Company Law - Topic 5

Share Capital Reductions Chp

8 p 226-246, Chp 10 p 274
279.
Buy-backs, financial assistance
and dividends
The Capital Maintenance Rule
protects creditors
The money a company receives from the
sale of its share issues constitutes
company funds that are known as - the
companys issued capital. In the event of
a winding up of the company it is the
issued capital against which creditors can
lodge their claims for repayment of the
debt the company owes them.
A general rule has been accepted in law
that Ltd Cos must maintain their capital.
 The capital maintenance rule
comes from Trevor v Whitworth
In Trevor v Whitworth [1887] 12 App C
409, Whitworth died and his executors
sold his holding in shares back to the
company, but before payment was
complete the company went into
liquidation and the liquidator refused to
pay. The court held that a company cannot
purchase its own shares and therefore
issued capital should not be returned to
shareholders before creditors.
The Rule in Trevor v Whitworth
is now in the Corporations Act
Sec 259A incorporates the capital
maintenance rule as a general rule a
company must not acquire shares in itself.
But because of modern economic
circumstances and corporate activities the
Act allows exemptions to the capital
maintenance rule and self-acquisition. A
reduction in capital is now permitted if it
does not materially prejudice creditors.
Capital reductions must be fair,
reasonable and be approved.
Sec 256B(1) A company may not reduce
its share capital in a way not otherwise
authorised by law if the reduction is
fair and reasonable to the companys
shareholders as a whole.
- does not materially prejudice the
companys ability to pay its creditors.
Sec 256C - a reduction must receive
approval by shareholders.
 What is not fair and
reasonable?
In Re Vacola Manufacturing Co [1966] VR
97, a share capital reduction involved a
benefit payment only to the ordinary
shareholders of the company and not to
the preference shareholders. It was held
that this was not valid because fairness
would require at least equal treatment for
preference shareholders the same as for
the ordinary shareholders.
 What is fair and reasonable?
In Winpar Holdings Ltd v Goldfields
Kalgoorlie Ltd [2001] NSWCA 427, a
cancellation of minority shares for
reasonable consideration had the effect of
giving the majority shareholder 100%
control and extra benefits arising from that
control. The minority shareholder argued
that this was not fair. The court disagreed
and said that all the shareholders had
received had reasonable benefits.
Statutory remedies that reverse
the onus of proof
Sec 256B(1)(b) permits a reduction of
capital if it does not materially prejudice
creditors. Sec 1324(1A) allows creditors to
apply for an injunction to stop a reduction
where insolvency is involved.
Sec 1324 allows a shareholder to apply for
an injunction to stop a reduction that is not
fair. (s 1324(1B).
The Co. must prove it is not prejudicial to
creditors, and that it is fair to all members.
 Shareholder approval
Sec 256B(1) allows a capital reduction if it
is approved by the shareholders, but the
approval requirements vary according to
what kind of share reduction it is:
An equal reduction of ordinary shares
needs approval by an ordinary resolution
by general meeting s 256C(1).
A selective reduction requires a special
resolution s256C(2). Notice of a resolution
must first be given to ASIC (14 days).
Liability for contravention of the
correct procedures
Once a reduction has taken place it cannot
be reversed even if the correct procedures
have not been followed, but - the directors
can be personally liable to a civil penalty
s 256D(3), s 1317E or a criminal offence if
it is dishonest s 256D(4).
If the reduction causes the Co to become
insolvent or takes place when it is
insolvent the directors may be liable under
588G, or liable to the liquidator s 588M.
Some reductions are permitted
and are exempt from s 256B(1)
Since 1998 s 257A -permits a share buy
back. A company may want to buy back
some of its own shares for a variety of
reasons:
Tax advantages to the shareholders.
To reduce the impact of company debt.
To increase the value and earnings of
shares, in recessionary conditions.
To prevent a takeover.
 S 257B -10/12 Rule for Buy
Backs
Equal buy-backs is one of five different
kinds of permitted share buy backs.
The general rule is that a Co can buy back
up to 10% of its shares within 12 months.
No shareholder approval is needed for this
The shares are then cancelled s 257H
and ASIC must be notified in 28 days.
Equal access means that the same % is
bought back from each ordinary share
holder on the same terms - s 257B(2),(3).
 When the 10/12 rule limit is
exceeded- s 257C(1),(2) and G
When exceeded there must be an ordinary
resolution passed by shareholders at a
general meeting giving its approval.
In a Group as a general rule, the issue or
transfer of shares by a company into
another entity such as a subsidiary,
partnership or trust which it controls, will
be void as an indirect self-acquisition. s
259C(1) unless wholly owned and there is
no un-fair discrimination to shareholders.
 Buy-Back Case Study 1
In August 2011, GPT Property Manager
said it would re-start a buy-back of its
securities at a time when its profit
guidance was strong. The CEO indicated
that the buy-back would enhance returns
for the security holders. The share price
went 2.6% higher on this announcement.
This is an example of a Co with a strongly
performing core business but seemingly
under valued by a depressed market.
