CAPITAL MAINTENANCE AND DIVIDEND

LAW
 CAPITAL MAINTENANCE

 Capital maintenance is a fundamental principle of company law: that limited companies should not be
allowed to make payments out of capital to the detriment of company creditors.

 Therefore the Companies Act contains many examples of control upon capital payments.

 These include provisions restricting dividend payments, and capital reduction schemes.
 CAPITAL MAINTENANCE

The rules which dictate how a company is to manage and maintain its
capital exist to maintain the delicate balance between the members'
enjoyment of limited liability and the creditors' requirements that
the company shall remain able to pay its debts.
 REDUCTION OF SHARE CAPITAL

 Reduction of capital can be achieved by: extinguishing/reducing liability on partly paid shares; cancelling
paid-up share capital; or paying off part of paid-up share capital.

 Court confirmation is required for public companies. The court considers the interests of creditors and
different classes of shareholder.

 There must be power in the articles and a special resolution.

 REDUCTION OF SHARE CAPITAL

 If a limited company with a share capital wishes to reduce its issued share capital it may do if:

 The power to do so has not been restricted by the company's articles (if it does not have power in the
articles, these may be amended by a special resolution).

 It passes a special resolution. (If the articles have been amended, this is another special resolution.)

 It obtains confirmation of the reduction from the court

 SOLVENCY STATEMENT

 A solvency statement is a declaration by the directors, provided 15 days in advance of the meeting where the
special resolution is to be voted on.
 It states there is no ground to suspect the company is currently unable or will be unlikely to be able to pay its
debts for the next 12 months.
 All possible liabilities must be taken into account and the statement should be in the prescribed form, naming
all the directors.
 It is an offence for directors to deliver to the Registrar a solvency statement without having reasonable
grounds for the opinions expressed in it.
 WHY REDUCE SHARE CAPITAL?

 A company may wish to reduce its capital for one or more of the following reasons.

 The company has suffered a loss in the value of its assets and it reduces its capital to reflect that fact.
 The company wishes to extinguish the interests of some members entirely.
 The capital reduction is part of a complicated arrangement of capital which may involve, for instance,
replacing share capital with loan capital.
 METHODS OF REDUCING SHARE CAPITAL
METHOD WHAT HAPPENS EFFECTS
Extinguish or reduce liability on Eg Company has nominal value £1 Company gives up claim for
partly paid shares shares 75p paid up. Either amount not paid up (nothing is
• Reduce nominal value to 75p; returned to shareholders)
or
• Reduce nominal value to a
figure between 75p and £1
Pay off part of paid-up share Eg Company reduces nominal Assets of company are reduced by
capital out of surplus assets value of fully paid shares from £1 30p in £
to 70p and repays this amount to
shareholders
Cancel paid-up share capital Eg Company has £1 nominal fully Company can resume dividend
which has been lost or which is no paid shares but net assets only payments out of future profits
longer represented by available worth 50p per share. Difference is without having to make good past
assets a debit balance on reserves. losses
Company reduces nominal value
to 50p, and applies amount to
write off debit balance
 ROLE OF THE COURT IN REDUCTION OF SHARE
CAPITAL
 When the court receives an application for reduction of capital, its first concern is the effect of the reduction
on the company's ability to pay its debts, that is, that the creditors are protected.

 If the reduction is by extinguishing liability or paying off part of paid-up share capital, the court requires that
creditors shall be invited by advertisement to state their objections (if any) to the reduction.

 Where paid-up share capital is cancelled, the court may require an invitation to creditors.
 ROLE OF THE COURT IN REDUCTION OF SHARE
CAPITAL
Two possible approaches are:

1. To pay off all creditors before application is made to the court; or, if that is not practicable.

2. To produce to the court a guarantee, say from the company's bank, that its existing debts will be paid in
full.
 CONFIRMATION BY THE COURT

 If the court is satisfied that the reduction is in order, it confirms the reduction by making an order to that
effect.

 A copy of the court order and a statement of capital, approved by the court, to show the altered share
capital is delivered to the Registrar who issues a certificate of registration.
 DISTRIBUTING DIVIDENDS

 A dividend is an amount payable to shareholders from profits or other distributable reserves.

