Legal Capital Rules Flashcards
(98 cards)
1
Q
What are Legal Capital Rules?
A
The rules constraining what a firm may do with a shareholder equity.
2
Q
What is the Purpose of Legal Capital Rules?
A
To resolve the conflicting interests of creditors and shareholders regarding capital allocation.
3
Q
What Documentary Requirements are there under the Legal Capital Rules upon Registration?
A
A Statement of Capital and Initial Shareholdings.
CA 2006 – §9-§10.
4
Q
Broadly, what are the Two Categories of Legal Capital Rules?
A
The Raising and Maintenance of Capital Rules.
5
Q
Why do the interests of Creditors and Shareholders conflict?
A
Shareholders, as residual claimants, wish to profit-maximize at all costs whereas creditors, as secured claimants, only seek repayment and thus the mitigation of unnecessary risk.
6
Q
Structurally, how is Creditors’ and Shareholders’ conflict of interest exacerbated?
A
Shareholders hold great influence over the Board, which enables them to profit excessively at the expense of Credtiors.
7
Q
How may Shareholders go about profiting excessively at the expense of Creditors? (A-RUC)
A
- Asset Diversion, i.e. withdrawing assets from the firm’s cushion.
- Risk shifting, i.e. increasing the firm’s risk profile.
- Underinvestment, i.e. quitting projects that don’t profit-maximize.
- Claim dilution, i.e. taking on divergently unproductive debt.
8
Q
Are Creditors capable of benefiting themselves at the expense of Shareholders?
A
Yes, but to a comparatively lesser degree. E.g.:
- Loan acceleration.
- Covenants against dividends.
- Risk-shifting.
9
Q
What are the Two Sub-categories of the rules regulating the Raising of Capital?
A
- Minimum Capital Rules.
- Payment for Shares Rules.
10
Q
Broadly, what do the Minimum Capital Rules pertain to?
A
The amount of capital which must be invested into a public company by its shareholders before trading.
11
Q
What is the Par Value of a Share?
A
The nominal value at which a share is allotted.
12
Q
What is Nominal Share Capital?
A
The amount of capital belonging to a company upon registration.
13
Q
What is Share Capital?
A
The aggregate par value of a company’s outstanding shares.
14
Q
What is Paid-Up Share Capital?
A
The amount already paid by shareholders to a company in exchange for shares.
15
Q
What is Called-Up Share Capital?
A
The amount yet unpaid by shareholders to a company in exchange for shares already purchased, exceeding no more than 75% initial price.
CA 2006 – §581 & §586.
16
Q
What is a Share Premium?
A
The amount above par at which a share is being alloted.
17
Q
What is to be done with the Profits made on Share Premiums?
A
The aggregate value gained must be transferred to a Share Premium Account.
CA 2006 – §610.
18
Q
How may the proceeds of a Share Premium Account be utilized?
A
To write off expenses or commissions paid on share issuances, or to give company members stock options.
CA 2006 – §610.
19
Q
What is the Technical Difference between Share Allottment and Issuance?
A
Allottment is the portioning of shares, while issuance is the execution of said portioning.
See: Companies Act 2006 – §549-§577.
20
Q
For a UK PLC, what is the Minimum Nominal Value of allocated share capital?
A
£50,000.
Companies Act 2006 – §763.
21
Q
Is there a Minimum Capital Requirement for LLCs?
A
No.
22
Q
Can Minimum Capital Requirements honestly be said to protect Creditors?
A
No. The sums they require are microscopic relative to the debts owed by PLCs, and they don’t even need to be maintained after registration.
23
Q
How do Creditors chiefly go about protecting themselves against Insolvency?
A
By drafting contracts and clauses which afford them such protection, e.g. representations, warranties, covenants, and conditions precedent.
24
Q
What is the Purpose of regulating Payment for Shares?
A
To guard against shareholder dilution and, to a lesser degree, to protect creditors.
25
How is Fair Consideration guaranteed in Payment for Shares?
By requiring that all shares must have a **fixed minimum nominal value**, i.e. par value.
## Footnote
Companies Act 2006 -- §542.
26
In exchange for Shares, which forms of Consideration are acceptable?
**Cash** and **Non-Cash** Consideration.
## Footnote
CA 2006 -- §582.
27
Is it possible to issue shares below par value, i.e. at a Discount?
**No**. This is known as the '**No Discount Rule**'.
## Footnote
Companies Act 2006 -- §582(1); *Ooregum Gold Mining Co. of India v Roper* [1892] AC 125.
28
If a share's par value is low, its stock price high, and its most recent issuance below market price but above par, are the Directors exposed to legal liability?
