Corporate Finance – LLM Lecture 6 Comprehensive Notes

Lecture Setting & Scope

• 6th lecture in the LLM Company-Law module.
• Focus: Corporate finance within the Companies Act No. 07 of 2007 (Sri Lanka) – mainly §§ 50-60.
• Links to prior lectures: Companies Act overview, shareholders, corporate veil, perpetual succession, director’s duties, term-paper guidance.
• Exam type: open-book → emphasis on analytical use of sections/cases, comparative comment (UK, SG, NZ, AU, IN preferred; US less useful).

Essential Background Concepts

• Stakeholder shift (1982 → 2007 Act)
  • 1982: Shareholder-centred.
  • 2007: Wider stakeholder view – shareholders, directors, creditors (key for finance), employees, suppliers, community & state.
• Company Constitution
  • Single document: Articles of Association (AoA) – § 13 (objects, rights, internal rules).
  • Optional object clause → if included, ultra vires doctrine (-§§ 16-17) applies.
• Promoters / Initial shareholders
  • Named in incorporation documents (§ 4) – synonym: subscribers.
  • Provide subscribers’/initial capital (must be recorded in articles and issued “immediately” on incorporation – § 50(1)).
• Shareholder statutory bundle (§ 49(3))
  1. 1 share = 1 vote.
  2. Right to dividends (when lawfully declared).
  3. Right to equal share in surplus assets on winding-up.
  • Extra rights may be added by Articles (e.g. preference dividends).

Terminology Refresh

• Finance = doing business with the money available.
• Legal capital = only amounts contributed in exchange for shares issued (NatWest v IRC).
• Capital vs Income
  • Capital appears as a liability (to shareholders) and should not erode through trading; income may fluctuate and be spent.

Issue vs Allotment of Shares

• Allotment = contractual commitment between company & subscriber (offer + acceptance) – shareholder becomes entitled.
• Issue = registration of that allotment in the company’s share register – shareholder acquires full legal status & rights (dividends, voting).
• Main cases:
  • Aurgam Gold Mining (1892)
  • Cohen v Segal (1970)
  • Lewis v Williams (1999)

Core Statutory Provisions (2007 Act)

• § 4 (1) – initial shareholders & subscribers’ capital.
• § 13 – content of Articles.
• § 16 – Articles = contract between company & shareholders.
• § 49(3) – core shareholder rights.
• § 50 – Issue of initial shares: must be effected immediately after incorporation.
• § 51 – Subsequent issues
  • Subject to Articles + §§ 52 & 53.
  • Board “may issue” → director duty (must notify ROC within 20 working days – § 51(4)).
• § 52 – Consideration
  • Board must decide price fair & reasonable (§ 52(1)(b)) — usually on auditor advice.
  • No issuance for non-valuable consideration (echoing English contract law).
• § 53 – Pre-emptive rights (mainly private companies): existing members must be offered new shares before outsiders.
• § 57 – Solvency test (defined – see below).
• § 58 – Stated capital = total of paid-up + unpaid capital (including subscribers’ capital) subject to § 59.
• § 59 – Reduction of stated capital
  • Requires special resolution + public notice (2 months) + solvency test.
  • Contractual prohibition with a creditor overrides (§ 59(3)).
  • Officers personally liable for wrongful reduction (§ 59(6)(b)) → example of piercing the veil.

Comparison: 1982 vs 2007 Regime

Forms of Capital (Illustrative Example)

Assume per-share price Rs 10 (initial), later Rs 15/20.

Double-Entry Logic (simplified)

1. Shareholder injects Rs 1,000,000:
   • Debit Cash $+1{,}000{,}000$
   • Credit Share-Capital $+1{,}000{,}000$ (liability to shareholder)
2. Company buys laptop Rs 100,000:
   • Debit Laptop (Fixed Asset) $+100{,}000$
   • Credit Cash $-100{,}000$
   • Share capital unchanged ⇒ capital not eroded; only asset composition changes.

