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Company Law: Legal Capital
- Module
- Company Law
- Institution
- Kings College London (KCL)
Comprehensive notes on Company Law in the UK: Legal Capital.
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TOPIC 8COMPANY LAW
8. CORPORATE FINANCE: PART 2 LEGAL CAPITAL:
1. OVERVIEW OF LEGAL CAPITAL:
WHAT IS LEGAL CAPITAL?
Legal capital is another form of equity finance.
It is important to distinguish between ‘capital’ in its ordinary business sense
and ‘legal capital’, which is what we are concerned with.
1. CAPITAL: the net worth of a business (the value of the company’s assets,
once it has paid its liabilities assets – liabilities = net worth).
2. LEGAL CAPITAL: the amount of a company’s equity that, legally, is not
allowed to leave the company (i.e. through dividends or other means). This is
meant to protect creditors, by allowing them to access this reserve in the
event of default.
! Do creditors truly need this protection? Do they not have other ways of protecting
themselves, e.g. covenants?
o On the balance sheet of a company, the assets and liabilities of the
company are listed. On the liabilities side, there is an entry titled
‘shareholders’ capital / share capital’ – when we speak of legal capital, we
are referring to this entry on the balance sheet.
o There are rules regarding how this legal capital is raised and maintained.
! The regulation of this will be explored in further detail below.
KEY CONCEPTS OF LEGAL CAPITAL:
® NOMINAL/PAR VALUE OF SHARES: according to section 542 of CA 2006,
shares in a limited company must each have a fixed nominal value. For
example, if there is £100 in share capital and 100 shares, the nominal value of a
share will be £1.
o Nominal value does not make any reference to the market value of a
share – this is simply the value that the company has ascribed to that
share to determine the share capital of the company, even if the share is
being sold above this on the market.
o A share can be issued on the market for more than the nominal value.
When it is issued for more, the extra value is known as the ‘share
premium’ and this is kept in a share premium account – for example, the
share is issued for £1.20 and thus, the premium is 20p.
o A share cannot be issued on the market for less than the nominal value,
as confirmed in Ooregum v Gold Mining Co v Roper and section 580.
o When the share is bought after being issued, there can be cash (cash,
cheque, etc.) and non-cash consideration (‘money or money’s worth’).
The value of the non-cash consideration is a matter for the directors’
business judgment, as seen in Re Wragg. However, note that Wragg also
,TOPIC 8
COMPANY LAW
highlighted that fraudulent/sham transactions are exempt from this, as
well as consideration that manifests from the terms of the contract, as
seen in Hong Kong Gas Co v Glen.
® ALLOTED CAPITAL: according to section 546, this is the sum of the nominal
value of issued shares.
RAISING CAPITAL – RULES:
There are rules behind the raising of capital, mainly for the purpose of
ensuring there is a reserve that can be used when paying creditors back.
Below are three key areas in which capital is raised and within these, there
are specific rules:
(i) MINIMUM SHARE CAPITAL REQUIREMENT:
According to section 763, the minimum share capital for public companies is
set at £50,000. Any public company with a share capital below £50,000 will be
inadequate.
! KEY QUESTION: is this minimum capital requirement effective/desirable? Should it
be extended to private companies, or abolished altogether?
(ii) POWER TO ALTER SHARE CAPITAL:
According to section 617, the power to alter share capital can be done in
accordance with the statutory provisions of Part 10 where there is the
intention to reduce share capital, or Part 17 where there is the intention to
increase share capital.
A reduction of share capital would impact creditors significantly.
This reduction in share capital can occur where there has been a decrease in
the value of the company’s assets.
(iii) AUTHORITY TO ALLOT SHARES:
Who has the authority to issue shares in the company?
Directors of the company can allot shares in the company, but the allotment
has to be done in accordance with sections 549 to 551 of CA 2006. These
sections control the directors’ right to allot shares, i.e. how and when they can
exercise this power:
o Section 550: directors can exercise any power of the company, as long
they are not prohibited from doing so in the company’s articles (i.e.
directors’ authority to allot shares can be restricted by the company’s
articles/constitution).
! In addition, the company’s allotment of shares must be done for a proper purpose,
i.e. not to deflect goals or to disenfranchise others, but to actually raise capital (this
is discussed in the directors’ duties notes).
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COMPANY LAW
o Section 551: the authorisation for the directors to issue shares can be
granted under the articles or by ordinary resolution. The resolution or
article must state: the maximum of share capital that can be allotted, the
period of time for which the authority is granted (there is a maximum of
five years) and how that authority can be revoked (e.g. ordinary
resolution).
The consequences of breaching section 549: the allotment will not be
considered to be invalid; rather, the directors will be liable to a fine.
When speaking of allotting shares, we must also discuss pre-emption rights:
PRE-EMPTION RIGHTS (sections 560-577, CA 2006):
_ PRE-EMPTION RIGHTS: this is a right of first refusal, given to existing
shareholders when the company is proposing a new allotment of equity securities
wholly for cash (rather than non-cash consideration). These pre-emption rights
protect shareholders against dilution (reduction of the value of existing investors’
shares and their ownership of the company).
® EQUITY SECURITIES: these are participating shares regarding
income, capital or convertibles. These financial assets represent an
ownership interest in the company, realised in the form of shares of
common stock (in essence, they are financial assets that represent
the shares of the company and common stock is the most prominent
type of equity security).
Ù TO SUMMARISE, SIMPLY: the company wishes to issue more participating
shares. This can be risky (due to dilution) for existing shareholders, so certain
pre-emption rights are in place to protect them from this risk.
! In private companies, pre-emption rights can be contractual – this means they can
be incorporated into shareholder agreements, articles of association, etc.
REQUIREMENTS: the securities must be offered first to the relevant
shareholders in proportion to their existing shareholdings (i.e. considering the
class they belong to); and the offer must be kept open for 14 days, for
shareholders to decide whether they want to take up these pre-emption
rights.
EXCEPTIONS: the securities can be excluded and disapplied if they are
allotments of bonus shares (this is non-cash, a bonus); allotments made for
non-cash consideration (remember, the securities must be ‘wholly for cash’);
or to employee share schemes (this constitutes a reward).
CONSEQUENCES OF BREACH: company officers responsible for breach of
the above requirements are liable to compensate members whose preemption
rights were breached.
EXCLUSION: pre-emption rights can be excluded in private companies only,
through the articles; further, pre-emption rights may also be excluded when
the allotment is offered on the basis of a class right, i.e. in relation to a
particular class of shares.
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