Chapter 7 Maintenance OF Capitalvf PDF

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School of Law, Northumbria University

Company Law

CHAPTER 7 MAINTENANCE OF CAPITAL



PRESCRIBED READING:

Textbook Chapter 7.1 – 7.2, 7.11 – 7.24, 8.12- 8.13 Casebook Chapter 10

7.1

INTRODUCTION

The purpose of this chapter is to introduce you to the concept of maintenance of share capital and consider the circumstances in which the share capital of a company can be reduced. The law in this area was simplified by CA 06.

Learning Outcomes: By the end of this chapter you should:

(a)

understand what is meant by maintenance of share capital;

(b)

be aware of the exceptions to this principle;

(c)

understand the methods by which share capital can be reduced.

7.2

THE PRINCIPLE OF MAINTENANCE OF CAPITAL

The principle of capital maintenance is often misunderstood. The ‘capital’ referred to here is the money which shareholders have paid or agreed to pay to the company in exchange for the shares which they receive. That capital (which will be money or money’s worth) will naturally be used by the company for its business, and in the course of business it may well be lost or its value diminished. So in that sense the capital is not “maintained” and there is no separate untouched fund of money known as “capital” which the company keeps. What maintenance means in this context is that The principle also requires that shares in the company must not be issued at a discount.

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7.3

Company Law

PAYMENT FOR SHARES

CA06 S.580 prohibits the issue of shares at a discount.

An issue of shares in

contravention of S.580 leads to the allottee being liable to pay the amount of the discount together with interest.



See Casebook 10.2. Textbook 7.12.

Note that the prohibition relates to the nominal or par value of the share and not its market value. The two figures may be very different.

If there is a difference between Any premium payable when a share is issued must be credited to a share premium account and is largely treated in the same way as nominal capital. Sometimes people are puzzled by the fact that someone will pay £4 for a share which only has a nominal value of £1. To understand this, imagine that there was a company as big as Microsoft, which was a limited company with only two issued shares of £1 each. (This is entirely possible although it is admittedly unlikely.) If you were to acquire a £1 share in the imaginary company you would own one third of a company which is worth billions of pounds. Is it likely that the company would sell you that share for only £1?



See Ooregum Gold Mining Co. of India v Roper [1892] AC 125 ; Casebook 10.3 for an illustration of the prohibition of the issue of shares at a discount.

Shares can be paid for in cash or ‘in kind’, i.e. in return for assets or the provision of services. Where shares are paid for 'in kind', For example, . If the assets are not in reality worth as much as the nominal value of the shares then effectively the shares have been issued at a discount.



See Re Wragg Ltd. [1897] 1 Ch 796; Casebook 10.3.1. See also Textbook 7.12

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Company Law

For public companies the rules are much tighter. CA06 s. 593 provides that although shares can be allotted for non-cash consideration, the consideration in question must be independently valued in accordance with Companies Act provisions.



See Casebook 10.3.2 and Textbook 7.14.

7.4

DISTRIBUTIONS TO BE MADE OUT OF PROFITS , but many also seek a The rules in the company’s articles will determine who decides

whether or not a dividend is paid. Usually it will be the directors.

Under Table A (see art 102) and the model articles (see arts 30 and 31) the members officially declare the dividend but it cannot be in excess of the amount recommended by the directors. Shareholders normally have no right to force directors to declare a dividend.



See Casebook 10.4.1. Textbook 7.21.

Distributions in contravention of the provisions have the following consequences: The directors are liable to repay the unlawfully paid dividend to the company;



See Re Exchange Banking Co., Flitcroft's Case (1882) 21 ChD 519;

Casebook 10.4.2. Textbook 7.21.4

A member who knew or had reasonable grounds to believe that the distribution was unlawful is liable to repay it.



See CA06 s 847 Casebook 10.4.2. Textbook 7.21.4

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7.5

Company Law

A COMPANY MAY NOT PURCHASE ITS OWN SHARES

In accordance with the principle of maintenance of share capital, the general rule is that a company may not buy its own shares, as this would in effect be a return of capital to the selling shareholder.



