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.
The Companies Act contains rules that dictate how a company is to manage and maintain its capital to strike a balance between member's enjoyment of limited liability and the creditor's requirement that the company shall remain able to pay its debts.
The company must follow the rules related to dividend payments and capital reduction schemes.
PROCEDURE FOR REDUCING CAPITAL
A limited company may reduce its issued share capital if:
It has the power to do so in its Articles.
It gains the power to reduce its capital by altering its articles through a special resolution.
it obtains confirmation of the reduction from the court (PLC) or makes a statement of solvency (Ltd)
REASONS FOR REDUCTION OF SHARE CAPITAL
- The has suffered a loss in the value of its assets.
The company wishes to extinguish the interests of some members entirely.
The company wishes to change its capital structure.
METHODS OF REDUCTION OF SHARE CAPITAL
- The Company Act 2006 (UK) permits a company to reduce its issued share capital by the following methods:
The company can reduce the liability of member on partly paid share. For example, if members pay 75 cents for shares with a nominal value of $1 and the company decides to reduce the nominal value of shares to,let say, 85 cents, the members would only be liable to pay 10 cents per share instead of the remaining 25.
The company can pay off part of the paid up share capital out of surplus assets. For example, if shares with a nominal value of $1 is fully paid up and the company decides to reduce the nominal value to 70 cents, the company can repay the members the extra 30 cents that they have paid.
The company can simply write down the nominal value of its paid up capital if it falls below its net assets by debiting its reserves and crediting its assets.
COURT APPROVAL
- 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 creditors.
If the reduction is by extinguishing liability or paying off part of the paid up share capital, the court requires the company to invite its creditors to state their objections (if any), usually through an advertisement.If the paid up capital is canceled, the court may require an invitation to creditors.
The company usually tries to persuade the court to avoid having to advertise by:
Paying off the creditors before making an application or
By providing a guarantee that the existing debts will be paid off.
The second concern for the court is the effect of the reduction on the various classes of shareholders and their rights over the company.
If the reduction involves a variation of the rights of different classes of shareholders, then their consent must be obtained. it is usual, though not mandatory, for the company to reduce the value of every class of every class of shares equally.
The court may require the company to publish explanations for the reduction of the nominal value in order to prevent the company from misleading or confusing people who may deal with the company in the future.
if the court is satisfied, it issues an order, confirming the reduction of the capital. A copy of the court order and a statement of capital, approved by the court is sent to the Registrar.
SOLVENCY STATEMENT
A private limited company may reduce its capital through a special resolution, supported by a solvency statement. it need not apply to the court.
A solvency statement is a declaration by the directors, provided within days in advance of the meeting where the special resolution is to be passed. It states that there are no grounds for the directors to believe that the company will not be able to pay all of its possible debts for the next 12 months.
The statement should be in the prescribe from, naming all the directors. The solvency statement, along with the copy of the special resolution must be sent to the registrar within 15 days from the passing the resolution.
DIVIDENDS
DECLARATION OF DIVIDENDS
- All companies have the power to declare dividends. Dividends are the return given to the members of the company for their investment.
A dividend becomes a debt when it is declared and due for payment. Directors cannot be forced to declare Dividends.
The following rules are applicable regarding dividend payments:
Dividends may be declared in General Meetings.
Directors have an implied authority to declare dividends.
Directors may declare interim dividends if they think its justified without the approval of members. However, final dividends must be approved by the members, usually by an ordinary resolution with a simple majority of members is sufficient.
Dividends are usually declared payable on the Paid Up Share Capital.
Dividends can be paid in the form of cash, or other forms such as shares.
FUNDING OF DIVIDENDS
Dividends can only be paid out of the Distributable Profits of the company. Companies are not allowed to pay dividends out of their undistributable reserves {share capital and share premium}
Distributable Profit refer to the Accumulated Retained Earnings of the company, derived after writing down any accumulated losses brought forward from previous years or incurred in the current year. It represents the Retained Earnings figure included within the equity section of the company's Statement of financial position.
PUBLIC COMPANY DIVIDENDS
- In addition to the normal rules, a public limited company can only pay dividends if its Net Assets are equal to or greater than its Called Up Share Capital and Undistributable Reserves
Undistributable reserves comprises of the following:
Called Up Share Capital(capital redemption reserves)
Share premium.
Any surplus of accumulated unrealized profits or losses(such as Revaluation Surplus)
Any reserves that the company is prohibited from distributing by law or its own constitution.
The rules relating to dividends are not applicable in the following situations:
The issue of bonus shares
The repurchase of company shares out capital or profits
A Reduction of share capital
The distribution of assets to members on liquidation
CONSEQUENCES OF BREACH OF DIVIDENDS RULES
If dividends are paid out of the undistributable reserves of the company, the directors and members may choose to make good of the unlawful distribution, usually by withdrawing the dividends
The directors are held liable since they are responsible for declaring interim dividends and recommending the final dividend to members at the AGM
The directors are liable if, without preparing proper accounts, they declare or recommend a dividend which proves to be paid out of Undistributable Reserves.
The directors are liable if they make some mistake of law or interpretation of the constitution which leads them to declare or recommend an unlawful dividend
However, the directors will not be held liable if they declared dividends which they could have reasonably assumed to be lawful, based on accounts which they had reasonable grounds to believe, were properly prepared.
A member may obtain an injunction to restrain the directors from paying an unlawful dividend
Members cannot authorize the payment of an unlawful dividend or release the directors from their liability to pay it back
If an unlawful dividend is knowingly accepted by members, directors are allowed to claim indemnity{compensation} from the members
The company can recover from members, any unlawful dividends if the members knew or had reasonable grounds to believe that it was unlawful
If an unlawful dividend is paid by mistake on the basis of Erroneous Audited Accounts, the company may claim compensation from the auditors, if it can be proved that the error was undiscovered due to the negligence of the auditors
