Welcome to Capital Maintenance and Dividend Law!
Hello there! Welcome to one of the most important parts of your Corporate and Business Law (LW) studies. Don't worry if the title sounds a bit "dry" at first—it’s actually all about one simple, fair idea: protecting the people who lend money to a company.
In this chapter, we are going to explore why a company can’t just give all its money back to its shareholders whenever it feels like it, and the strict rules it must follow when it wants to pay dividends or buy back its own shares. Think of this as the "Company Rulebook for Keeping the Piggy Bank Safe." Let’s dive in!
1. The Doctrine of Capital Maintenance
Imagine you lend £1,000 to a friend to start a business. You feel okay about it because you know they have £5,000 of their own money in the business "pot" as a safety net. But what if, the next day, your friend gives that £5,000 back to themselves as a "gift" and leaves the pot empty? You’d be pretty worried about getting your £1,000 back, right?
Capital Maintenance is a legal principle designed to prevent this. It says that once a company has issued share capital, it must preserve that capital as a permanent fund for the protection of its creditors (the people the company owes money to).
The Core Rule: A company generally cannot return its share capital to its members (shareholders) except in very specific, legally defined ways.
Why is this important?
Because shareholders have limited liability. If the company goes bust, creditors cannot chase the shareholders for their personal houses or cars. Therefore, the creditors' only "security" is the capital held within the company itself.
Quick Review:
- Capital = The safety net for creditors.
- Maintenance = Keeping that safety net in place.
2. Dividends (Distributions)
A dividend is a way a company shares its success with its owners. In legal terms, this is called a distribution. However, a company can't just hand out money if it hasn't actually made a profit.
The Basic Rule for All Companies
A company can only pay a dividend out of distributable profits. Here is the formula you need to know:
\( Distributable \ Profits = Accumulated \ Realised \ Profits - Accumulated \ Realised \ Losses \)
Key Terms Explained:
- Realised Profits: Profits the company has actually earned (usually cash or a legal right to cash).
- Unrealised Profits: "Paper profits." For example, if a company owns a building that went up in value on paper, but they haven't sold it yet, that profit is unrealised and cannot be used to pay a dividend.
Extra Rules for Public Companies (PLCs)
PLCs are held to a higher standard because they deal with the public's money. A PLC can only pay a dividend if:
- Its net assets are not less than the total of its called-up share capital and its undistributable reserves.
- The dividend doesn't reduce the net assets below that total.
Analogy: Think of a PLC like a tall person who wants to jump. They can only jump if they are standing on a very high platform (the net asset buffer) and the jump doesn't make them fall below a certain safety line.
Key Takeaway
Private companies just need to cover their past losses. Public companies need to cover their losses plus keep an extra buffer of reserves untouched.
3. Serious Loss of Capital (PLCs only)
If a Public Company (PLC) loses a lot of money, it has to act fast. If its net assets fall to half (or less) of its called-up share capital, the directors must call a General Meeting of the shareholders. They must do this within 28 days of becoming aware of the situation to discuss what (if anything) should be done.
Common Mistake to Avoid:
Students often think the company must shut down or stop trading. This isn't true! They just have to hold a meeting to talk about the problem.
4. Reduction of Share Capital
Sometimes, a company has more capital than it needs, or it wants to wipe out accumulated losses to start paying dividends again. It can reduce its capital, but it must follow strict procedures to ensure creditors aren't cheated.
How Private Companies (Ltd) Reduce Capital:
- Pass a Special Resolution (75% majority vote).
- The directors sign a Solvency Statement. This is a formal promise that the company can pay its debts for the next 12 months.
How Public Companies (PLC) Reduce Capital:
- Pass a Special Resolution.
- Obtain Court Approval. The court will check to make sure creditors are protected.
Memory Aid:
- Private = Fast & DIY (Solvency Statement).
- Public = Formal & Supervised (Court Approval).
5. Purchase and Redemption of Own Shares
A company might want to buy back its own shares from a shareholder. There are two main ways this happens:
- Redemption: The shares were issued with the "agreement" that the company would buy them back at a certain date (Redeemable Shares).
- Purchase: The company decides later on that it wants to buy back shares that are already in circulation.
The Rules for Both:
- The shares must be fully paid. You can't buy back shares that the shareholder hasn't finished paying for!
- They are usually funded by distributable profits or the proceeds of a fresh issue of shares made for that purpose.
The "Capital" Exception (Private Companies Only)
A private company may be allowed to use its actual capital to buy back shares if it runs out of profit/fresh issue money, but this is a very complex process involving special resolutions, audits, and public notices. For your exam, just remember that this is generally a privilege for Private companies, not PLCs.
6. Financial Assistance
Financial Assistance is when a company gives a gift, a loan, or security to someone else so that person can buy the company's shares.
Example: A company lends £5,000 to Bob so Bob can buy £5,000 worth of shares in that same company.
The Prohibition
For Public Companies (PLCs), financial assistance is generally illegal. It is a criminal offence for the company and its officers.
The Exceptions
It is not illegal if:
- The company’s main business is lending money (like a bank).
- The money is provided for an Employees' Share Scheme.
- The assistance is given in good faith in the interests of the company (e.g., as part of a larger business deal).
Did you know?
Private companies used to be banned from giving financial assistance too, but the law changed in 2006. Now, private companies are generally free to give financial assistance, provided they don't break other rules (like the rule against returning capital illegally).
Final Summary Checklist
Before you move on, make sure you're comfortable with these points:
1. Why maintain capital? To protect creditors.
2. Where do dividends come from? Realised profits minus realised losses.
3. PLC Dividend Rule: Must maintain a buffer of net assets.
4. Reducing Capital: Private needs a Solvency Statement; Public needs Court Approval.
5. Financial Assistance: Banned for PLCs (with small exceptions), allowed for Private companies.
Don't worry if this seems tricky at first! The key is to always ask yourself: "Is this action taking away the safety net from the creditors?" If the answer is yes, there is probably a strict rule to stop or control it.