Company Law - Share Capital

Corporate Personality

  • Key principle in company law: A company is a separate legal entity, distinct from its shareholders, directors, and managers.
  • Business structures:
    • Sole Trader, Partnership: Single legal entity.
    • Shareholders: Separate legal entities.

Legal Effect of Articles of Association - Recap

  • Articles bind the company and the shareholder(s).
  • Articles bind the shareholders to each other, but only in their capacity as shareholders.
  • Relevant case law examples:
    • Hickman v Kent & Romney
    • Pender v Lushington
    • Woods v Odessa
    • Rayfield v Hands
    • Eley v Positive GS New British Iron

Share & Shareholders - Overview

  • Topic areas:
    • Share Capital – Definition & Types
    • Class Rights – Definition & Variation
    • Issuing Shares – Authority & Payment
    • Capital Maintenance

Share Capital Definition

  • A share is “the interest of a shareholder in the company measured by a sum of money, for the purpose of a liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders” - Borland’s Trustee v Steel Bros & Co Ltd (1901).
  • In simple terms, a share represents a bundle of rights.
  • The rights are determined by the company and may be found in the Articles of Association or a Shareholder Agreement.
  • The rights usually given will depend on the type of share you acquire.

Share Capital – Ordinary & Preference Shares

  • Ordinary Shares
    • Voting Rights: Full voting rights.
    • Dividend Rights: Not fixed, and paid after preference share dividends.
    • Surplus on Winding up: Entitled to surplus assets after the repayment of preference shares.
  • Preference Shares
    • Voting Rights: Usually none, subject to Articles.
    • Dividend Rights: Fixed dividend paid in priority to other dividends, cumulative.
    • Surplus on Winding Up: Entitled to repayment of initial capital, but cannot participate in surplus.

Share Capital – Ordinary & Preference Shares - Investor's Perspective

  • Ordinary Shares
    • Riskier because they are the last to be paid out on a winding up – so if the company is insolvent you get nothing.
    • Advantage is that ordinary shares will appreciate in value if the company is successful, and therefore you share in the upside.
  • Preference Shares
    • Provide a guaranteed income, and less risky because they are repaid before Ords.
    • The downside is the shareholder will not benefit from capital appreciation and cannot vote on company business.

Share Capital – Ordinary & Preference Shares - Company's Perspective

  • Ordinary Shares
    • Carry voting rights, therefore majority shareholders might give away control.
  • Preference Shares
    • Do not dilute control, but dividends must be paid (or they are rolled up until eventual payment) and so reduce the discretion of directors over how they use of the company’s profits.

Rights of Members - Meetings

  • The rights of members (i.e. shareholders) to influence decisions taken in a company are, generally, limited.
  • Directors make the day-to-day decisions, and shareholders’ powers are restricted to voting on resolutions (or for larger shareholders, proposing resolutions).
  • VERY IMPORTANT CONCEPT = NO DIRECT CONTROL BY OWNERS; POWER EXERCISED THROUGH MEETINGS & RESOLUTIONS!
  • Detail of rules for meetings & Resolutions covered in Podcast in Week 4.

Class Rights

  • A company is free, subject to its Articles, to create different classes of shares, with each share carrying different rights.
  • Examples of share classes:
    • "A": Full Voting Rights, Fixed Dividends, Surplus on Winding Up
    • "B": No Voting Rights, No Fixed Dividends, No Surplus on Winding Up
    • "C": No Voting Rights, Fixed Dividends, No Surplus on Winding Up

Class Rights - examples

  • Management Shares – A class of share with extra voting rights to retain control of the company in particular hands (eg Facebook)
  • Deadlock Articles – A company with two investors (eg JV) may have two classes of shares. Articles may provide that eg two directors are nominated by each class of share
  • Variations of dividend, capital and voting rights

Class Rights- Can they be varied?

