Chapter 9 - Companies: finance

Question 1

What is a share?

Answer 1

A share is a transferable form of personal property, carrying rights and obligations, by which the interest of a member of a company limited by shares is measured.

Question 2

What are the different types of shares? (3)

Answer 2

• Preference
• Ordinary
• Redeemable

Question 3

Define preference and ordinary shares and compare with respect to the following: i) Dividends, ii) Voting rights, iii) Pre-emption rights, iv) Right to share in capital upon winding up, v) Right to participate in a rights issue

Answer 3

Preference shares - a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends
Ordinary shares - a share entitling its holder to dividends which vary in amount and may even be missed, depending on the fortunes of the company

Question 4

What is a redeemable share?

Answer 4

A redeemable share is one which is issued on terms that it can be bought back by the company at the option of the company or the shareholder.

Question 5

When do shares have class rights?

Answer 5

Shares which have certain rights not enjoyed by other shares in the company are grouped in a class and are said to have class rights.

Question 6

How may the rights attached to a class of shares be varied?

Answer 6

The rights attached to a class of shares can be varied only in accordance with the articles or according to the procedure set out in the Act by a special resolution of the class or written consent from at least 75% in nominal value of the issued shares of that class.

The holders of at least 15% of the issued shares of the class in question (who did not consent or vote in favour of the variation) may apply to the court, within 21 days, to have the variation cancelled as ‘unfairly prejudicial’.

A class right is varied only if the right itself is altered. An alteration which affects how the right ‘operates’, but which leaves the right unchanged is not a variation.

Question 7

On what basis may the directors of any company allot shares?

Answer 7

1) There must be authority given either by the articles or by ordinary resolution. It can be general or specific, conditional or unconditional.
2. The authority must state the maximum number of shares to be allotted and state the expiry date for the authority, which must be not more than five years after the authority.

The authority may be given, varied, renewed or removed by an ordinary resolution, even if this constitutes an alteration of the articles (which would normally require a special resolution).

Question 8

What is a rights issue?

Answer 8

A rights issue is an allotment of additional shares made to existing members, usually pro rata to their existing holding in the company’s shares. If the members do not wish to subscribe for additional shares under a rights issue they may be able to sell their rights and so obtain the value of the option.

Question 9

What is a bonus issue?

Answer 9

A bonus issue is the capitalisation of the reserves of a company by the issue of additional shares to existing shareholders, in proportion to their holdings. Such shares are normally fully paid-up with no cash called for from the shareholders.

Question 10

What is the right of pre-emption?

Answer 10

In essence this is a right of first refusal for existing shareholders before a company may proceed with a share issue

Question 11

How must companies proceed with honoring shareholders pre-emptive rights when offering new shares?

Answer 11

Must offer equity shares to existing share holder on a pro rata basis. They must wait at least 21 days after which shares which are not accepted may then be allotted on the same (or less favourable) terms to non-members

Question 12

Do ordinary shareholders have statutory pre-emption rights?

Answer 12

Yes

Question 13

Do preference shareholders have statutory pre-emption rights?

Answer 13

Preference shareholders do not have rights of pre-emption unless they are specifically conferred by the company’s articles of association or terms of issue of the shares.

Question 14

For which types of share offerings does the statutory rights of pre-emption not apply?

Answer 14

• Bonus shares
• Shares issued for non-cash consideration
• Employee share schemes
• Exclusions in the Articles (private companies only) or by special resolution

Question 15

Can shares be issued at a premium or discount?

Answer 15

Shares must be paid for in money or money’s worth. They can be issued at a premium but not, as a general rule, at a discount.

Question 16

For what purpose can a company’s share premium account be used and for what purposes can it not be?

Answer 16

Can:
* To write off the expenses of the issue of those shares and any commission lawfully paid on the issue
* To be allotted to members as fully paid bonus shares
* In applying special rules for group reconstruction relief and merger relief

Can’t:
* As a dividend
To write off expenses incurred in connection with the formation of the company
To write off expenses incurred in connection with an issue of debentures

Question 17

How must shares be paid for?

Answer 17

Shares must be paid up in money or money’s worth

Thus, payment may be cash or a ‘non-cash’ consideration of sufficient value. For instance, a company may issue shares in payment of the price agreed in the purchase of a property. Whilst a blatant and unjustified overvaluation will be declared invalid, the courts generally will not wish to intervene in a directors’ valuation of an asset acquired for shares if it appears reasonable and honest

Shares can be partly-paid (not the same as offering at a discount) where there is a part of the price to be paid at some later time.

Question 18

What are the further restrictions for public companies with regards to paying for shares?

