Day 144 Maintenance of share capital

Maintenance of share capital

The share capital represents the amount of member’s contribution to the company. It is the equity of the corporation that is expected to produce further economic benefits and support the business’ daily operations. Sometimes the company may want to increase this equity capital, in order to raise more available funds. In contrast, the entity may act in opposite due to the variation of capital structure, avoid a takeover by reestablish control on the stock, or provide returns to investors. However, both the common law and the Corporations Act strictly regulated the procedure, as to protect the rights of creditors. Hence the company may only process the capital reduction, share buy-backs and financially assist on share purchase under certain circumstances judicially agreed. 

The creditors will assess the company’s debt repayment ability based on its share capital. So any reduction on it will substantially prejudice their rights. Under section 256B, the purpose of the reduction must be fair and reasonable to the interest of shareholders as a whole. Therefore, both the majority and minority parties should receive a considerable benefit from the action. Other factors such as the adequate compensation or practical deprivation of shareholder’s rights should be accounted as well. In addition, the conduct must not materially compromise the entity’s ability to pay-off its debts. This is fairly important since the goal of these restrictions is to protect creditors. Moreover, the reduction must be approved by ordinary resolution (if equal reduction) or by special resolution(if selective reduction) in the general meeting. 

Besides the share capital reduction, the company may simply want to buy-back its shares. The S.259A and 259C prohibit the corporation to acquire shares itself or transfer shares to an entity it controls, unless the exemptions apply in S.257A. Similar to the reduction, this share buy-back should not materially prejudice creditors. Thereby the company needs to follow a series of procedures to comply with the statutory provision listed in S.257B. The most commonly used one is the 10/12 rules, which the entity may purchase its own shares at maximum 10% annually without the shareholder’s approval. 

At last, the part 2J.3 forbids the corporation to provide direct or indirect financial assistance to parties to purchase its or its holding company’s share. Section 260A has suggested the conditions that the assistant is permitted. It can either be: no material prejudice applied to company, members or creditors, shareholder has approved the decision under S.260B, or if the exemption in S.260C applies. Where the approval of shareholders must be given in the form of a special resolution, a unanimous resolution passed by all ordinary shareholders, or the acquisition will lead the company becomes a subsidiary of the holding company, and the special resolution is passed in that holding company. 

In conclusion, we should remember the major purpose of these provisions is to protect creditors and the members. Consequently, those factors that may affect these parties’ rights need to be considered first.