Unit 5 - Equity (CH 4)

Question 1

What are the two ways companies generally obtain finance?

Answer 1

Equity finance - Prospective shareholders pay money or give property to the company in return for shares
Debt finance - Companies borrow money to fund expansion or day-to-day operations

Question 2

What does Chapter 4 address regarding shares?

Answer 2

How shares are created and allotted to shareholders, and how ownership of shares changes through: (1) Transfer, (2) Transmission, and (3) Buyback

Question 3

What is allotment and what happens to the total number of shares in the company?

Answer 3

Company creates NEW shares and gives them to existing or new shareholders in return for payment (usually cash, sometimes property)
Company issues share certificate and enters person on register of members
Total number of shares INCREASES
Example: 200 shares → allot 100 → 300 shares total

Question 4

What is share transfer and what happens to the total number of shares?

Answer 4

Shareholder (transferor) sells or gives shares to another shareholder or new person (transferee)
Total number of shares REMAINS THE SAME
Only the identity of shareholders changes
Example: 200 shares → transfer 50 → still 200 shares total

Question 5

What is buyback and what happens to the total number of shares?

Answer 5

Company buys back its own shares from one or more shareholders
Shares are CANCELLED
Total number of shares DECREASES
Think of it as reverse of allotment
Example: 200 shares → buyback 100 → 100 shares remaining

Question 6

How do allotment, transfer, and buyback affect shareholder power?

Answer 6

Allotment: Dilutes existing shareholders’ percentage (unless they receive new shares)
Transfer: Transferor’s percentage decreases; transferee’s increases; others unchanged
Buyback: Remaining shareholders’ percentage increases
All three methods affect at least one shareholder’s percentage holding, which determines voting power

Question 7

Emma has 251 shares (25.1%) out of 1,000 total. Company allots 100 shares to Geeta. What happens to Emma’s power?

Answer 7

Before: 251/1,000 = 25.1% (can block special resolutions requiring 75%)
After: 251/1,100 = 22.82% (can NO LONGER block special resolutions)
Significant power reduction without Emma’s consent - this is why allotment is tightly controlled

Question 8

Emma (500 shares/50%), Farha (400/40%), Geeta (100/10%) = 1,000 total. Company buys back all Geeta’s shares. What happens?

Answer 8

After buyback: Emma (500/900 = 55.5%), Farha (400/900 = 44.44%)
Emma now has OVER 50% - can pass/block ordinary resolutions alone
Before she needed Farha’s support for ordinary resolutions
This concerns Farha who has lost relative power

Question 9

What’s the difference between “allot” and “issue”?

Answer 9

Allot (s 558): Person acquires unconditional right to be included on register of members (when shares transferred, paid for, and board passes resolution to register)
Issue: Person’s name is actually entered on register of members
Often used interchangeably but technically different

Question 10

What are the three questions to consider when allotting shares?

Answer 10

Are there any constitutional restrictions on allotment?
Do the directors have authority to allot shares?
Are there any pre-emption rights?

Question 11

What is authorised share capital and how does it affect modern companies?

Answer 11

Pre-CA 2006: Upper limit on shares in memorandum
CA 2006 (1 Oct 2009): ASC clause transferred to articles (s 28(1))
If pre-2009 company hasn’t updated articles: ASC still in articles
Can be removed by ordinary resolution (exception to normal rule!)
Must file copy at Companies House

Question 12

How do you remove constitutional restrictions on allotment for different types of companies?

Answer 12

Pre-CA 2006 companies (not updated): Ordinary resolution to remove ASC
All companies: Check articles for any limit on number of shares → remove by special resolution under s 21 CA 2006 if present

Question 13

What authority do directors of private companies with one class of shares have to allot shares?

Answer 13

If incorporated UNDER CA 2006: Directors have AUTOMATIC authority (s 550) - only need board resolution
If incorporated BEFORE CA 2006: Must pass ordinary resolution to “activate” s 550 (protects shareholders of older companies)
Articles may restrict: Can remove restriction by special resolution

Question 14

What authority requirements apply for PLCs or private companies with more than one class of shares?

