpose, these are accumulated, realised profits

Question 17

What are accumulated profits and losses?
What are realised profits?
What are relaised losses? (2)

Answer 17

Accumulated Profits and Losses:
• ‘Accumulated’ = previous year’s profits (if they have not been used for other purposes) are amalgamated with the current year’s profits and create an overall figure
• Company cannot issue a dividend based on a profit it makes in one year if that profit has not offset any losses from previous years

Realised Profits and Losses:
• S.853 CA2006 = realised profits and losses will be determined based on generally accepted accounting practices at the time
• e.g. profits (or losses) must actually have arisen by the balance sheet date
• Financial Reporting Standard 18 = profits are only realised when realised in cash or other assets and the ultimate cash realisation can be assessed with reasonable certainty

• S.841 CA2006 = realised losses =
• (i) Any amount written off for depreciation or diminution in the value of assets; or
• (ii) Any reasonable amount retained to provide for any clearly defined liability, which is:
○ Likely to be incurred, or
○ Certain to be incurred but amount or date is uncertain

Question 18

What are the net asset rules for a public company to make a distribution?
What are a company’s net assets? What are its un-distributable reserves?

Answer 18

Net Asset Rules
• S.831 CA2006 = public company can only make a distribution if the amount of its net assets is more than the aggregate of its called-up share capital and un-distributable reserves

• S.831 CA2006 = net assets = ‘the aggregate of the company’s assets minus the aggregate of its liabilities
• A company’s un-distributable reserves are:
  1. Its share premium account;
  2. Its capital redemption reserve;
  3. Any other reserves prohibited to distribute by enactment or articles

Question 19

What are relevant accounts in relation to a distribution?

When can accounts be relied on? (2)

Answer 19

• S.836 CA2006 = Distribution can only be made if relevant accounts (last annual accounts) can be relied on

• Accounts can only be relied on if:
1. The accounts were properly prepared in accordance with the CA2006; and
2. The auditor has reported on the accounts (unless exempt from audit)
If requirements not met = accounts cannot be relied upon and the distribution is unlawful

Question 20

What is the process for paying a dividend?

How is a dividend usually paid?

Answer 20

• Process = a matter for the company’s articles
• Model articles = 3 stage process:
1. Directors recommend an amount of distributable profit to pay out
2. Members vote and an ordinary resolution is passed
3. The dividend is paid based on the rights of the members.

• Usually paid via a dividend warrant = a cheque
• Usually paid in cash unless articles provide for some other form of payment
• Art.34(1) MA for private; Art.76(1) MA for plc = can pay all or part by transferring non-cash assets of equivalent value

Question 21

What is the liability of directors regarding payment of an unlawful distribution?
May directors be granted relief? Who can they also seek relief from?
When will members be liable?

Answer 21

Liability of the Directors
• Directors who authorised the payment of an unlawful distribution = jointly and severally liable to repay the amount of the distribution to the company
• Directors liable to repay the full amount of the unlawful dividend where an unlawful dividend is paid based on improperly prepared accounts
• Directors liable to only pay the amount that is unlawful where company has distributed profits based on properly prepared accounts

• Relief under s.1157 CA2006 only granted if director acted honestly and reasonably in paying out the unlawful dividend
• A director ordered to repay dividends can seek recovery from members who were aware of the illegality

Liability of the Members:
• If at time of distribution, a member knows or has reasonable grounds for believing that it was made unlawfully, the member is liable:
1. To repay the distribution to the company; or
2. To repay the company a sum equal to the value of the distribution