 Prohibition on Co financial
assistance to buy its shares
Financial assistance is where a Co lends
money to an individual to be used to
acquire shares in the Co.
Before 1998 it was prohibited unless their
was shareholder approval, now under s
260A -260D the same protection for
creditors and shareholders applies but
there have been modifications to make it
the same as other capital reductions, so
as to give Cos more flexibility.
Under 260A financial assistance
must meet certain requirements
The assistance must not materially
prejudice the interests of the Co, its
shareholders and its ability to pay its
creditors. s 260A(1)(a)
It has prior shareholder approval 260B
or
It is exempted under 260C eg, an
employee share scheme.
 Case Study ASIC v ADLER
[2002] NSWSC 171
Williams was the founding CEO of HIH
Insurance which grew to be one of
Australias largest insurers. His purchase
of AFI Insurance for $590m from Adler in
1998 with a misleading prospectus that
fooled shareholders and investors, by
2000 HIH was insolvent with debts of $5 b.
At the same time he gave $10m to Adler
who was also a director of HIH, through
Adlers PEE Co to buy shares in HIH($4m)
 ASIC v ADLER
Although Adler kept most of the money for
his own purposes the aim of the loan from
Williams was to prop up the failing share
price of HIH, which it failed to do.
HIH and its subsidiaries was materially
prejudiced in breach of s 260A, and both
Williams and Adler were found to be in
breach of the Act (civil penalties) and of
their duties as directors. They were also
sentenced to prison for dishonesty.
 Buy Back Case Study 2
In Feb 2012 the Macquarie Investment
Bank CEO announced that it was still
committed to a buy back of 10% of its
shares but was waiting for approval by the
Australian Prudential Authority (APRA).
The buy back was intended to raise its
share price which has been dropping since
the GFC had affected its debt ratio, and
profits at a time when it was cutting staff
and wanting to raise more share capital.
 Payment of Dividends Rules
are Replaceable
A dividend is where a company returns
profits to its shareholders in the form of
cash or bonus shares. Dividends can be
interim or final at the end of the financial
year, without prior shareholder declaration.
S 254U, 254 W(1) It is the directors who
have the power to fix the time and size of
the payment of dividends. Directors can
decide not to pay a dividend and the
shareholders cannot force payment.
 Old Law on the Payment of
Dividends
Prior to June 2010 a dividend could only
be paid out of profits as distinct from the
sale of fixed assets. The case law
revolved around differing legal definitions
and accounting methods of determining
the meaning of profits.
In Ammonia Soda v Chamberlain (1918) 1
Ch 266, a dividend can be paid out of a
current profit despite previous years of
losses.
Improper Payment of Dividends
law now follows s 256B(1)
S 254 T was amended in June 2010
making most of the case law irrelevant.
(1) a company must not pay a dividend
unless:
The Co assets exceed its liabilities before
the dividend is paid and there is sufficient
excess to pay the dividend.
The payment is fair and reasonable to
shareholders as a whole.
It does not materially prejudice creditors.
 Remedies - improper Payment
of Dividends
If the payment does not satisfy the capital
reduction rules in s 256B(1) then the Co is
in breach of s 254D. The dividend will still
stand but the directors may be liable for a
civil penalty s 256D(2),(3), s 1317E.
The directors may also be in breach of
their insolvency duties s 588G.
They may also contravene s 254T(1)(c)
and breach their fiduciary duty and duty of
care, and be personally liable.
 Injunctions, Imputation Credits
Shareholders and creditors may also be
able to apply to the court for an injunction
to stop the payment of a dividend because
it is unfair, or materially prejudices the Co.-
s 1324
Imputation credits can be attached to
dividends(as franked credits) to overcome
the problem of the unfair double taxing of
company profits. Australian resident
shareholders can get a tax credit offset.
Sample test and Exam Question
. A founding member and director of a Pty
Ltd Co is unhappy with the fact that the
other two members and directors who hold
a majority of shares have passed a
resolution to make an acquisition of his
shares without his consent. He believes
that this is unfair. Discuss the relevant
statute and case law. (20 marks)
 Sample Test and Exam
Question
. Using relevant case law examples
explain the attitude of the courts and the
principles they apply to the competing
claims of power in a company between the
members in general meeting and the
board of directors in making management
and business decisions. Does the
application of statute law change your
answer? (20 marks)
 Key Points of Focus
The Indoor Management Rule from
Trevor v Whitworth.
Sec 259A now incorporates the rule from
Trevor v Whitworth into the Act.
There are now 3 exemptions in the Act to
this rule as long as they are fair and
reasonable to all shareholders and do not
materially prejudice creditors sec 256B(1).
 Key points of focus continued
Why is their a difference in regard to what
the Courts consider is fair between the
Vacola case and the Winpar case?
Three kinds of reductions in capital are
exempt from sec 256 B requirements:-
- buy backs explain the 10/12 rule
- financial assistance explain ASIC v
Adlers case
- Payment of dividends explain new
rule in sec 254T