Answer 14

Directors MUST obtain shareholder permission
Ordinary resolution required under s 551
Resolution must state:

Maximum number of shares to allot
Expiry date (max 5 years from resolution)

Authority can be renewed for further 5 years
Must FILE ordinary resolution at Companies House (exception!)

Question 15

What’s the alternative to passing a s 551 resolution after incorporation?

Answer 15

Authority to allot can be included in articles at incorporation
Must specify: maximum shares and expiry date (within 5 years of incorporation)
Still subject to 5-year maximum

Question 16

What are statutory pre-emption rights under s 561 CA 2006?

Answer 16

Rights of first refusal over shares being allotted
Company must offer “equity securities” to existing ordinary shareholders FIRST
On same or more favourable terms
In proportion to existing shareholding (preserve their percentage)
Purpose: Protects shareholders from dilution

Question 17

What are “equity securities” under s 560 CA 2006?

Answer 17

Ordinary shares
Rights to subscribe for ordinary shares
Rights to convert securities into ordinary shares
Basically: anything that affects voting power at general meetings

Question 18

What are the procedural requirements when making a pre-emption offer?

Answer 18

Offer must state period for acceptance (s 562(4))
Cannot be withdrawn within that period
Minimum 14 days for acceptance (s 562(5))
If shareholders don’t take up: directors can offer to others

Question 19

Emma (600 shares/60%), Farha (300/30%), Geeta (100/10%). Company allots 500 new shares. How many must be offered to each?

Answer 19

Emma: 300 shares (60% of 500)
Farha: 150 shares (30% of 500)
Geeta: 50 shares (10% of 500)
This preserves their percentage holdings

Question 20

What are the three statutory exceptions to pre-emption rights?

Answer 20

Bonus shares (s 564)
Non-cash consideration - wholly or partly (s 565)
Employee share schemes (s 566)

Question 21

How can articles of association affect pre-emption rights?

Answer 21

Private companies can exclude statutory pre-emption via articles (s 567)
Can exclude generally or for particular allotments
Model Articles have NO pre-emption rights
Companies often include bespoke provisions (e.g., 21 days instead of 14)
Check articles FIRST before advising on pre-emption

Question 22

How can private companies with one class of shares disapply pre-emption rights?

Answer 22

Pass special resolution under s 569
Applies to companies with s 550 authority to allot
Disapplies s 561 statutory pre-emption rights

Question 23

How can PLCs or private companies with multiple classes disapply pre-emption rights if they have general authority?

Answer 23

If s 551 ordinary resolution gave GENERAL authority to allot
Pass special resolution under s 570 to disapply pre-emption
Disapplication lasts as long as s 551 authority (up to 5 years)

Question 24

What additional requirements apply when disapplying pre-emption for a specific allotment under s 571?

Answer 24

Special resolution must be recommended by directors (s 570(5))
Directors must make written statement containing:

Reasons for recommendation
Amount purchaser will pay
Directors’ justification of that amount

Statement sent with notice of GM or written resolution (s 571(7))
Offence to knowingly/recklessly include misleading information (s 572)

Question 25

Summarize the approach to pre-emption rights for allotment.

Answer 25

Check articles first for bespoke provisions If statutory pre-emption applies (s 561): offer proportionally, min 14 days To disapply: Private, one class: s 569 special resolution PLC/multiple classes with general authority: s 570 special resolution Specific allotment authority: s 571 special resolution + directors' written statement

Question 26

What does Model Article 21 say about payment for shares?

Answer 26

All shares MUST be fully paid when allotted Buyer pays entire amount when receiving shares If articles don't include MA 21: shares can be partly paid (remainder due when contractually obliged or on winding up)

Question 27

What is share premium and how is it treated?

Answer 27

If share value increased: may allot for MORE than nominal value Example: £1 nominal share allotted for £1.75 £1.00 = nominal value → share capital £0.75 = premium → share premium account (s 610) Share premium treated as capital and MUST be maintained

Question 28

What resolutions must be filed at Companies House within 15 days after an allotment?

Answer 28

All special resolutions Ordinary resolution removing ASC (pre-CA 2006 company) Ordinary resolution activating s 550 (pre-CA 2006 company) Section 551 ordinary resolution granting authority to allot

Question 29

What forms must be filed at Companies House after allotment and when?

