Reduction of capital – everything you need to know

There are a number of reasons why a company may wish to carry out a reduction of capital. Below, we’ll take you through the different routes required by both private and public companies. We will also walk you through some of the points that directors need to consider to ensure that all legal requirements are met.

Set up a limited company using our Fully Inclusive Package

Before the introduction of the Companies Act 2006, private companies could only effect a reduction of capital by obtaining a court order. Today, the procedure for reducing capital depends on the legal formation of the company. Private companies no longer need a court order, making things quicker, easier, and less expensive.

Reasons why a reduction of capital may be required

There are a number of 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 eliminate losses: as a company can only pay a dividend from surplus profits, eliminating accumulated losses that would otherwise prevent these payments is sometimes desirable.
• To return surplus capital: if a company has a surplus of cash or assets, these may be paid directly to shareholders by canceling the shares issued to them.
• 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 capital in order to create enough distributable profits to do so.

Redesignation – a guide to converting your company shares

Some companies also do this as a way to reorganise or simplify their group structures.

The result of capital reduction is that the number of shares in the company will decrease by the reduction amount. However, the company’s market value won’t change – there will simply be fewer shares available to trade.

What are the requirements for a reduction of capital?

The following conditions will need to be met:

• The articles of association should not prohibit 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 types 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).

You can find the rules for share capital reduction in Chapter 10 of Part 17 of the Companies Act 2006.

 How does a company go about reducing its share capital?

The reduction of capital is set out in the Companies Act 2006 and there are two ways this can be done, depending on the type of company:

• By special resolution with confirmation of the court – private limited companies may wish to use this route; however, it has to be taken by public limited companies.
• By special resolution supported by a solvency statement of the directors – this route is for private limited companies only. However, there may be occasions when a private limited company may prefer to obtain a court order.

Either route needs a resolution by at least 75% of the eligible members of the company.

What steps does the reduction of capital procedure include?

This route is open to private limited companies only and falls under Sections 642 and 643 of the Companies Act 2006. There are a number of steps:

• The passing of a special resolution.
• The issuing of a statement of solvency by the directors.
• A statement of capital, showing the company’s share capital as reduced.
• A statement by the directors confirming the solvency statement wasn’t made more than 15 days before the date the special resolution was passed.
• The filing of form SH19(644) with Companies House.

What is a special resolution?

Under the Companies Act 2006, certain important decisions have to be passed by ‘special resolution’ – one of which is the decision to reduce share capital. It’s a way of helping to protect minority shareholders against important decisions being made without due consideration and needs 75% of shareholders to agree to it, in order to pass.

What information must the solvency statement include?

The solvency statement must be signed in writing by all directors, confirming that, as of the date of the statement:

• There are no grounds on which the company could be found to be unable to pay or discharge its debts, and
• In the 12 months following the statement, it will be able to pay or discharge any debts as they fall due. Or, if the company is being wound up, that it will be able to do this, in full, within 12 months of the commencement of the winding-up.

Pre-emption rights – the key to maintaining your shareholdings

The solvency statement shouldn’t be made more than 15 days before the date of the passing of the shareholders’ special resolution.

Note, failing to have reasonable grounds for believing the opinions in a solvency statement and still signing it, constitute an offence that could lead to up to two years of imprisonment or a fine.

What are the things the directors need to know before providing a solvency statement?

If you’re the director of a private limited company, there are some things you need to be sure about, and do, before signing a solvency statement. These include:

• Carefully considering the financial position of your company and the effect of reducing any capital.
• Taking account of the company’s liabilities, including any that are likely to arise over the following 12 months.

To do this, directors need to fully review the company’s financial status, including future projections. This involves considering the company’s current accounts showing its net assets, projected business plans, cash flow, and net assets for the following 12 months.

Alternatively, if the company is due to be wound up in the next 12 months, it’s necessary to show a plan of how this will be done, along with how any liabilities will be discharged within 12 months of the commencement of winding up.

Is there any guidance about what steps to take before making a solvency statement?

The Company Law Committee of the City London Law Society provides some guidance, letting directors know what steps they can take before making their statement of solvency, to avoid risking committing an offence under the Companies Act 2006. This includes:

• Seeking advice from an independent auditor or accountant. Although this isn’t necessary under the Companies Act 2006, it can ensure the directors fully understand the decision they’re reaching, and whether it’s the right one.
• Keeping records of the information they’ve considered, as this demonstrates they’ve exercised reasonable care, skill, and diligence in reaching their decision.
• Considering any potential risks to the company’s business model, e.g. potential insolvency of suppliers or loss of customers.
• Considering different factors depending on the circumstances: for example, whether the company is trading or non-trading.

There are also a number of directors’ duties laid out in the Companies Act, including the duties to promote the success of the business, exercise reasonable care, skill and diligence, and act within their powers.

How must 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 might a private limited company seek a special resolution via the court?

Even though it’s only public limited companies that have to gain a special resolution in court, there may be times when this method is preferable for a private limited company. For example, if not all the directors are willing to sign the solvency statement or if they simply wish to be guided by the court, especially if there are creditors who may oppose the reduction.

Why do companies use multiple share classes?

As one might imagine, though, the solvency statement procedure is easier and less costly than going via the court-approved route.

What is the court procedure for approving a reduction in shares?

After a company has gained shareholder approval to reduce its capital, the next step is to apply to the court for a confirmation order – the court can grant this on any terms and conditions it sees fit. Generally, the court will agree to a reduction of capital so long as it’s 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.

Does a reduction of share capital need to be reported to Companies House?

Within 15 days of passing the resolution, Form SH19 needs to be filed with Companies House, along with:

• a copy of the shareholders’ special resolution
• a directors’ statement of solvency
• a directors’ compliance statement, stating that the solvency statement wasn’t made more than 15 days before the date of the special resolution and was given to the members before the resolution was passed.

Closing a company – a guide to voluntary dissolution and strike off

The SH19 form is effective when it is processed by Companies House, i.e. the reduction of capital does not take place until this happens.

Are there alternatives to reducing share capital?

There are various ways a company can achieve a similar effect to reducing share capital without having to do exactly that. These include:

• Purchasing its own shares (Companies Act, Section 690).
• Redeeming preference shares (Companies Act, Section 687).
• Adopting a solvent scheme of the arrangement, allowing shares to be transferred rather than canceled and reissued.

How we can help you reduce your share capital

If you are thinking about reducing your share capital, our Company Secretarial Team can help you every step of the way. Our Reduction of Capital Service (from £165.00 plus VAT) provides you with expert advice, together with the processing and completion of all documentation you need to reduce your share capital.

If you would like to know more about this service, please get in touch with our CoSec Team today on 0203 984 5389, or email us at [email protected].