Share Capital and Capital Maintenance

Share Capital and Capital Maintenance

Syllabus tag: KASNEB CPA | Intermediate Level | CA21 Company Law | Topic 8 Share Capital and Capital Maintenance

Lesson objectives

By the end of this topic, you will be able to:

• Distinguish the classes of share and the rights attaching to each
• Explain the doctrine of capital maintenance and why it exists
• State the conditions for reducing capital and for a share buyback
• Explain when a dividend may lawfully be paid
• Describe how class rights are varied

Why this matters

Members enjoy limited liability, so creditors can look only to the company's assets. Capital maintenance is the body of rules that stops the members quietly taking those assets back. Every rule in this topic protects creditors rather than shareholders.

Classes of share

Class	Rights
Ordinary	Vote; dividend at the directors' discretion; residual assets on winding up
Preference	Fixed dividend paid first; usually no vote; priority on winding up
Cumulative preference	Arrears of dividend carried forward and paid before ordinary dividends
Redeemable	Issued on terms that they will or may be bought back
Deferred (founders')	Rank behind ordinary shares

Preference shareholders are often described as being in a safer position than ordinary shareholders. They are — as to income and as to priority — but they have no vote, so they cannot influence the decisions that determine whether the company can pay them at all.

The doctrine of capital maintenance

Share capital is regarded as a permanent fund available to creditors. It may not be returned to members except by procedures the Act permits.

The consequences:

• Shares may not be issued at a discount below nominal value
• Capital may not be reduced except by the statutory procedure
• Dividends may be paid only out of profits, never out of capital
• A company may not generally provide financial assistance for the purchase of its own shares

The rule is not there to protect shareholders from each other. It exists because the price of limited liability is that the capital stays in.

Reducing capital

A company may reduce its share capital by special resolution, with the protections the Act requires — which involve either court confirmation or a solvency statement by the directors, depending on the route taken.

Legitimate reasons include cancelling capital no longer represented by assets, returning capital genuinely surplus to requirements, and eliminating a deficit so that dividends may resume.

Creditors are entitled to object, because a reduction removes the very fund they relied on.

Buying back shares

The Companies Act 2015 permits a company to purchase its own shares, which the previous law largely prohibited. Conditions apply: the purchase must be authorised, funded from permitted sources, and the shares are cancelled or held in treasury.

The concern the rules address is straightforward. A buyback returns cash to selling shareholders and reduces the assets available to creditors — so it is permitted, but only on terms.

Dividends

A dividend may be paid only out of profits available for the purpose — accumulated realised profits less accumulated realised losses.

Two points recur in examinations:

• The test uses accumulated figures, not the current year alone. A company with a profitable year but larger losses brought forward has no distributable profit.
• The profits must be realised. An unrealised revaluation surplus is not distributable, which is why the revaluation surplus in IAS 16 sits separately in equity.

Directors who authorise an unlawful dividend may be required to repay it, and a shareholder who knew or ought to have known of the illegality may have to return it.

:::checkpoint A company reports a profit of KES 6 million this year against accumulated losses brought forward of KES 9 million. The directors propose a dividend of KES 4 million, pointing to the current year's profit. Advise them. :::

Class rights and variation

Rights attaching to a class of shares may be varied only with the consent of that class — typically a special resolution of the class or written consent of the prescribed proportion.

A minority of the class who did not consent may apply to the court to have the variation cancelled, within the statutory period.

The protection exists because a bare majority of the company as a whole could otherwise strip a minority class of the very rights they paid for.

Issuing shares

Directors may allot shares only where authorised by the articles or by the members.

Pre-emption rights require that new shares be offered first to existing members in proportion to their holdings, so that a member's percentage is not diluted without their consent. These rights may be disapplied by special resolution.

Payment. Shares may be paid for in cash or in kind, but not at a discount to nominal value. Where the consideration is non-cash, it must be genuine — the rule against discount cannot be evaded by accepting property at an inflated valuation.

:::checkpoint A company with two equal shareholders issues new shares to one of them only, without offering them to the other. Identify the right infringed and state the remedy available. :::