Only if they did not act ***bona fide*** in the **best interests** of the company when setting the price.
## Footnote
*Shearer v Bercain* [1980] 3 All ER 295; *Re Sunrise Radio Ltd*. [2010] 1 BCLC 367; *Mutual Life Insurance Co. of New York* *v Rank Organization Ltd.* [1985] BCLC 11.
29
For LLCs, how is the '**No Discount Rule**' examined in cases of Non-Cash Consideration?
With deferrence to the Board's **commercial judgement**, which goes unquestioned so long as it isn't, "clearly **colourable** or **illusory**."
## Footnote
*Re Wragg Ltd.* [1897] 1 Ch 796.
30
For PLCs, how is the '**No Discount Rule**' examined in cases of Non-Cash Consideration?
With **mandatory independent valuation** of the non-cash consideration prior to allotment.
## Footnote
Companies Act 2006 -- §593-597.
31
Is Non-Cash Consideration acceptable off-the-bat for PLCs?
**No**. §598-§604 strictly govern the use of non-cash consideration during a company's initial period, i.e. first two years post-registration.
32
What transpires upon Breach of the Payment for Shares Rules?
The allottee will be liable to repay the company their **discount** + **interest**, but _may_ also be liable to repay the **shares' entire nominal value** + **premium(s)** + **interest**.
## Footnote
Companies Act 2006 -- §593.
33
What transpires upon Transference of Illegitimately Discounted Shares?
Generally, all subsequent purchasers will be held **jointly** and **severally** liable for the **discount** + **interest** (or even more).
## Footnote
Companies Act 2006 -- §588 and §605.
34
Is there a Defence against purchasing Illegitimately Discounted Shares?
Having demonstrably acted in **good faith**.
## Footnote
Companies Act 2006 -- §588 & §605.
35
How do the Payment for Shares Rules protect Creditors or Shareholderes?
They practically don't. For shareholders, **share dilution** is untouched. For creditors, any increase in the **asset pool** is good, and where shares are issued to release a debt, they are worth much less in insolvency.
36
What was the Precedent set in *Centros*?
EU firms are **free to incorporate** in whichever Member State they so desire, even if they **don't transact** there whatsoever.
## Footnote
*Centros Ltd. v Erhvervs-og Selskabsstyrelsen* [1999] ECR I-1459
37
What was the Economic effect of *Centros* on the UK?
A large influx of relatively small, but economically significant LLCs.
## Footnote
Becht, Mayer, & Wagner -- *Where Do Firms Incorporate? Deregulation and the Cost of Entry* [242]
38
Why were LLCs attracted to the UK after *Centros*?
The UK had the **simplest** and **lowest-cost** incorporation procedures in the Union.
## Footnote
Becht, Mayer, & Wagner -- *Where Do Firms Incorporate? Deregulation and the Cost of Entry* [242].
39
With respect to Regulation, what does the *Centros* corporate migration strongly imply?
That, if two States' corporate law is of **comparable quality**, "then **price** considerations should **dominate**."
## Footnote
Becht, Mayer, & Wagner -- *Where Do Firms Incorporate? Deregulation and the Cost of Entry* [242].
40
According to Becht et al., which Price Considerations are most relevant to prospective incorporators?
* Incorporation Costs.
* Minimum Capital Requirements.
Becht, Mayer, & Wagner -- Where Do Firms Incorporate? Deregulation and the Cost of Entry [242].
41
According to Becht et al., why are Price Considerations so dominant as opposed to Non-Price Considerations?
The 'penetration' of **Registration Agents** has reduced and amplified the significance of non-price and price considerations due to their **expertise** and **profit-maximizing incentive**, dually respectively.
## Footnote
Becht, Mayer, & Wagner -- *Where Do Firms Incorporate? Deregulation and the Cost of Entry* [242].
42
According to Becht et al., what has been the Regulatory outcome of *Centros*?
**Inter-State competition** for the title of **lowest-cost** corproate law, resultant from the clear permission of regulatory arbitrage.
## Footnote
Becht, Mayer, & Wagner -- *Where Do Firms Incorporate? Deregulation and the Cost of Entry* [242].
43
What is Armour's central point against the Threat of Regulatory Arbitrage?
Due to States' inability to charge **franchise taxes** on *Centros*-style incorporated firms, they **lack the profit incentive** to rush to the bottom.
## Footnote
Armour -- *Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition* [394].
44
Why does Armour nevertheless believe that States may be motivated to relax Regulation?
**Revenue from legal services** may be an invaluable economic resource, and **private legislatures**, e.g. the Takeover Code, are better than public legislatures at **extracting marginal revenues** from firms through **fees**.