  • Yes – Class rights can be varied, the procedure depends on whether the matter is included in the Articles:
    • Is a procedure contained in the Articles?
      • Yes? Must follow the procedure set out in the Articles
      • No? Variation requires a special resolution or written consent (i.e. 75% majority) of shareholders in that class
  • But if a 75% majority can vote to alter the class rights of a share, could this not potentially detriment the minority shareholders?

Class Rights – Minority Protection

  • S.633 Companies Act 2006 (CA06) provides some protection to minority shareholders who feel unfairly prejudiced by a change in class rights.
  • If holders of ≥ 15% of the shares in that class object to the variation, they may ask a court, within 21 days of the resolution, to cancel the variation on the grounds that it is unfairly prejudicial
  • Important principle:
    • The courts will only cancel the variation if it represents an actual change to the rights themselves
    • Courts will not intervene if the variation merely affects the value, enjoyment or power derived from the rights

Class Rights – Minority Protection - Case Law

  • Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald (1986)
    • Claimant acquired a 10.67% stake in the Defendant company, with special rights attaching to those shares, including pre-emption rights and the right to appoint a director to the board
    • Defendant company passed a special resolution to remove these rights, but the courts held this was unlawful.
    • In providing these special rights they had effectively created new class of share, with one shareholder.
    • Alteration therefore required the shareholder’s consent, which they refused
    • This case illustrates the requirement in company law for class rights to be varied with a 75% majority of shareholders in that class
  • White v Bristol Aeroplane Co (1953)
    • The company had ordinary and preference shares in issue, both classes of share carried full voting rights
    • The Co made a bonus issue to ordinary shareholders only, as permitted by the Articles
    • Preference shareholders objected to the bonus issue on the grounds it reduced their voting power in the company, which effectively amounted to a variation of their rights without consent
    • The court held that the bonus issue was valid, and rejected the call for cancellation
    • The court stated that the bonus issue was NOT a variation of class rights and therefore did not require consent from preference shareholders
  • Greenhalgh v Aderne Cinemas Ltd (1950)
    • The company had two classes of ordinary shares in issue – 50p shares and 10p shares. Each share carried one vote.
    • The company passed a resolution to subdivide each 50p shares into five 10p shares. This effectively gave each existing 50p shareholder four new shares in the company (and 4 extra votes!)
    • The 10p shareholders objected to the subdivision as it diluted their voting power in the company
    • The court held that the subdivision was NOT a variation of class rights as the voting rights of the 10p shares remained completely unchanged. It was merely the power they enjoyed from the shares that had changed.

Issuing Shares Authority to Issue Shares

  • Directors may wish to raise extra capital by way of a share issue
    • Imagine someone pitching for investment on Dragon’s Den!
  • The problem for existing shareholders, is if another investors purchases the new shares in the company it will reduce their own proportionate stake i.e. it will dilute their control in the company
  • Company Law therefore requires Directors to seek authority to issue new shares
  • Authority may be given:
    • By the Articles of Association (unlikely)
    • By passing an ordinary resolution of shareholders (i.e. > 50% majority
  • Authority must state the maximum no of shares and expiry date

Issuing Shares – Terminology

  • Nominal Value
    • Every share has a nominal value, which is fixed at the time of incorporation. The nominal value forms the Share Capital Reserve in a company’s accounts.
    • E.g. X Ltd issues 1,000 £1 Ordinary shares
    • £1 = “Nominal Value” Share Capital Reserve = 1,000 x £1 = £1,000

Issuing Shares – Terminology - Partly Paid Shares

  • This is where the shareholder does not pay the full amount of nominal value for the shares immediately.
  • This is permitted by the Companies Act 2006, and the outstanding (“unpaid”) element is the shareholder’s liability in the event of winding up.
  • The Share Capital Reserve is still credited with the full nominal value, but the unpaid element is recorded as a debtor.
  • E.g. X Ltd issues 1,000 £1 Ordinary shares for £1 each. The company receives 40p per share immediately, with the rest unpaid.
    • Dr Cash (1,000 x 40p) £400
    • Dr Debtors (1,000 x 60p) £600
    • Cr Share Capital (1,000 x £1) £1,000