See CA06 S.658; Casebook 10.5.1. Textbook 7.16

However, there are now many exceptions to this basic rule.



See Casebook 10.5.2 for the background to the reform of this basic rule.

contain the provisions relating to the purchase by a company of its own shares.



See Textbook 7.17.2

The authorisation required for the purchase depends upon whether it is a market or offmarket purchase. A market purchase relates to the purchase of shares on a recognised investment exchange, such as the stock exchange.

So this will be relevant only to public

companies. It requires ordinary resolution authority. The resolution must include details relating to price, the number of shares to be purchased and the duration of the authority. The resolution must be filed at Companies House.



See Textbook 7.17.5

An off market purchase is, broadly, a purchase other than on a recognised investment exchange and requires special resolution approval. There are detailed procedural requirements which apply

perhaps the most important of which is

that, broadly, the member whose shares are to be purchased cannot count in the vote.



See Textbook 7.17.3

. CA06 S. 692(2) requires that a purchase of shares is made out of distributable profits or the proceeds of a fresh issue of shares.

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Company Law



See Casebook 10.5.3.



However, private companies may also purchase their own shares out of capital see

To do so the company must comply with the detailed

requirements set out in those sections. These include a special resolution and a declaration from the directors that the company is solvent and will be able to pay its debts as they fall due within the next year.

Casebook 10.5.3 and Textbook 7.17.10, 7.17.11. .

7.6

A PUBLIC COMPANY MUST NOT GIVE FINANCIAL ASSISTANCE FOR THE PURCHASE OF ITS OWN SHARES



See Casebook 10.6, Textbook 7.18

. This rule used to apply to both private and public companies. Although it was intended to be helpful – to creditors in particular – in practice it caused many difficulties. As was stated by the Government in its White Paper (Cm. 6456): “

The rules relating to public companies are set out in ss 677- 683. S 678 (1) states the basic prohibition of financial assistance and 677 defines “financial assistance”. The definition is a broad one. There are exceptions to the rule – see e.g. s 678 for the principal purpose and larger purpose exceptions. These were considered in Brady v Brady [1988] 2 ALL ER 617; Casebook 10.6.2. See also Textbook 7.18.1

7.7

REDUCTION OF CAPITAL

A reduction of issued share capital is generally illegal unless authorised by statute (Trevor v Whitworth (1887) 12 App Cas 409). CA 06 allows a company to reduce its capital by passing a special resolution, provided – if it is a private company - that the resolution is either supported by a directors’ statement of solvency or is confirmed by

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Company Law

the court. If the company is a public company the resolution must be confirmed by the court.



See CA06 ss 641-651; Casebook 10.7, Textbook 8.13.

It is a criminal offence for a director to make a solvency statement without having reasonable grounds for the opinion expressed in it (s 643 (5)). How is a reduction in capital effected?

There are a variety of methods of reducing issued share capital. For example the company could reduce share capital by reducing the nominal value of shares which have been only partly paid up. This would have the effect of extinguishing the outstanding liability on those shares and would therefore reduce the issued share capital. Alternatively a company could reduce the nominal value of fully paid shares and return the excess to members. Similarly a company could reduce the nominal value of fully paid shares, but without returning the excess to members. This would be appropriate if the assets of the company no longer represent paid up share capital whereas in the two earlier examples the company is likely to have more capital than it needs.



See Textbook 8.13.

The Government wanted to also reform the rules of capital maintenance relating to public companies but believed this to be impossible under existing EU legislation. The Government has stated that it is therefore “seeking to give priority to … reform of the 2nd Company Law Directive.”

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SELF-TEST QUESTIONS

1.

Explain how the rules of capital maintenance are intended to protect creditors and state whether you think they are effective.

2.

List the main elements of the maintenance of capital rule.

3.

Why might a company wish to reduce its share capital?

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Company Law

NOTES

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