LAWS10083 Company law -Capital Maintenance, Study notes of Law

Download LAWS10083 Company law -Capital Maintenance and more Study notes Law in PDF only on Docsity! Capital Maintenance Week 9 Chapter 13: Capital Maintenance Precap: A company cannot distribute profits if after the distribution the net asset value would be equal to the amount of share capital stated and share premium accounts and its other un distributable reserves. This rule can be circumvented in 2 ways: 1. Instead of making a distribution, the company can offer to buy back some of its shares. An advantage of this is that it would amount to a reduction in the stated share capital of the company as it would be distributing some of its assets. This will allow for easier distribution of profits in the future as net asset value would have to be equal to a lower aggregated capital account value. 2. Another possibility is by directly reducing the share capital value or reduction of any other capital account value. This will facilitate a distribution as per the same logic as above. Acquisition of own shares Trevor v Whitworth (1887) 12 Ap Cas 409 HL- 19th century HL rule that a company cannot acquire its own shares, even though there was an express power to do so in its memorandum, as this would result in a reduction of capital. The main reasons to this objection can be summarised as being: (1) an acquisition will amount to a cancellation of those acquired shares, which will reduce the represented issued share capital of the company; (2) this is objectionable as it can be seen as a diversionary way of distributing assets of the company to the shareholders if the rules of distribution of profits cannot be met. Today, acquisition of own shares by a company have become more common then before. There are several reasons for this- to name a few:  The company may be able to meet its investment needs from internally generated profits and so has a lesser need of externally provided equity finance.  It may be an exit strategy for investors who no longer see the company as an attractive opportunity, whilst keeping those shareholders that still see prosperity. The 2006 Act now legitimises two forms of repurchases- redemption and repurchase. The Act however, still begins by stating in s. 658(1) and confirming the common law rule that a limited company cannot repurchase its own shares except in accordance to the provisions of that part. Defaulting on this provision can amount to the officer of the company and/or the company being liable. Acquisition through a nominee The s.658 prohibition can be avoided if the company purchased the shares through a nominee rather than directly. The shares are treated as held by the nominee on its own account and the company is regarded as having no beneficial interest in them (s. 660). In any event that the nominee fails to pay when called upon to do so the full amount of the shares, then any other subscriber to the memorandum and the directors of the company shall be held jointly and severably liable (s.661). This rule will however only apply where the nominee acquires the shares as a subscriber to its memorandum where the shares are issued by the company to the nominee or where the nominee acquires the shares partly paid from a third person (.s660). It does not apply where the nominee acquires fully paid shares from a third party, even where he does so with funds provided by the company (s.660). Rationale of this section is that the company receives the full price of its shares as an addition to the assets. Since the shares remain in the hands of the nominee they are not cancelled and therefore do not affect the company’s capital accounts. Company may not be a member of its holding company The prohibition of a company on the purchase of its own shares is supplemented by s. 136 which holds that a company cannot be a member of its holding company either directly or through a nominee (.s144). Any transfer or allotment of shares from an existing shareholder of the holding company to a subsidiary is void. This seeks to avoid the reduction of share capital which would result from a subsidiary acquiring the shares of the holding. Specific exceptions to the no acquisition rule There are many exceptions to the general rule.  A company may acquire its own shares by way of gift- s.659 “otherwise than for valuable consideration” . Held to be permissible under common law in Castigliones Will Trust Re  By way of forfeiture for non-payment of calls- s.659. For public companies, they must cancel the shares and reduce the share capital if the shares are not disposed of within three years of forfeiture- s. 662.  There are also provisions which permit the court to issue a compulsory purchase order as a remedy for some wrong done to the shareholder. An acquisition of shares by the company under a reduction of capital carried out under the provisions below is exempted from the prohibition. 1. Where a public company is permitted to acquire its own shares (directly or through a nominee), then so long as it holds those shares (i.e. does not cancel or dispose off) and decides to show them as assets in its balance sheet, an amount equal to that value must be transferred out of the profits available for distribution to an undistributable reserve- s.669. the effect is that the amount available for distribution will be reduced by the purchase value. thus treating the purchase of shares as a distribution to the shareholder whose shares the nominee acquired. Redemption and repurchase The legislature believes that by way of redemptions and repurchases, the transaction of purchase of own shares can be structured in a way to protect the interests of creditors. accordingly, but as this is a payment out of capital, there will be no need for a corresponding transfer of value to a CRR. If PCP is greater than the nominal value of