In times of tight finances, companies are spending increasing amounts of time and money exploring a variety of alterative fundraising schemes. Sometimes, however, it is worth first “checking the sofa cushions” of your group’s balance sheets to see whether there are any capital funds or dividends which could be shaken loose by a little legal and accounting innovation. While capital reductions have previously been prohibitively expensive, the new solvency statement procedure can reduce the time and expense involved.
What is a capital reduction?
Reducing capital involves the cancellation of existing issued shares or repayment of paid-up share capital (thus reducing the nominal value of issued shares and the balance in the share premium account) or otherwise extinguishing the liability of holders of such shares to pay any amounts which have not yet been paid.
When might this be relevant?
Your group may have members which occupy a position with small capital requirements, for instance, but whose balance sheets have large share premium accounts or a large number of shares in issue. These members might be historic holding companies now sandwiched between productive trading companies and ultimate parent companies. In this position, any accumulated losses in such companies could “block” the ability to pass the full amount of dividends available in trading subsidiaries up to the ultimate shareholders of the parent company.
What’s the issue?
Preserving the capital “cushion” of companies is a major concern of UK company law. The idea is to protect creditors in the event of insolvency. On this basis, transactions which seek to reduce a company’s capital (by cancelling shares or capital reserves) or which have similar effect (share buybacks and financial assistance on the acquisition of own shares) are tightly controlled. Similarly, the rules relating to distributable reserves prevent companies from declaring dividends to the extent that they have accumulated losses from previous years.
In other words, it is easy to put capital into a company, but rather more difficult to take it out. That said, the position has been relaxed somewhat by the Companies Act 2006. Among other changes to capital preservation rules, it is now possible, at least for private companies, to use the “solvency statement” procedure to cancel any issued shares (so long as there remains at least one non-redeemable share in issue) or reduce or eliminate their share premium account or capital redemption reserves.
What’s the benefit?
It was formerly necessary to obtain court approval for any capital reduction. A reduction of capital by solvency statement can be accomplished more quickly and at less cost than the standard court approval.
What’s the catch?
The directors of the company making the statement of solvency are personally liable for the content of their statement and must therefore be sure to take appropriate advice and consider the position carefully before doing so. Although there will be fewer professional costs than with a court-approved capital reduction, in most cases it will still be necessary to involve legal and accounting professionals (see further below under “What is the process?”).
What is the result of reducing capital?
The reserve arising from a reduction supported by a solvency statement is treated as a realised profit (unless shareholders resolve otherwise or if the memorandum or articles of association state otherwise). Where a company has accumulated realised losses, the reduction of capital may be set off against these, and any surplus will be distributable reserves. Where the company has sufficient cash reserves, these might be distributed as dividend to members or used to buy back any of the company’s shares using the statutory share buyback provisions.
Can my company do it?
Private companies may make use of this procedure provided their articles of association do not prohibit or restrict them from reducing the company’s capital using the solvency statement procedure. The company’s shareholders need to pass a special resolution to reduce share capital. The special resolution must be supported by a solvency statement made by the directors not more than 15 days before the special resolution is passed.
What is a solvency statement?
The solvency statement is a unanimous statement of the directors of the company that, having taken account of all of the company’s liabilities (including any contingent or prospective liabilities), they have formed the opinion that:
- as at the date of the statement, there is no ground on which the company could be found to be unable to pay (or otherwise discharge) its debts; and
- the company will be able to pay (or otherwise discharge) its debts as they fall due during the year immediately following the date of the statement.
If it is intended to wind up the company within the coming year, the solvency statement must also confirm that such winding up will be done on a solvent basis.
The solvency statement does not amount to a personal guarantee by the directors that the company will remain solvent for the twelve month period following the date of the solvency statement. However, a criminal offence will have been committed if the directors make a solvency statement (which is delivered to the Registrar of Companies) without having reasonable grounds for the opinions expressed in it. Every director who is in default could face up to two years’ imprisonment or a fine (or both).
When can directors sign a solvency statement?
Directors must have regard to their general duties as directors. Among other things, since a capital reduction is potentially to the detriment of the company’s creditors, the directors will need to have regard, in particular, to the need to foster business relationships with suppliers, customers and other creditors of the company and the desirability of maintaining a reputation for high standards of business conduct.
Before approving and signing the solvency statement, the directors need to consider the financial position of the company and the likely effect of the reduction of capital. This consideration needs to take account of financial projections for at least the next twelve months.
The amount of preparation and level of supporting documentation will vary depending on a variety of factors including:
- the financial health of the company and state of the market generally;
- the relative size of the reduction of capital; and
- amounts (including prospective and contingent amounts) owing to creditors.
What the directors need to consider may differ considerably depending on the company’s circumstances. For example, the position of a non-trading company is likely to be very different from the position of a trading company. The directors will also wish to consider other potential threats to the company’s business model including, for example, the effect of unforeseen events such as the insolvency of a supplier or the loss of a major customer.
At a minimum, directors will need to consider a set of recent management accounts including working capital projections and existing debts of the company and those to be discharged over the coming 12 months. While it is not necessary to obtain independent third party advice, having taken advice is helpful in showing that the directors had reasonable grounds for their opinions. It will therefore be appropriate in most circumstances to take legal and accounting advice beforehand.
In certain circumstances, directors may wish to obtain a letter of comfort from the company’s auditors confirming that their reasoning and methodology appears to be sound. It may also be appropriate for a subsidiary to seek a letter of support from its ultimate parent company.
What if a director is unable or unwilling to sign the solvency statement?
If the company plans to undergo the capital reduction using the solvency statement procedure, any dissenting directors must resign. Alternatively (and in particular if there is any doubt that a solvency statement can properly be made), the company may wish to consider the court approval route.
In certain circumstances the solvency statement could be used effectively to unlock capital reserves no longer required for a company’s operation, for instance on the sale of key assets. Although the new procedure greatly facilitates capital reduction for private companies, it is not to be undertaken lightly. Please contact us for further information on how we might be able to assist you in this regard.