Issuing Shares – Premium & Discount

  • Issuing shares at a Premium
    • This means selling the shares for a price which is HIGHER than their nominal value - the premium is the price paid above the nominal value. (eg market value)
    • E.g. X Ltd issues 1,000 £1 ordinary shares for £1.80 per share fully paid
      • £1 = ”Nominal Value”
      • 0.80p = “Premium” (£1.80-£1)
    • The premium must be credited to a “Share Premium Reserve”
      • Dr Cash (1,000 x 180p) £1,800
      • Cr Share Cap (1,000 x £1) £1,000
      • Cr Share Premium (1,000 x 80p) £800

Issuing Shares at a Premium Continued

  • S.610 CA06 requires that the £800 in the Share Premium Reserve can only be used for the following:
    • Writing off expenses of the issue of new shares
    • Writing off any commission paid on the issue of new shares
    • Issuing bonus shares
  • The reserve is not distributable in any other way – E.g. it could not be paid out as a dividend!

Issuing Shares at a Discount

  • This means selling shares for LESS than their nominal value
  • This is FORBIDDEN according to s.580 CA06
  • If shares are issued at a discount the shareholder must pay up the discount plus interest
  • Note that issuing at a discount is not permitted by company law, but issuing shares partly paid is permitted:
    • Issue £1 ord shares for £1 per share, 40p paid up = ok
    • Issue £1 ord shares for 40p per shares = illegal

Paying for Shares

  • Do companies have to receive cash for their shares?
  • Private Companies
    • Private companies can issue shares for cash and non-cash consideration, such as property or investments.
    • To protect shareholders, the courts will interfere if the value of any non-cash consideration is “illusory, past or patently inadequate”
    • E.g. imagine a company issues £1m of new shares in return for a piece of land. This is ok as long at the land is actually worth £1m. If the land is only worth, say, £200,000 the courts will intervene to either cancel the share issue or force the shareholder to pay up the difference.
  • Public Companies
    • Stricter rules contained in CA06 apply to Public Companies:
      • S.584 Founding shareholders (initial subscribers) must pay for their shares in cash
      • S.585 Payment must not be in the form of services
      • S.586 At least ¼ of the nominal value of shares must be paid up, together with the whole amount of any premium
      • S.587 Non cash consideration must be received within 5 years of issue
      • S.593 Non cash consideration must be independently valued and reported on by a person qualified to be the company’s auditor. The valuation must be carried out within 6m prior to issue

Capital Maintenance Rules

  • The Share Capital Reserve, mentioned above, is regarded in law as the “creditors’ buffer”
    • This idea is largely notional in practice, but the principle is key in Company Law.
  • A company’s undistributable reserves are an accounting entry, not real money – however the amounts are to be maintained and kept aside for creditors
  • As a general rule, companies are FORBIDDEN from reducing their capital (buffer fund) by returning it to shareholders, whether directly or indirectly without passing a special resolution with consent of creditors

Dividends

  • Directors are not compelled to declare dividends, subject to any specific requirements within the Articles
  • Funding Dividend Payments
    • The general rule is that dividends can only be made out of distributable profits, and not out of capital
    • Distributable profits are accumulated, realised profits less accumulated, realised losses
    • A public company can only pay a dividend if its net assets are not less in value than the aggregate value of its called-up share capital and undistributable reserves
      • Undistributable reserves include: Share Premium Reserve, Share Capital Reserve, Capital Redemption Reserve, Revaluation Reserve

Dividends - Consequences of an Unlawful Dividend

  • If dividends are paid in contravention of the above rules, the company must recover the payment from:
    • The shareholder, unless they had no reasonable grounds to know the dividend was unlawful
    • Any director, unless he can show he exercised reasonable care in relying on the audited accounts
    • The auditors, if the dividend was paid in reliance on their incorrect accounts