The maintenance of capital

Certain aspects of maintenance of capital have already been considered. The rules relating to the issue of shares and payment for those shares have been considered. It is now proposed to consider certain other rules relating to the maintenance of capital, namely the provision of financial assistance to acquire a company’s own shares and the rules relating to a company purchasing its own shares.

The existing statutory prohibition is, in general, removed for private companies by the Companies Act 2006. The 2006 Act retains the prohibition of financial assistance by a public company or by its subsidiaries (which may be private) for the purpose of acquiring the public company’s shares (s 678 CA 2006).

A public company is also forbidden from providing financial assistance for the purpose of facilitating the purchase of its holding company shares where that holding company is a private company (s 679).

Although this clearly represents a relaxation of the position in relation to private companies, directors will still need to consider their general duties as directors to the company, and particularly in the context of the company’s potential insolvency.

Section 678 CA 2006 provides that where a person is acquiring or proposing to acquire shares in a public company, it is not lawful for that company or any of its subsidiaries to give financial assistance, directly or indirectly, for the purpose of the acquisition before or at the same time as the acquisition takes place.

Section 677 defines financial assistance. It means:

(a)  financial assistance given by way of gift;

(b)  financial assistance given:

(c)  financial assistance given:

(d)  any other financial assistance given by a company where:

(a)  the company’s principal purpose in giving the assistance is not to give it for the purpose of any such acquisition; or

(b)  the giving of the assistance for that purpose is only an incidental part of some larger purpose of the company and the assistance is given in good faith in the interests of the company.

Section 679 deals with assistance by a public company for the acquisition of shares in its private holding company.

In such a situation it is not lawful for a public company that is a subsidiary of the company to give financial assistance directly or indirectly for the purpose of the acquisition before or at the same time as the acquisition takes place. The same exceptions apply as in relation to s 678.

If a company contravenes s 678 or s 679, an offence is committed by the company and every officer in default (s 680 CA 2006).

Section 681 provides that the prohibitions do not cover:

(a)  a distribution of the company’s assets by way of:

(b)  an allotment of bonus shares;

(c)  a reduction of capital;

(d)  a redemption of shares;

(e)  anything done in pursuance of an order of the court under Part 26 (order sanctioning compromise or arrangement with members or creditors);

(f)  anything done under an arrangement in pursuance of s 110 of the Insolvency Act 1986 or Art 96 of the Insolvency (Northern Ireland) Order 1989 (liquidator in winding up accepting shares for the company’s property); or

(g)  anything done under an arrangement made between a company and its creditors binding on the creditors by virtue of Part 1 of the Insolvency Act 1986 or Part 2 of the Insolvency (Northern Ireland) Order 1989.

Section 682 provides that certain transactions are not prohibited:

(a)  in the case of a private company; or

(b)  in the case of a public company if:

The transactions to which the section applies are:

(a)  the lending of money in the ordinary course of business;

(c)  the provision of financial assistance by the company for the purposes of or in connection with anything done by the company (or another company in the same group) for the purpose of enabling or facilitating transactions in shares in the first mentioned company or its holding company between and involving the acquisition of beneficial ownership of those shares by:

(d)  the making by the company of loans to persons other than directors employed in good faith by the company with a view to enabling them to acquire fully paid-up shares in the company or its holding company to be held by them by way of beneficial ownership.

As has been noted, there are criminal sanctions applying where there is a breach of the sections (s 680). In addition, the transaction itself is unlawful and void. There are various other consequences:

(a)  Any guarantee issued in connection with the transaction is itself void: see Heald v O’Connor [1971] 1 WLR 497.

(b)  The company may sue its directors for breach of duty as they are liable in a similar way to trustees in relation to misapplication of trust funds: in Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555, an agent acting for Cradock bid for the shares in the claimant company. This was accepted by 79 per cent of the shareholders of the claimant company. The purchase price of £195,000 was borrowed by Cradock from the District Bank. The claimant company’s cash balance of £325,000 was transferred to the bank and then loaned through the third party to Cradock. He used it to repay the loan. This was illegal under the Act. The company was able to sue its directors for breach of duty.

In Belmont Finance Corpn Ltd v Williams Furniture Ltd [1980] 1 All ER 393, the first defendant, Williams, held all the shares in the second defendant company (City). All the shares in the claimant company were owned by City. James was the chairman of all three companies. One Grosscurth, who was the controlling shareholder of Maximum, wished to acquire the claimant company. James believed that this would be beneficial to the Williams Group. The following negotiations were concluded: Maximum was sold to Belmont Finance for £500,000, and Grosscurth bought the share capital of Belmont for £489,000. No independent valuation of Maximum was carried out.

In the Court of Appeal it was held that Belmont had provided financial assistance to Grosscurth and his associates in relation to the purchase of Belmont share capital and that this was illegal and therefore the money was held on constructive trust for Belmont.

(c)  Furthermore, other persons receiving corporate property with knowledge that it is being applied for a wrongful purpose are liable to the company on the basis of constructive trust: see Selangor United Rubber Estates Ltd Co v Cradock and Belmont Finance v Williams Furniture.

(d)  There is also the possibility that the company can sue for conspiracy if two or more persons have got together to accomplish the unlawful act: see Belmont Finance v Williams Furniture.

It should be recalled that prior to the 2006 Act, private companies were also, in general, subject to a prohibition on the provision of financial assistance. While this is no longer the case generally, unless they are facilitating the acquisition of shares in a public company, some of the earlier case law provides useful guidance on what constitutes financial assistance and may, therefore, cause public companies in the future to fall foul of the law.

The question of the provision of financial assistance arose in Parlett v Guppys (Bridport) Ltd