What are the circumstances that prompt a company to consider a reduction of its share capital? What is the result of such a reduction, and what are the relevant procedural requirements for doing so?
This article aims to provide a concise guide on the subject that will answer the above questions.
What does a Reduction of Share Capital mean?
Under the Companies Act 2006 (‘the 2006 Act’), procedures exist to allow a company to undertake a reduction of share capital. This is literally a reduction of the share capital account of a company. The share capital account of a company is the total amount paid to the company for its shares (the aggregate amount subscribed).
The procedure for private limited companies to reduce their share capital under the 2006 Act has been simplified in comparison to previous legislation.
Some examples of how a company may effect a reduction of share capital are:
- reduce the value of the company’s share capital to reflect capital losses;
- cancel further liability on partly paid shares; or
- pay back to members capital which is not needed.
The reasons for a reduction of share capital
Reducing share capital creates a reserve which is treated as a realised profit for accounting purposes, and thus has a positive effect on the distributable reserves of a company (unless, where a reduction has to be confirmed by court, and the court orders to the contrary).
Therefore reductions of share capital are frequently undertaken by companies to create and / or increase distributable reserves, or conversely to reduce accumulated losses.
Even if a company is currently trading profitably, the effect of accumulated realised losses suffered by a company in previous trading periods can block the payment of dividends. As a method of ‘clearing’ these past losses so that dividends can be declared, a reduction of share capital is therefore convenient.
When a company finds it has surplus cash (arising through the sale of assets for example) it can return this to shareholders through a reduction of share capital by repaying the existing paid-up share capital.
If a company wishes to fund a buyback/purchase of its own shares but has insufficient distributable reserves (and a fresh issue of shares or a purchase out of capital is not an option) a reduction of share capital to create the required distributable reserves can be undertaken in advance of the buyback.
Restrictions on the reduction of share capital
- No restrictions in the company’s Articles of Association (or any other document such as a Shareholders’ Agreement) preventing the reduction of share capital must exist;
- one non-redeemable share must be left after the reduction if the reduction is supported by a directors’ solvency statement; and
- in a court supported reduction creditors can object.
Approval of Shareholders
Private companies limited by shares can carry out a reduction of share capital by special resolution of the shareholders, either supported by a directors’ Solvency Statement or with the approval of the court.
It is important to note that public companies may only reduce their share capital by special resolution following confirmation by the court.
Reduction of Share Capital – Directors Solvency Statement (Private Companies only)
The directors must state the opinion that if there is no plan to wind the company up in the next 12 months, that the company will be able to pay its debts as they fall due in the year following the statement, and that in the event of a planned winding up, that all debts will be paid in full within 12 months of commencement of the winding up. They must also state that there is no ground on which the company could be found to be unable to pay its debts as at the date of the statement.
Directors can face unlimited personal fines and up to 2 years imprisonment if a Solvency Statement is made without reasonable grounds for these opinions.
Finally, the statement must be made and circulated or made available to shareholders no more than 15 days in advance of the resolution to reduce the capital taking place.
Reduction of share capital requiring court confirmation
- An application to the court to confirm the reduction of share capital sets out the circumstances of the reduction;
- it must be supported by a witness statement from a director verifying its contents and how creditors’ interests will be protected;
- the court is obliged to ensure creditors will be paid or obtain their consent to the reduction; and
- it is available to both private and public companies.
A reduction of share capital only takes effect on registration of the required filings at Companies House, which may take a number of days, however Companies House has a same day service for an additional fee.
There are various Companies House filing requirements and a general filing fee is payable regardless of whether the same day service is used.
Reductions of share capital are most usually undertaken to create distributable profit reserves which in turn can then be used for a buyback of shares or for the payment of dividends to shareholders. For private companies, directors who are able to make a solvency statement will find the process relatively simple. For companies that already have distributable profit reserves however, a direct buyback of shares might be the more straightforward option, which is worth considering as an alternative.
The information provided in this article about reduction in share capital is intended as a general guide only. It is not exhaustive or tailored to your individual circumstances.