share capital
One of the main issues in UK law is making sure that creditors can access the company's funds to pay their debts. This is done through capital maintenance rules, which are meant to protect the company's capital. Some commentators and authors argue that these regulations are unnecessary and not effective at protecting the goal, especially when there are other ways to assess the corporation's solvency, like directors' responsibilities and contractual mechanisms.
To understand the possible outdated nature of the rules, we need to first look at the main goals of the doctrine. The capital maintenance doctrine primarily aims to provide important safeguards for creditors. Owing to the Solomon doctrine and limited liability concept, creditors can pursue shareholders' or directors' personal assets to address any remaining debts. Directors have the authority to make corporate decisions that could result in excessive investment or poor business choices leading to company insolvency, this is a risk both shareholders and creditors (Trevor v white). Measures have been implemented to protect the company's assets and ensure that distributions are made only after assessing the financial position of the company to guarantee that the net assets never fall below its share capital. Achieving this objective can be done by implementing capital maintenance regulations, as seen in the legal frameworks of the UK and Germany. Alternatively, it may also involve imposing restrictions on shareholder distributions, a practice observed in the US. Both methods aim to protect the company's assets against insolvency and ensure that creditors' rights are upheld.
The aforementioned regime has been subject to significant scrutiny from the CLRSG. Notably, in 2001 and 2005, several alterations were implemented to British legislation in this realm. The CLRSg contends that if it were not for constraints imposed by EU law, more substantial modifications would have been enacted. They assert that the provisions represent the most intricate and technically demanding provisions observed within the 1985 act. Thus, the old law was deregulated to eliminate burdensome provisions that were applicable to private companies, including the prohibition on financial assistance. A consultation exercise revealed that most respondents placed little importance on a company's share capital when seeking credit, and instead prioritized the company's worthiness and its likelihood of meeting claims. Especially considering that alternative remedies better suited to addressing the necessary protection, such as duties of directors, wrongful trading provisions, and disclosure requirements among others were available.
It has been established that the rules are related to creditor protection. They regulate the acquisition and maintenance of capital by imposing restrictions on directors regarding unauthorised distributions that could be
considered unlawful returns of capital. We will now review the different rules and assess whether they may be outdated.
The theory of aggregate capital suggests the presence of a distinct fund with a designated amount, established through a subscription price or 'par value.' Capital maintenance rules prohibit the sale of shares at a price lower than their nominal value. This principle was highlighted in Orregum Gold Mining Co v Roper when the court refused to issue shares at market value, which was less than their nominal value. Creditors can be confident that the company has resources equal to its authorized share capital. However, issuing shares in exchange for non-monetary assets bypasses this requirement, as seen in the Wragg case where courts ruled that challenges to a director's decision on benefit and share price equivalence are not allowed. The courts have upheld the validity and enforceability of these transactions. It's important to note that these principles don't apply to public companies due to potential exploitation risks. In fact, additional conditions are imposed, requiring an independent valuation for non-monetary considerations. The effectiveness of this valuation as a protective measure is subject to debate due to associated costs and timing, as well as the fulfillment of this purpose by shareholder remedies and disclosure requirements.
Before distributing to shareholders, it is important to assess the company's financial position. According to common law, distributions should only come from the company's distributable profits; not doing so could make directors liable. In the case of Re Exchange, five directors were held responsible for allowing distributions despite having bad debts in the accounts. In Queen Moats House, the directors were required to pay 78 million for exceeding distributions from reserves. The Progress Property Ltd case indicates that understanding unlawful distributions is essential, and in the Madoff Services case, liability is determined by fault. In this case, the courts ruled that directors seeking a tax advantage are not liable. However, this decision was overturned by the HoLs who held that ignorance of the law is no excuse. This rule can be seen as a legitimate way to control self-interested directors. These distributions may also be structured as concealed gifts, citing Re Halt Gauge and the intra-group case.
To reduce the impact of share reduction on companies, the CLRSG has introduced a simplified process for private companies. They now need to obtain a resolution along with a solvency declaration. Public companies still have to submit the resolution to the court, giving creditors an opportunity to raise objections.
Directors can avoid litigation by buying back their own shares. Initially, common law restricted share redemption to minimize creditor risk. However, these limitations have been eased to give companies more flexibility with share capital.
In conclusion, it can be confidently asserted that creditors do not place much importance on share capital. Research by CLRSG shows that investors consider this factor of little significance when deciding whether to extend credit to the company or not. Cheffins argues that there are several reasons for this, with the merger and acquisitions records as well as the company's accounts providing limited insight. Furthermore, it is asserted that the historical nature of the share capital, being based on a past price no longer aligning with the company's current assets, contributes to this situation. The link between share capital and company success is small. Customized contracts may impose limitations on distributions, offering alternative mechanisms.
Moreover, one could argue that the need for a minimum share capital is ineffective as it only places unnecessary burdens on low-risk industries and provides little protection for high-risk industries. Despite the default rules, directors have obligations based on fiduciary duties, contracts, and disclosure requirements to safeguard creditors. The regulations on capital maintenance are inadequate and misdirected. One could argue that these rules are outdated, but the primary policy objective of safeguarding shareholders will remain in the future.
The main concern is to avoid insolvency, which is the only situation where creditors may not be fully repaid. Therefore, companies should take steps to protect their assets and supervise their operations to prevent insolvency.