Reduction of Capital in Companies - Essay Example

? Company Law 2006 – An Analysis Question No Reduction of Capital Reduction of share capital will certain times will be opposed by creditors or particular class of shareholders whose shares are reduced as it will create bad impact on creditors’ buffer. As per the sections 641 to 649 of the Companies Act, 2006, a public company can reduce its share capital with permission from a court. It is obvious for the management of a company to resort to reduction in share capital, mainly to extinguish a shortfall on its profit & loss account. By eliminating the loss in the profit & loss account through reduction of share capital, company can declare dividends. Even when a company is trading profitably, the accumulated loss in its profit & loss account obstruct a company’s ability to declare dividends. A public company’s Articles of Association should have a provision for the reduction of share capital prior to seeking consent from shareholders for a reduction of capital. In case, if the Articles of Association of a company does not contain a restriction for the reduction of capital, then it may be altered by passing a special resolution in the member’s meeting. Under the CA 2006, a measure of creditor’s protection is offered by the express need that the solvency statement should cover all the details of liabilities of the company. In opposition to the court sanctioned procedures, the creditors do not have any privilege to object to a diminution of share capital. The statement of solvency should take into account all the contingency and prospective liabilities. If the company is having a shareholder’s agreement or availed bank finance, then consent from these stakeholders is necessary for reduction in share capital. It is necessary to get the shareholders’ approval through special resolution wherein more than 75% of members have to vote for the resolution.1 The Article 32 of the Second Company Law Directive2 is authorising creditors of a public company to apply to a court if they oppose a reduction in share capital, which is meant for creating undistributable reserve which is in excess of 10% of the capital so reduced or to simply writing off present losses3 . As per section 646 of CA 2006, creditors can oppose to the planned reduction if it involves either the payment of paid-up capital to any shareholder or a diminution of shareholder liability as regards to unpaid capital unless the court deems that creditor should not be able to oppose or should be capable to oppose in a wider ambit as per section 645. In Russell v Northern Bank Development Corporation Ltd4 , it was held by the House of Lords that a company will be binding by an agreement by members that they will not encourage a shareholder’s resolution to vary its capital whereas it may not be binding itself, not to employ its authority bestowed on it by statue to vary its share capital. In British and American Trustee and Finance Corpn Ltd v Couper, the court was of the opinion that in case of reduction of capital, if objection is raised, the court will consider whether correct procedure was followed, whether creditors’ interests are not impacted and whether the scheme is equitable and fair between the parties footing upon the background of each cases5. The same view was also affirmed in the case Prudential Assurance Co Ltd v Chatterley –Whitfield Collieries Ltd6. In Re Saltdean Estate Co Ltd7 , it was held that if precedence is offered to the various classes as per the terms of issue, no separate class meetings are to be held to approve a reduction of capital. In the above, there was an opposition for a reduction of capital which was to be enforced by repaying the preferred shares. The reduction of preferred shares was approved by the court and it was opined by the court, that no variation of rights of preferred shareholders was there and there is no necessity to get the approval by a separate class meeting. The above view was also confirmed in House of Fraser Plc v ACGE Investments Ltd8. However, if the Articles of Association of the company does have a provision that privileges attached to a class of shares shall be considered to be altered by diminution of paid-up capital on that class of shares, then there is a need to conduct a separate class meeting shall have to be convened as 9held in Re Northern Engineering Industries Plc10. “Variation of Class Rights” CA 2006 has some safeguarding provisions to the holders of a class of shares against the privileges on their shares being varied. A class of non-voting shares or a minority class of shares would be susceptible to the privileges on those shares being varied by the majority shareholders. Sections 630 to 640 Companies Act 2006 deals with variation of class rights of shares of a company. Variation in class rights of a share capital of a company which consists various classes of shares can be made only as per the provision of section 630 of the CA 2006 if there is a provision in the Articles of Association of the company. If there is no provision in the articles, a special resolution is to be made for the variation of such rights by the holders of such shares11. The procedure set out in the CA 2006 is to be followed if the proposal is to modify the essence of the rights of a class of shareholders. It is to be noted that provision to modify or to introduce a new process pertaining to class rights could be regarded as a variation of class rights as it would be deemed as an annulment of right. In Re House of Fraser Plc12, the move by the company to confirm by a court as regards to reduction of capital was opposed by two preference shareholders. In this case, the court was of the opinion that preference shareholders’ priority had been accomplished and hence, not altered or varied. 