purchased shares (purchased at a premium) the company is given permission to reduce the CRR, share premium account and revaluation reserve accordingly. Thus the capital yardstick will be reduced by the amount of PCP. Protection for shareholders Law relating to intra- shareholder conflicts arising out of redemptions and repurchases. This is particularly needed for repurchases as redemptions other than out of capital cause no problems. Protection varies according to whether the purchase if off market or market, the essential distinction being whether the purchase took place on a recognisable investment exchange (s. 693). Market purchases create fewer risks as the purchase will be public. Off market: s. 694. Off market purchase can only be made in pursuance of a contract the terms of which have been authorised by a special resolution before it is entered into. In the case of the public company the authorising resolution must specify the expiry date which must not more than 5 years upon passing of the resolution (s. 694(5)). This disallows directors on acting upon stale authority. A member holding shares to which the resolution relates cannot exercise voting rights of those shares s. 695(2). And if the resolution would not have been passed but for those votes than it is void s. 695. Resolution is also ineffective if a copy of the resolution or the memorandum is not available to the members s. 696. Market: s. 701. Cannot purchase own shares (market purchase) unless such purchase has been authorised by the company in a general meeting. Ordinary resolution suffices. Those whose shares are to be purchased can vote on the resolution as their identity will almost be unknown in advance. Members authorise the company to go into the market and purchase shares (general power compared to specific power relating to contracts). It must specify the maximum number of shares to be repurchased an minimum price (s. 701 (2)). The expiry date of the resolution must not be more than five years later than the date of adoption. Copy of the resolution must be sent to the Registrar within 15 days . Additional protection is offered by the listing rules. Treasury Shares A company should be able to retain repurchased shares and re-issue them as required. To avoid any issues relating to the manipulation of prices of shares by directors, this possibility is limited to public companies. This is because FSMA provides adequate protection to avoid such possibilities. These shares may be subsequently sold by the company for cash- s. 727, being a sale by the company of existing shares. This entails that the shareholder consent for the allotment of new shares is avoided being a speedy process. Where the proceeds of sale equal the purchase price, the cash is to be treated as a distributable reserve. This is because they were initially acquired by distributable reserves, which were effectively reduced by the initial purchase s. 731. Any excess price must be transferred to the share premium account. S. 731 (4). Whilst the shares are in treasury they cannot exercise any rights attached to them and any purported exercise is void s. 726. Neither can a dividend be paid or any other distribution be made in fvour of treasury shares- . s 726 (3). Failure by the company to perform If a company cannot perform redemption contract say for example because it has not raised enough proceeds from the fresh issue to purchase the shares and it has inadequate profits, then as per s. 735 a company is not liable for damages in respect of its failure to repurchase or redeem. Courts can grant specific implement orders, but will not do so where it can be shown that the company is unable to meet its cost of redeeming out of distributable profits. The ban on recovery of damages can be circumvented by use of an indirect procedure- British and Commonwealth Holdings v Barclays. In this case a consortium of banks promised to take shares from a shareholder if the company could not redeem them and the company had promised to indemnify the banks in respect of actions by which it made it impossible for it to redeem. It was held that the section did not prevent the banks suing the company on its promises, even if the whole scheme was designed in manner to ensure the shareholder could sell the shares to the company even if they had no distributable reserves. Reduction of capital In a reduction of capital what is necessarily reduced is the amounts stated in the company’s capital account- s. 641 (includes issued share capital, share premium, CRR). Statutory Procedures The 2006 Act provides that the share capital of a company can be reduced in any way (s. 641(3)), but sets out three typical situations by which share capital can be reduced. 1. Reducing or extinguishing any uncalled liability on its shares- s. 641 (4)(a) 2. Cancelling any paid up share capital which is lost or unrepresented by available assets s. 641 (4)(b). 3. By paying off any paid up share capita which is in excess of the company wants s. 641 (4) (b). Procedure applying to all companies The act states that a special resolution and a court order confirming the reduction is required- s. 641 (1)(b). the court process provides necessary protection for the creditors and minority shareholders. Creditor protection- the practical pressure generated by the court process used to be towards making sure that the company discharges or secures the creditors’ outstanding claims at the time of the reduction. This meant that the creditors were overprotected, because in effect creditors obtained either payment of or security for their debts, putting them in a better position than that before the reduction. This changed, and it is no longer the case that every creditor is entitled to object to the reduction of capital who, at the relevant time, has a debt which would be admissible in proof when the company