Chapter 9 - Capital Maintenance

Question 1

What was the creditor protection rationale for the existence of the rule against returning share capital to shareholder identified in Trevor v Whitworth (1887)?

Answer 1

Persons who deal with and give money to the company rely on the fact that the company is trading with a certain amount of capital already paid (by shareholders) and they are entitled to assume no part of the capital which has been paid into the coffers of the company has been subsequently paid out.

Question 2

Does the rationale in Trevor v Whitworth continue to be relevant today?

Answer 2

Yes, although in reality private companies tend to have less that £100 in share capital.

Question 3

What are the two key components of the capital maintenance doctrine?

Answer 3

1 A limited company cannot reduce its share capital except as authorised by statute.
2 Distributions to members may be mad only out of profits available for the purpose.

Question 4

Identify 5 sets of legal rules that support the doctrine of capital maintenance.

Answer 4

1 Minimum share capital rules (s 763-767)
2 Basic prohibition of a company reducing its shares (s 617)
3 Requirement that shareholders distributions are only from profits for the purpose (s 829-853)
4 Detailed exceptions to reductions in share capital (Parts 17 and 18 of the Act).
5 The member last principle on winding upm (IA s107)

Question 5

What is the minimum share capital requirement for a public company?

Answer 5

£50,000 (1/4 paid up) - s 761 CA

Question 6

Outline the process by which a public company may reduce its share capital.

Answer 6

s 645-651 CA:
1 A special resolution must be passed
2 The company must settle a list of creditors for the court, and either:
- obtain the consent of all creditors
- pay off, or set aside a sum to pay off any creditor
who does not consent.
3 The company must present a petition to the court confirming the reduction
4 The court may make an order confirming the reduction.
5 Register with the Registrar of Companies:
- special resolution
- copy of the court order
- statement of capital as reduced

Question 7

Outline the process by which a private company may reduce its share capital.

Answer 7

s642-644 CA:
1 Directors conduct a review of the company’s solvency
2 Every director signs a solvency statement
3 Directors send a proposed special resolution to the members
4 Members pass a special resolution
5 File with the Registrar within 15 days:
- a copy of the solvency statement
- a copy of the special resolution
- a statement of capital as reduced
- confirmation statement that the process has been complied with

Question 8

Of what must the court be satisfied before it confirms a reduction of capital?

Answer 8

1 That all creditors who did not consent have been paid off, or that sufficient money has been set aside with which to pay them.

2 Whether the reduction is fair and equitable to shareholders.

Question 9

Is a public company permitted to acquire its own shares out of capital?

Answer 9

Yes, but only by using distributable profits, and even then there is no effective reduction in total nominal share value.

Question 10

What is a distribution?

Answer 10

A distribution of company assets to a shareholder, usually as a dividend.

Question 11

What is the process for the declaration of a dividend set out in the model articles for private companies limited by shares, and the model articles for public companies?

Answer 11

There may be final (annual) dividends, and interim dividends. Annual dividends are typically recommended by directors and declared by ordinary resolution of members.

Question 12

Are dividends affected by whether shares are fully paid up?

Answer 12

Yes, dividends will be proportionate to the amount paid up.

Question 13

Do dividends have to be paid in cash?

Answer 13

Yes, unless the articles permit otherwise.

Question 14

What is the test applied by the court to determine whether or not a payment is disguised return of capital to a shareholder?

Answer 14

Whether or not the payment is a genuine exercise of power by the company resulting in a genuine payment, rather than a disguised gift out of capital.

Question 15

What restriction does CA 2006 s 830 Place on the payment of dividends?

Answer 15

A company may only make a distribution out of profits available for the purpose.

Question 16

What is the significance of accumulated in the definition of “profits available for the purpose” in s830?

Answer 16

Profits and losses are totalled, determining whether the accumulated profits are in the positive (i.e. not just a single year’s profits.

Question 17

How are profits available for the purpose calculated?

Answer 17

Realised profits - realised losses - dividends paid.

Question 18

What is the effect of the additional restriction on payment of dividends by a public company imposed by s831?

Answer 18

A public company must only make a distribution up to the amount by which its net assets exceed the aggregate of its called up share capital and undistributable reserves.

Question 19

What are the “relevant accounts”?

Answer 19

The last annual accounts prepared in accordance with the Act.

Question 20

Is transfer of an asset at book value by a subsidiary to its parent ever a distribution?

Answer 20

If an asset is transferred at book value, there is no distribution.

Question 21

Is unlawful payment of dividends a criminal offence?

Answer 21

No, but civil remedies are available to members under s 847.

Question 22

Are directors liable to compensate the company for unlawfully paid dividends?

Answer 22

Directors are jointly and severally liable for unlawful distributions

Question 23

What is the potential liability of a member under CA 2006 s847?

Answer 23

A member may be liable to repay any sum received if he knew that the distribution was made in contravention of the statutory distribution rules.

Question 24

Is knowledge that a dividend is paid in contravention of the CA 2006 a precondition of the shareholder liability under s 847?

Answer 24

Either actual knowledge, or reasonable grounds for believing that the dividend was unlawful.

Question 25

What was the mischief that the laws prohibiting financial assistance for share purchase were designed to address and is this behaviour still regarded as a mischief today?

Answer 25

1 Manipulation of a company’s share price
2 Use of an acquired company’s assets to pay off the debt incurred to buy the company.

The second point is no longer contentious.

Question 26

Give three typical examples of a company providing financial assistance for the purchase of its shares.

Answer 26

1 Company A lending money to X, who uses that money to buy shares in A.
2 Company A guaranteeing a loan for X, who uses the money to buy shares in A.
3 X borrowing money from a bank, and using it to buy Company A, whose resources are used to pay off the loan.

Question 27

Who is potentially criminally liable when a company gives financial assistance for the purchase of its own shares?

Answer 27

S 680 states that if a company contravenes the prohibition on the giving of financial assistance, the company and every officer of the company in default commits an offence. Liable to a fine and up to 12 months imprisonment.

Question 28

What is the legal basis for the liability of directors in relation to the giving of financial assistance for purchase of shares?

Answer 28

S 680 CA.

Question 29

What are the limits on political donations by a company?

Answer 29

Companies may make annual donations of up to £5,000, beyond which resolution of the member is required.

Question 30

Can a public company give financial assistance for the purchase of its own shares?

Answer 30

No, prohibited by s 678 and 679.

Question 31

May a private company provide financial assistance for the purchase of its shares?

Answer 31

There is no direct prohibition on financial assistance for a private company, but the standard legal principles apply. e.g. where there are no distributable profits, a payment to a member cannot be made.