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Capital Rules Notes

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Capital Rules An important to note is that share capital is only one part of a company's total assets, and often a very small part. Other tea sources of finances include loans or retained profits.

Objectives of capital rules Protection of creditors:

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This is the traditional rationale for capital rules.

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Ensures that there is a minimum level of capital before trading begins.

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Ensures transparency in capital arrangements and that capital is not returned to shareholders unless in accordance with stating rules. o

Procedures for formal reduction of capital.

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Regulating ability of companies to repurchase their own share.

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Capital may be a guide for returns via dividend payments.

Protection of investors:

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Some controls on the price at which shares are bought (e.g. 'No discount' rule)

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Measures to prevent dilution of share holders' interests.

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Prevent manipulation of the share price controls on purchases on own shares.

Raising Capital Nominal value of shares All shares must have a nominal value. (CA2006s.542(1)) Any allotment of a share value without a fixed nominal value is void. (CA2006s.542(2)) The share capital = number of shares x nominal value. The no discount rule, shares may not be issued at a price below their nominal value. (CA2006s.580(1)) Any shareholder purporting to take a share at a price below their nominal value remains liable for the difference. (CA2006s.580(2)) Lowry's Case Lord Wright said that there is a general duty to obtain the full market value for shares but this could be adjusted for good reason. Shearer v. Bercain

Cited Lord Wright. Stated that although there is a feeling of freedom for directors to choose the offer price of shares they generally have a duty to obtain the full market value unless there is a good reason to accept less. Share Premiums The share premium is the difference between the offer value and the nominal value. All share premiums must be placed in a special account and identified as the share premium account on the balance sheet. (CA2006s.610(1)) The rules on share premiums apply whether cash or non cash consideration is given for the shares. The premiums are treated in broadly the same way as share capital with a couple of important exceptions:

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The premium account maybe used to pay off the costs of issuing shares. (CA2006s.610(2))

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The company may use the premium account to pay up new shares to be allotted to members as fully paid up bonus shares. (CA2006s.610(3))

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The balance of the premium account may be used in a group reconstruction. (CA2006s.611)

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Disapplies the rules relating to share premiums in respect of shares issued as part of a merger. (CA2006s.612)

There is no requirement that shares in a private company can be paid for in whole or in part at the time they are allotted but the shareholder will be liable to pay up the remaining value of the share at the request of the company or in liquidation. Shares of a public company must be paid up to at least a quarter of their nominal value and the whole of any premium value. (CA2006s.586(1))

Payment for shares: cash and non cash consideration Shares including share premiums must be paid for in money or monies worth. This could include goodwill or knowhow. (CA2006s.582(1)) Re Wragg The value which the company attaches to non cash consideration is not to be assessed for adequacy in a private company. Tintin Exploration The non cash consideration could be found to be insufficient, and thus invalidate the shares, where the directors acted in bad faith. Re White Star Line The non cash consideration was obviously not of equivalent value to the shares and was merely illusory.

There are much more stringent rules in relation to public companies accepting non cash consideration for payment for shares. A public company may not accept an undertaking to do work or perform services as consideration for shares. (CA2006s.585(1)) A public company may not accept a long term undertaking in exchange for shares. (CA2006s.587(1)) A breach of CA2006s.585(1) shall leave the holder liable to pay the amount left outstanding on both the nominal value and the premium value shares. A breach of CA2006s.587(1) shall leave the holder liable to pay the amount left outstanding on both the nominal and the premium. Subsequent holders will also be liable if they are not a bona fide purchaser for value without notice. (CA2006s.588) If a person gives a contract to do work in consideration for shares in a plc. Then he will remain liable to do the work notwithstanding the failure of the undertaking to be good consideration for the shares. (CA2006s593(1)) All noncash consideration provided to a plc. In exchange shares must be independently valued. (CA2006s.593(1)) If an independent valuation has not been obtained then the allotment remains valid but the person must pay the nominal premium values. (CA2006s.604) The courts have a discretion to provide relief against liability arising from invalid non cash consideration. Re Bradford Investments

1. The principle behind the rules that the company must receive assets worth at least the allotted value and the premium. If this is the case then no liability need arise.

2. Not on the facts though. Re Ossory Estates

1. The principle behind the rule was that the company must receive assets worth at least the allotted value and the premium.

2. On the facts this was a so relief from liability was granted.

Minimum capital rules There is no minimum capital requirement for private companies in the UK. In this respect UK is very different to other EU member states which significant minimum capital rules. Centros Denmark had a high minimum capital requirement and so Centros simply registered in the UK and then used the free movement provisions of the EU to allow it to trade in Denmark.

