9. Share Capital(2)

COMPANY LAW BAB 2202/LAW 2034

SHARE CAPITAL

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Share Capital

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Share Capital

Share Capital is the fund raised by a company through the issuance of common or preferential shares to individuals / institutional investors for the growth and expansion related aspects of the company.

It is also known as Equity Financing through which the shareholders of the issued capital receive rights of ownership in the concerned company by buying shares of the same.

Buyers of the Share Capital become owners of the company in accordance to their stake in the same and hence possess certain degree of control over its operation.

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Share Capital The amount of share capital a company

possesses is a variable. As a company issues more and more shares to the public in lieu of fund, the amount of share capital increases.

In the balance sheet of a company, issuing the share capital, it only reports the initial amount at which the share capitals were issued in the primary market. The company does not take into account any price appreciation or depreciation occurring due to the transactions in the secondary market into its balance sheet.

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Maintenance ofShare Capital The common law has designed a

number of rules to ensure that a company’s share capital remains intact as a fund to which the creditors can turn to as security for their debts.

A reduction of share capital is generally illegal unless authorized by legislation: Trevor v Whitworth (1887)

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Maintenance ofShare Capital Of course in practise the money obtained

will be used to purchase assets and companies can obtain loans or incur debts exceeding the amount of capital secured or raised.

However it is a fundamental rule that share capital must be maintained and that the company should not use the share capital except for the purposes set in the objects clause of the Memorandum.

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Maintenance ofShare Capital The principle therefore means that:

Paid up share capital must not be returned to members;

Members’ liability in respect of the share capital not yet paid up must be reduced and

Shares must be fully paid for.

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Maintenance ofShare Capital

Because of this principle, the rules developed by the courts prevent a company from purchasing its own shares, or issuing shares at a discount or paying dividends out of capital.

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Maintenance ofShare CapitalThe maintenance of share capital involvesconsideration of the following matters:a) the consideration paid for the sharesb) company purchasing its own sharesc) financial assistanced) reduction of capitale) issuing shares at a discountf) payment of dividends

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a) the consideration paid for the shares - Shares are not all issued for cash. Some issues, for example, bonus issues arise as a result of a capital restructuring of the company, sometimes called a rights issue.

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b) company purchasing its own shares – s67 CA 1965, prohibits a company from purchasing its own shares. The rationale for this is:

Possible unfair treatment to other shareholders

Possible infringement of the concept of separate legal personality

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Exceptions are as listed in s 67A. This is normally referred to as a buy-back of shares.

1) Notwithstanding the provisions of section 67, a public company with a share capital may, if so authorized by its articles, purchase its own shares.

(2) A company shall not purchase its own shares unless- (a) it is solvent at the date of the purchase and will not become

insolvent by incurring the debts involved in the obligation to pay for the shares so purchased; (b) the purchase is made through the Stock Exchange on which the shares of the company are quoted and in accordance with the relevant rules of the Stock Exchange; and (c) the purchase is made in good faith and in the interests of the company.

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c) financial assistance – the governing provision in the CA 1965

Section 67. Dealing by a company in its own shares, etc.(1) Except as is otherwise expressly provided by this Act no company shall give, whether directly or indirectly and whether by means of a loan, guarantee or the provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company or, where the company is a subsidiary, in its holding company or in any way purchase, deal in or lend money on its own shares.

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Maintenance ofShare CapitalThe definition of financial assistance: Charterhouse Investment Trust Ltd v.

Tempest Diesel Ltd [1986 Ch 1] Hoffmann J. that “there is no definition of giving

financial assistance in the section, although some examples are given. The words have no technical meaning and their frame of reference is in my judgement the language of ordinary commerce. One must examine the commercial realities of the transaction and decide whether it can probably be described as the giving of financial assistance by the company…”

Note: This is a UK case.

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Why the prohibition? The rationale is that if a company

supports the purchase of its own shares, it causes a de facto diminution in the company's value.

Such financial assistance also artificially inflates a share's price above its market level.

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For examples of financial assistance see pg 446 - A. Sulaiman, A. Bidin, P. Hanrahan, I. Ramsay and G. Stapledon, 'Commercial applications of company law in Malaysia', (3 ed, 2008).

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For permissible financial assistance – see s67(2) CA 1965.

For consequences of breach – see s67(3),(4) &(5)

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d) reduction of capital - a capital re-organisation that has the effect of allowing the return to shareholders of capital that would otherwise not be distributable. A reduction of capital is used to increase distributable reserves to make dividend payments possible, or to make a large return of capital more efficient. This is provided for in s64 CA 1965. Note the conditions stated therein.

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e) issuing shares at a discount – Section 59.

(1) Subject to this section a company may issue shares at a discount of a class already issued if -(a) the issue of the shares at a discount is authorized by resolution passed in general meeting of the company, and is confirmed by order of the Court;(b) the resolution specifies the maximum rate of discount at which the shares are to be issued; (c) at the date of the issue not less than one year has elapsed since the date on which the company was entitled to commence business; and (d) the shares are issued within one month after the date on which the issue is confirmed by order of the Court or within such extended time as the Court allows.

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f) payment of dividends - A portion of a company's earnings that is distributed to shareholders. The amount of earnings distributed as dividends is usually determined by the board of directors and divided by the number of shares, but preferred shareholders often have guaranteed dividends.

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Maintenance ofShare Capital A Company shall not make payment of

dividends to its shareholders except out of the profit or in pursuant to S60 CA 1965.

S365 CA 1965 stated that dividends should include bonus and payment by way of bonus.

Therefore any bonus issued must follow the principles laid down by S 365 CA 1965 i.e. payment made out of profit.

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(i) A dividend cannot be paid if: (a) it would result in the company’s assets

being insufficient to pay its debts; (b) it is paid out of the borrowed money

unless the company has divisible profit available.

(ii) A dividend can be paid: (a) Out of the profit of one year without

making losses of previous year. (b) Out of the profit arising from the bona

fide revaluation of unrealized fixed assets.

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Maintenance ofShare Capital What is the meaning attributed to

the term ‘profit’? The Companies Act 1965 is silent on

this and as such this has been determined by reference to decided cases.

For liability issues, see s 365(2)(b)

Documents

9. Share Capital(2)