3.

Capital maintenance and dividend law

a) Explain the doctrine of capital maintenance and capital reduction. (a) b) Examine the effect of issuing shares at either discount, or premium (a) c) Explain the rules governing the distribution of dividends in both private and public companies. (a)

2urchasin$ its own shares. &owever% the act places strictest control in reducin$ capital via a strin$ent procedure. The company must first pass a special resolution and then apply to the court to confirm the special resolution. If reduction takes either of the first forms espoused above% the court may re+uire the company to settle a list of creditors entitled to ob'ect. The court will not confirm the reduction until its satisfied that all creditors have either consented to the reduction or had their debts dischar$ed or secured. The courts concern is twofold i.e. o !re the creditors protected3 o Is the reduction fair in its effect on different classes of shareholders3 If satisfied% the court issues an order to that effect. Then% the company must file documents with the re$istrar $ivin$ details of the reduction. ! copy of the court order and a minute approved by the court must be attached. If the re$istrar is satisfied% he issues a certificate of re$istration. If the capital of a public company $oes below 45%555 pounds% then it must re1re$ister as a private company. 6or private companies however% the procedure is less ri$orous; with them bein$ re+uired to pass a special resolution supported by a solvency statement. The solvency statement is a statement by each of the directors that the company will be able to meet its debts within the followin$ year. If made without reasonable $rounds% the directors are punishable by fine and0or imprisonment. Copies of the resolution% solvency statement and a statement of capital must be filed with the re$istrar within /4 days.

CAPITAL MAINTENANCE The members contribute capital to the company. This should be maintained in the company may by way of net assets. This is further known as the buffer fund. Its called the shareholders funds and comprises of the share capital plus undistributable reserves. Undistributable reserves include; hare premium account. Capital redemption reserve. !ccumulated unreali"ed profits less accumulated unreali"ed losses. !ny other reserve identified by the companys constitution as undistributable. The rules of capital maintenance e#ist in order to prevent a company reducin$ its capital by returnin$ it to its members% whether directly or indirectly. This means that as a $eneral rule% a limited company cannot reduce its share capital or purchase its own shares. &owever% loan capital is not sub'ect to maintenance. (evelopment of the principle of capital maintenance addresses three areas; a) *estrictions on reduction of capital. b) *estrictions on payment of dividends. c) !ssistance $iven to outsiders to ac+uire the companys shares. a) Reduction of Capital ! company may reduce its capital at any time for any reason , ection -./). This may take several forms includin$; *educe0cancel liabilities1 this may be done on partly paid shares where the company $ives up any claim for money owin$. *eturn capital in e#cess of the companys needs1 this may be done by repayin$ cash to shareholders. Cancel paid up capital no1lon$er represented by the assets1 if company has debit balance on reserves% it can write this off by reducin$ capital and thereby does not need to make $ood past losses. /

Purchase of own shares ! company may purchase its own shares. There are two types of the purchase;

7arket purchase ,purchase in stock e#chan$e) !n ordinary resolution re+uired statin$ the ma#. no. of shares and the ma#. and min. prices. The authority to purchase lasts for a specific time 9 ma# /: months.

8ff1market purchase ,purchase directly from shareholders) ! special resolution re+uired. Contract for sale must be available for inspection by members at least /4 days before and after the meetin$. ;endors may not vote on the resolution with shares which are to be purchased.

&owever% the company may issue partly paid up shares% with public havin$ minimum of <4= set. 6urther% the price is to be paid with money or moneys worth% includin$ $oodwill and know1how. The company may in alternate accept a non1cash consideration% if its of sufficient value. (ebentures can however be issued at discount if they dont have the immediate ri$ht to convert to shares. If shares are issued at discount on the nominal value% the allotee and any other subse+uent holders must pay the full nominal value with interest at the appropriate rate ,4=) section /55 of the !ct. Issuing shares at premium hares can however be issued at premium i.e. hi$her price than the nominal value. This may be paid in the form of cash or some other assets. ection -/5 re+uires that such premiums be deposited to a share premium account% which can only be used for; >ritin$ off e#penses of the issue of those shares. Capital e#penses such as preliminary e#penses of formin$ the company. ! discount on the issue of debentures. 2urchase of own shares out of capital by private companies. >ritin$ off any commission issued on the sale of those shares. Issuin$ bonus shares. If the company obtains non1cash consideration for its shares which e#ceeds the nominal value of the shares% the e#cess should also be credited to the share premium account. Permissible capital payment (private companies) 2rivate companies can purchase shares out of capital% sub'ect to any prohibition0restriction in the articles. &owever% the followin$ formalities may be complied with; The directors must make a statutory declaration statin$ that the company will be able to pay its debts as they fall due in the ne#t year.

! few additional notes on the procedure include; The articles must authori"e the purchase. The shares to be purchased must be fully paid. The purchase shares must be cancelled. The company may make a return to the re$istrar within one month% accompanied by a revised statement of capital. The company may finance the purchase from the followin$ sources; (istributable profits1 a transfer e+uivalent to the nominal value of the purchased shares must be made to the capital redemption reserve ,this is a non1distributable reserve used only for bonus issues). 2roceeds of new issue. 2rivate companies may make a permissible capital payment% but only to e#tent that distributable profit and the proceeds of any new issue are insufficient. Issuing shares at Discount !s a $eneral rule% shares cannot be issued at a discount on their nominal value s4:5. Its only in ri$hts issue where shares are issued at discount but also then% discount from the market price and not their nominal value. If this rule is breached% the issue is still valid% but the allotee must pay1up the discount plus interest.

