MAINTENANCE OF SHARE CAPITAL:
As a general rule, a company’s capital must not be increased or reduced unless the company’s ordinary
business warrants such a step. One of the reasons for this rule is the need to maintain that capital fund
To which creditors rely for payment when extending capital facilities to that company.
Therefore, this doctrine of maintenance of share capital is designed to protect the company’s creditor.
Case: Re exchange Banking Co (1882) Jessel MR: stated that, the creditor gives credit to the
company on the faith of the representation that the capital shall be applied for purposes of the
business. The creditor has a right to say that the corporation shall keep its capital and not return it to
the shareholders. A company is expected to be active; therefore the share capital can’t be kept docile.
The company must regulate the use of its share capital.
Outcomes of maintaining share capital:
Dividends paid to shareholders may only be paid out of a company’s profit. Capital invested by
shareholders can’t be returned to them except when;
1) Capital can be returned to the shareholders under the companies Act with Court’s approval.
2) The company is put into liquidation;
3) The company redeems purchases its own shares.
The question is: why this strictness on maintenance of capital?
The rationale for this strict rule is that to safeguard the interests of the creditors of the company and other
people whose interests would be negatively affected by the reduction in the company’s capital or assets.
The House of Lords explicitly explained this in the case of Trevor V Whiteworth (1887) 12 App Cas
409 thus;
“one of the main objects contemplated by the legislature in restricting the power of limited
companies to reduce the amount of their capital is to protect the interests of the outside public
who may become its creditors, the effect is to prohibit every transaction between the company
and a shareholder by which money already paid to the company is returned to him, unless the
court has sanctioned the transaction”
In this case court went on to say
“paid up capital may be diminished or lost in the course of the company’s trading, that is a result
which no legislature can prevent, but persons who deal with and give credit to the company
naturally rely on the fact that the company is trading with a certain amount of capital already
paid; as well as upon the responsibility of its members for the capital remaining on call and they
are entitled to assume that no part of this capital which has already been paid to the company
has been subsequently paid out except in the legitimate course of business”
In order to ensure strict observance of this, the law has come up with rules and provisions on maintenance
of capital. They include the following;
Rules/ Provisions on Maintenance of Capital.
1. It is illegal for a company to acquire/ repurchase its own shares except as provided by law.
Thus a company cannot use its own capital to buy its own shares as was held in the case of Trevor V
Whiteworth above that it is ultra vires for a company to purchase its own shares even if the memorandum
gives express authority to do so.
Trevor V Whiteworth (1887) 12 Apll Cas 409 Facts: During winding up, a shareholder claimed the
balance of the principal for fully paid up shares he had sold to the company before winding up. It was
held that it was ultravires for a company to purchase its own shares albeit the memorandum gives
authority to do so. The transaction is also objectionable on the following grounds: The value of the
remaining shares is curtailed if the company paid more than the actual value of shares. The company
is adversely affected if it repaid the principal on the stock exchange. Repurchasing is different from
forfeiture or surrender.
Holding: When a share is forfeited or surrendered, the amount which has been paid upon it remains with
the company, the shareholder being relieving of liability for future calls, whilst the share itself reverts to
the company, bears no dividend, and may be re-issued. When shares are purchased at par, and transferred
to the company, the result is very different. The amount paid up on the shares is returned to the
shareholder; and in the event of the company continuing to hold the shares (as in the present case) is
permanently withdrawn from its trading capital. It appears to me that …it is inconsistent with the essential
nature of a company that it should become a member of itself. It cannot be registered as a shareholder to
the effect of becoming debtor of itself for calls, or of being placed on the list of contributories in its own
liquidation. (Lord Watson at 423)
Section 68. (1) Subject to this section, a company limited by shares may, if authorised, by its
articles, issue preference shares which are or at the option of the company are to be liable, to be
redeemed.
(2) Subsection (1) is subject to the following—
(a) shares shall not be redeemed except out of profits of the company which would otherwise be
available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of
the redemption
2. A company may not issue shares at a discount unless as provided by law.
In Ooregum Gold Mining Co. of India Y Roper (1892) AC 125, the directors sought to issue shares
at a discount. It was held that shares are not to be issued at a discount and whoever takes shares in return
for cash must either pay or become to pay the full nominal value of those shares. However the companies
Act authorizes issue of shares at a discount subject to certain conditions.