## Footnote
Armour -- *Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition* [396].
45
Why does Armour believe that Regulatory Liberalization might, in some asepcts, lead to a 'Race to the Top'?
**Procedural safeguards** will be needed to protect affected constituencies against **opportunisitic motives** regarding regulatory arbitrage.
## Footnote
Armour -- *Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition* [397].
46
According to Armour, why might States other than UK become hotspots for incorporation?
Certain States may seek to **optimize** their jurisdiction with regard to a **particular firm structre**, e.g. blockholding, thus appealing to that type of firm above and beyond other States.
## Footnote
Armour -- *Who Should Make Corporate Law? EC Legislation vs. Regulatory Competition* [401].
47
What is Gerner-Beuerle et al.'s explanation for why *Centros* has had a 'Modest Effect'?
The resultant arbitrage mainly centered around **economic issues** that primarily affected **start-ups**, and didn't touch on more **real-seat-based areas**, e.g. labor, tort, or insolvency law.
## Footnote
Gerner-Beuerle et al. -- *The Illusion of Motion Corporate (Im)Mobility and the Failed Promise of Centros*.
48
What are the Maintenance of Capital Rules?
The rules governing the **utilization** of shareholder equity.
49
What is the Purpose of the Maintenance of Capital Rules?
To **guard** against the **return of share capital** to shareholders, except as perscribed by law.
* Flitcroft’s Case* (1882) 21 Ch. D. 519; *Trevor v Whitworth* (1887) 12 App Cas 409 (HL).
* “A limited company cannot in any other way make a return of capital.”*
* “A company cannot make payments out of share capital.”*
50
Foremost, what do the Maintenance of Capital Rules guard against?
**Asset Diversion**.
51
What are the Exceptions under the Maintenance of Capital Rules? (**DBRRF\***)
* **D**ividends.
* Share **B**uybacks.
* Share **R**edemptions.
* **R**eductions of Capital.
* **F**inancial Assistance.\*
52
What are the Arguments in favor of the Maintenance of Capital Regime?
It protects all creditors by acting as a **collective covenant** on all firms and increases efficiency by **minimizing transaction costs**.
53
What are the Arguments against the Maintenance of Capital Regime?
* Grounds of efficiency only justify it as an **optional** regime.
* It **mimics** what creditors can otherwise acheive through contract.
* It's likely inefficient à la no such thing as **one-size-fits-all**.
54
What is the definition of a Dividend, i.e. 'Distribution'?
Any **disbursement of assets**, whether in cash or otherwise, to a firm's **shareholders** that is not:
* An issuance of bonus shares;
* A reduction of share capital;
* A share buyback; or
* An asset diversion during insolvency.
Companies Act 2006 -- §829.
55
What are the Two Types of Dividends?
**Annual** and **Interim**.
56
What are SCRIP and DRIP Dividends?
SCRIPs describe the option to receive **stocks alongside cash** in one's dividend package, whereas DRIPs describe the **reinvestment** of one's capital into the firm through the **purchase of outsanding shares**.
57
Between SCRIPs and DRIPs, which is typically Perferred?
**DRIPs**, since unlike SCRIPs, which comprise new shares on the mraket, they **aren't dilutive**. Nevertheless, SCRIPs increase a stock's **liquidity**.
58
With whom does the Discretion to issue Dividends lie with?
The Board, who can either make a recommendation at the AGM or issue interim dividends on an *ad hoc* basis.
59
Where is the Procedure for the Declaration and Payment of Dividends set out?
In the **Articles of Association**.
60
Why would a Board choose to issue Dividends? (**SASA**)
* **Satisfy shareholders**, especially those who are reliant upon them.
* Increase the firm's **Attractiveness** as an investment.
* **Signal** the firm's financial health, given the costliness of issuing dividends.
* Mitigate **Agency Costs**.
61
What is Easterbrook's criticism of the Signalling Hypothesis?
Firms' financial health is easily verifiable given the wealth of reporting they are legally obligated to publish, especially given independent auditors' role to play therein.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [651].
62
According to Easterbrook, what are the Two Problems that Dividends seek to address?
Agency costs in the form of **monitoring** and **risk aversion**.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [652-654].
63
According to Easterbrook, what is the priamry benefit of keeping firms in the capital markets from an agency costs perspective?
Firms which regularly **rely** upon external financing will be beholden to the lenders' and investors' **interests**, and will be more likely to act in accordance with those interests, thus decreasing agency costs.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [654].
64
According to Easterbrook, how do Dividends act to keep firms in Capital Markets?
They can act to **recalibrate** capital structure, efficiently lowering equity and creating space for more debt, thus compelling firms to **maintain proximity** to capital markets.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [655].
