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transcript
Why can’t we do this at book value?
Everything you need to know about maintenance of capital
4 July 2012
Glafkos Tombolis
James Wilkinson
What does it all mean?
What are the rules?
Distributions in kind
Decision tree analysis
Real-life examples
Agenda
1 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
What does it all mean?
2 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
A company’s balance sheet
3
Assets 100
Liabilities (50)
Net assets 50
Share capital 10
Share premium account 10
Profit and loss account 30
Shareholders’ funds/equity 50
Why can’t we do this at book value? – Everything you need to know about maintenance of capital
What does it all
mean?
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What does it all
mean?
Share capital – no specific statutory definition, but see Sections
540(1) and 548 CA 2006
Share premium account and merger reserve – Sections 610(1)
and 612 CA 2006
Other undistributable reserves – Section 831(4) CA 2006
–capital redemption reserve
–excess of accumulated unrealised profits over accumulated
unrealised losses (revaluation reserve)
–any other reserve designated as such in articles
Distributable reserves – Section 830 CA 2006
What is “capital”?
Basic rule: Share capital and other non-distributable
reserves (e.g. share premium) constitute a “buffer” primarily
for the benefit of creditors and shareholders (in that
order)
It is the relationship between this “buffer” and the company’s
net assets that will determine whether maintenance of
capital rules have been breached
5 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
What does it all
mean?
Basic rule
“One of the main objects contemplated by the legislature, in
restricting the power of limited companies to reduce the amount
of their capital as set forth in the memorandum, is to protect the
interests of the outside public who may become their creditors
… the effect of these statutory restrictions is to prohibit every
transaction between a company and a shareholder, by means of
which the money already paid to the company in respect of his
shares is returned to him, unless the Court has sanctioned the
transaction. Paid-up capital may be diminished or lost in the
course of the company’s trading; that is a result that no
legislation can prevent; but persons who deal with, and give
credit to a limited company, naturally rely upon the fact that the
company is trading with a certain amount of capital already paid
… and they are entitled to assume that no part of the capital
which has been paid into the coffers of the company has been
subsequently paid out, except in the legitimate course of its
business”.
Lord Watson, Trevor v Whitworth 6 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
What does it all
mean?
The rules
7 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
The basic common law rule: a distribution of a company’s assets
to a shareholder, except in accordance with specific statutory
procedures, is a return of capital that is unlawful and ultra vires the
company
Section 851 CA 2006 – common law rules on distributions
preserved
Trevor v Whitworth (1887) – A company cannot lawfully make a
distribution out of capital
Aveling Barford v Perion (1989) – Undervalue sideways or
upstream transactions are distributions
Progress Property v Moorgarth Group (2010) – Must consider true
character of transaction to determine if a distribution at all.
Directors’ intentions likely to be relevant factor
8
The rules
8
Common law
Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Company cannot own shares in its holding company > to prevent
indirect acquisition by a company of its own shares
Restrictions on paying commissions to subscribers for shares >
would reduce capital, effect of a discount
Shares cannot be allotted at discount to nominal value > absolute
prohibition to ensure a minimum level of capital is maintained to
protect interests of creditors
Companies Act 2006 - General
The rules
Reductions of capital > only by court sanction or solvency
statement so as not to adversely affect creditors
Companies may not acquire their own shares (certain exceptions
exist) > to protect third parties from disguised reduction of capital,
indirect ownership by the company of itself and manipulation of its
share price
Financing of redemption > potentially prejudicial to interests of
company’s creditors so can only be done out of distributable
profits, a fresh issue of shares or, if a limited company, out of
capital
Value of premiums on shares must be credited to share premium
account > share premium is a non-distributable reserve and may
only be reduced as per reduction of capital procedures
10 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Companies Act 2006 – General
(cont.)
The rules
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PLCs can only make distributions if, at time, net assets are not less than
share capital + undistributable reserves and if and to extent that the
distribution does not reduce net assets to less than that total
PLC shares cannot be allotted unless at least ¼ paid up > ensures PLC
has a minimum level of paid up capital which serves as fund for protection
of creditors’ interests
PLCs cannot accept non-cash consideration without independent
valuation > ensures PLC receives money or money’s worth for issued
shares, protecting creditors from PLC acquiring worthless assets
Duty of directors of PLCs to report serious loss of capital > to protect best
interests of company’s creditors and shareholders
UK PLCs cannot provide financial assistance in connection with the
acquisition of their shares/shares of holding company > to prevent outflow
of assets from the PLC with nothing in return
11
Companies Act 2006 – PLCs
The rules
Directors’ duties (Sections 170-181 CA 2006). In particular,
company law does not recognise a concept of group benefit.
Therefore, any proposed transaction must be in the best interests
of the particular company
Reviewable transactions:
–transactions at an undervalue – Section 238 Insolvency Act 1986
–preferences – Section 239 Insolvency Act 1986
–transactions defrauding creditors – Section 423 Insolvency Act
1986
Capacity – check powers in articles (and/or memorandum of
association)
12 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Don’t forget…
The rules
Distributions
13 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Company must have “profits available” – Sections 830(1) and
853(4) CA 2006
Question is an accounting one
Distribution must be justified by “relevant accounts” – Sections
836-839 CA 2006
Post balance sheet events to be taken into account
Basic rule
Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Check articles
Comply with Companies Act formalities for distributions in Part 23
(Section 829 et seq.)
Distributable reserves must equal or exceed original book value –
ex parte Westburn Sugar Refineries Ltd (1951)
“Mark-to-market” – Section 846 CA 2006:
–must do where, following upwards revaluation, uplifted book
value exceeds DRs
–can do where DRs equal to or exceed book value, but market
value is higher; provides statutory cover
15 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Distributions
“Express” distributions in kind
What is a “distribution”? “ ‘…..Every distribution of a company’s
assets to its members, whether in cash or otherwise…” (Section
829(1) CA 2006)
Non-cash asset: Section 1163 CA 2006
Aveling Barford and other case law: extremely wide concept of
benefits flow and types of transactions caught
Codification of Aveling Barford: Section 845 CA 2006
Progress Property v Moorgarth (2010) – the court will not always
apply a purely objective test
Decision tree analysis
16 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
“Dressed up” or de facto
distributions
Distributions
The most comprehensive technical analysis on distributions
available – 168 pages
Particularly useful in relation to intra-group transactions, such as:
–dividends received on investment in subsidiary
–subsequent reinvestment of dividends received from subsidiary
–dividends received from pre-acquisition profits
–sales of asset by parent to subsidiary
–sales of asset by subsidiary to parent followed by dividend of
resulting profit
–capital contributions
ICAEW Tech 02/10
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Decision tree analysis
18 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
19 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Distributions
Does the transaction involve the provision of
services to a member (direct or indirect)
No distribution
Distribution – company must have sufficient
DRs immediately prior to transfer to cover
amount by which consideration is less than
book value
Yes
Does the transaction involve the
transfer/sale/disposition of a non-cash asset to a
member (direct or indirect?)
No
Is the company receiving any consideration for the transfer?
Theoretical risk of
distribution of services
provided at below cost
Yes No No Yes
Does the company have positive
DRs immediately prior to transfer?
Distribution in specie.
Company must have
sufficient DRs to cover book
value of non-cash asset being
transferred
Yes No
Is the company receiving consideration equal to
or greater than book value of non-cash asset?
Yes No
No distribution
Distribution – unless
consideration is market
value or Progress
Property applies
Non-cash distributions
20 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Distributions
Non-cash distributions
Positive distributable
reserves immediately prior
to transfer
Negative distributable
reserves immediately prior
to transfer
Market value
Less than market value but more than book value
x
Book value
x
Less than book value
but only if distributable
reserves are sufficient in
amount to cover the
difference between the
consideration paid and the book value
x
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21
Why can’t we do this at book value? – Everything you need to know about maintenance of capital
22 Why can’t we do this at book value? – Everything you need to know about maintenance of capital
Glafkos Tombolis
Partner
ddi 020 7710 1672
glafkos.tombolis@kemplittle.com
James Wilkinson
Associate
ddi 020 7710 1679
james.wilkinson@kemplittle.com
Kemp Little LLP
Solicitors
Cheapside House
138 Cheapside
London EC2V 6BJ
Tel: 020 7600 8080
Fax: 020 7600 7878
www.kemplittle.com
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