13 As per s633 of CA 2006 ?at least 15% of shareholders has the right oppose any proposed variation who did not give their approval of such variation should apply to the court within 21 days to see that variation is cancelled by the court. Thus, the variation will have no impact till the same is validated by the court. Normally, the court will not interfere and will confirm the variation as proposed by the shareholders of that class. In some cases, court did not approve the variation as the variation has been approved by a resolution which ignored the interest of that particular class. However, in Re Holders Investment Trust Ltd14, reduction in capital was not approved by the court as it found the scheme as unjust and declined to approve the reduction by remarking that it fell significantly well below the verge of anything that can be reasonably called as fair15. The statutory provision of variation of class rights are buttressed by a rule of common law emphasised in the British American Nickel case. In this case, it was held that members who cast their vote at a class meeting must operate in the interest of the class as a whole. In Allen v Gold Reefs of West Africa Ltd, it was held that in casting their vote, the members of a company must look into advantage to the company as a whole in bona fide way. The same view was also expressed in the Re Holders Investment Trust Ltd also. From these decisions, we can understand that a class should not act against its own interest while acting for the benefit of the company as a whole. Further, class rights could never be altered or varied except to the holder’s advantages16. “Answer to Question 2 (a)” It is acknowledged truth that when economic conditions of a company deteriorate the intensity of fraudulent trading by director and by the companies will soar. Section 213 of the Insolvency Act 1986 states that a director will be held to recoup the losses occurred due to fraudulent trading. Section 214 of IA 1986 states the same in case of wrongful trading. As per Section 213 IA 1986, during the winding-up process of a company, if it is found that any company has carried on the business with an aim to deceive its creditors, the court may, on the basis of the application made by a liquidator to demonstrate that any person who intentionally did the business in that style, and these persons are accountable to make such a contribution to the assets of the company as the court may view. As per Section 993 of CA 2006, a criminal offence is imposed on directors in case of fraudulent trading irrespective of fact whether the company is being wound up or not. Fraudulent trading demands that the affairs of the company have been carried out with an aim to deceive the creditors of the company. In Re Purpoint Ltd17, it was held that the court has the authority to defer debts which is payable by a company to any individuals found accountable for wrongful trading. In Re Bangla Television Ltd, Valentine v Bangla Television Ltd, if a company transfers an asset for no consideration just before its insolvency thereby increasing the net deficiency of the company, then, for such deficiency, the company directors will be held accountable severally and jointly. In Re Continental Assurance Co of London Plc, it was held that there should be some link between the losses which the liquidator seeks to recover with that of the wrongfulness of the director’s demeanour18. Likewise, when a company is facing insolvency process, the liquidator will look into whether any prior period transactions have prejudiced the interest of the creditors. In such case, the liquidator may initiate to annul the impacts of transactions. Under section 127 of the Insolvency Act, 1986, a court may order the sale of such company assets, which was transferred for not adequate consideration. Under section 238 of the IA 1986, if prior to the liquidation process , if the company has gifted or sold the assets of the company which is far less than market value, the liquidator may treat the above transaction as undervalued sales or transfer. However, liquidator can commence such proceedings within twenty-four months prior to the date liquidation process. Moreover, a liquidator may not initiate the above said action if the company is able to demonstrate that such transaction has been made in good faith with the rationale of doing business, or if it deemed the transaction that would bring advantage to the company as a whole. Under section 423 of IA 1986, any transactions that have been taken place at undervalue for which an action may be initiated by a liquidator without any time limit. Under section 239 of IA 1986, any preferential transactions that have occurred could be made as voidable transaction. Under section 244 of the IA 1986, any extortionate credit transactions could be voidable at the hands of liquidator19. John’s action of selling off particularly valuable CG tools and equipment to his sister for a nominal price of ?5 will be regarded undervalued transfer by the liquidator. CG action of transferring ownership of a storage shed to the Engineering Department of the local further education college as a gift will be treated as an undervalued transfer by the liquidator of the company. “Answer to Question 2 (b)” A floating charge is one, which is shifting in nature will remain dormant until some crucial event happens as held in Illingworth v Holdsworth20. Floating charges will be normally created on current assets like stock or moveable assets. Floating charge holder does not have a right to hold the property until crystallisation of a legal event. A company under liquidation can avoid some floating charges under section 245 of the IA, 1986; if a floating charge is created within one year where to whom it has been granted is not connected to the company or two years if the beneficiary is connected to the company. The company should be under the liquidation process under the section 123 of the IA 1986 where the recipient is not connected to the company. In case, if a person is connected to the company, insolvency is not a criterion to invalidate the floating charge. The directors of a company will be held personally liable for their role in such voidable or void transactions21. CG borrows ?10,000 from Lenda plc in January 2006. As per s.876 (2) of the Companies Act, 2006, there is an obligation to maintain a register of all charges entered into by the company. Under section 860 and section 894, the company has to register the charges with the Companies House within three weeks of the creation of each charge. If charge is not registered, it would be void against the company’s liquidator. However, as held in Wright v Horton, non registration of charge with the Company House will not invalidate the charge in any way. In this, case, since Lenda Plc registered the charge well before six years of insolvency proceedings, the floating is valid and will ranking behind the fixed charge holders. The ?12,000 is actually paid to CG one hour before the floating charge is executed as a charge in addition to ? 