S. 67 of the Act provides that a company may issue shares at a discount of a class already issued except
that;-
a) The issue of the shares at a discount must be authorized by resolution passed in a general
meeting of the company and must be sanctioned by court;
b) The resolution must specify the maximum rate of discount at which the shares are to be
issued;
c) The resolution can only be made after the company has already been in business for more
than a year;
d) The shares to be issued at a discount must be issued within one month after the court
has sanctioned the issue.
3. A company must not give financial assistance for the acquisition of its own shares.
A company is prohibited from giving financial assistance for the acquisition of its shares to a person
whether directly or indirectly.
- The ban on financial assistance prevents the management of a company from interfering with the
normal market in the company’s shares by providing support from the company’s resources to selected
purchasers.
- The prohibition is not limited to situations where there is a reduction in the resources of the company,
it can include a gift to enable someone to purchase its shares.
Statutory prohibition
S. 63 (1)of the Companies Act 2012 provides that it shall not be lawful for a company to give whether
directly or indirectly any financial assistance for the purpose of or in connection with a purchase or
subscription made or to be made by any person of any shares in the company or its subsidiary or holding
company.
Meaning of assistance for the purpose
• Meaning clear
Belmont Finance Corp v Williams Furniture Ltd (No.2) [1980] 1 ALLER 393 (CA)
If A Ltd buys from B a chattel or a commodity, like a ship or merchandise, which A Ltd genuinely wants
to acquire for its own purposes, and does so having no other purpose in view, the fact that B thereafter
employs the proceeds of the sale in buying shares in A Ltd should not, I would suppose, be held to offend
against the section; but the position may be different if A Ltd makes the purchase in order to put B in
funds to buy shares in A Ltd. If A Ltd buys something from B without regard to its own commercial
interests, the sole purpose of the transaction being to put B in funds to acquire shares in A Ltd, this would
in my opinion, clearly contravene the section, even if the price paid was a fair price for what is bought,
and a fortiori that would be so if the sale to A Ltd was at an inflated price. The sole purpose would be to
enable (i.e. to assist) B to pay for the shares. If A Ltd buys something from B at a fair price, which A Ltd
could readily realize on a resale if it wished to do so, but the purpose or one of the purposes of the
transaction is to put B in funds to acquire shares of A Ltd, the fact that the price was fair might not, I
think, prevent the transaction from contravening the section, if it would otherwise do so, though A Ltd
could very probably recover no damages in civil proceedings, for it would have suffered no damage. If
the transaction is of a kind which A Ltd could in its own commercial interests legitimately enter into, and
the transaction is genuinely entered into by A Ltd in its own commercial interests and not merely as a
means of assisting B financially to buy shares of A Ltd, the circumstance that A Ltd enters into the
transaction with B, partly with the object of putting B in funds to acquire its own shares or with the
knowledge of B’s intended use of the proceeds of sale, might, I think involve no contravention of the
section, but I do not wish to express a concluded opinion on that point. (Buckley LJ at 402)
• Commercial reality test
Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] 1 BCLC 1: The words [financial assistance]
have no technical meaning and their frame of reference is in my judgment the language of ordinary
commerce. One must examine the commercial realities of the transaction and decide whether it can
properly be described as the giving of financial assistance by the company, bearing in mind that the section
is a penal one and should not be strained to cover transactions which are not fairly within it. (Hoffman J
at 10)
Barclays Bank plc v British & Commonwealth Holdings plc [1996] 1 WLR 1 (CA)
NOTE: Such a transaction is unlawful and any money advanced is unrecoverable. In Selangor United Rubber
Estate Ltd v Cradock (No.3) (1968) 1 WLR 155, creditors instructed the company to advance money to
Selangor Company Ltd in effect buying them out. It instructed Selangor to advance loans to Woodstock
Co. he instructed the bank to pay an equivalent of the advance made by the contanglo company to that
Compnay. Then the Cradocks instructed Woodstock to repay the loan to the bank. At the end of it, he
had control over Selangor and there was no unpaid creditor. It was held that the transaction was unlawful
because it amounted to financial assistance.
