Reduction of share capital

It is a fundamental principle of law that a company should, except in limited circumstances, maintain its share capital.

This stems from the need to protect third parties dealing with a limited company against the risk that its assets could be spirited away, leaving nothing to support its debts. More recently, creditors have tended to rely less and less on the level of a company’s share capital as an indicator of its creditworthiness. In recognition of this shift in attitude, a new procedure to simplify reductions of share capital was introduced by the Companies Act 2006.

Distributal reserves

• There are a number of reasons why it may be desirable for a company to reduce its share capital. The main driver is likely to be the effect on the company’s distributable reserves. A reduction of share capital creates a reserve which is immediately distributable as a realised profit. This is likely to be very attractive for companies that have large share capitals where historically carried-forward losses have prevented them from declaring any dividends or redeeming shares.
• Before October 2008, limited companies seeking to reduce their share capital required the approval of the High Court. Unless large sums of money were involved, this could be a prohibitively expensive exercise, though it is still available for those who wish to use it. The new procedure avoids the need for court approval as it supports the reduction of share capital by way of a statement of solvency made by the directors.
• The new system is a quicker, easier and cheaper option. Importantly, and in contrast to the court-approved procedure, there is no right for a creditor to object to a reduction of capital supported by a solvency statement.
• The shareholders are required to pass a special resolution to reduce the company’s share capital once the directors have made a statement of solvency.

Criminal sanctions

• Importantly, the directors face criminal sanctions if they make a solvency statement without having reasonable grounds for the opinions expressed in it. The nature and extent of the comfort that a board of directors will want before making a solvency statement depends on the circumstances of that particular company. It is incumbent on the directors, along with their professional advisers, to take a detailed look at the current and future finances of the company before carrying out the procedure.
• Nevertheless, provided the company is in solid financial shape, the advantages of the new procedure are readily apparent: the professional costs will typically be a fraction of those involved with the court-approved procedure and it is a much shorter process.

For more information on share capital, please contact our commercial team.