20000 which was received by the CG in 2008. Hence, CG has not registered the floating charge on ? 20000, within 21 days of creation of such charge, and hence it would become void. Even though, Beatrice had paid the ?12,000 to CG just one hour before the execution of charge document, the timing of the event is not significant. Since, Beatrice is the wife of John, managing director of CG; it falls under facility received from a connected person. CG under liquidation can avoid some floating charges under section 245 of the IA, 1986, if a floating charge is created within two years if it received from connected persons, which can be declared void against the liquidator of the company. “Answer to Question 2 (c)” In January 2006, CG borrowed ?10,000 from Lenda plc and this is secured by a floating charge over CG's vehicles without covering any other assets. The floating charge is properly registered with the Company House. The corporate (company) provisions of the Enterprise Act 2002 came into effect from 15th September 2003 and from that date onward, the order of sequence as to who gets what from the residual in a liquidation process was transformed. Under the new act, PAYE and VAT liabilities which are known as crown creditors are no more known as secured claims in a liquidation process, and they do not have any preferential sequence during the repayment process. Further, if a bank holds debentures in the company, it would have preferential payment next to preferred creditors. Now, the new act had earmarked “prescribed a part” of the available sum which has declined the funds available to crown creditors in a preferential manner in a liquidation process. Thus, in a nutshell, the new act introduced a ring fence for a percentage of amounts, which is known as prescribed part that has to be employed to defray a dividend to unsecured creditors. Order of Sequence in repayment of the proceeds in an Insolvency Proceeding; Creditors with the fixed Charges over the assets of the company Banks which is having debentures and is having floating charge and Crown Creditors other than money set apart as prescribed part Unsecured creditors The aggregate sum available to unsecured creditors after making payment to secured creditors and the new smaller class of preferential creditors should be set apart as follows: That qualified amount, which must be earmarked to unsecured creditors The balance available is then arrived at for the floating charge holder. The prescribed part is Half of the first ? 10,000 of the sum “balance 20% “ It is to be noted that the amount borrowed by CG ?90,000 from Dee Bank plc will fall under unsecured creditors as the floating charge was not registered with the Company House. Since , the amount taken from Beatrice , wife of John, managing director , it will be come under an amount borrowed from connected person and is voidable by the liquidator and will qualify to payment only after Lenda PLC lending as regards to prescribed part. It is assumed that CG Ltd has CG borrowed ?90,000 from Dee Bank plc ?300 after secured and preferential creditors. 50% of the first ? 10000 (i.e. ?300) is ?150 “20% balance “ ? 30 “The prescribed part is” ? 180 Thus, Lenda Plc will be getting ?120 out of the balance available of ? 300 as a floating charge holder after deducting qualified part of ? 180 which is available to unsecured creditors of CG Plc22. “Answer to Question 2 (d)” It is to be noted that the amount borrowed by CG ?90,000 from Dee Bank plc will fall under unsecured creditors as the floating charge was not registered with the Company House within 3 weeks under section 860 and 870 of the CA 2006. An unregistered charge will be void against the liquidator of the company. Thus, an unregistered charge will form part of unsecured creditors in a liquidation process and as such, a charge holder loses his precedence against other creditors. A court has the authority to permit the late registration. Under s 876 of CA 2006 and a company is required to enter the charges created in the register of charges of the company and failure to adhere to this is an offence but does not make it invalid one.23 ”Answer to Question 2 (e)” A director in an UK company can be ordered as a disqualified director by a court and such order is to be registered with the Company House. Further, the disqualified director is not permitted to function as a management consultant for any company in UK. Sylvia and the manager are liable to be punished up to 24-month imprisonment as it constitutes as a criminal offence. Further, Linda and the manager shall be personally held accountable for any debts incurred by the company while acting as a management consultant to the company24. References Birds, J, Hildyard R, Robert & Boardman N, Annotated Companies Legislation (Oxford University Press 2012) Biz.gov.uk. ‘Effect of Disqualification ‘< www.bis.gov.uk/assets/insolvency/docs/.../effects-of-a-disqualification > accessed 3 January 2013 Bourne, N, Bourne on Company Law 5/e (Taylor & Francis 2011) Hannigan, B, Company Law (Oxford University Press 2012) Hunt, J & Evans, S, ‘Reduction of Share Capital ‘January 2012 http://www.everymanlegal.co.uk/wpcms/wp-content/uploads/Fact-Sheet-Reduction-of-Share-Capital.pdf > accessed 1 January 2013 Kelly, D et al, Business Law (Taylor & Francis 2011) NABARRO, ‘Void and Voidable Transactions on Insolvency” accessed 1 January 2013 Purnells .co.uk, ‘The Definition of the Prescribed Part and Case Study’ < http://www.purnells.co.uk/limited-company/the-prescribed-part/the-definition-of-the-prescribed-part.html < accessed 3 January 2013 Sealy, L & Worthington S, Cases and Materials in Company Law (Oxford University Press 2007) Read More