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Raising Capital Notes

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Raising Capital
Contents
G&D Chapter 11: Legal Capital, Minimum Capital & Verification...........................................217
Meaning of Capital................................................................................................................................. 217
Nominal Value and Share Premiums............................................................................................. 218
Nominal Value.................................................................................................................................... 218
No Issue of Shares at a Discount................................................................................................. 218
Share Premium.................................................................................................................................. 218
Minimum Capital.................................................................................................................................... 219
Objections to Minimum Capital................................................................................................... 219
Disclosure and Verification................................................................................................................ 220
Initial Statement and Return of Allotments...........................................................................220
Abolition of Authorised Capital................................................................................................... 220
Consideration Received upon Issue.......................................................................................... 220
G&D Chapter 12: Dividends and Distributions............................................................................... 221
Basic Rules................................................................................................................................................ 221
Public and Private Companies..................................................................................................... 221
Identifying the Amount Available for Distributions................................................................222
Interim and Initial Accounts......................................................................................................... 222
Interim Dividends............................................................................................................................. 222
Adverse Developments Subsequent to the Accounts.........................................................222
Disguised Distributions....................................................................................................................... 222
Intra-Group Transfers..................................................................................................................... 222
Consequences of Unlawful Distribution....................................................................................... 223
Recovery from Members................................................................................................................ 223
Recovery from Directors................................................................................................................ 223
Reform........................................................................................................................................................ 223
Central Issues..................................................................................................................................... 223
G&D Chapter 13: Capital Maintenance............................................................................................... 223
Acquisition of own Shares.................................................................................................................. 224
General Prohibition.......................................................................................................................... 224
Redemption and Repurchase....................................................................................................... 224
Reduction of Capital......................................................................................................................... 228
G&D Chapter 24: Share Issue - General Rules................................................................................232 Directors' Authority to Allot Shares............................................................................................... 232
Pre-Emptive Rights............................................................................................................................... 232
Allotment................................................................................................................................................... 234
G&D Chapter 33: Winding Up, Dissolution and Restoration.....................................................234
Collection, Realisation and Distribution of the Company's Assets....................................234
Armour, Legal Capital: an Outdated Concept? (2006) 7 EBOR 5............................................235
Armour, Share Capital and Creditor Protection (2000) 63 MLR 355....................................236
Questions....................................................................................................................................................... 237

G&D Chapter 11: Legal Capital, Minimum Capital &
Verification
Meaning of Capital
In the context of limited liability, we have seen there are ex post controls to protect the interests of creditors like personal liability for certain wrongdoing directors. Minimum capital requirements are an example of an ex ante control, as it ensures the company has some minimum level of capital out of which it can satisfy its debts. In this context, capital simply means assets contributed to the company by shareholders, typically when they pay their subscription and / or share premium.
Legal capital is typically less than total NAV as company may also turn to debt financing at the outset, and will have (hopefully) generated profits when trading. NAV is the shareholders' equity - if (NAV-Legal Capital) > 0, the surplus can be distributed as dividends, but no dividends may be paid if (NAV-Legal Capital) < 0.
Alternative to legal capital: minimum capital rules - this is a requirement in the UK for public companies per the Second European Company Law Directive 1977. This means a certain amount of money must be paid in when the company incorporates.
UK company law gives companies great freedom to set their own level of legal capital but their choice can have consequences. Legal capital affects the level of dividend payments that can be declared, eligibility to recapitalise (share buy-backs by company)
and reduction in legal capital must be done in a way that protects creditors.

Nominal Value and Share Premiums
Nominal Value
Legal capital - amount that the company receives from those who subscribe to shares.
But note the difference between nominal and par value - par value incorporates a share premium. S542(1), (2) - all shares allotted must have a fixed nominal value or else the allotment is void. This means a company may issue eg 20,000 £1 shares or 50,000 10p shares. What the shareholder actually pays for the shares can be any amount as long as it is not less than the nominal value - S580. To give themselves maximum flexibility,
companies often opt to keep the nominal value as low as possible. When a company issues more shares after successfully trading for some time, it will be right for them to set a price above par to prevent the later investors from gaining a disproportionate share of the company.
Company Law Review contemplated abolishing par value for private companies but eventually resiled from the proposal. Second Directive - thought to require retention of par value (Art 8).
No Issue of Shares at a Discount
S580(1) - if share is allotted for less than nominal value, the shareholder is liable to pay the company the shortfall. This is meant to be for the good of creditors but may actually be harmful - a company on the verge of insolvency may be desperate to issue new shares but will be unable to do so if their nominal value is too high. However, there are ways around this like issuing a new class of shares.
Perhaps this rule is more about protecting existing shareholders from dilution through having new shares issued too cheaply. However, this only arises where shares are issues for less than market price, which is not strictly related to nominal value, so it is not so helpful to them either. Oddly, there is no duty to issue shares at a premium where the market price is above nominal value - Hilder v Dexter [1902]. However, directors have a duty to act for the success of the company and should ordinarily obtain the best price which they can - Lowry v Consolidate African Selection Trust Ltd [1940].
Share Premium
The amount received by company as nominal value is part of legal capital. The premium is part of legal capital too - S610. This is because it makes no sense for a shareholder to subscribe to shares and for the monies to be immediately paid out as dividends to the other shareholders.
However, money obtain from nominal value and from premium are not treated in exactly the same way. S610 - two exceptions and two reliefs:

