Special Features of Corporate Law - Assignment Example

 COMPANY LAW – AN ANALYSIS Answer to Question No 1 Reserves A company’s fiscal policies should contain a scheme for maintaining adequate reserves. Reserves are an efficient fiscal management technique and a vital credit element in the analysis of financial flexibility. Every company and every well-managed company should create reserve fund. A reserve fund can be either general reserve, allocate fund to an equalisation of dividend reserve, contingency reserve or a taxation reserve or any reserve a company may desire but within the taxation angle. When company is earning good profits, it is prudent to build up reserves so that it can meet any eventually in case if there is downturn in its performance. Lenders including banks and rating agencies will give due regard to reserves accumulated by the company while sanctioning a line of credit or in their rating respectively. To decide the quantum of reserve to be appropriated from revenue of the company each year, it is wise for the company to allocate the same by using a flat rate percentage of operating revenues. A minimum of either five or ten percent should be targeted. Whether reserves are earmarked in the guise of redemption reserve, general reserve, they are significant indicator of a company’s financial health. (Incorvaia 2003) . Some countries allow companies who keep regular books of accounts on the accrual basis to appropriate reserves from their profits to meet contingent liabilities. Certain countries insist that a business should deduct some percentage from profits as statutory reserve every year from its profits. This is known as statutory reserve. This statutory reserve can be utilised to pay dividend in case if there is inadequacy of profits. A company can create a general reserve and allocate certain percentage of profits every year and this is called general reserve and the director are authorised to use the same when they prefer or if it necessitates and only requirement is that the directors have to disclose the same. Revenue reserves or distributable reserves As a prudent financial planning, limited companies hardly ever distribute their whole of profits and usually set apart a portion of profit in the guise of reserves. These reserves can be construed as “retained profit” or the balance of “gains and loss account.” Directors of the company usually carry out this to boost the confidence of the investors in the funding of the business. In exercising this option, directors are communicating their inclination not to employ those funds for dividends. However, these falls under general reserves, there is still hope that these general reserves can be used for the declaration of dividend. (Browne 2001:267) As on 31st December 2008, Webb Ltd is having £20,000 in their balance sheet as distributable reserves which are shown as Profit & loss account. Share Premium reserve It is the contribution by shareholders while subscribing the shares. Share premium account cannot be used to declare dividends. It can be utilised to issue fully paid bonus shares to the shareholders. One another illustration of this kind of reserve is options, where share holders contribute funds to purchase an option which offers them the privilege to purchase shares at a later date. Shareholders who are willing to pay the company are permitted to exercise the right of an option by exercising an option to purchase shares later. Shareholders have to pay extra money on exercising their option. Some argue that the option price is mere revenue as it does not really form part of the issue price of the share. As on 31st December 2008, Webb Ltd is having £10,000 in their balance sheet as share premium reserve. Forfeited share reserves If a shareholder fails to pay the calls on partly paid shares, then such part amount paid by such applicant will be transferred to forfeited shares reserve account. Under law, company is not required to return the money to such defaulted applicants. Thus , the applicants will loose their money if they fail to pay the call money , However , a company can reissue such forfeited shares at full price to any new applicants Thus , money stands to the credit of call money account will be transferred forfeited share reserve account. (Hey-Cunningham 2002: 157). Capital Redemption Reserve: A private company is entitled to redeem shares out of capital. However, according to Companies Act, in case of other companies, shares may be redeemed only out of company’s distributable profits or out of the capital raised by issue of new shares solely for the redemption. In case of issue of shares which are redeemable, the manner and the terms of redemption should be specified at or before the time of the issue of such shares. According to S.170, in case where share are redeemed out of gains of the business, a sum equivalent to their nominal value should be transferred from gains of the business to a separate capital redemption reserve. This share redemption reserve is just like the share premium account which is a statutory capital reserve. Thus, capital redemption reserve account can be used for the following purpose only: Under S.135, it cannot be used for reduction of capital. Under S.171, either for purchase or redemption of shares out of capital. It can be applied only for the allotment of fully paid bonus shares. It is to be noted that no capital redemption reserve is needed if the redemption is made out of the fresh issue of shares and in such cases, proceeds of the fresh issue is used to repay the debentures. ( De Freitas 1989). In case, if the shares are to be redeemed at a premium, the fundamental rule is that the premium must be deferred out of distributable profits. If shares are originally issued on premium, then balance in the share premium account may be utilised to meet the premium obligation while at the time of redemption of shares. Immediately after the redemption, shares that are redeemed will be construed as cancelled on redemption and there will reduction to that extend in the company’s issued capital. However, redemption of shares does not have any impact on the authorised share capital of the company. (Abbot et al: 386) As on 31st December 2008, Webb Ltd is having £10,000 in their balance sheet as capital redemption reserves. Revaluation Reserves This is created when property is revalued and not from transferring the funds from profits of the business. This is a notional fund and this cannot be utilised for dividend payments. The asset revaluation reserve is the profits arising due to revaluation of non-current assets. This profit is not transferred or recognised in the P& L account but simply added to the revaluation reserve. A company , under ‘ transfers from / to reserves’ in the Statement of Changes in Equity , changes to the asset revaluation reserve are exhibited. Suppose, if a company’s reserve is increased by £20000 during 2008, which was the profit on selling investments. This gain would be shown as a significant item by way of separate note. The reserve was increased by £300,000 in 2007, being £ 250000 shown as a pivotal item from disposing off an old property and £ 50000 transferred from the asset revaluation reserve. This transfer represents the amount of property revalued in earlier years. It is to be noted that this revaluation gain will never be booked as profit in the books. Some companies may make adjustments to its equity which is called a “revaluation reserve.” Companies may not disclose the details of these adjustments , it is most likely happens to be the adjustments due to foreign-currency translations and reserves created due to revaluation of fixed assets. Thus, changes in these reserves have to be treated as non-operating cash flows. As on 31st December 2008, Webb Ltd is having £30,000 in their balance sheet as revaluation reserves. Answer to Question No 2 Purchase of own shares by a company According to section 30 of the Companies Act, a company, subject to the stipulations in the Articles of the company, may buy its own stocks which may include any redeemable shares issued by the company and can meet the payment obligations of the acquisition of its own shares or redemption of shares otherwise than either from the amount raised from the fresh issue of share or out of distributable gains of the company. It is to be observed that the share price paid by the company shall not exceed its nominal value of its shares. There should be provisions in the Articles of the company for authorising the company for the purchase of its own shares. As per the Companies (Shares, Share Capital and Authroised Minimum) Regulations 2008, in case of acquisition of its own shares by private company out of capital, the director’s statement has to be made under section 714(5). (www.berr.gov.uk) When a company can purchase its own shares by using its capital without court’s approval or issuing a declaration of solvency? The Companies Act 1981 introduced the concept of a company redeeming or acquiring its own shares. For private companies, the capacity to acquire its own shares may enable a company to buyout a disinterested or dissenting minority. It may facilitate the company to acquire the interest of a one or many other members of the family. This is more significant where the shareholders involved who are having an interest in the company but do not have adequate liquidity in their individual capacity. Further, as a private company does not enjoy an external market for the company’s shares, the acquisition of own shares by a company will facilitate their shareholders to realise the real benefit for their investments. Thus, under Companies Act 2006, only private companies are authorised to purchase its own shares from the proceeds of its capital. Thus, if a private company wishes to acquire its own shares from payment out of capital for the purchase or redemption of its own shares must include a statement made by director which should be in writing and should indicate that the director’s statement is made under the section 714 and should be signed by all the directors of the company individually. Further, the director statement should include the details like whether the business of the company is of a banking company or that of an insurance company. (www.berr.gov.uk) For instance, Jarvis Securities Plc has acquired between ninth and seventeenth of May 2006, 38,500 shares at a mean price of 79.30 pence which is to be held by Jarvis as treasury shares. (Brough 2005:91). However, there is a restriction placed by the public company to acquire its own shares out of its capital as in the case of private companies. The public companies may issue redeemable preference shares may however be helpful for public companies wishing to raise short run finance without overloading their equity / loan gearing in favour of loan capital. A company may also employ the purchase of shares to bring the company’s share capital into line with its net asset value. This would help the company in dishearten any hostile takeover attempts where the net asset value of a company is too high in relation to its share capital. In case of public company, there are stringent safeguard in case of acquisition of its own share capital mainly to safeguard the interest of the creditors like application to be made to court.