Solvency Test (§ 57)

• Two cumulative limbs:
  1. Liquidity test (§ 57(1)(a)) – company can pay debts as they fall due in ordinary course.
  2. Balance-sheet test (§ 57(1)(b)) – \text{Value of Assets} > \text{Liabilities} + \text{Stated Capital}.
• Must be satisfied for:
  • Reduction of capital (§ 59)
  • Distributions / dividends (§ 56)
  • Financial assistance (§ 70)
  • Major transactions (§ 185)
  • Share buy-backs, amalgamations, etc.
• Directors must sign solvency certificate; false certification → personal & criminal liability (§§ 213, 214).

Capital Maintenance Doctrine

• Origin: 19th-century English common law – Flitcroft’s Case principle: capital is a “security fund” for creditors.
• Rationale
  • Protect creditors who advance funds relying on capital figure.
  • Preserve shareholders’ last-priority entitlement (return of capital only on winding-up).
• Mechanisms in 2007 Act
  • Stated-capital regime (no par value, but disclosure).
  • Solvency-test filter for capital reductions, distributions, buy-backs, etc.
  • Personal liability of officers for unlawful reductions or distributions.
• Criticisms / modern challenges
  • Too rigid; may trap funds that could be better used elsewhere.
  • Accounting argument: focus should shift to real-time asset values & cash-flow forecasting.
  • Fin-tech & asset-light models (e.g. Uber, PickMe, SPEs) question link between capital & capacity.

Practical / Ethical Issues Discussed

• Donations by promoters/directors to the company → need consideration; otherwise not capital (English law dislikes gratuitous transfers).
• Political donations by companies – no explicit Sri Lankan prohibition (unlike UK), but directors’ disclosure duties §§ 183-184 + possible veil-lifting for abuse.
• Asset contributions (director’s car/building) acceptable if:
  • Fair value assessed (auditors),
  • Shares issued or lease/rental properly recorded.
• Misuse of deposit-taking finance companies (e.g. Golden Key, F&G, ETI) illustrates failure of capital maintenance & regulator oversight.

Key Case Bank (selected)

• Salomon v Salomon (1897) – separate personality & creditor priority.
• Flitcroft’s Case (1882) – capital inviolability.
• National Westminster Bank plc v IRC (1994) – definition of legal capital.
• Hatton National Bank v Lankatile (2015) – solvency certificate validity.
• Global Rubber Industries (Pvt) Ltd CoHC 2010 – distribution struck as unlawful; directors personally liable.
• Colombo Stock Exchange v PC House (2014) – breach of listing rules, capital erosion.
• Damitha Perera v Valuable Finance – misuse of share issues at discount → fiduciary breach.

Sections Touching Director Liability (cross-references)

• § 51(4-5) – failure to notify ROC of share issue → company liable (veil intact).
• § 59(6)(b) – wrongful capital reduction → officers personally liable (veil pierced).
• §§ 183-184 – interest disclosure.
• §§ 219-225 – reckless trading & fraudulent preference (winding-up context).
• §§ 213-214 – false solvency certificates.

Examination & Writing Tips

• Bring a clean hard-copy Act; annotate during study with:
  • Star-marks on key sections.
  • Cross-references (e.g. at § 4 note “see § 50”).
• Start answers on shareholders’ rights with § 49(3) before minority remedies.
• When analysing director duties, cite § 51 (power to issue) plus solvency-related duties.
• Compare 1982 vs 2007 to show reform reasoning; add foreign best practice (UK 2006, NZ 1993 no-par value model, etc.).
• Use solvency equations and double-entry illustrations for clarity.

Further Reading / Resources

• Harsha Cabral, Company Law of Sri Lanka – Ch. on solvency (“silver thread” metaphor).
• Kanag-Isvaran & Pathirana, Company Law (selected chapters uploaded).
• Articles on no-par value & stated capital (LMS uploads).

Pending Uploads (promised by lecturer)

• Special chapter from Dr Cabral’s book.

Take-away Summary

• Post-2007 Sri Lankan company finance pivots on stated capital and the solvency test rather than par value & court-approved capital maintenance.
• Directors wield greater flexibility (no authorized-capital ceiling), but their decisions are policed by solvency certification, disclosure, and potential veil-piercing liability.
• Understanding the flow of sections (§§ 4 → 50 → 51 → 52 → 53 → 58 → 59 → 57) plus basic double-entry logic equips you to analyse any corporate-finance problem, from share issues to winding-up.