There is a minimum capital requirement for public companies though. A public company must have a minimum paid up share capital of at least 25% of the nominal value on each share and all of the premium on each share. (CA2006s.761) A public company must have an allotted nominal share capital of at least PS50000. (CA206s.763) The minimum capitals do little to protect creditors, even if the requirements were higher, the best one can say is that higher requirements might serve as a barrier to entry and thus discourage some frivolous or reckless incorporations.

Alloting Shares Shares are taken to be allotted when a person acquires the unconditional right to be included in the company's register of members in respect of the shares. (CA2006s.558) Natwest v. IRC Shares are only issued when the entire process of application allotment and registration has been completed.

Directors' authority to allot shares The directors must not allot shares unless there is a power to do authorised by the articles or by a general resolution. (CA2006s.549) If a private company has only one class of share then the director may exercise company powers to allot shares provided not prohibited by articles. (CA2006s.550) Model Articles for Private Companies

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Contains no restriction on the ability of the company to issue shares.

Model Articles for Public Companies

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Article 43 enables the company to issue new shares.

A director who allots shares without authorisation is guilty of an offence personally. (CA2006s.549(4)) An absence of authority under CA2006s.549 will not affect the validity of the allotment. (CA2006s.549(6)) Directors may be authorised to make allotments by the articles or by an ordinary resolution of the company. (CA2006s.551(1))

Allotting shares: existing shareholders pre emption rights Existing share holders have a mandatory pre emption right in respect of any new offer of shares. Their entitlement is to a pre-emption right in proportion to their existing

shareholding. (CA2006s.561)

The pre-emption rule applies to equity securities, defined in CA2006s.260 as shares allotted otherwise than in accordance with pre existing rights. Offers to existing shareholders for them to exercise their pre-emption rights must be open for at least 14 days. (CA2006s.562(5)) There are important exceptions to the rules on pre-emption rights:

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Pre-emption rights do not apply in relation to bonus shares (CA2006s.564)

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Pre-emption rights do not apply in relation to allotments for non cash consideration. (CAs.565)

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Pre-emption rights do not apply to securities held under an employee share scheme (CAs.566)

Enables a private company to opt out of the pre-emption rights by a provision in the articles. (CA2006s.567) Directors of a private company with only one class of share may be given the power to indefinitely disapply the pre-emption rights either by the articles or by a special resolution. (CA2006s.569) Directors of other companies may disapply pre-emption rights if called by the articles, or by special resolution. (CA2006s.570) CA2006s.5678, s.569, s.570 these provisions are not in the model Articles. The company and directors must, if the company they fail to comply with pre-emption rights, pay compensation to those persons to whom an offer should have been made. Claims are time bared after two years though. (CA2006s.563) Nothing in CA2006 invalidates an allotment of shares in breach of pre-emption rights. Although in Re Thundercrest Mr Justice Baker did, did, somewhat unconvincingly decide that there could be a rectification of the register. Failure to comply with the pre-emption rights can give rise to a s.994 unfair prejudice claim (as in Re Coroin) Similarly if the directors deliberately set the issue price so that the hold of preemption rights cannot exercise those rights then this could be an unfair prejudice under s.994. Re Sunrise

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Although the directors are free to set the price, this must be done after consideration of the value which could and should be extracted for them. Relevant considerations will be how much shareholders are able to afford,

whether there is to be a discount for any increased risk or whether there should be a discount to encourage the issue to be taken up.

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It will not be fair to simply decide to allot shares a nominal value without consideration of the other factors (although after consideration the directors may conclude to issue a nominal price).

Maintaining capital Trevor v. Whitworth Lord Watson made it absolutely clear that there is nothing to protect paid up capital being diminished or lost in the course of trading, it must not be applied for anything other than the legitimate course of business though.

Formal reductions of capital A company has a special resolution, which must either by a solvency statement or by a court order. (CA2006s.641(1)) The ability to support a special resolution by a solvency statement is only available to private companies, and consists of a declaration by each of the directors to the effect that there is no ground upon which at the present time the company could not pay all of its debs and that the company will remain able to do so for at least 12 months following the declaration. (CA2006s.642, s.643) A director who makes a solvency statement without reasonable grounds commits an offence. (CA2006s.643(4)) The director will be liable for a fine and face imprisonment if he commits an offence under CA2006s.643(4). (CA2006s.643(5)) A public company may only reduce its share capital by making an application to the court for permission (after a special resolution being passed). A company (private or public) may apply to the court for permission to reduce its share capital. (CA2006s.645) Creditors are entitled to object to the reduction if it can be shown that the reduction would result in a real likelihood that the company would be able to discharge its debt. The solvency declaration was intended to make it easier for private companies to reduce their share capital, but the penalties in CA2006s.643(5) include imprisonment for up to two years if the director cannot prove he had reasonable grounds for making the solvency declaration. The process of going via the court and allowing creditors to object is potentially a more arduous process, but there is no risk to the directors personally and so is perhaps to be favoured even in a private company.

Share buybacks and redeemable shares

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