Answer 29

Form SH01: Return of allotment and statement of capital (within 1 month) PSC forms: If new PSC or change in PSC percentage bands (PSC01, PSC02, PSC04, PSC07)

Question 30

What internal company records must be updated after allotment and within what timeframes?

Answer 30

Register of members: Amend within 2 months PSC register: Amend if necessary Share certificates: Prepare and issue within 2 months Minutes: Keep minutes of board and general meetings (s 248, s 355)

Question 31

What are the key characteristics of share transfer?

Answer 31

Shareholder (transferor) sells/gives shares to another person (transferee) Total number of shares UNCHANGED Only IDENTITY of shareholders changes Transferor's percentage decreases; transferee's increases Other shareholders' percentages UNCHANGED

Question 32

Why might existing shareholders be concerned about a share transfer even though their percentages don't change?

Answer 32

Can shift power dynamics between shareholders Example: If minority shareholders combine holdings, they may gain blocking power May not want to work with new shareholder Potential for conflict This is why articles often contain transfer restrictions

Question 33

What are common share transfer restrictions in articles?

Answer 33

Transfers to family/existing shareholders: permitted Transfers to outsiders: require board approval Pre-emption on transfer: must offer to existing shareholders first at fair value Purpose: Prevent unwanted persons becoming shareholders, avoid conflict

Question 34

What can and cannot articles do regarding share transfers?

Answer 34

CANNOT: Prevent shareholder from selling shares or purchaser from buying CAN: Give board discretion to refuse to REGISTER the transfer Person only becomes shareholder when entered on register of members (s 113) Model Article 26: Board can refuse to register transfer

Question 35

What happens if the board refuses to register a share transfer?

Answer 35

Transferee: Beneficial owner (entitled to economic benefits) Transferor: Legal owner (name remains on register) At general meetings: Legal owner attends but must vote per beneficial owner's wishes Dividends: Legal owner receives but must pass to beneficial owner

Question 36

What are the first two steps in transferring shares?

Answer 36

Transferor completes and signs stock transfer form + provides share certificate (ss 770-772) Stamp duty payment (if applicable): by Buyer If sale price OVER £1,000: 0.5% stamp duty (rounded up to nearest £5) Minimum stamp duty: £5 If GIFT: NO stamp duty

Question 37

What are the final steps in transferring shares and what must the company do?

Answer 37

3. Transferee sends stock transfer form + share certificate to company 4. Company must: Issue new share certificate to transferee (within 2 months - s 776) Enter name on register of members (within 2 months - s 771) Notify Registrar via annual confirmation statement (CS01)

Question 38

What is CREST and when is it used?

Answer 38

Electronic payment system for shares Stamp duty reserve tax: 0.5% on whole purchase price Limited relevance to private companies with share certificates More common for public company shares Mentioned for completeness

Question 39

What is transmission of shares and when does it occur?

Answer 39

AUTOMATIC process where shares pass by operation of law: Death: Shares automatically pass to personal representatives (PRs) Bankruptcy: Shares automatically vest in trustee in bankruptcy Different from transfer (which is voluntary)

Question 40

What rights do PRs and trustees in bankruptcy have under Model Article 27?

Answer 40

Do NOT automatically become shareholders ARE entitled to any dividends declared on shares Can choose to: Be registered as shareholders themselves (unless directors refuse), then sell Sell shares directly in capacity as representative/trustee

Question 41

What is the principle of maintenance of share capital and why does it exist?

Answer 41

Share capital = money provided by shareholders for shares Foundation on which company rests CANNOT be reduced because creditors look to it for payment of debts Paid up capital cannot be returned to shareholders Shareholders' liability for unpaid capital cannot be reduced

Question 42

What are the main consequences of the maintenance of share capital principle?

Answer 42

Dividends can ONLY be paid from distributable profits (NOT capital) Company must NOT generally purchase its own shares Protects creditors who cannot sue shareholders directly (limited liability)

Question 43

What are the three exceptions to the maintenance of share capital principle?

Answer 43

Company can buy back shares following correct procedure (s 690) Company can purchase shares under court order (s 994 - unfairly prejudiced minority) Company can return capital to shareholders in winding up (after paying debts)

Question 44

Why might a company buy back its own shares?

Answer 44

Shareholder wants to leave but can't find buyer Transfer restrictions prevent sale Disgruntled shareholder causing problems Director retiring (resignation conditional on buyback) Better to buy out difficult shareholder than work unproductively Sometimes no good commercial reason (e.g., director retiring)

Question 45

What are the financial risks associated with share buyback?

Answer 45

Shares are CANCELLED Company must PAY outgoing shareholder (financially worse off) Reduces profits available for dividends Reduces capital available for creditors Less money for shareholders in winding up May leave company in risky financial position

Question 46

What directors' duties must be considered when buying back shares?

Answer 46

Section 172: Act in way most likely to promote success of company (long-term benefit) Section 174: Exercise reasonable care, skill and diligence Must not leave company in risky financial position Must justify that buying out shareholder is better than continuing to work with them

Question 47

What's the difference between market purchase and off-market purchase?

Answer 47

Market purchase: Buyback on stock market Off-market purchase (s 693): Not on stock market - relevant to private companies (covered in this chapter)

Question 48

What are the seven requirements for a valid share buyback?

Answer 48

Articles must not forbid buyback (s 690(1)) Shares must be fully paid (s 691(1)) Company must pay at time of purchase (s 691(2)) Payment from distributable profits or proceeds of fresh share issue (s 692(2)(a)) Ordinary resolution authorising buyback contract (s 694) Contract available for inspection (15 days before GM + at GM, or with WR) (s 696(2)) Contract kept at registered office for 10 years after completion (s 702)

Question 49

What are distributable profits under s 830 CA 2006?

Answer 49

Accumulated realised profits LESS accumulated realised losses Shown on balance sheet under "profit/loss reserve" This is what company can use to pay for buyback (or dividends)

Question 50

What must be done before the board meeting for a buyback out of profits?

Answer 50

Check articles don't limit s 690 power to buyback Prepare accounts to ascertain available profits Confirm shares are fully paid

Question 51

What must the board resolve at the board meeting for a buyback?

Answer 51

Decide method of finance Approve draft terms of purchase Resolve to call GM or propose written resolution Make contract/memorandum available: If WR: circulate with resolution If GM: at registered office for 15 days before GM and at the GM

Question 52

What resolution do shareholders need to pass for buyback and are there voting restrictions?

Answer 52

Ordinary resolution to authorise buyback contract (s 694) Voting restrictions: WR: Holder of shares being bought is NOT eligible to vote GM: Resolution invalid if passed on strength of votes from shares being bought (s 695)

Question 53

What happens after shareholders pass the buyback resolution?

Answer 53

Keep minutes/WR for 10 years (s 355) Board meeting: Resolve to enter contract; authorise director(s) to execute After completion (within 28 days): File return of purchase (SH03) and notice of cancellation Keep contract copy at registered office for 10 years Cancel shares, update register of members and PSC register

Question 54

Why are there special voting restrictions for buyback resolutions?

Answer 54

Personal interests don't usually prevent voting, BUT buyback is exception Shareholder selling shares has obvious personal interest Could vote in favour even if not good for company WR: Selling shareholder NOT eligible member (cannot vote) GM: Resolution not effective if seller's votes made difference (s 695)

Question 55

What practical issue must be considered regarding company's ability to buy back shares?

Answer 55

Company may have sufficient distributable PROFITS for buyback BUT those profits may be invested in assets (machinery, property) Profits not necessarily sitting in bank account Must check: Company's cash position Whether company can pay for shares AND meet short-term liabilities Directors must consider s 172 and s 174 duties

Question 56

Which companies can buy back shares out of capital and what's the key restriction?

Answer 56

Only PRIVATE companies can use capital (s 709) Unless articles forbid it PUBLIC companies CANNOT buy back out of capital Must EXHAUST distributable profits first before using capital Means buyback is partly from profits, partly from capital

Question 57

What is the directors' statement of solvency requirement for buyback out of capital?

Answer 57

Made no sooner than 1 week before GM States company is solvent and will remain solvent for 1 year after buyback Directors must have reasonable grounds Consequences if company insolvent within 1 year: Seller and directors may contribute to losses Criminal sanctions for statement without reasonable grounds

Question 58

What auditors' report is required for buyback out of capital?

Answer 58

Must be annexed to statement of solvency (s 714) Confirms auditors not aware of anything suggesting directors' opinion is unreasonable Provides independent verification of directors' statement

Question 59

What special resolution is required for buyback out of capital?

Answer 59

Special resolution to approve payment out of capital (s 716) This is IN ADDITION to s 694 ordinary resolution authorising buyback Voting restrictions: WR: Holder of shares being bought NOT eligible (s 717(2)) GM: Holder may vote but resolution not effective if their votes made difference (s 717(3))

Question 60

How must the statement of solvency and auditors' report be made available?

Answer 60

WR: Sent with resolution GM: Available for inspection at meeting If NOT complied with: special resolution is ineffective

Question 61

What public notices are required for buyback out of capital and when?

Answer 61

Within 7 days of special resolution (s 719) London Gazette notice stating: Shareholders approved payment out of capital Amount of capital to be used Date of special resolution Where statement/report available Creditors can apply to court within 5 weeks to prevent (s 721) PLUS: Notice in appropriate national newspaper OR notice to each creditor

Question 62

What must be filed at Companies House for buyback out of capital and when?

Answer 62

Copy of statement of solvency and auditors' report (s 719(4)) Filed before or at same time as notices published Ensures public record of company's intentions

Question 63

How long must the statement and report be available for inspection at the registered office?

Answer 63

From time company publishes first notice Until 5 weeks after special resolution (s 720) Allows creditors to review before objecting

Question 64

When must the payment out of capital be made?

Answer 64

NO EARLIER than 5 weeks after special resolution NO LATER than 7 weeks after special resolution (s 723(1)) Board has 2-week window to complete Allows time for creditors to object

Question 65

What is the timeline sequence for buyback out of capital?

Answer 65

Board prepares accounts (no more than 3 months before statement) Directors make statement of solvency + board meeting (no more than 1 week before GM) GM/WR - pass ordinary + special resolutions Within 1 week of SR: File documents + publish notices 5-7 weeks after SR: Board resolves to enter contract + make payment

Question 66

What are the two ways shareholders can make money from their shares?

Answer 66

Capital appreciation: Share value increases as company makes profit (e.g., £1 share becomes £1.50) Dividends: Company distributes profits to shareholders

Question 67

What are the legal requirements for paying dividends under s 830 CA 2006?

Answer 67

Company can only pay dividend if it has profits available for purpose Available profits = accumulated realised profits LESS accumulated realised losses Shown on balance sheet under "profit/loss reserve" If no profit in current year: can use previous years' profits

Question 68

What is the process for declaring dividends under Model Article 30?

Answer 68

Directors decide: Whether to recommend dividend How much it should be Shareholders approve: Pass ordinary resolution to declare the dividend

Question 69

How do dividends relate to the maintenance of share capital principle?

Answer 69

Dividends can ONLY be paid from distributable PROFITS NEVER from capital Protects creditors by ensuring capital base remains intact Fundamental principle connecting dividends to creditor protection

Question 70

What are the main topics covered in Chapter 4 Equity Finance?

Answer 70

Introduction (equity vs debt finance) Three ways shares change hands (allotment, transfer, buyback) Allotment procedure (constitutional, authority, pre-emption) Transfer and transmission Maintenance of share capital Buyback (out of profits and capital) Dividends

Question 71

What are the four learning outcomes for Chapter 4?

Answer 71

Understand principle of maintenance of share capital Advise on procedure to allot shares in company Advise on mechanics for transfer and transmission of shares Advise on how to buy back shares out of profit or capital

Question 72

What are the most important statutory provisions in Chapter 4 that you should recognise?

Answer 72

s 172: Directors' duty to promote success of company s 550: Private companies with one class - authority to allot s 551: Authority to allot (PLCs and multiple classes) s 558: Definition of allotment s 561: Pre-emption rights s 569-571: Disapplication of pre-emption s 690: Power to buy back shares s 709: Private companies can use capital s 830: Distributable profits definition