65
What is an Anciliary Benefit of Dividends' recalibratory effect?
It works to **roughly equate** shareholders' and creditors' **interests** in the firm, thus lowering the potential for unilateral opportunism.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [655].
66
Why would a Board choose not to issue Dividends?
At large enough sizes, they might advantage shareholders at **creditors' expense**. Likewise, they are **quite costly** and incur additional **transaction** and **tax** costs.
## Footnote
Easterbrook -- *Two Agency-Cost Explanations for Dividends* [650].
67
From what source can Dividends be issued?
**Distributable profits**, which are a firm's, "accumulated, realised profits... [subtracted by] its accumulated, realised losses."
Companies Act 2006 -- §830.
68
For PLCs, what is the **Net Asset Restriction** on Dividend Distributions?
A prohibition on issuing dividends where a firm's **net assets** are **lower** than its **called-up share capital** + **undistributable reserves** + (**AUP - AUL**), or where a distribution **would** put its net assets below that threshold.
## Footnote
Companies Act 2006 -- §831.
69
What does the term 'Undistributable Reserves' describe? (**SCNR**)
A company's:
* **S**hare premium account;
* **C**apital redemption reserve;
* **N**et accumulated unrealized profits; and
* **R**eserves so prohibited by the Articles.
Companies Act 2006 -- §831.
70
What form must Dividend Distributions take?
**Cash**, unless otherwise authorized by the firm's Articles.
## Footnote
*Wood v Odessa Waterworks Co.* (1889) 42 Ch D 636.
71
How is a Company determined to be Capable of issuing dividends?
With reference, most usually, to its **previous annual accounts**.
## Footnote
Comapnies Act 2006 -- §836.
72
What is the Penalty for unlawfully paying out a Dividend?
The receipient will be **personally liable** to repay the funds, unless they are ***bona fide***. The authorizing directors will be **liable to the company** for the sum.
## Footnote
Companies Act 2006 -- §847; *Flitcroft's Case* (1882) LR 21 Ch D 519.
73
What's the point of issuing Interim Dividends?
As before, to **signal financial health** and **satisfy shareholders** by delivering a **steadier** stream of income.
74
Why is the M&M Irrelevance Hypothesis incorrect?
Because its core assumptions, namely perfect markets, perfect rationality, perfect information, and zero transaction costs are fallcious.
75
What are the Problems with our current approach to Determining dividends?
It's backwards looking and is thus **vulnerable to discrepancies** between historical and real-time performance and conditions. It's also **inflexible**.
76
Is Directors' Liability for Unlawful Distributions Strict or Fault-based?
With the case law split, the matter is ultimately **fact-specific**.
## Footnote
See: *Re Paycheck Services 3 Ltd.* [2010] UKSC 51 (**Strict**) -- *cf* -- *Burnden Holdings (UK) Ltd v Fielding* [2019] EWHC 1566 (Ch) (**Fault-Based**) & Companies Act 2006 -- §1157.
77
What Factors are considered when determining Directors' Liability in issuing dividends Unlawfully?
The director's **constructive knolwedge**, **intentions**, and the **facts** at the material time.
## Footnote
*Holland v* *Commissioners for Her Majesty's Revenue* [2010] UKSC 51; *Dovey v Cory* [1901] AC 477; Ferran -- *Directors' Liability for Unlawful Dividends* [321-326]
78
Generally speaking, are Firms permitted to Acquire their own shares?
**No**.
## Footnote
Companies Act 2006 -- §658(1); *Trevor v Whitworth* (1887) LR 12 App Cas 409.
79
Are there exceptions to the General Rule against Share Repurchase and Redemption?
**Yes**.
See: Companies Act 2006 -- §659; §684-§689; and §690-§708.
80
What are the Potential Advantages of Share Repurchases and Redemptions?
They may be used to:
* Provide an **exit route** for shareholders, thus **facilitating intital investment**.
* Increase **stock liquidity** for **private** companies.
* **Generate value** for shareholders **without altering** their normative **expectations**.
* **Signal** the company's financial **health** and future **prospects**.
* **Optimize tax** obligations.
* **Reorganize capital** structure.
* **Facilitate** employee **share schemes**.
* **Productively enrich** cash-flush **endgame** **firms**.
R. Moore et al, *Returning Value to Shareholders: Giving Something Back* (2012) 23(8) PLC 23.
81
What are the Potential Disadvantages of Share Repurchases and Redemptions?
They may:
* **Mislead** the market through **false signalling**.
* **Undermine** the **Capital Maintenance** Rules.