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 The auditors must make a statement supportin$ the directors declaration. ! copy of the directors statement and the auditors report must be vailable to members before the resolution approvin$ the payment is passed% otherwise it will be ineffective. ! special resolution must be passed within one week of the directors statement. ! public notice ,in the $a"ette) must be made within one week of the resolution% invitin$ creditors to apply to the courts to prevent the payment within five weeks if they ob'ect. The payment out of capital must be made between five and seven weeks followin$ the resolution. The documents must be filed with the re$istrar. The company may only reduce its capital for three reasons; The companys capital is no lon$er represented by available assets ,i.e. it has been sufferin$ losses in the value of its assets). The company wishes to cancel0e#tin$uish the liability of a class of a share e.$. one pound ?5p paid could become ?5p fully paid up share. The company wishes to re1structure its capital fundin$ and may for instance% now wish to replace some of its shares by way of loan capital. There are mainly three ways of reducin$ share capital; o @#tin$uish0reduce liability on partly paid shares1 where the company $ives up a claim for amount not paid up. Aothin$ is returned to shareholders. o 2ayin$ off part of paid up share capital out of surplus assets1 the company assets are reduced. o Cancel paid1up shares which have been lost0 no lon$er represented by value of assets1 where the company may resume payments out of future profits without havin$ to make $ood past losses. The courts are involved because creditors ri$hts could be adversely affected. a) Restriction on payment of dividends 3

! company can only make a distribution ,e.$. pay a dividend) out of profits available for that purpose i.e. distributable profits. (istributable profits are the accumulated reali"ed profits ,so far as not previously utili"ed by distribution or capitali"ation) less the accumulated reali"ed losses ,so far as not previously written off in a reduction of capital) section :35. (efinition of terms; o 2rofit0loss1tradin$ or capital. o !ccumulated1 overall profit0loss% not 'ust one year in isolation. 2revious years included o *eali"ed1 not revaluation reserve. &owever% provisions ,e.$. depreciation) are deemed reali"ed. (ividends are normally declared payable on the paid up amount of share capital e.$. a fully paid up /B share will carry entitlement to twice as much dividend as a /B share 45 c paid. !$ain dividends are payable either in cash or by che+ue or warrant sent by post. If shares held 'ointly% dividend is paid to the first named 'oint holder on the re$ister. The power to declare dividends is $iven to the directors by the company constitution. 7embers dont have automatic ri$ht to receive dividends. They approve one at the companys $eneral meetin$ but cannot vote to increase the amount proposed by directors. (ividends are normally paid based on the paid1up share capital of the company. It may take the form of cash payment ,normal) or other form ,e.$. scrip dividend). The dividend is a company debt only from the date it is declared and due for payment. If declared and unpaid% its deferred but may become statute barred after - years. (ividends may only be declared out of profits declared for that purpose. This is defined as accumulated reali"ed profits less accumulated reali"ed loss. There is no distinction drawn between capital and revenue profits.

Additional rules for a public company

! public limited company can only declare a dividend if both before and after distribution its net assets are not less than the a$$re$ate of its called up share capital and undistributable reserves. Undistributable reserves include; hare premium account. Capital redemption reserve. !ccumulated unreali"ed profits less accumulated unreali"ed losses. !ny other reserve identified by the companys constitution as undistributable The latest audited accounts are used to make the calculations Infringement of dividend rules If dividend is paid otherwise than out of distributable profits% the directors and shareholders may be involved in makin$ $ood the unlawful distribution. The directors are responsible since they either recommended the dividend to the members or they declared interim dividends; They are liable if they recommend or declare dividend which they know is paid out of capital. If they declare dividend out of capital without preparin$ any accounts 9 its their duty to ensure profits are available. If they declare dividend a$ainst the 7emo or !rticles of association i.e. unlawful dividend. The directors may however honestly rely on proper accounts irrespective of whether the accounts turn to be improper later. 6or the members; o !ny may obtain an in'unction restrainin$ the company from payin$ unlawful dividend. o 7embers cannot vote in a $eneral meetin$ to authori"e payment of unlawful dividend or release directors from liability to pay it back. o The company may recover from members an unlawful dividend if the members know or have reasonable $rounds to believe its unlawful. .

o If directors are held liable to pay back unlawful dividend% they may claim indemnity from the members who knew of the irre$ularity at time of receipt. o 7embers knowin$ly receivin$ unlawful dividends may not sue the directors for its return. If unlawful dividend is paid out of error% neither the members nor the directors are liable. The company may then claim a$ainst its auditors if it was caused by mistake0ne$li$ence on their part. Re London & General Bank !n auditor colluded with directors to alter an audit report% leadin$ to false declaration of profits. 8n li+uidation% the company was allowed to claim from the auditor due to his failure to report the true financial position.