( Brough 2005 :89) There is a restriction for a limited company to finance the acquisition of its own shares. The Belmont case law gives us a valuable insight of the issue. In Belmont Finance Corp v Williams Furniture’s Ltd 1 , City Industrial Finance Ltd possessed all the shares in Belmont. For both Belmont and city, Mr. James was the chairman of the Board of directors. Contrary to the statutory restriction and in breach of fiduciary duty on a company to offer financial help for the acquisition of its own shares , director’s of Belmont paid £500,000 of Belmont’s money under a designed scheme to assist a company namely Maximum to buy shares in Belmont from City. Finally, City received £ 489,000 of that money. Belmont successfully asserted that City was responsible to account as a beneficial trustee for that amount. A limited company is viewed as not a trustee of its own funds under Companies Act. It is being regarded as their beneficial owner. However, the directors of a limited company are having a fiduciary duty are regarded as the trustee of the company’s funds which are under their supervision and control. If they misapply these funds, then they commit a breach of trust. Hence, if the directors of a corporation in infringement of their fiduciary responsibility have misapplied the company’s funds and thus facilitate that fund to be possessed by a stranger, then such stranger will become a constructive trustee for such misapplied funds. In view of the above, the court held that City is liable for damages as constructive trustees. Thus, the long arm of the equity is wide enough to counter this kind of financial transaction. (Burrows et al 2007:233) Purchase of own shares by a Company Where the company has adequate distributable reserves, purchase of own shares has customarily been employed as a mechanism to eliminate a dissenting or retiring shareholder. In case of a buy-back of shares, it is ordinarily considered as a distribution of profit and it is, taxable at twenty five percent in UK. However, it is probable to organise for a capital buy-back to be regarded as a capital receipt provided that some terms and conditions have been satisfied with. The conditions are given below: The corporation must be engaged in trading The corporation must be unquoted The shareholder must be a UK resident who falls under UK tax bracket After the buy-back ,there must be a considerable reduction in the individual’s shareholding and, in any event, they must have fallen less than thirty percent At least he should own the shares for five years The transaction must be carried for the advantage of the trade in general. A written approval from HM Revenue and Customs can be received to make sure that this is approved in advance. (Abbot et al: 387). Further, the Article of the company should state the conditions on which the redemption can be affected. The Article should contain the provision relating to formula for arriving at the redemption amount or the manner in which it is to be calculated must be set out in advance. The provision in the Articles can set a period or date during which the shareholder or company may opt for redemption. Further, the Articles may state that the director may before the issue draft such provision in this regard. An acquisition of own shares, though having abundant obstacles to cross through, does have the benefit of being within the power of the company and can thus be very attractive. Formation of a new holding company A company may structure its acquisition of its own shares by forming a new holding company so that it can acquire its shares with out court’s approval or without adhering the solvency statement procedure. This arrangement engrosses the shareholders who wish to prolong together with any other investors, be that finance providers or the management team like venture capital houses or banks thereby forming a new company and employing this vehicle to purchase the shares of the existing company. This would permit the present shareholders to accept their current shares into shares of the new company mainly to circumvent any capital gains tax at this juncture at the same time offering the exiting shareholders the privilege to receive loan, notes shares, cash or an assortment of those. (Correia 2007:1626). Answer to Question No 3 Permissible Capital Payment for redemption: What is permissible capital Payment? It is defined under section 734 the Companies Act 2006. Permissible Capital Payment connotes the total amount paid on purchases of its own shares or redemption minus the aggregate sum of distributable profits and the sum collected due to any fresh issue of shares made for the sole purpose of the purchase or redemption. The impact of this limitation is that payment out of capital is permitted only as a last resort only when all the aforesaid means have been exhausted. Section 734 is applicable where payment of capital is effected either by purchase of own shares or by redemption by private company out of capital. If the allowable capital payment is less than the nominal amount of the shares purchased or redeemed, the differential amount must be transferred to the company’s capital redemption reserve. If the permissible capital payment is higher than the nominal amount of shares purchased or redeemed – (a) The credit of any “capital redemption reserve”, share premium account or fully paid share capital of the company in case of a private limited company. (b) Any credit amount symbolising unrealised profits of the company for the time being lying to the credit of any revaluation reserve kept by the company May be minimised by an amount not exceeding the sum by which the permissible capital payment exceeds the nominal amount of the shares. Where the sums collected out of fresh issue of shares are made use by the company in executing the purchase of its own shares or redemption in addition to a payment out of capital. (Morse, Britain & Palmer: 568) In the given case, Webb Ltd is a private company. Since, it can redeem the shares out of its capital. £ Redeemable Shares of £1 each 50000 Premium on redemption (As decided by the directors of 15000 Webb Ltd) Total amount required for the redemption 65,000 Amount available for Webb Ltd as per the balance sheet as on 31st December 2008. £ 1) Capital Redemption Reserve 10000 2) Share Premium Account 10000 3) Profit & Loss account 20000 4) Proposed fresh issue of shares 15000 ----------- Total amount available for redemption 55,000 There is a shortfall of £ 10000 for the redeeming the shares with premium on redemption. Since Webb Ltd is a private company, it can use its paid up capital to adjust this short fall of £ 10000. Only Private companies are permitted to employ the fully paid capital for the purpose redemption. Since , Webb Ltd is a private company , first it has to employ its available distributable profits and the amount raised from the fresh issue of shares designed for the sole purpose of redemption and then any gap or shortfall can be met from capital. This is called “permissible capital payment.” In Webb Ltd, the permissible capital payment available is £ 10000. Webb Ltd has the following options: 1) The directors may reduce the premium on redemption to £ 5000 instead of £ 15000. In such a case, the redemption of £ 1 each 50000 redeemable preference shares might be redeemed along with premium of redemption £5000. In such a situation, Webb Ltd need not use its paid capital for redemption purpose. 