Exceptions to this rule/ instances where the company may give financial assistance as set under
section 63 (2) of the Companies Act, 2012:
a) The lending of money by the company; where the lending of money is part of the ordinary
business of a company;
(b) The provision by a company, in accordance with any scheme for the time being in force, of money
for the purchase of, or subscription for, fully paid shares in the company or its holding company, being
a purchase or subscription by trustees of or for shares to be held by or for the benefit of employees of
the company including any director holding a salaried employment or office in the company;
(c) The making by a company of loans to persons, other than directors, in good faith in the
employment of the company with a view to enabling those persons to purchase or subscribe for
fully paid shares in the company or its holding company to be held by themselves by way of
beneficial ownership; and
(d) The assistance is given in good faith in the interests of the company.
What does not amount to financial assistance?
Section 63 (3) This section does not prohibit—
(a) a distribution of a company’s assets by way of dividend lawfully made or a distribution made
in the course of the company’s winding up;
(b) the allotment of bonus shares;
(c) a reduction of capital confirmed by order of the court under this Act;
(d) a redemption or purchase of shares made in accordance with this Act;
(e) anything done in accordance with an order of court under this Act and compromises and
arrangements with creditors and members;
(f) anything done under an arrangement made in accordance with the insolvency law acceptance
of shares by liquidator in winding up as consideration for sale of property; or
(g) anything done under an arrangement made between a company and its creditors which is
binding on the creditors by virtue of the insolvency laws.
Contravention of section 63
Subsection (4) provides that where a company acts in contravention of this section, the company
commits an offence and is liable to a fine not exceeding one thousand currency points.
Subsection (5) provides that where a company commits an offence under subsection (4), every
officer of the company who contributes to the default commits an offence and is liable on
conviction to imprisonment not exceeding two years or a fine not exceeding two hundred
currency points or both.
4. If a company is to pay dividends then they can only be paid out of the company’s profits
but not out of its working capital.
Dividends are any return paid/given to a shareholder on his investment/shareholding in a company.
Unless the Articles state otherwise, a shareholder receives dividends on his shares. A shareholder is
not entitled to payment unless the directors have declared the dividends and authorized payment of
the same to the shareholders. In Makidayo Oneka Vs Wines And Spirits (U) Ltd And Another
(1974) HB.2, the principle was laid that unless the articles and terms of the issue of shares confer a
right upon a shareholder to compel a company to pay a dividend; it is the discretion of the directors
to recommend to a general meeting that a dividend be declared.
If the company adopted table A, Article 116 provides that a company shall only pay dividends out of
profits. Furthermore, where a company has an article equivalent to article 114 of table A, if the
directors have recommended a certain sum for dividend, the general meeting has no discretion to
increase that sum. However, a shareholder or a debenture holder can seek a court injunction to restrain
a company from declaring a dividend.
5. A company may not pay interest out of its capital except as authorized by law.
s. 75 of the Act provides that a company may pay interest out of its capital in certain cases in particular
where shares were issued so that the company can raise money to cover expenses of construction of any
works or buildings. The shareholders who paid for the shares may be given interest on the money they
paid and this interest may be paid out of the company’s capital. However the payment is subject to the
following conditions.
a) The payment must have been authorized by the articles or by a special resolution.
b) The payment must have also been sanctioned/ authorized by the registrar of companies.
c) The registrar may first make an inquiry into the circumstances surrounding the entire transaction
before he authorizes the payment and he can charge the cost of the inquiry on the company.
d) The payments must be made within the period fixed by the registrar.
e) The rate of interest must not exceed 5% per year.
6. A company may not reduce its capital except as provided by law.
Section 76 of the Companies Act, 2012; provides for the reduction of capital. A company may by special
resolution or if its articles provide so reduce its capital but this reduction must first be confirmed by court.
Section 76 (1) provides that subject to confirmation by the court, a company limited by shares or
a company limited by guarantee and having a share capital may, if authorised by its articles, by
special resolution reduce its share capital in any way, and, in particular, without prejudice to the
generality of the foregoing power, may—
(a) extinguish or reduce the liability on any of its shares in respect of share capital not paid up;
(b) with or without extinguishing or reducing liability on any of its shares, cancel any paid up
share capital which is lost or un-represented by available assets; or
(c) with or without extinguishing or reducing liability on any of its shares, pay off any paid up
share capital which is in excess of the requirement of the company, and may, if and so far as is
necessary, alter its memorandum by reducing the amount of its share capital and of its shares
accordingly.
Subsection (2) provides that a special resolution under this section is in this Act referred to as
“resolution for reducing share capital”.
