Directors' responsibilities for transactions with shareholders
Directors are responsible for ensuring their company complies with requirements applicable to certain transactions, including raising money from shareholders.
Issuing new share capital
Rather than borrowing, a private company may raise money by issuing additional share capital. In exercising their powers, directors need to comply with their general duties outlined in this guide, and be aware of certain specific requirements (including provisions in CA2006 s540-592).
- If there is more than one class of share, directors need to be given the power to issue shares in the constitution or by shareholder resolution. Otherwise, if there is only one class of share, the directors have the necessary power, unless the constitution restricts them.
- The shares may need to be offered to existing shareholders first (known as “pre-emption rights”).
- The shares must not be offered to the public.
- The shares may not be issued at a discount to their par or nominal value.
- If a private company wishes to give financial help for the purchase of its shares, the directors need to consider their general duties carefully and in particular whether the assistance, if given to a member of the company, may amount to an unlawful distribution (see “paying dividends to shareholders” below).
Different provisions may apply to other types of company. For instance, there are strict and narrow rules about when and how public companies may provide assistance for the purchase of their own shares (breach of which is a criminal offence) and a public company may issue shares to the public (although this is a highly regulated activity for which professional advice should be sought).
Paying dividends to shareholders
Dividends and other distributions may only be made out of profits available for the purpose, known as “distributable profits”, based mainly on that part of a company’s accumulated profits in the accounts that are realised profits (CA2006 s829-853). The procedure for declaring and paying dividends is contained in the company’s constitution.
Distributions made in breach of the statutory requirements are unlawful distributions and a director may be liable to repay the company for the whole of an unlawful distribution even if the director was not a shareholder and did not receive any of the distribution.
For further information on the law on dividends, refer to ICAEW’s Introduction to the Law on Dividends.
For in-depth guidance, including on what is meant by “realised profits”, refer to the ICAEW’s Tech 02/17BL.
Returning capital to shareholders
The general rule is that a company must not return its capital to its shareholders. Broadly speaking, capital refers to funds equivalent to the aggregate amount received by the company on all past issues of shares.
However, a private company may reduce the amount of its capital (so potentially increasing the amount that it can lawfully repay to shareholders), so long as it follows specified procedures. In particular, the transaction must be approved by a special resolution of shareholders; and either the directors must provide a statement that the company can at the date of the statement pay its debts as they fall due and will be able to do so during the next twelve months (a “solvency statement”) or the company must obtain Court approval (CA2006 s641-640).
A private company may also buy back or redeem its own shares. There are a number of complex restrictions on these powers. In particular, the price paid must first be paid out of distributable profits or, in certain cases, the proceeds of a new issue of shares. If the price or part of it is to be paid out of capital, there are further requirements, including publicity requirements. These rules do not apply to certain very small scale buy-backs within specified thresholds (CA2006 s684-737).
Further restrictions apply to public companies. Directors should consider seeking professional assistance with these formal and prescriptive legal processes; the consequences of errors can be difficult to address.
Non-commercial transactions with shareholders
What would otherwise be a normal transaction between a company and its shareholder may, in some cases, where it is not at market price, represent a distribution (that will be unlawful unless made out of distributable profits). This can arise, for instance, where a company is a wholly owned subsidiary and it sells its property, provides services or makes loans to the parent (as shareholder) or sister company at an undervalue.
For other sections of this guide, please see below: