Debt Financing - Capital Maintenance

Question 1

What is capital maintenance

Answer 1

A principle that ensures a company does not disadvantage its creditors to pay shareholders and requires that a company’s income be recognized only after recovering its costs.

Question 2

Two main approaches to cm

Answer 2

1. Codification of Common Law (e.g., Guyana, Jamaica): Requires dividends to be paid only out of profits.
2. Statutory Replacements (e.g., Barbados, Trinidad): Largely replaces common law rules with solvency-based tests.

Question 3

What is the capital maintenance rule in trevor v whitworth

Answer 3

The rule prohibits a company from purchasing its own shares and prevents issuing redeemable shares, as it is akin to returning capital to shareholders which could leave the company unable to pay its debts. This rule protects creditors.

Question 4

Re halt george…

Answer 4

In this case, excessive remuneration paid to a non-active director was considered an unlawful distribution of capital, demonstrating the rule’s application to disguised distributions.

Question 5

Two limbs of the capital maintenance rule

Answer 5

1. A company cannot purchase its own shares even if authorized in the articles of association.
2. A company is prevented from issuing redeemable shares because future redemption is equivalent to purchasing its own shares.

Question 6

Aveling barford v perion ltd

Answer 6

The court held that selling a valuable asset at an undervalue to a company owned by the sole shareholder constituted an unlawful distribution of capital.

Question 7

Re exchange banking co, flitcroft’s case

Answer 7

1. Share capital must not be returned to shareholders unless profits are available.
2. Directors can be personally liable for allowing dividends paid out of capital.

Directors can’t pay dividends out of capital—they must only pay them out of profits.

Even if shareholders agree to it, it’s still illegal if it reduces the company’s capital base. The directors will be held personally liable if they approve such payments.

It’s all about protecting creditors. Capital is like a safety net for them, so directors can’t just dip into it.

Question 8

Rules of the cm doctrine

Answer 8

1. No purchase by a company of its own shares.
2. No reduction of capital except by provisions.
3. No financial assistance to purchase own shares.
4. No dividends to be paid out of capital.

Question 9

Exceptions to the rule in trevor

Answer 9

S42 TCA

S38 BCA

1. A subsidiary must sell its shares in the parent company within five years of becoming a subsidiary.
2. A company may hold shares as a legal representative, unless it or the holding body corporate or a subsidiary has a beneficial interest in the shares

Or

Hold shares by way of security of a transaction entered into it in the ordinary course of business.

Question 10

What is a dividend

Answer 10

A payment made by a company to its shareholders from the company’s profits, which must not come from capital.

Question 11

Bond v barrow hematite steel co ruling…

Answer 11

Dividends must not be paid out of capital; they must be paid from profits.

Question 12

Ammonia soda co v chamberlain. Fixed vs circulating capital

Answer 12

Fixed capital: Long term investments in assets used over many years, such as machinery and equipment.

Circulating capital: Cash and resources required for day-to-day operations, including inventory and operating expenses.

Question 13

What happens if there’s no balance in the profit and loss account?

Answer 13

Any dividend paid must come from paid-up capital, which would reduce the company’s paid-up capital.

Question 14

Why should there be a balance to the profit and loss account?

Answer 14

1. Dividends come from profits – not capital
   A company can’t pay dividends unless it make real profits. You cyah just dip into the company’s capital to pay shareholders. That’s illegal.
   2. Protecting the company and its creditors
      Keeping a balance means the company still strong. If they pay out money they doh really have, it could mash up the business and leave creditors in trouble.
   3. The law say so
      In both T&T and Barbados, company law say dividends must only come from retained earnings or realised profits. If the Profit and Loss account showing losses or zero, no dividends allowed.
   4. Directors could get in trouble
      If directors approve dividends without profits to back it up, they could be personally liable — meaning they might have to pay it back themselves.
   5. It shows the company healthy
      A positive balance in the P&L shows the company makin’ money. That’s when it safe to give out dividends.

