Everything you need to know about the Reduction of Capital
There are various reasons behind reducing the share capital by a company. Before the introduction of the Companies Act 2006, the only way a private company could effect a reduction was through a court order. Today, the way a company can reduce its capital depends on its legal formation, and private companies no longer need a court order.
Reasons to reduce the share capital
There are several reasons why a company might want to reduce its share capital:
- Reduce liability: the most common reason is to reduce the number of shares to a more manageable level, i.e. to reduce liability.
- To return surplus capital: if a company has a surplus of cash or assets, these may be paid directly to shareholders by cancelling the shares issued to them.
- To eliminate losses: as a company can only pay a dividend from surplus profits, eliminating accumulated losses which would otherwise prevent these payments is sometimes desirable.
- To support share buy-back or redemption: if a company wants to buy back or redeem shares out of its distributable profits, it may carry out a reduction of share capital to create enough distributable profits to do so.
Capital reduction results in decreasing the number of share in the company. However, the market value of the company will not change – there will be fewer shares available to trade.
Requirements for reducing share capital
The following requirements will need to be fulfilled:
- The articles of association should not prevent the reduction of share capital. If they do, they can be amended by passing a special resolution.
- There has to be at least one non-redeemable share in issue after the share capital is reduced (these type of shares can’t be redeemed during the lifetime of the company, and can only be obtained at the time of winding up of assets).
Steps to the reduction of capital procedure
Here are a number of steps:
- The passing of a special resolution.
- The issuing of a statement of solvency by the directors.
- The filing of form SH19(644) with Companies House.
- A statement of capital, showing the share capital of the company as being reduced.
- A statement by the directors confirming the solvency statement was not made more than 15 days before the date the special resolution was passed.
What is a special resolution?
What information must be included in the solvency statement?
The solvency statement should be signed in writing by all directors, confirming that, as of the date of the statement:
All directors must sign the solvency statement in writing. Below are the information which must be included in the solvency statement:
- There are no grounds on which the company can be found to be unable to pay or discharge its debts, and
- In the 12 months following the statement, any debts will be paid or discharged as due. Or, if the company is wound up, it will be able to do this within 12 months of the beginning of the winding-up.
How can a solvency statement be made available to the members of a company?
- If the special resolution is proposed as a ‘written resolution’, a copy of the solvency statement must be given to every eligible member at or before the time the proposed written resolution is submitted; or
- If the special resolution is proposed at a general meeting, members must be able to view a copy of the solvency statement throughout the meeting.
Why does a private limited company seek a special resolution via the court?
What are the court procedures to approve a reduction in shares?
After a company has obtained shareholder approval to reduce its capital, the next step is to apply to the court for a confirmation order. This can be granted by the court on any terms and conditions that it considers appropriate.
The court will generally agree to a capital reduction as long as it is satisfied that:
- The company’s creditors have consented to it – or there are measures in place to protect the creditors.
- Shareholders have been treated fairly and have had the reasons for the share reduction properly explained to them. This is usually done by a circular, and the court will want to see evidence of this.
- The company has complied with all procedural requirements.
Do you need to report the reduction of share capital to Companies House?
Form SH19 is required to be filed with Companies House within 15 days of passing the resolution, along with:
- A copy of the shareholders’ special resolution,
- A directors’ statement of solvency, and
- A directors’ compliance statement.
What are the alternatives to reducing share capital?
There are a number of ways a company can achieve a similar effect to reducing share capital without having to do exactly that. These include:
- Purchasing its shares.
- Approving a solvent scheme of the arrangement, allowing shares to be transferred rather than cancelled and reissued.
- Redeeming preference shares.