Technology &
Internet Law
Maintenance of the Share Capital Accounts -
Legal Compliance with Companies Acs in the UK
What you need to know
The share capital accounts of companies incorporated in England and Wales are subject to strict regulatory requirements. The Companies Act 1985 provides for the maintenance and reduction of this share capital in separate accounts for the benefit of creditors in a winding up. The Companies Court exercises its supervisory jurisdiction to ensure that the creditors interests are not prejudiced by ensuring the company has the power to do so under the Companies Act.
Dealings with Share Capital
Due to the difference in nature between share capital and a company's own finances, English company law requires directors of companies to observe statutory provisions when they wish to:
- reduce funds in the share capital accounts. More...
- purchase of the company’s own shares.
- obtain financial assistance in the acquisition of company’s shares. More...
- pay a dividend except out of distributable profits.
Share Capital, Limited Liability and Separate Legal Entities
Incorporated into the concept of a company as a trading vehicle, is that the trading entity is a separate legal entity from its shareholders and its separate legal personality protects the shareholders from personal liability. Up until the 18th century companies had not been conceived and the legal fiction which afforded protection to shareholders simply did not exist. Limitation of personal liability is therefore in the enactments by Parliament creating company law that regards avoidance of personal liability as a privilege that comes at a price.
Wrongful Trading
That price principally involves detailed and complex laws geared to protect the interests of creditors against abuse of the privilege of limitation on liability. In more recent times, the law has been amended to expose officers of the company, in practice the directors, to personal liability where that privilege has been abused. For example, where the directors continue to trade when they know or should have known that the company was insolvent and unable to meet its debts as they fall due and payable. The term of art used in the Companies Act is "wrongful trading". Such wrongful trading renders the directors to be personally liable for the debts of the compamy - allowing the creditors of the company to pursue the directors to recover debts otherwise payable by the company. Liability commences from the time when the directors knew or should have known about the position and should have stopped trading.
Capital Accounts
A company’s financial composition may consist of a mixture of share capital and monies derived from revenue – this is a simplified statement of its composition as there may be a different status for monies which have been paid for the shares over and above the par value, known as a premium. A company may have as little capital as £1. In order to reassure trading partners as to the company's longevity and financial commitment from investors, companies often allot shares and increase the paid up capital in much larger sums to generate creditor confidence. The PLC suffix to company names serves this purpose precisely. Public limited companies are required under the Companies Act have to have at least £50,000 of issued share capital, with at least £12,500 paid up to commence trading.
Security of Creditors
The share maintenance and reduction provisions of the Act are designed to ensure that the share capital accounts are treated as the funds of third parties and the Act seek to secure the interests of third parties to the company by requiring the directors to treat the funds as such - in the interests of creditors rather than as working capital or funds that may be applied to the day to day business of the company. Once money invested in the company has been capitalised, rather than treated as a loan to the company or retention of profit, it cannot be treated as the company's own money to do with as it wishes - because it is not - it is creditors' security. The creditors have traded with the company on the basis that it is of a certain capital value and a change of position without appropriate regulation and dispose of capital for other purposes would therefore be unfair and inequitable.
Maintenance of Share Capital
Consistent with the principles of preservation and maintenance of capital, the law protects creditors by the following means:
- The company may not reduce its share capital, except in limited circumstances with the consent of the court: section 137, Companies Act 1985.
- A company may not purchase its own shares: section 143, Companies Act 1985, except in certain limited circumstances, and in the case of private companies only. The reason for this is that in paying a third party for its own shares means that, in reality, capital has been taken out of the company without appropriate consents.
- The company may not give financial assistance in the purchase of its own shares: section 151, Companies Act 1985. For more detail on the financial assistance exception, click here. This flows as a consequence of the rule against the purchase of company’s own shares. Exceptions to this rule include a procedure to allow financial assistance in strictly limited circumstances where the directors of the company effectively guarantee the debts of the company for a period of 12 months: section 155, Companies Act 1985.
- The company may not pay dividends to shareholders unless there are adequate distributable profits. In the absence of such profits, payment of a dividend is effectively a reduction of capital and, therefore, a potential threat to the interests of creditors.
Breaches of these laws and other related laws carry criminal penalties for the directors - typically consisting of a maximum fine of up to £5,000 and up to 2 years in prison. The penalties indicate the gravitas with which the law regards the preservation of capital for protection of creditors.
Legitimate Circumvention of the Default Legal Position
There are many circumstances in which there may be legitimate reasons to circumvent the law set out in the Companies Act. For example, if a company suffers an extraordinary loss which results in a significant reduction in its capital asset base, its shares will be overpriced and it may legitimately wish to reduce the capital in order to reflect the true value of the asset base. Alternatively, a company may wish to buy the shares of a consenting shareholder in the event of an impasse. Again, a company may wish to be divided up in the event of a shareholder impasse.
The legal requirements relating to the these various exceptions to the rules are covered in the articles referred to above.
NEED TO KNOW MORE?
For further information on managing the share capital accounts and capital reductions,
contact Maitland Kalton.
Should you prefer to telephone, call us on +44 (0)207 278 1817.
Kaltons Solicitors, Suite 302, Spitfire Studios, 63-71 Collier Street, London, N1 9BE. Telephone +44 (0)20 7278 1817
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