is being wound up. In order to obtain a real right of objection the creditor must demonstrate the existence of either situation 1 or 2 above, an admissible debt claim and a real likelihood that the reduction would result in the company being unable to discharge its debt- s. 646 (1) (b). Confirmation by the court The court is required to settle a list of creditors as far as possible without requiring an application from a creditor to be included on the list. However, as a part of that process, the court may set a date by which the claim must be notified to it or the creditor loses the right to object- s.646 (3). If a creditor has been ignorant of the reduction proceedings, he can object and if after the reduction process the creditor is not paid, then the court on application of such a creditor can order other members whose uncalled liability was reduced to contribute to the extent to pay the creditor- s. 653. Once the list of objecting creditors is settled, the court may not confirm the reduction unless all objecting creditors have consented to the reduction or their claims have been discharged or secured- s. 648 (2). The company must deliver to the registrar a copy of the reduction order and the newly revised issued share capital statement who must certify and publicise them- s.649. Minority shareholders- court require and insist on two shareholder protection measures- that the reduction treat the shareholders equitably and the reduction proposal be properly explained to members who approved it. The protection also revolves around the phenomenon that their objections will be plausible if the reduction of likely to significantly harm their entitlement interests. Procedure available to private companies only Reduction of capital without court confirmation to mitigate the delay and expensive court process.  Solvency statement-s. 641- special resolution of each type of class of members whose rights are varied by the reduction must be sought, which is to be supported by a solvency statement from the directors. This statement in essence transfers responsibility of the reduction from the court to the directors. This is a statement by each director, who must sign to it asserting that he has formed the opinion on (1) the current financial position being such that there is no ground on which the company can be found unable to pay its debts; (2) that the company will be able to pay its debts within 12 months of winding up, if the company is wound up within one year after the date of reduction- s. 643. They are required to take into account prospective (liabilities that will certainly become true in the future) and contingent liabilities. 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 (4). A copy of the statement must be provided to the members voting on the reduction- s. 642 and must be made within 15 days prior to the reduction resolution being passed. Upon adoption of the resolution, the company has 15 days to notify the registrar of the changes, and registration by the registrar renders the reduction effective.  The test for legality of a distribution by such a company is a solvency test? Financial Assistance o Beneficial to rearrange its share capital in changing circumstances. E.g. of these circumstances are highlighted in s. 641(4)- e.g where capital is in excess of the company’s liabilities; when it wants to reduce its members liability to pay uncalled capital; and where the company would like to reflect a diminution in the net asset value. The last of these mainly affect the creditor Redeemable shares  This is the first major exception to the general rule found in s. 658.  S. 684 provides that a limited company can issue redeemable shares. (to be or liable to be redeemed)  Private company may issue redeemable shares unless prohibited to do so in its articles. Public company can only issue redeemable only if it is authorised to do so.  S. 687- general rule for both private and public, they must redeem shares only from the available distributable profits or from the proceeds of a fresh issue of a shares, made for the purpose of the redemption.  For a private company only they can also redeem shares from a payment out of capital. This is to the limit of PCP (permissible capital payment) (PCP= purchase price + total of distributable profits and proceeds of a fresh issue. Thus the company must first use up the total of profits and proceeds of fresh issue in order to make any payment out of capital. This is to protect the creditor’s interest to ensure there are enough assets to pay the debt. The safeguard ensured in making a payment out of capital is that there should be an approval by members (given by a special resolution, which requires 75% majority vote, but ignore the votes attached to the shares that are being redeemed i.e. the members who hold redeemable shares cannot vote on the special resolution;) (directors solvency statement- must be made within one week before the adoption of the special resolution- this statement forces the directors to consider the effects of reducing capital in paying any future or current debt- the directors need to consider all the liabilities bot prospective (actual- liability will certainly become true in the future) and contingent (may arise in the future) liabilities of the company- the company must also issue an auditor’s report to supplement the solvency statement- the auditors need to specify the PCP value which has been specified in the solvency statement has been properly calculated and they are not aware of any circumstance that makes the solvency statement unreasonable in all circumstances) and transparency (the company must within one week after the adoption of the special resolution, the company must advertise the adoption of the resolution in the gazette and either insert a similar ad in the newspaper or notify all creditors by letter- within 15 days after the adoption of the resolution, the company must send to the registrar solvency statement and the copy of the audit report to the registrar- requirement of inspection- I,e. make available all documents (for 5 weeks after the registration) to any public and creditors for inspection who can apply to court for the cancellation of the resolution. The court can ask the company to cancel the resolution, change or amend the articles…) Payment out of capital must be made any time between the 5 weeks but no later than 7 weeks.  