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1)In the context of limited companies which of the following describes the principle of capital maintenance?
A.Payment to members should not be made out of capital to the detriment of creditors.
B.A company’s ordinary shares may never be issued at premium.
C.Capital must always be at or above the amount set in the articles of association.
D.Creditors should not be paid if this would result in reduction of capital.
Option A?
Can you please explain the principle of capital maintenance?2)Tina has subscribed for 500 £1 shares in X Ltd. The company called up only 20p per share and Tina has paid that sum.
Which statement correctly sets out Tina’s present liability of X Ltd?
A. She has no further liability.
B.She is liable to pay a further £500.
C.She is liable to pay the understanding amount on the shared.
D.She has unlimited liability.
Option C?For question 2 the answer is correct – Tina is liable to pay the amount outstanding on those 500 $1 shares
She has paid 20 cents per share so now has a further 80 cents per share to pay to X Ltd when the directors “call up” that 80 cents
As for question 1 … I can’t type out a detailed explanation of the principles of capital maintenance … here’s a very brief synopsis
Company law specifically makes detailed provision for the protection of those people that supply goods and / or services to a company on credit. The reason for this is because, unlike the members of a company who are able to control the activities of the board of directors by exercising their voting rights, there is no possibility for the creditors of a company to act as a united body
And yet those people have supplied their goods and services in good faith based on the understanding that the company will always have net assets
How do they know that? Because net assets = capital employed (you learned for your F3 paper) and so long as that capital is maintained there will be net assets
That is, there will be more assets than liabilities and thus there will be sufficient funds available to settle the claims of the creditors
Any payments made to the members of a company (normally by way of a dividend payment) must be made out of “profits available for distribution” and that expression is itself explained as profits that don’t fit in to the description “share capital plus undistributable reserves”
“Share capital plus in distributable reserves” is the aggregation of the share capital of the company plus specified reserves such as the Share Premium Account, the Capital Redemption Reserve and Accumulated Unrealised Profits less Accumulated Unrealised Losses
So at any point in time there should be net assets at least equal to that aggregate amount and in that way the creditors’ interests are protected
To make a payment to the members that has the effect of reducing that aggregate figure is therefore illegal
OK?
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