Answer 18

• Shares taken by subscribers must be paid up in cash
• Shares cannot be paid for by an undertaking by someone to do work or perform services for the company or any other person.
• Shares must be paid up at least as to one-quarter of the nominal value plus the whole of any premium payable (except for shares allotted in pursuance of an employees’ share scheme).
• Shares cannot be allotted as fully or partly paid up otherwise than in cash if the payment is or includes an undertaking which may be performed more than five years after the allotment.
• Any payment otherwise than in cash must be independently valued.

Question 19

Are shares generally freely transferable?

Answer 19

Shares are generally freely transferable and may be transferred in a paper or paperless format.

Question 20

What are the capital maintenance restrictions in place within company regulations? (3)

Answer 20

The law seeks to protect creditors by maintaining shareholders’ funds in the company. It does this in the following ways:
* Restricting dividends so that they can only be paid out of distributable reserves
* Shares may not be issued at a discount
* Restrictions on any reduction in share capital

Question 21

What are the different restrictions placed on the reduction of share capital? (3)

Answer 21

Restrictions on:
* reduction of share capital
* the repurchase of own shares
* the redemption of shares

Question 22

What is the reduction of share capital by a company, why might a company do it and how will they go about doing it?

Answer 22

A reduction in share capital is a legal process that allows a company to reduce the amount of money it has invested in its shares.

Acompany will do this if its capital exceeds the company’s needs, or the company’s net assets have fallen in value to below the amount of its capital (as recorded in the accounts) and that position is likely to be permanent.

It can do this by reducing the liability on partly paid shares or reducing the amount of paid up share capital (either returning it to shareholders or applying it to another purpose).

Question 23

What are the procedures companies must follow when reducing their share capital?

Answer 23

Question 24

What is the purchasing of own shares by a company, and when is this allowed?

Answer 24

When a company buys back its own shares from the market

Generally speaking a company is prohibited from acquiring its own shares save in limited circumstances

A company can buy back its shares when:
* Complying with a court order (e.g. buying out an unfairly prejudiced minority)
* Forfeiture or surrender of shares in accordance with the articles where there is a failure to pay for them
* Redemption or purchase of shares in accordance with the Companies Act
* Acquisition of shares in a permitted reduction of share capital

Question 25

When must a company file with the registrar regarding the buying back of shares?

Answer 25

A return must be sent to the Registrar within 28 days.

Question 26

What is the redemption of shares by a company, and when is this allowed?

Answer 26

This is when shares are issued on terms which allow them to be redeemed at a later date. The detailed terms of redemption will be set out in the articles of association. However the company can only exercise its powers of redemption if it complies with the rules in the Companies Act. Redeemable shares can only be issued when there are other shares issued that are not redeemable.

Question 27

What are the procedures companies must follow when redeeming shares?

Answer 27

Question 28

From what can redeemable shares be redeemed out of?

Answer 28

* distributable profits of the company; or * the proceeds of a fresh issue of shares made for the purposes of the redemption. * capital subject to certain conditions (private companies only)

Question 29

Outline the other alterations to share capital (4)

Answer 29

Question 30

How must a market purchase be authorised?

Answer 30

A market purchase, ie, one made on a recognised investment exchange, must be authorised by a resolution of the company which specifies the maximum number of shares that can be acquired and states a maximum and minimum price that can be paid for them.

Question 31

How must an off-market purchase be authorised?

Answer 31

An off-market purchase, ie, one that is not conducted through a recognised investment exchange, must be authorised by a contract approved by (or conditional upon approval by) a special resolution. A return giving details of the purchase must be sent to the Registrar of Companies within 28 days.

Question 32

Can private companies provide financial assistance for the purchase of shares?

Answer 32

Under the Act, private companies are no longer prohibited from giving financial assistance for the acquisition of their shares.

Question 33

Can public companies provide financial assistance for the purchase of shares?

Answer 33

A public company (or its subsidiary) is prohibited from giving financial assistance at or before the time of an acquisition of shares in the public company, unless the principal purpose of the assistance is something other than the proposed acquisition (s.678) or the giving of assistance is only an incidental part of some larger purpose and (in either case) it is given in good faith in the interests of the company. In addition to this certain transactions are permitted for all companies. These include: * Where the lending of money is in the company's ordinary course of business. * Where the financial assistance is given in good faith in the interests of the company for the purposes of an employees' share scheme. * The making of loans to employees (not directors) in good faith to enable them to acquire fully paid shares in the company.

Question 34

What is a dividend?

Answer 34

A dividend is one type of distribution of a company's assets to members of the company.

Question 35

What are the restriction around the reserves dividends can be paid from?

Answer 35

The general rule is that any distribution can only be made out of distributable reserves and not out of undsitributable capital reserves

Question 36

What are distributable and undistributable reserves?