Premiums for redeemable shares- s. 687- if the company can redeem the shares at a premium, the premium can only be paid from the distributable profits. If the redeemable shares were originally issued with a premium then it is possible to pay the premium using the proceeds of the new issue of shares. The amount to be paid is limited to the difference between aggregate of premiums received under redeemed shares and the other is the current amount of the share premium account.  S. 688 once redeemed the shares must be cancelled and thereafter the company must reduce the issued share capital by the nominal value of the shares redeemed. Repurchase of its own shares  S. 690- company can purchase its own shares but this can be restricted by its articles.  Repurchase- after the repurchase there must be at least one member who holds a non- redeemable share. This is to ensure there is no situation in which there is no member left in the company.  There is no commitment like redemption in advance where in redemption the terms of redemption are normally set out at the time of original issue. This makes repurchase more useful.  General rule: Only fully paid shares can be repurchased and second when the shares are repurchase they must be cancelled and the share capital must be reduced by the nominal value of the cancelled shares. However, the company has an option not to cancel the shares, but hold the repurchased shares as treasury shares.  Holding treasury shares does allow the company to receive dividends or even vote at any meetings. The money used to purchase shares that are going to become treasury shares can only be paid out of distributable profits.  The repurchase must come from either the distributable profits or the proceeds of a fresh issue of shares. For a private company the repurchase can also be made out of capital under the same conditions of redemption mentioned above. There is an additional requirement for repurchase by way of cash- i.e. the annual limit for cash purchase is the amount of the less of the following 2 (1) £15,000 or (2) 5% of share capital, whichever is less.  Members are required to approve the terms of the purchase depending on whether it is a market or off market purchase. Market purchase- a company may make a market purchase if the purchase has been authorised by a resolution, ordinary resolution is valid- which means only 50% of the majority vote, this is because this is more secure. The resolution should state the max number of shares, the min and max price to be paid and the expiry date which is no longer then 5 years from the date of the resolution. Off market purchase- cannot make this unless the terms of the off market purchase contract has been approved by members. There are two way of approving (1) resolution is adopted before the company enters into the contract for repurchase and (2) no repurchase will take place until the terms of the contract have been approved by a resolution. After 2013, an ordinary resolution will suffice. Reduction of capital by special resolution  S. 641 (1) provides that a company may reduce its shares by special resolution if it is supported by the solvency statement; and approved by court if it’s a public company.  Condition- there must be at least one member who holds a share that is not a redeemable shares.  Solvency statement, which supports the resolution- the directors need to form a solvency statement 15 days before the adoption of the resolution. The special resolution is a written document on which the directors need to form their opinions on 2 things (1) that at the date of the statement there is no ground on which the company could be found to be unable to pay or otherwise discharge its debts and liabilities (2) the company will be able to pay the debts for the next 12 months following the adoption of the resolution and if there is an intention of winding up the company, they should be able to pay within 12 months from the date of winding up all debts. (3) within 15 days of the adoption, the company must register the solvency statement plus revised statement of capital with the registrar. The reduction of capital is only effective upon the registration of the documents. (4) if the special resolution is adopted as a written document the solvency statement must be made available to members a week prior to the adoption. In forming their opinions the directors must consider all prospective and contingent liabilities.  