Question 15

What is paid up capital?

Answer 15

Paid-up capital is the money that shareholders have actually paid into the company for their shares.

So if a company sells 1,000 shares for $10 each, and shareholders pay all the money — the paid-up capital is $10,000.

Think of it like this:
• Authorized capital – how much the company could raise by selling shares.
• Issued capital – how many shares the company actually sold.
• Paid-up capital – how much money the company actually got paid for those shares.

Question 16

Prohibited dividends according to Sec 54 TCA & Sec 51 BCA

Answer 16

A company cannot declare or pay dividends if it believes it may be unable to pay its liabilities or if its realizable assets would be less than its liabilities and stated capital.

Question 17

Why did the law in trevor change?

Answer 17

Originally prohibiting share buybacks, the law changed to adapt to modern financial practices and investments.

What Trevor v Whitworth said:
The court held that a company cannot buy back its own shares because that would reduce its capital — and capital must be protected for creditors. That ruling became a strict rule of capital maintenance.

The idea was:
Capital is a “sacred fund” that must stay untouched — can’t return it to shareholders by buying back shares.

But why did the law change later?
1. Too rigid for modern business
• Businesses needed more flexibility to manage their capital.
• Sometimes, buying back shares was actually a smart move — e.g., to reorganize, invest better, or reward shareholders.

2.	Didn’t hurt creditors in every case
•	If the company still had enough assets to cover debts, why block a buyback?
•	Lawmakers realize: protecting creditors shouldn’t mean choking the business.

3.	New rules could protect both sides
•	Modern laws (like the Companies Acts in T&T and Barbados) now allow share buybacks — but with conditions:
•	The company must be solvent.
•	It must follow statutory procedures (e.g., solvency tests, resolutions).
•	Directors can be held accountable if things go wrong.

Summary:
Trevor v Whitworth was about strictly protecting capital.
But over time, the law realized:
We could allow buybacks — just do it responsibly.

Question 18

Reasons companies may buy back their own shares

Answer 18

1. Attract investors by promising to repurchase shares later.
2. Boost Share Price: Fewer shares in the market can make each one more valuable, so the price goes up
3. Facilitate easier share sales for large investors.

Prevent Takeovers: Fewer shares available means it’s harder for someone else to buy up enough to take control.

Question 19

What is the solvency rule

Answer 19

The solvency rule says a company can only buy back its own shares if:
1. It is able to pay its debts as they become due, and
2. Its assets are greater than its liabilities, after the buyback.

This rule protects creditors, so the company doh give out money to shareholders and end up broke.

• Before a company can buy back shares, directors must:
• Declare solvency (in writing),
• Ensure the company can pay debts, and
• Confirm that assets > liabilities + stated capital after the transaction.

•	If they get this wrong, directors can be personally liable and the transaction can be voided.

Question 20

What conditions allow for the buyback of shares in Trinidad (s43) and Barbados (s39)?

Answer 20

1. To settle a debt or legal claim.
2. To eliminate fractional shares.
3. To repurchase shares from employees or officers.
4. To comply with court orders.

Question 21

Requirements for redeemable shares

Answer 21

Shares can only be redeemed if they were originally issued as redeemable, with specified conditions in the articles of association.

Sec 45 TCA & Sec 41 BCA

A company cannot redeem shares if it is unable or would, after that payment, be unable to pay its liabilities as they become due or

the realizable value of the company’s assets would, after that payment, be less than the aggregate of its liabilities

Question 22

What protects creditors in share redemption situations?

Answer 22

A company cannot redeem shares if it is insolvent or if the redemption would render it insolvent.

Question 23

What does Sec 46 TCA & Sec 42 BCA state about donated shares?

Answer 23

A company can accept its own shares as a gift, provided legal steps for reducing capital are followed if debts remain on the gifted shares.

Question 24

What are capital adjustments?

Answer 24

S49(1) TCA

Legal changes to a company’s capital structure, including alterations to the stated capital account or changes in share organization.