* **Deplete** long-term **liquidity**.
* **Increase** **leverage**, if debt-funded, and thus **firm fragility**.
* Incur **opportunity costs**, e.g. R&D or CapEx.
* **Personally enrich** insiders at other **stakeholders' expense**.
* **Decrease firm**, and thus **economic**, **productivity**.
* **Increase** **wealth** **inequality**.
* **Concentrate shareholding power**.
82
When is a Share Repurchase deemed Legal?
When all of the **Legislative** requirements are met, and a **Shareholder Resolution** is passed.
## Footnote
See: Companies Act 2006 -- §684-§690.
83
Are all Share Repurchases the same?
**No**. Legislation distinguishes between **Market** and **Off-Market** Repurchases.
## Footnote
Companies Act 2006 -- §694.
84
What Effectually is the Distinction between Market and Off-Market Share Repurchases?
While **both require** a Shareholder **Resolution**, the **latter must** pertain to a **specific** share, and thus contract, whereas the **former must not**.
## Footnote
Companies Act 2006 -- §694.
85
How must a Repurchase be Funded?
Either through **Distributable Profits** or a **Fresh Share Issuance**.
## Footnote
Companies Act 2006 -- §692.
86
Are Public and Private Companies equally capable of Share Repurchases?
Under certain circumstances, private firms **may** **repurchase** shares out of **capital**.
## Footnote
Companies Act 2006 -- §692; §714-§723.
87
How are Repurchased Shares held by a Company?
As **Treasury Shares**, wherein any **associated rights cannot be exercised**. It may later either **liquidate**, **cancel**, or **distribute** them to employees.
## Footnote
Companies Act 2006 -- §724-§733.
88
What are Redeemable Shares?
Shares which may be **repurchased** by the **issuing company** from a shareholder on or after a **specific date** or **event** at a **predetermined price**, i.e. the Call Price.
89
Are Redeemable Shares permitted under Company Law?
**Yes**.
## Footnote
Companies Act 2006 -- §684.
90
Do Redeemable Shares require Prior Authorization by a Firm's Articles?
For **Public** Companies, **Yes**.
For **Private** Companies, **No**.
Companies Act 2006 -- §684.
91
For Public Companies, must the Terms of Redemption be specified in the Articles?
**No**. The Board can determine the **Terms**, **Conditions**, and **Manner** **discretionarily** prior to execution.
## Footnote
Companies Act 2006 -- §685.
92
How must a Redemption be Financed?
**Identically** to a **Repurchase**, subject to the **same exceptions**.
## Footnote
Companies Act 2006 -- §687.
93
Do Redeemed Shares become Treasury Shares upon redemption?
**No**. They **must** be **Cancelled**.
## Footnote
Companies Act 2006 -- §688.
94
Although Share Repurchases and Redemptions may indirectly lead to fewer existing shares, a Reduction of Capital is distinct attempt at such a goal. What are its Advantages?
They may allow the Firm to:
* **Return surplus** value to shareholders.
* **Reorganize capital** structure.
* **Boot shareholders**.
* **Transform** otherwise undistributable **reserves into realized profits**, i.e. distributable reserves.
* **Downsize** the scale of the operation.
95
What Legislative or Constitutional Barriers exist for Reductions of Capital?
**Special Resolution**, followed by **Court Approval** and subject to **Creditor Objection**.
## Footnote
Companies Act 2006 -- §641-§648.
96
What are Requisite Grounds of a Creditor Objection?
That a reduction of capital presents a '**Real Likelihood**' of **decreasing** the firm's **repayment** **capacities**.
## Footnote
Companies Act 2006 -- §646-§648; *Re Liberty Internationl Plc.* [2010] EWHC 1060; *Prudential Assurance Co. Ltd. v Chatterley-Whitefield Collieries Co. Ltd.* [1949] AC 512; *Re Royal Scotland Assurance Plc.* [2011] SLT 264; *Re Vodafone Group Plc.* [2014] EWHC 1357.
97
Whose Interests must the Court account for regarding Reductions of Capital?
1. **Creditors**.
2. Shareholders.\*
Companies Act 2006 -- **§645**; *Scottish Insurance Corp. v Wilsons* [1949] AC 462\*; *Re Northern Engineering Industries Plc.* [1994] BCC 618\*;
98
Must Private Companies also go through the Courts to legalize a Reduction of Capital?
**No**. They may **instead** utilize the **Solvency Statement Mechanism** in addition to a Special Resolution.
## Footnote
Companies Act 2006 -- §643; *BTI 2014 LLC. v Sequana SA* [2016] EWHC 1686; *LRH Services Ltd. v Trew* EWHC 600.
