Capital Maintenance

• share capital may be nominal, issued/allotted, called-up and paid-up

• ordinary and preference shares may carry different voting, dividend and return-of-capital rights; class rights have a protective class-consent procedure

• a rights issue offers cash shares pro rata; a bonus issue capitalises reserves and raises no new cash

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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

• power to declare dividends is given to the directors by the company’s constitution

• 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 dividend is a company debt only from the date it is declared and due for payment

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

• unclaimed dividends become statute barred after 6 years

• dividends are distributions out of accumulated realised profits less accumulated realised losses; a public company must also satisfy the net-assets test

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

3 Capital Maintenance – Reduction of Capital

• a company may reduce its capital, but only under the strictest control

• 3 authorities are required

  • special resolution

  • power in the constitution

  • consent of the court

• and for only 3 reasons/situations

  • 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

• a private company may alternatively reduce capital by special resolution supported by a directors’ solvency statement, without court confirmation

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 the premium payable on the redemption of shares or debentures

  • write off the expenses of, discounts allowed on or commissions paid on any issue of shares or debentures

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

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 not specified by the constitution, then special resolution is needed

  • 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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• bought-back shares may be held in treasury rather than cancelled; while held they carry no vote and no dividend, and may later be sold, transferred for an employee scheme or cancelled