In Re Moorgate Mercantile Holdings Ltd (1980) ALLER 40, there was a proposal by the
company to reduce its capital on the ground that the paid up capital had been lost. It was held
that in exercising its jurisdiction to confirm a reduction of capital on such ground, the court
should require evidence of laws and provisions for safeguarding creditors especially where the
loss is less than the amount to be reduced. Moreover such a company may be required to add its
name “and reduced”.
REDUCTION IN CAPITAL
A company has no power to reduce its capital except in accordance with the Act. This is necessary
in order to ensure that creditors have reliable funds for satisfying their claim by preventing undue
depletion thereof by the company.
Under section 76, the reduction of capital must be authorized by the company articles.
Section 76 (1) provides that subject to confirmation by the court, a company limited by shares
or a company limited by guarantee and having a share capital may, if authorised by its articles,
by special resolution reduce its share capital in any way.
There are three specific instances of reduction provided for under section 76 of the CA
(a) Extinguish or reduce the liability on any of its shares in respect of share capital not paid up;
(b) With or without extinguishing or reducing liability on any of its shares, cancel any paid up
share capital which is lost or un-represented by available assets; or
(c) with or without extinguishing or reducing liability on any of its shares, pay off any paid up
share capital which is in excess of the requirement of the company, and may, if and so far as is
necessary, alter its memorandum by reducing the amount of its share capital and of its shares
accordingly.
INCREASE OF ISSUED CAPITAL:
The general rule is that the company’s issued capital shouldn’t be increased unless the company’s
ordinary business warrants such a steps. The rationale is to maintain the capital fund upon which the
creditors rely for payment. In the case of Flitcofts (1882) 21 Ch.D. 519: The directors had allowed
debt to be credited in the company’s accounts creating imaginary profits with the knowledge that
debts were bad. It was held that the creditor has no other debtors other than the company . He
therefore has the right to insist that the company must keep its capital and not return it to the
shareholders. Dividends must therefore only be paid out of profits.
CAPITAL AND DIVIDENDS:
A dividend is a cash payment paid to the shareholders. These are paid on a quarterly basis. It’s a
portion of corporate profits paid out to stockholders. The Corporations' profit can either be re-
invested in the business (retained earnings) or be distributed to shareholders. Cash is distributed to
shareholders through dividends or share repurchases. The doctrine of maintenance of capital dictates
that dividends are paid out of profits made out of share capital.
Generally, return is not fixed, but depends on the profitability of the company.
• Capital rights
Birch v Cropper (1889) 14 App Cas 525: Every person who becomes a member of a company limited by
shares of equal amount becomes entitled to a proportionate part in the capital of the company, and
unless it be otherwise provided by the articles of the company, entitled as a necessary consequence to
the same proportionate part in all the property of the company, including its uncalled capital. He is
liable in respect of all moneys unpaid on his shares to pay up every call that is duly made upon him.
But he does not by such payment acquire any further or other interest in the capital of the company.
His share in the capital is just what it was before. His liability to the company is diminished by the
amount paid. His contribution is merged in the common fund. And that is all. When the company is
wound up, new rights and liabilities arise. The power of the directors to make calls is at an end; but
every present member, so far as his shares are unpaid, is liable to contribute to the assets of the
company to an amount sufficient for the payment of its debts and liabilities, the costs of winding-up,
and such sums as may be required for the adjustment of the rights of the contributories amongst
themselves. (Lord Macnaghten at 543-544).
• Dividend rights
Table A, arts 114-122
Article 114. The company in general meeting may declare dividends, but no dividend shall exceed the
amount recommended by the directors.
In the case of Case-Makidayo Oneka vs. Wines and Spirits Ltd and Anor (1974 ) Court held that
unless the articles and terms of issue of shares confer a right upon a shareholder to compel a company
to pay a dividend, the directors have the discretion to recommend to a general meeting that a dividend
be declared. A shareholder or a debenture holder can seek a court injunction, restraining a company
from declaring a dividend. The Companies Act states that dividends have to be paid out of profits,
but “what are profits?”.
Patel v Inland Revenue Commissioner [1971] 2 ALL ER 504 : The following principles are in my
view, correct: (1) if the articles of association of a company contain an article similar to art 80 in the
present case, directors who recommend a final dividend have power at the same time to stipulate the
date on which such dividend shall be paid. (2) If a final dividend is declared by a company without
any stipulation as to the date for payment, the declaration of the dividend creates an immediate debt.