Answer 36

**Distributable reserves:** * 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). **Undistributable reserves:** * Share premium account * Capital redemption reserve * Any surplus of accumulated unrealised profits over accumulated unrealised losses (known as a revaluation reserve) * Any reserve which the company is prohibited from distributing by statute or by its articles.

Question 37

What are the additional restrictions for public companies with regards to dividend payout?

Answer 37

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. The dividend which it may pay is limited to such amount as will leave its net assets at not less than that aggregate amount.

Question 38

What are the consequences if a dividend is made in contravention of the Act?

Answer 38

If a distribution is made in contravention of the Act and the receiving member knows or has reasonable grounds for believing that the distribution is made unlawfully, that member will be liable to repay it. The directors may also be liable to repay the amount of the dividend as a result of the breach of directors' duties which will have occurred.

Question 39

When does a dividend become a debt?

Answer 39

A dividend is a debt only when it is declared and due for payment

Question 40

What is a debenture?

Answer 40

A debenture is the written acknowledgement, usually a formal legal document, of a debt by a company, which normally contains provisions as to repayment of capital and interest. The debt may be unsecured or may be secured on some or all of the assets of the company by the creation of a charge over the company's assets.

Question 41

What is a charge? What are the different types of charges? (2)

Answer 41

A charge is security given to the creditor as security for a particular debt. If the debt is unpaid the creditor may take the asset and sell it to repay the debt. A charge can be fixed or floating

Question 42

What is a fixed charge?

Answer 42

A fixed charge is a form of protection given to secured creditors relating to specific assets of a company. It attaches to the relevant asset as soon as the charge is created.

Question 43

What is a floating charge?

Answer 43

Unlike a fixed charge, a floating charge permits a company to deal with the charged assets without the permission of the chargeholder until such time as the charge crystallises (thereby becoming a fixed charge).

Question 44

What liberty over the asset does a company have with regards to a floating or fixed charge over it?

Answer 44

For fixed charges, the company cannot deal with the asset unless the charge holder consents. For floating charges, the company can continue dealing with the asset until the charge crystallises.

Question 45

What is meant by crystallisation?

Answer 45

A floating charge becoming fixed

Question 46

What are events causing crystallisation?

Answer 46

* The liquidation of the company * Cessation of the company's business * Active intervention by the chargee, generally by way of appointing a receiver * Any event specified in the charge, such as non-payment of interest on the due date or notice given by the chargee that the charge is converted into a fixed charge

Question 47

How may a creditor enforce the recovery of a fixed or floating charge upon liquidation of a company?

Answer 47

For fixed charges, the charge grants the holder the right of enforcement against the identified asset in the event of default in repayment so that the creditor may realise the asset to meet the debt owed. If the asset is insufficient the holder is an unsecured creditor for the balance. For floating charges, usually enforce recovery through the company or the holder appointing an administrator or liquidator

Question 48

If a company becomes insolvent when might fixed and floating charges become invalid?

Answer 48

For fixed charges, if created to secure a debt within six months before a company becomes insolvent, then it may be invalid as a preference (2 years if with connected person). For floating charges, if created within twelve months before liquidation, may become void automatically on liquidation. (2 years if with connected person).

Question 49

What is an advantage of a floating charge?

Answer 49

A floating charge has some advantage in being applicable to current assets which may be easier to realise than fixed assets subject to a fixed charge.

Question 50

What are the principle disadvantages of floating charges?

Answer 50

The holder of a floating charge cannot be certain until the charge crystallises which assets will form their security. Even when a floating charge has crystallised over an identified pool of assets the chargee may find himself postponed to the claim of other creditors. A floating charge may become invalid automatically if the company creates the charge to secure an existing debt and goes into liquidation within a year thereafter (s.245 IA); the period is only six months with a fixed charge.

Question 51

Regarding registration of charges, what documents must a company keep available for inspection?

Answer 51

A company must keep available for inspection: * a copy of every instrument creating a charge which is required to be registered; * a register of charges, listing all fixed and floating charges and giving the names of the chargees, the amount of the charge and a short description of the property charged. They must be available for inspection by any creditor or member free of charge and by any other person on payment of a fee. Must also deliver prescribed particulars to Registrar within 21 days, which then issue a certificate of registration.

Question 52

Failure to register a charge will:

Answer 52

Failure to register is an offence punishable by fine. However the court may extend the period for registration where it is satisfied that the failure (or mistake) was inadvertent or not likely to prejudice the company's creditors or shareholders, or otherwise just and equitable. Non-compliance for registartion renders the charge void against any: * Liquidator * Administrator * Creditor The money secured by the (void) charge is then payable on demand.