The court must confirm the resolution of a public company. The court considers the procedure by which the reduction is carried out is properly followed and is formally correct. Whether the costs of the reduction of the capital has been explained to the members properly so they can make an informed choice on whether or not to approve the resolution. The court must consider the interest of affected parties, mainly the creditors interests (also future creditors and investors interests) the court must be also satisfied that the reduction affects all shareholders of equal standing in the same manner and if there are any treated differently they must have consented to it. The court must consider the minority shareholder interest as the supermajority vote does not achieve this. Notes from seminar 24/11/16 Financial assistance Maintain share capital for the protection of shareholders and capital. Capital maintenance is a fictional doctrine as to some people? The Basic Prohibitions There are two prohibited situations: (i) a public company (or that company’s subsidiary) cannot give direct, or indirect, “financial assistance” to a purchaser of the public company’s shares – prior to, during or after the share acquisition. (s 678 CA 2006); and (ii) a public company, which is a subsidiary of a private company, cannot give direct, or indirect, “financial assistance” to a purchaser of the private company’s shares – prior to, during or after the share acquisition. (s 679 CA 2006). Hence, there can be assistance by “a private company”: see s 682(1)(a) CA 2006. When we speak of financial assistance we refer to the money a company will give you or lend to you in order to facilitate the purchase of the shares of the said company. Problems with Financial Assistance:  Guinness the beer company- wanted to increase their drink portfolio. Looking at buying a distillery and this business had a good cash flow.  At the same time Argyll foods were on the same acquisition trail and were doing so aggressively. This was a hostile bid for the distillery and this leads to an increase in share price. Argyll made a complete cash based bid for Distillers (the distillery company)  Guinness had a cash and shares offer; shares in Guinness. The success of that bid is dependent on the success of Guinness shares. Suppose Argyll bid £20 per share and Guinness on the other hand bid £12 per share and 1 Guinness share for every share. If their share is worth more than £9 then it means that their bid is higher.  Therefore, Guinness had to ensure that their share value must remain high in order for them to beat the Argyll bid  Guinness decided that the best way to do that is to get people to buy their shares as an increase in buying means high demand and the share price will go up. This is called a share support scheme, common in London at that time. Guinness gave an indemnity to these people in the event they lost money form a drop in share price. This breached the prohibition of financial assistance as you are indemnifying the people to buy your shares.  The authorities found that this was illegal.  This case can be said to have made people aware of the prohibition of financial assistance. Severance It may be possible to sever an offending part from a transaction: see Neilson v Stewart 1991 SC (HL) 22, at p 38; 1991 SLT 523; and Carney v Herbert [1985] AC 301 (PC). Get rid of part of the transaction that involves financial assistance. The Main Exceptions: They are not too easy to apply. Strict interpretation of the law- Brady v Brady. Taking a too literalistic approach to this matter- some say. There are 2 main exceptions: (a) “purpose exception”, and (b) no asset/capital reduction. (a) where giving of financial assistance: (i) not “principal purpose” (ss 678(2), (4) CA 2006); or (ii) “part of some larger purpose”(ss 679(2), (4) CA 2006). (“Purpose exception” – see below) this would cover the property case we speak of in the problems of financial assistance. This exception has two parts- you can fall under any one of the two parts to ensure that the financial assistance is not prohibited. The financial assistance has to be in good faith for the benefit or interest of the company. In Brady they said the directors need to genuinely believe that the assistance is for the benefit of the company (pg 777- read the Sealey book which summarises the case) Brady v Brady- haulage and drinks company split up of brothers case- 3 features:  Made a distinction between a purpose and why a purpose is formed- the reason may be more important than the purpose- useful guidance in the relation between the 2 in para 19 of the Chaston case- reason relates to why an act was done- purpose refers to what a transaction was trying to achieve. Anglo Petroleum Ltd v TFB (Mortgages) Ltd [2007] EWCA Civ 456; [2007] BCC 407- a purpose must be intended. Purpose necessitates an intention  (b) “financial assistance” by a public company either where: (i) there is no reduction of “net assets”; or (ii) the “financial assistance” comes from “distributable profits”. (S 682(1)(b) CA 2006). (No asset/capital reduction) “Distributable profits” – see s 683(1) CA 2006. [NB This is similar, in certain respects, to the old “whitewash procedure”, under ss 155-158 CA 85, which allowed private companies to “whitewash” any financial assistance, in certain circumstances. Whilst this procedure is not applicable under the CA 2006, its validity may still be an issue in relation to private companies prior to the CA 2006, especially where there is a liquidation: see DP Sellar QC, Company Law section in Company and Commercial Law Updates 2006, The Edinburgh Law Review Seminar Series 2006, University of Edinburgh, June, 2006, p 11.] Other Exemptions Other exemptions include: a dividend, a “distribution” on “winding up”, “bonus shares”, reduction of share capital, money lending and “employee” share schemes: see ss 681 (“conditional exceptions”); and see 682 CA 2006 (“unconditional exceptions”). The “Purpose Exemptions” [formerly s 153 CA 85] These are contained in: (i) ss 678(2), (4) CA 2006 (public companies) and (ii) 679(2), (4) CA 2006 (public companies giving assistance to private parent companies). - “financial assistance” either: (i) not “principle purpose”, or (ii) “is part of larger purpose”. Ss 678(2), (4) and 679(2), (4) CA 2006 (see above). ** Brady v Brady [1989] AC 755 (HL(E)) [deals with the old s 153 CA 85, but still relevant]. The “purpose exceptions” have been the subject of some uncertainty. Public Companies Becoming Private Companies To get round the prohibition on “financial assistance” by public companies, under the CA 2006, such a company could re-register as a private company. Ss 89, and 97-101 CA 2006.