 Various rules have been created to ensure that dividends are only paid out of available profits.
 POWER TO DECLARE DIVIDENDS

RULES RELATED TO THE POWER TO DECLARE A DIVIDEND

The company in general meeting may declare dividends
No dividend may exceed the amount recommended by the directors who have an implied
power in their discretion to set aside profits as reserves.
The directors may declare such interim dividends as they consider justified.
Dividends are normally declared payable on the paid-up amount of share capital. For
example a £1 share which is fully paid will carry entitlement to twice as much dividend as a
£1 share 50p paid.
A dividend may be paid otherwise than in cash.
Dividends may be paid by cheque or warrant sent through the post to the shareholder at
their registered address. If shares are held jointly, payment of dividend is made to the first-
named joint holder on the register.
 DISTRIBUTABLE PROFIT

 Profits available for distribution are accumulated realised profits (which have not been distributed or
capitalised) less accumulated realised losses (which have not been previously written off in a reduction or
reorganisation of capital).

Distributable profits may be defined as 'accumulated realised profits ... less accumulated realised losses’.
 'Accumulated' means that any losses of previous years must be included in reckoning the current
distributable surplus.
 'Realised' profits are determined in accordance with generally accepted accounting principles.
 DISTRIBUTABLE PROFIT

 Depreciation must be treated as a realised loss, and debited against profit, in determining the amount of
distributable profit remaining.
 A revalued asset will have deprecation charged on its historical cost and the increase in the value in the asset.
 The Companies Act allows the depreciation provision on the valuation increase to be treated also as a realised
profit.
 Effectively there is a cancelling out, and at the end only depreciation that relates to historical cost will affect
dividends
 DIVIDENDS OF PUBLIC COMPANIES

A public company may only make a distribution if its net assets are, at
the time, not less than the aggregate of its called-up share capital and
undistributable reserves.

It may only pay a dividend which will leave its net assets at not less than
that aggregate amount.
 UNDISTRIBUTABLE RESERVES

 Undistributable reserves are defined as:

 Share premium account

 Capital redemption reserve
 Any surplus of accumulated unrealised profits over accumulated unrealised losses (known as a
revaluation reserve). However a deficit of accumulated unrealised profits compared with accumulated
unrealised losses must be treated as a realised loss
 Any reserve which the company is prohibited from distributing by statute, its constitution or law
 DIVIDENDS OF PUBLIC COMPANIES

The dividend rules apply to every form of distribution of assets, except the following:

 The issue of bonus shares whether fully or partly paid

 The redemption or purchase of the company's shares out of capital or profits
 A reduction of share capital
 A distribution of assets to members in a winding up
 RELEVANT ACCOUNTS

 The profits available for distribution are generally determined from the last annual accounts to be prepared.

 Whether a company has profits from which to pay a dividend is determined by reference to its 'relevant
accounts', which are generally the last annual accounts to be prepared.
 INFRINGEMENT OF DIVIDEND RULES

 In certain situations the directors and members may be liable to make good to the company the amount of
an unlawful dividend.

 The directors are held responsible since they either recommend to members in general meeting that a
dividend should be declared or they declare interim dividends.
 INFRINGEMENT OF DIVIDEND RULES

 The directors are liable if, without preparing any accounts, they declare or recommend a dividend which
proves to be paid out of capital. It is their duty to satisfy themselves that profits are available.

 The directors are liable if they make some mistake of law or interpretation of the constitution which leads
them to recommend or declare an unlawful dividend. However in such cases the directors may well be
entitled to relief as their acts were performed 'honestly and reasonably'.
 INFRINGEMENT OF DIVIDEND RULES

 The position of members is as follows

 A member may obtain an injunction to restrain a company from paying an unlawful dividend.
 Members voting in general meeting cannot authorise the payment of an unlawful dividend nor release
the directors from their liability to pay it back.
 The company can recover from members an unlawful dividend if the members knew or had reasonable
grounds to believe that it was unlawful.
 INFRINGEMENT OF DIVIDEND RULES

 If the directors have to make good to the company an unlawful dividend, they may claim indemnity from
members who at the time of receipt knew of the irregularity.

 Members knowingly receiving an unlawful dividend may not bring an action against the directors.