(3) If a final dividend is declared and is expressed as payable at a future date a shareholder has no right
to enforce payment until the due date for payment arrives… (4) In the case of an interim dividend
which a board has resolved to pay, it is open to the board at any time before payment to review its
decision and resolve not to pay the dividend. In my view it follows from these principles that in the
case of an interim dividend which the directors resolve shall be paid, they can at or after the time of
such resolution, decide that the dividend shall be paid at some stipulated future date. If a time for
payment is so prescribed, a shareholder has no enforceable right to demand payment prior to the
stipulated date. (Lightman J at 512).
The Companies Act does not indicate when dividends should be declared. Article 116 of Table A
provides that a dividend shall not be paid otherwise than out of profits.
What are profits?
Lee Neuchattel Asphalt Co (1889) 41 Ch. D. 1, at p. 13. A company was formed for the purpose
of acquiring and working out a concession in a mine. The company proposed to pay a dividend out
of the profits shown on its reserve account. This was challenged by a shareholder on grounds that
since the company's assets weren’t equal to its share capital and that since the mining concession was
a wasting asset, dividing annual proceeds amounted to dividing the company’s capital assets.
Court rejected the shareholders contention and held that: There was nothing in the act to say
how accounts are kept, what is to be put into capital accounts, income accounts and what’s
to be left to the men of business. Losses of capital need not to be made good before the
company declares a dividend.
This is called a declarational announcement date. Companies who effectively manage their cash flow
tend to sustain and grow their dividend pay-outs over time. Dividends are normally declared at the
company’s general meeting. Shareholders however, act on the director’s recommendations. They
shouldn’t exceed this.
Importance of dividends:
1 Attractive returns.
2 Companies that pay dividends are usually historically stable.
3 Less volatility-dividends help lessen the potential fall of a company's stock price.
4 Increased yield-dividends provide income Favourable tax treatment.
The legal rules relating to the payment of dividends are as follows:-
a) Dividends shouldn’t be paid if this would lead to the company being unable to pay its debts
when they fall due.
b) It’s permissible to pay dividends out of profits without making up losses on fixed capital. Thus
in Bond v Barrow Hematite Co [1902] Ch. 353, the court held that while as a general rule where a
company may declare a dividend without paying regard to the loss of fixed capital, if such a
step is challenges, the company has a burden of justifying such action.
c) Dividends should only be paid after making good the loss of circulating capital during the year.
d) This therefore means that losses of previous years need not be made good before payment of
a dividend. Moreover in Ammonia Soda Co v Chamberlain (1918) 1 Ch. 266, it was held that a
company may declare a dividend without having made good the loss of the previous years. In
the case, a declaration of a dividend was challenges on the ground that for about 3 years, the
company had made losses so that the profits made in the 4th year could not be considered
profits for a declaration of a dividend without making good the loss of the previous years.
However, the court pointed out that in declaring a dividend in such circumstances, directors
must act honestly and reasonably taking into account the previous years.
e) Profits of previous years may be distributed by way of dividend from a reserve fund.
f) A profit made on the sale of a company’s fixed assets can be distributed to members by way
of dividend.
g) Competent values permit a company to distribute a surplus on its capital account which results
from a revaluation of the company’s assets made in good faith.
NOTE: Once a dividend has been declared, it becomes a shareholder’s property (it is a debt from the
company) and he can consequently sue for it.
Dividends are usually paid in cash though they can be paid in other form of property.
A company may recycle the profits instead of declaring dividends.
The power to declare dividends is vested in the directors. This is subject to the AOA. The reason for
this is to:
- Avoid conflict of interest
- Checks and balances
- They are not doing so as individuals but as an organ
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SELF ASSESSMENT QUESTIONS
1. What do company lawyers mean by the word ‘capital’?
2. What is the essential difference between (a)(nominal capital and (b) issued/allotted capital? Do
these differences matter?
3. Why is it possible for a company to increase its capital with relatively little regulatory scrutiny?
4. Reductions of capital, by contrast, are subjected to sophiscated regulatory controls. Outline what
these controls are
5. There are detailed rules as to the payment for shares in the Companies Act, 2012 what are these,
and how have they been interpreted by the courts
6. What choices are legally open to a company which has made distributable profits in a financial
year?