2) The director may go for fresh issue of shares £ 25000 instead £ 15000 so that shares can be redeemed with £ 15000 as premium on redemption. In this option also, Webb Ltd need not use its present paid up capital for the redemption purpose. It is to be noted that 5% debenture worth £ 10000 is due after more than one year as on 31st December 2008. It is assumed that the repayment of debenture is met by the profits generated during the year ahead or from internal accruals. Answer to question No 4 Redenomination of Company Shares from Sterling to Euros It is to be noted that Royal Ascent was given to Companies Act 2006 on 8 November 2006. According to Companies Act 2006, subject to any restriction in the company’s articles, a company is at liberty to issue shares in any currency that it desires as per section 542(3). A company is now permitted to have its share capital in a combination or a mixture of denomination. For instance, one kind of company share may be issued in US dollars and another kind of shares can be issued in euros or sterling or some other currency according to wish of the company. Redenomination connotes the precise exchange of a national currency unit into a euro unit. It is to be recalled that it does not impact the fundamental character of shares of a company if it is redenominated into Euro. However, a company is forbidden to redenominate its existing any class of or its existing capital from one currency to another. For instance, a company cannot redenominate from sterling to euros and vice versa. For redenomination, lot of procedure has to be followed. First of all, the existing shares have to be annulled with the approval from court for capital reductions as explained in 2006 Act or in the case of private companies, redemption or acquire its own shares out of its share capital under the Companies Act and then, the company can issue new shares in what ever currency they prefer. (Mayson 2006). Further, section 622 has enforced new procedures that will enable a company limited by shares to easily redenominate its shares. This necessitates passing of resolution by members. It is to be noted that unlimited companies having a share capital can redenominate their share capital. Further, subsection 2 of section 622 emphasises that the spot rate shall be utilised when redenominating company’s share from one currency to other currency. Further, the member’s resolution must specify that company is empowered to redenominate its share capital. Further, subsection 4 of section 622 explains about the choice of spot rates for redenomination purpose. Under this section, a company is at liberty to pass a conditional resolution. However, such member’s approval for the redenomination at spot rates will lapse if the redenomination has not been carried out with in 4 weeks of passing of the resolution by members. In case, if member’s resolution has been lapsed, then company cannot redenominate its share capital from one currency to the other provided a new resolution is passed by members authorising the redenomination of company shares. Further, subsection (7) of section 622 demonstrates that, if a company desires, it may prohibit or restrict a redenomination of its share capital by incorporating a new articles in the articles of the company. It should be observed that this section does not make provision for the minimum authorised to prolong to be denominated in euro or sterling. This connotes that if under section 761, if a public company has obtained a trading certificate or where a private company has become public company by way of re-registration, then such a company is free, if it desires, to redenominate the whole of its share capital including authorised minimum share capital fixed by the act in to any currency of its choice. Section 623 demonstrates how the denominated share’s nominal value has to be calculated after it has been redenominated under new currency. Section 624 makes it obvious that a redenomination of a company’s share capital will not have any impact any obligations or rights affecting the members under the constitution of the company. Redenomination of company shares in to new currency does not affect the voting rights, the entitlement of dividend etc. (Verlag Goyang Media Ltd 2008:140). List of References Abbot Keith, Pendlebury Norman & Wardman Kevin. (2007) Business Law. London: Cengage Learning EMEA. Brough Gordon H. (2005). Private limited companies: formation and management. London: Sweet & Maxwell. Browne David (2001). Heinemann Business Studies for AS Level. London: Heinemann. Burrows Andrew S, McKendrick Ewan & Edelman James. (2007) Cases and materials on the law of restitution. Oxford: Oxford University Press Correia Carlos, Flynn David , Uliana Enrico & Wormald Michael. (2007) Financial Management. Durban: Juta & Company Limited. De Freitas J.D (1989). Company Law. Birmingham: Castlevale Ltd. Hey-Cunningham David. (2002). Financial Statements Demystified. London: Allen & Unwin. Incorvaia John. (2003).Reserves are essential to financial health. City& County, 118(1). Mayson Stephen W. (2006). Mayson, French and Ryan on Company Law. Oxford: Oxford University Press. Morse Geoffery, Girvin Stephen, Frisby Sandra, Marshall Enid A, Hudson Alastair, Morris Richard, Crabb Leticia. (2005). Charlesworth’s Company Law. London: Sweet&Maxwell. Morse Geoffrey. Britain Great & Palmer Francis Beaufort. (2007). Palmer’s Company Law: annotated to the Companies Act 2006. London: Sweet & Maxwell Verlag Goyang Media Ltd. (2008). Companies Act 2006. Frankfurt: Books on Demand. Read More