Study Notes · 48 sections
A company's capital represents the funds contributed by shareholders that must be maintained for the protection of creditors. The capital maintenance rule prevents a company from distributing its capital back to shareholders, ensuring that assets equivalent to the capital remain within the company as a cushion for creditors.
Shareholders have limited liability - they are only liable for the amount (if any) unpaid on their shares. Creditors rely on the company's assets as security for debts. If shareholders could take out capital at will, creditor protection would be undermined. Capital maintenance rules ensure shareholders cannot extract value at the expense of creditors.
A company may only make distributions to shareholders out of PROFITS available for the purpose. It cannot distribute its capital except through specific, regulated procedures such as capital reduction or purchase of own shares.
Under CA 2006, a company may only make a distribution if its accumulated, realised profits less its accumulated, realised losses are sufficient for the distribution. For public companies, an additional solvency statement is required for substantial transactions.
In this Act, "profits" means accumulated, realised profits of the company, less its accumulated, realised losses. Realised profits are those which have been achieved in terms of cash or other assets.
Investment companies have special rules allowing them to make distributions out of capital gains and surpluses on investment revaluations that would otherwise be unrealised. This recognises the nature of their business.
A dividend is a distribution of a company's profits to its shareholders, typically in proportion to their shareholdings. Dividends can be paid from current or retained profits, but never from capital.
| Type | Features |
|---|---|
| Final dividend | Declared by AGM, paid to shareholders on record date |
| Interim dividend | Declared by directors between AGMs, paid immediately |
| Special dividend | One-time payment, often from exceptional profits |
| Preference dividend | Fixed rate paid to preference shareholders before ordinary shareholders |
Final dividends are declared by shareholders in general meeting (usually the AGM). Directors recommend the amount, but shareholders must approve. Interim dividends are declared by directors using their delegated authority - no shareholder approval is required. Both must be paid out of distributable profits.
Directors who declare or recommend dividends must ensure sufficient distributable profits exist. If they declare a dividend unlawfully, they may be personally liable to repay the company, and in some cases, to the company's creditors.
A distribution made when there are insufficient distributable profits, or that otherwise breaches capital maintenance rules. This includes dividends paid from capital, share purchases at an overprice, or other disguised returns of capital.
Where a distribution is made in contravention of this Chapter, every director who knowingly authorised the distribution is jointly and severally liable to repay the amount (unless they reasonably believed the distribution was lawful).
Shareholders who receive an unlawful distribution may be liable to repay it if they KNEW or HAD REASON TO BELIEVE the distribution was unlawful. However, innocent recipients who received in good faith are not liable to repay. This creates an incentive for shareholders to be aware of the company's financial position.
[2001] Ch 104
A company paid dividends when its accounts showed insufficient distributable profits. Some directors approved the dividends relying on projected future profits.
The dividends were unlawful. Distributable profits must be determined by reference to accumulated realised profits LESS accumulated realised losses at the TIME of distribution. Future profits cannot be taken into account.
Dividends must be paid out of profits already realised and accumulated. Anticipated future profits cannot justify a dividend.
Capital reduction is returning capital to shareholders or cancelling capital that has been lost or is no longer needed. It reduces the company's stated capital and therefore affects creditor protection, so it is carefully regulated.
A company may reduce its share capital by special resolution, supported by a solvency statement given by the directors. The solvency statement must state that the company will be able to pay its debts for 12 months after the reduction.
The solvency statement must confirm that: (1) having regard to the company's prospects and liabilities, the company will be able to pay its debts for the 12 months following the reduction, and (2) the company will be able to pay its debts as they fall due. Auditors must confirm the statement is reasonable.
For public companies or where greater creditor protection is needed, the court confirmation procedure applies. The court considers creditor objections and may sanction the reduction with or without conditions. This provides stronger protection for creditors.
Common reasons include: returning surplus capital to shareholders, cancelling capital represented by accumulated losses, facilitating a share buyback programme, or restructuring the company's balance sheet for tax or commercial reasons.
A company may buy back its own shares from shareholders. This is effectively a return of capital (unless purchased out of distributable profits) and therefore requires shareholder approval and compliance with capital maintenance rules.
A company must have authority to purchase its own shares, given by special resolution. The authority must specify the maximum number of shares, maximum price, and date when authority expires (maximum 5 years). This ensures shareholder control over capital reductions.
A company must not give financial assistance for the purchase of its own shares, unless certain exceptions apply. This prevents a company from funding someone else to buy its shares, which could artificially inflate the share price or enable asset stripping.
A company must not give financial assistance for the purpose of the acquisition of its own shares or the shares of its holding company. This applies to both private and public companies.
Financial assistance includes: loans, guarantees, security, or any other financial arrangement. Examples include a company lending money to someone to buy its shares, or providing security for a loan used to purchase its shares. The key is that the company's resources are used to fund the share purchase.
For private companies, financial assistance is permitted if approved by a special resolution and the company can pay its debts for 12 months following the assistance. This is called the "whitewash" procedure because it "cleans" otherwise prohibited assistance. It allows private companies greater flexibility while maintaining creditor protection.
A share buyback is a programme for a company to purchase its own shares on the stock exchange over time. Buybacks are used to return surplus capital to shareholders, support the share price, or adjust the company's capital structure.
Public companies can buy shares on the stock exchange using the market purchase route (s.718 CA 2006). This requires shareholder approval, pricing limits (usually 5% above market price), and ongoing reporting. This is the most common method for listed companies.
Companies can purchase shares directly from shareholders off-market (s.701 CA 2006). This requires an offer to all shareholders on equal terms, approval by an independent class if directors are interested, and compliance with capital maintenance rules. This is useful for buying out specific shareholders.
Since 2003, companies can hold purchased shares as "treasury shares" rather than cancelling them. Treasury shares can be reissued later for employee schemes or to raise capital. This gives companies greater flexibility in managing their capital structure.