Exception 1: company may apply the share premium account in paying up bonus shares [bonus shares can also be paid for using distributable profits] - this is unobjectionable to the company creditors as it simply moves money from the share premium account to the share capital account - S610(1)
Exception 2: share premium account may be applied to write off expenses /
commissions paid to generate the premiums - S610(2); share capital can be used to pay commission too - S553
Relief 1: S610 applies to premiums of cash 'or otherwise', so a share premium account must be set up in an M&A context where company A buys shares in company B in exchange for an allotment of company A shares. This means that company B's previously distributable profits end up being part of A's share premium account. SS612, 613 therefore offers merger relief.
Relief 2: corporate restructuring - S611 - issues at a premium by a wholly-owned subsidiary - company issuing the shares may value its assets by book value not market value. This means they can understate the value of their assets, reducing the share premium amount, as long as the figure derived is more than the nominal value of the shares. 

S614: Secretary of State for Business, Information and Services has power to make other forms of relief but has not done so.

Minimum Capital
Second Directive - minimum capital requirement for public companies - S761: £50K.
This is small change to a public company, and the £50K does not have to be handed over to the company at the time of the issuance of the shares - enough that ¼ of the nominal value of the shares paid up at time of issue - S586. However, this does put a little pressure onto companies to not set an overly-high premium as premium will not count towards the minimum. There is no minimum capital rule for private companies, making
England an attractive place to incorporate for EU businesses - Becht et al (2008).
S761 - where a company is incorporated as a public company, the minimum capital rule is not a pre-requisite to formation but to starting trading. S762 - public companies need a trading certificate from the Registrar of Companies House. Directors may be personally liable to third parties for losses occasioned by failure to do this and also may face criminal sanctions - S767.
If private company converts to public company - requirement that the company's allotted share capital be at least the authorised minimum is a condition for reregistration - S90.
What happens if share capital falls below the minimum capital? If a public company wants to reduce capital to below £50K, it will have to re-register as a private company -
S650(2). S764 - SS BIS has power to increase the minimum capital and get existing companies to increase their minimum capital too.
Objections to Minimum Capital
 There is a fixed requirement of either £0 or £50K but actually the level should depend on the riskiness of the business to be effective; low levels do not offer adequate protection to creditors but high levels discourage new entrants to the market. However, a gradated process would be hard to enforce / calculate.
Exceptions exist for industries like banking where minimum capital is taken seriously. Otherwise, most developed countries set minimum capital at a low level if at all.
 If minimum capital is not enough to protect the interests of creditors fully, then is it nevertheless a sort of cushion? Not really - minimum capital may soon be paid out legitimately eg as salary, or even initially paid in kind and therefore not be readily available to satisfy debts.
 S656 - if NAV falls below 50% called-up share capital then a public company must organise an EGM, but this is not very useful in practice

Disclosure and Verification
Asking companies to disclose how much money they have received as share capital is a good way of facilitating self-help, but this is only important when the company starts trading - later on, annual accounts etc are more useful. However, pre-existing shareholders will be interested to know at what rate shares have been allotted to newcomers to see if they are being diluted. Initial Statement and Return of Allotments
The number of shares, their aggregate nominal amount, any amounts left unpaid and the rights attaching to those shares must be disclosed - S10. S555 - more significant -
subsequent returns via allotments.
Abolition of Authorised Capital
Old rule that directors could not issue shares beyond the level of the authorised capital without the consent of shareholders but this was redundant as this could just be set at a higher level ab initio.
Consideration Received upon Issue
Quality / reality of the consideration received by a company upon issuance of shares.
For all companies:



Consideration promised does not be paid immediately
This is why there is a difference between paid-up capital and uncalled capital
Long-term uncalled capital can be an indication of creditworthiness as it serves as a personal guarantee from members but it is unclear if companies use this
S553 - commissions may be paid out of share proceeds but this may be no more than 10% of monies received - no such restriction on payments out of distributable profits - S552
Payments can be in kind - S582(1) - mostly for private companies, where it is commonly used; Re Wragg [1897] - parties' own valuation not readily disturbed so there is some scope to dilute

Public companies:


Must be paid up in cash or kind to ¼ nominal value and the whole of the premium due must be paid up too - S586
If the company wishes to stagger share payments, then it should set the nominal value higher as the whole of the premium must be paid up immediately
Non-cash issues - S583(3) [note that cash includes promise to pay at a later date / debt-equity swap] - public company may not accept work or personal services instead of payment; no allotment for consideration to be paid only more than five years later

Valuation of non-cash consideration:


Share-watering by inflating value - need independent valuation for public companies - Ch 6 Pt 17 CA 2006
SS593-595: exceptions for bonus issues; mergers and acquisitions
S93 - private company switching to public company cannot evade this process by allotting as a private company before re-registering - in such cases, reregistration will be refused until independent valuation procedure has been completed

Further provisions as to sanctions:

Civil liability on allottee towards the company
But by the time the company enforces its rights, the shares may have been sold 

Normal approach therefore joint and several liability on current holder and original allottee eg S588, 605
Normal equitable rules will apply so good faith purchaser for value will not be liable (but a donee will be)
Re Bradford Investments Plc (No 2) [1991] - usually, the CA imposes penal sanctions so the court has a discretion to forgive allottees but this is subject to overriding principles that the company receives money due, and the company has freedom to elect between different remedies where multiple remedies exist

G&D Chapter 12: Dividends and Distributions
Basic Rules
Legal capital - main impact on setting maximum amount payable by way of dividends or other distributions to shareholders.
Distribution rules - aimed at protecting creditors. Issue of shareholder / board conflict over the levels of distributions - managers may want to re-invest; investors may prefer cash-in-hand. There is a mutual veto arrangement in most AoAs - board to recommend dividend level; members may accept or reject but cannot unilaterally demand dividends above that level.
Public and Private Companies
Legal capital - distributions: S831 - no distributions if NAV < [paid up share capital +
non-distributable reserves], where share premium account is non-distributable.
If the company buys back its own shares (treasury shares), then the proceeds of this may not be distributed either. AoA may specify other categories of non-distributable reserves.
S830 - general rule - companies should only make a distribution only out of profits available for that purpose - S830(2) - company cannot pay out dividends out of current year's profits if they made a loss in previous FYs which has not been replaced yet; this only applies to realised profits and losses too - this is a matter for accounting practice but eg paper profit on real property which has gone up in value but has not yet been sold: S831. S831 only applies to public companies.

Identifying the Amount Available for Distributions
Usually the relevant figure depends on what is in the company's annual accounts. These are usually audited too. S836(2) - most recent statutory accounts to be used. S837(3),
(4) - statement of accounts to be laid before the general meeting.
Interim and Initial Accounts
S836(2)(a) - if distribution is to be made on basis of eg half-yearly profits then interim accounts can be used rather than last set of annual accounts if there were no distributable profits in the last set of official accounts. Requirements - S838, S839.
Interim Dividends
S831 - interim dividends may be paid out without interim accounts if the previous set of official accounts indicate there is a surplus adequate to cover the interim payment anyway. Art 70 model articles for public companies, Art 30 model articles for private companies - may pay out quarterly interim dividends in anticipation of final dividend for the year simply by board meeting.
Adverse Developments Subsequent to the Accounts
What if relevant accounts were seriously inaccurate, meaning paying out an alreadydeclared dividend would actually be unlawful? In this case, the directors would be in trouble - Re Cleveland Trust Plc [1991]. What about the case where the position of the company seriously and suddenly deteriorated? Company Law Review recommended that the dividend should not be paid out in that case. This is not part of the law so we must turn to directors' duties etc - but note this would be an unratifiable breach of directors' duties.
Not only must a director take into account subsequent profits when declaring dividend based on past financial year as part of his statutory duties, he must also avoid falling afoul of the common law rule against distributing capital - Trevor v Whitworth (1887).

Disguised Distributions
S829(1) - wide statutory definition. Ridge Securities Ltd v IRC [1964] - even wider at common law wrt disguised distributions. Issue is a transfer of value to the shareholder which does not purport to be a distribution. This tends only to apply to (virtually)
gratuitous transactions - Progress Property Co Ltd v Moorgarth Group Ltd [2010] -
usually the courts will give the company a margin of appreciation in valuation matters.
However, good faith alone is not enough to avoid the application of this rule - Re Halt
George (1964) Ltd [1982] - honest but mistaken belief of company in paying for professional services never received. But it may be necessary to look to subjective intentions of the parties as this is not about setting aside bad bargains - Progress
Property v Moorgarth - because the company would have still sold at the same price even to an outsider.
Intra-Group Transfers
May be done for book value rather than market value - S851.

Consequences of Unlawful Distribution
Recovery from Members
S847 - civil sanctions - if member knew or ought to have known the distribution was in excess of what could be distributed, they must pay it back. The member must merely know the distribution was more than profits received rather than know it was illegal per se - It's a Wrap (UK) Ltd v Gala [2006]. How far does this go? Does constructive knowledge extend to simply having received the annual report?
Note also common law remedy - proprietary remedies available as company assets misapplied in breach of fiduciary duty - Rolled Steel Products (Holdings) Ltd v British
Steel Corp [1986].
Recovery from Directors
Director has duty to restore company assets at common law - Flitcroft's Case (1882).
Directors will also be liable where they fail to give a true and fair view of the company's affairs in the accounts - Bairstow v Queens Moat Houses Plc [2001].

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