UK: Reducing Capital by Solvency Statement - Hints and Tips for Directors

Originally published May 30, 2012

Keywords: ICAEW, share capital, Companies Act, solvency statement procedure, CA06

The ICAEW has recently issued a helpsheet on the reduction of share capital under the Companies Act 2006 ("CA06"). This forms the background to this alert in which we set out some useful guidance for directors when considering a reduction of share capital under the solvency statement procedure introduced by the CA06.

One of the core principles of company law is that a company limited by shares must maintain its share capital for the protection of creditors. Accordingly, whilst the CA06 does permit the reduction of share capital it requires companies to comply with one of two set procedures.

These procedures are:

  • with court confirmation – available to both private and public companies; and
  • out of court but supported by a solvency statement – only available to private companies.

In both cases, a shareholders' special resolution is required.

Under the CA06 and subject to compliance with one of these procedures, a reduction of share capital may be effected in a number of ways, unless there is a specific prohibition in its articles of association. A company might use a reduction to repay surplus capital to shareholders, assist in the reorganisation of a corporate group, or create distributable reserves.

We have seen an increase in the number of clients using the solvency statement procedure for reducing a private company's share capital particularly in the context of reorganising and simplifying group structures. A reserve arising from a reduction in share capital using a solvency statement is treated as a realised profit for the purposes of the CA06 and, consequently, it may potentially enable cash or other assets to be distributed to shareholders.

What is a solvency statement?

A solvency statement must be made in writing and signed by all of the directors. In the solvency statement, every director is required to state that he has formed the opinion that (1) there is no ground on which the company could be found to be unable to pay (or otherwise discharge) its debts, (2) if it is intended to commence the winding-up of the company within 12 months of the date of the statement, the company will be able to pay its debts in full within 12 months of the commencement of the winding-up, and (3) in all other cases, 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.

A director who makes the solvency statement without having reasonable grounds for the opinions expressed in it risks imprisonment and/or a fine.

Can the solvency statement procedure be used to eliminate a deficit on the company's profit and loss account?

This is a question that often arises. It is not uncommon for a company to use a court confirmed reduction of capital to eliminate a dividend block resulting from an accumulated deficit on profit and loss accounts. But can a private company use the solvency statement procedure to do so?

In short, the answer is yes. The reserve arising on reduction may not all be able to be distributed; it must be set against the accumulated deficit first and only once that has been eliminated can the balance potentially be distributable.

What practical steps can the directors take to protect themselves against committing an offence?

Some time ago the City of London Law Society published a memorandum setting out a number of practical steps to reduce the risk of directors committing an offence under the relevant sections of the CA06. Its recommendations included:

  • Recording information relied on in reaching their opinion: The directors should undertake, and document, due diligence in relation to the company's debts. Any uncertainties regarding the company's liabilities or the resources available to meet them should be addressed.
  • Considering different factors depending on the circumstances: When forming their opinions, the directors should consider factors appropriate to the circumstances, for example, whether the company is trading or non-trading.
  • Obtaining reports from third parties: While there is no requirement for a report by any independent third party on the directors' conclusions, they may, in some cases, wish to obtain advice to reach their opinion or seek comfort on the processes that they have undertaken (or propose to undertake) to help satisfy themselves that their opinion expressed in the solvency statement is soundly based. Where directors give proper instructions and take account of the advice or comfort that they have received, it is likely to be helpful in showing that the directors had reasonable grounds for their opinions. But if the directors do not obtain a report from an independent third party or advice or comfort on the processes, this should not necessarily mean that they are unable to demonstrate that they had reasonable grounds for their opinions. We have seen instances where auditors have provided some level of comfort in support of directors' opinions and/or stress testing of company projections. However, this is by no means the norm.

In our experience, directors should also bear in mind the following:

  • Prepare cash flow projections and focus on identification of all liabilities: The CA06 specifically says the directors must take into account all liabilities (including any contingent or prospective liabilities).
  • The directors should look a minimum of 12 months into the future: In practice, it may be prudent for directors to consider beyond a 12 month horizon and thereby seek to accommodate some 'buffer' beyond the period actually covered by the solvency statement.

Further practical points to consider when reducing capital by way of the solvency statement route

  • Check the company's contractual arrangements for prohibitions or restrictions on the company's ability to reduce capital: For example, consent from a third party may be required under the terms of debentures, warrants, banking facilities or guarantees. Obtaining consent from third parties before the reduction of capital is carried out might affect the timing of a proposed resolution. The impact of any reduction in the context of a company's pension scheme (if applicable) should also be considered, together with the powers of the Pensions Regulator.
  • Consider imposing voluntary restrictions on the distributable nature of the reserve arising on reduction: For example, the shareholders' resolution could provide that the reduction reserve is only distributable when existing creditors have been paid. This would mimic the type of protection that may arise in a court confirmed reduction involving a repayment of paid-up share capital to shareholders, or a diminution of a liability on unpaid shares.
  • The special resolution must spell out precisely what is to occur so that the accounting follows the wording of the resolution: A common mistake is for the resolution to set out the result of the reduction but not the process by which it is to be effected e.g. the resolution should specify whether shares are to be cancelled and, if so, which shares.
  • Ensure there is at least one non-redeemable share in issue after the reduction: This is relevant where the reduction involves the cancellation of shares.
  • Take care when using the written resolution procedure: There is an inconsistency in the CA06 in relation to the timing requirements for written resolutions generally and for resolutions relating to reductions of capital using the solvency statement procedure. The statutory lapse date for written resolutions generally is 28 days whereas the CA06 requires the resolution approving a reduction of capital to be passed no more than 15 days after the directors' solvency statement. There are a couple of practical ways in which this can be addressed.
  • Where a reduction is undertaken to enable a company to make a distribution, the distribution will need to be considered after accounts have been drawn up reflecting the reduction: Since the reduction is only effective when the relevant paperwork is filed at Companies House, the relevant accounts to determine distributable profits cannot be prepared before filing has occurred.
  • Distribution in specie: If a distribution in specie is contemplated in conjunction with a reduction of capital, bear in mind that this will typically require a direction by shareholders as part of an ordinary resolution detailing the relevant dividend.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2012. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions