What is a capital reduction?
Capital reduction is the process by which a company reduces its shareholder’s equity through the repurchase and cancellation of shares or a reduction in statutory reserves. Simply put, it is a reduction in the amount of a company’s issued share capital in order to increase the distributable reserves of the company, reduce accumulated losses or to return surplus capital to the shareholders.
Chapter 10 of the Companies Act 2006 (“CA 2006”), provides a mechanism for the reduction of a company’s share capital. The term “share capital” includes share capital, share premium accounts and capital redemption reserves. Sections 642 to 644 CA 2006 enables a private company to carry out a reduction of its share capital by means of a solvency statement procedure. This procedure is not available for use by public companies.
Why would a company want to reduce its capital?
A company may wish to reduce its share capital for various reasons including the fact that certain demerger transactions will create a need for a capital reduction; it may want to return surplus capital to shareholders; it may have preference shares which are due to be redeemed; a company can reduce its capital to release a liability to pay up unpaid share capital; it may want to utilise the distributable reserves created to assist a buyback or redemption of shares; or rather unusually to distribute assets to shareholders. Most capital reductions are aimed at creating distributable reserves and/or eliminating a company’s financial losses.
How can a company’s capital be reduced?
A capital reduction can be achieved in various ways including:
A solvency statement is prepared by the directors to reflect that there are no grounds on which the company could be found to be unable to pay (or otherwise discharge) its debts in full as at the date of the capital reduction and for the following twelve months. If the intention is to strike off the company after the capital reduction the solvency statement will reflect this intention. This statement must be made no more than 15 days before the date on which a shareholders’ special resolution is passed to effect the capital reduction.
What are the director’s responsibility in relation to capital reduction?
It is important that each director is satisfied with the financial position of the company before the solvency statement is signed, because the directors may face criminal sanctions if they make a solvency statement without having reasonable grounds for the opinions expressed in it.
What are the benefits of capital reduction?
In business, profit and losses are outcomes of dealings. As most people would know, losses can have a negative effect on the retained profits of a company; resulting in the outcome that dividends cannot be paid to shareholders. A capital reduction can enable a company to rectify its negative position by creating distributable reserves, thereby eliminating losses. It can also enable a company to increase its distributable reserves which is treated as realised profit for the company’s accounting purposes, thereby creating a better outlook for the company provided it is in a solid financial shape.
Summary
A private company can reduce its capital through the solvency statement procedure in order to create distributable reserves or eliminate losses. However, each director needs to be satisfied with the financial position of the company before and after the capital reduction is made; in order to avoid being in breach of directors duties.
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