Capital Maintenance

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1 Capital Maintenance

• The members contribute capital to the company

• This should be maintained within the company by way of net assets

• Known as the buffer fund

• Called “shareholders’ equity“ and comprises share capital plus undistributable reserves

• Undistributable reserves are :-

  • Share premium account

  • Capital redemption reserve

  • Accumulated unrealised profits less accumulated unrealised losses

  • Any other reserve identified by the company’s constitution as undistributable

• Development of the principle of capital maintenance addresses three areas:-

  • Restrictions on the payment of dividends

  • Restrictions on the reduction of capital

  • Assistance given to outsiders to acquire the company’s shares

2 Capital Maintenance – Payment of Dividends

• Directors may pay interim dividends under the constitution; members declare a final dividend on the directors’ recommendation and cannot increase it

• Members do not have an automatic right to receive a dividend (they approve one at the company’s general meeting but cannot vote to increase the dividend proposed by the directors)

• Dividends are normally paid based on the paid-up capital of the company

• Dividends may be in the form of a cash payment (normal) or in another form (for example, a scrip dividend)

• A final dividend becomes a debt when declared; an interim dividend generally remains revocable until paid

• If it is declared and unpaid, it is a deferred debt

• Unclaimed dividends become statute barred after 6 years

• Dividends may only be declared out of profits available for the purpose

• This is defined as ‘accumulated realised profits less accumulated realised losses’

• There is no distinction drawn between capital profits and revenue profits

3 Capital Maintenance – Reduction of Capital

• A company may reduce capital in any way permitted by Companies Act 2006

• Use a special resolution plus court confirmation, or for a private company limited by shares the solvency-statement route

  • Special resolution

  • The articles may restrict or prohibit reduction but need not positively confer power

  • Court confirmation is required only for the court route

• A reduction is not limited to three reasons

  • The company’s capital is no longer represented by available assets (it has been suffering losses)

  • The company wishes to extinguish / cancel the liability of a class of share ‑ for example a £1 share, 70p paid could become a 70p share fully paid

  • The company wishes to restructure its capital funding and may, for instance, now wish to replace some of its shares by way of loan capital

• The court is involved because creditors’ rights could be adversely affected

4 Share Capital

• It is illegal to issue shares for an amount which is lower than the nominal value of the share

• Where shares are issued, whether for cash or otherwise, for an amount in excess of their nominal value, an amount equal to that excess shall be credited to the Share Premium Account

• The share premium account is an undistributable reserve and has very limited uses:-

  • Finance the issue of fully paid bonus shares to existing members

  • Write off preliminary and formation expenses

  • Provide for a premium payable on redemption of shares where the statute permits

  • Write off expenses, commissions or permitted discounts on an issue of shares; debenture wording is not a permitted use of the share premium account

• But the combination of ‘discounts allowed on’ and ‘issue of shares’ is an illegal combination

• A private company may allot shares for non-cash consideration without the public-company independent-valuation regime, but the no-discount rule still applies

• If the consideration is worth less than nominal value, the allottee remains liable for the shortfall

5 Share Capital

• Variation of class rights

  • Rights attach to a particular class of share and typically refer to:-

    • voting rights

    • entitlement to dividends

    • return of capital in a liquidation

  • If the variation of rights is specified by the constitution, then follow the constitution

  • If the constitution is silent, variation requires consent of at least 75% in nominal value of the affected class or a special resolution at a separate class meeting

  • Note, if constitution provides for the variation, it could require merely an ordinary resolution or could even require some greater majority than 75%

  • These provisions apply even for companies without a share capital, for example a company limited by guarantee

6 Treasury shares

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• For many years within English Law it was illegal for a company to hold shares in itself or in its holding company. As a natural pre-cursor it was illegal for a company to purchase its own shares.

• But then, towards the end of the last century, the law was changed and companies were allowed to purchase their own shares and cancel them.

• There is a lot of commercial sense in this basic concept. If the board of directors have confidence in the company’s prospects, and if the company has available funds, what better target for their investment than the company’s own shares? Subsequent cancellation would reduce the number of shares in issue and potentially strengthen earnings per share.

• A basic rule established from the start of this allowable activity was that the acquisition should be financed from distributable profits. The reasoning behind this particular requirement is to protect the interests of the company’s creditors. The practicalities of the rule are that an amount equal to the nominal value of the purchased shares should be transferred to a non-distributable element of equity out of “profits which would otherwise have been available for distribution” – more commonly referred to as “distributable profits”.

• The effect of this is to maintain the “buffer fund” or “creditors’ buffer fund”, statutorily described as ”share capital plus undistributable reserves”. Historically, these purchased shares had to be cancelled.

• Public and private companies may hold qualifying purchased own shares in treasury instead of cancelling them, subject to the statutory rules

• These are called “Treasury Shares” and here are some one-liners about them.

• Shares held in treasury:

  • are available for re-issue without the normal formalities associated with a share issue

  • need not be quoted solely in order to qualify as treasury shares

  • shall carry no voting rights

  • shall not be entitled to receive a dividend or similar distribution

  • when sold, shall cause any consideration received to be treated as a realized profit

  • when cancelled, shall cause the company to send a return to the Registrar within 28 days detailing the cancellation and the number and nominal value of the cancelled shares

  • arise only from the company’s permitted acquisition of its own shares and do not arise by withholding part of an initial allotment

• When treasury shares are cancelled the company must send a return to the Registrar – a Statement of Capital – effectively confirming that the company continues to satisfy the minimum share capital requirements for a public company.