Legal and economic roles of share capital

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CHAPTER 3 NEW ZEALAND

INTRODUCTION

The main statutory source of Company Law in New Zealand is the Companies Act 1993 1 that came into force on 1 July 1994. 2 It applies to all new companies incorporated or reregistered since that date and, from 1 July 1997, to all existing companies that failed to reregister.3 The Act is supplemented by various other statutes,4 the common law,5 and precedents. The distinction between public and private companies was abandoned under the Companies Act of 1993.6 Another innovation is that companies need not have a constitution, in which case the default provisions of the Act apply.7
Prior to the enactment of the 1993 Act, the capital maintenance doctrine applied in New Zealand.8 In addition to this, distributions to shareholders were subject to compliance with a common-law solvency and liquidity test.9 The 1993 Act moves away from capital maintenance and subjects distributions to the solvency and liquidity of the company, as certified by the directors.10

STRUCTURE OF SHARE CAPITAL

The Act does not use the concepts ‘authorised capital’ and ‘share capital’.11 For certain purposes reference is made to shareholders’ funds as being the aggregate of amounts received by shareholders for the issue of their shares plus reserves.12
One of the essential requirements for the registration and existence of a company is that it must have at least one share.13 The liability of shareholders is expressed with reference to any amount unpaid on their shares.14
Although a company is obliged to issue the shares specified in its application for registration immediately upon incorporation, 15 it need not receive any consideration for these initial shares.16 A company may be formed without any share capital.
Shares may not have a nominal or par value.17 The Act does not require the consideration received for the issue of shares to be reflected in any particular account of the company. However, a copy of the directors’ certificate setting out the amount or the present cash value of the consideration for the issue of shares must be registered 18 and may be inspected by shareholders. 19 In a sense, these certificates will give an indication of the contributed share capital of the company. Such disclosure is not required in respect of initial shares of the company, though.20 The board of directors may issue further shares at any time, to any person, and in any number it thinks fit.21 However, this right is subject to compliance with the Act and the constitution of a company.22 Compliance with the Act and the constitution of the company can be waived by unanimous assent of entitled persons.23 The Act controls the power of directors to issue further shares in different ways.
First, pre-emptive rights apply unless excluded in the constitution of a company.24 The default pre-emptive rights apply to any issue of shares by the company, regardless of the nature of the consideration for which the shares are issued.
A second measure controlling the power of directors to issue shares is the imposition of a positive duty on directors to consider the interests of the company and all the existing shareholders.25 The common-law duties of directors when further shares are issued are partially codified and extended. The directors have to determine by resolution that not only the consideration, but also the terms of the issue, are fair and reasonable to the company and all the existing shareholders.26 A determination by the directors is a precondition for the issuing of shares.27 A purported issue is void if the relevant determination was not made.28
Thirdly, shareholder approval is required in certain instances. The issue of further shares that rank equally with or in priority to existing shares is deemed to be an action affecting the rights attaching to existing shares.29 This is so unless the constitution expressly permits the issue of these further shares or the issue is subject to pre-emptive rights.30 Since the issue of further shares is deemed to be an alteration of shareholder rights, it has to be approved by special resolution of each interest group.31 Dissenting shareholders can exercise appraisal rights.32
The constitution of a company can also require that the issue of shares will be subject to shareholder approval. 33 In the event of non-compliance with this requirement, the issue will nevertheless be valid, 34 but the directors will incur criminal liability.35

CAPITAL CONTRIBUTIONS

Size of capital contribution

Although consideration for the issuing of shares is regulated, the purpose is to protect the company and its existing shareholders rather than the creditors of the company.36 The directors have to decide for which consideration and on which terms the shares will be issued.37 Then they have to resolve that the consideration and terms they decided on are fair and reasonable to the company and to all its existing shareholders.38 The directors who vote to adopt this resolution have to sign a certificate setting out the consideration, terms, and their assessment of the fairness and reasonableness of the issue.39 A director who fails to comply with the requirements pertaining to the certificate commits a criminal offence.
The regulation of consideration for and terms of issue of shares is solely for the protection of the company and its shareholders. As a result, the shareholders can by unanimous written assent 41 dispense with requirements as to authorisation of issues,42 determination and certification of consideration and terms,43 pre-emptive rights,44 any other restriction in the Act or the company’s constitution.45
The constitution of a company may provide that shares carry a liability to calls or may otherwise impose a liability on a shareholder.46 Unlike the liability to pay the consideration for the issue of a share, which remains a liability of the person to whom the share was issued or who assumed liability for the consideration at the time of issue, the liability to pay calls always rests on the present holder of a share.47

Form of capital contribution

Consideration for the issue of shares may be cash, promissory notes, contracts for future services, real or personal property, or other securities of the company.48
It is not clear whether the issue of bonus shares is regarded as an issue for no consideration. When shares that are ‘fully paid up from the reserves’ of the company are issued proportionately to all shareholders in a class, the directors do not have to pass a resolution and sign a certificate regarding the consideration and terms of issue.49 A leading commentary questions the justification for this exception by pointing out that such an issue can nevertheless disturb the overall equity interest in the company.50 The exception leaves shareholders of the other classes unprotected by the requirements designed to protect all existing shareholders.
The directors’ determination and certificate are also not required in the case of proportionate consolidations and subdivisions of shares.51 These actions clearly do not involve the reallocation of equity interests.52

The regulation of non-cash capital contributions

Where non-cash consideration is accepted either when shares are to be issued or when they are subsequently credited as paid up, wholly or partly, other than in cash, the directors must determine the reasonable present cash value of the consideration.53 They must also adopt a resolution declaring that the present cash value is not less than the amount to be credited for the issue of the shares.54 Then they have to sign a certificate describing the consideration in sufficient detail to identify it, stating the present cash value and the basis for assessing it, and declaring that the present cash value is fair, reasonable, and at least equal to the amount to be credited in respect of the shares.55 A copy of such a certificate has to be delivered to the Registrar for registration within 10 working days after it is given.56
The reference to an amount that is to be credited for the issue of shares has been criticised as being anomalous, given the absence of a concept of nominal capital.57 Presumably, this provision can only apply if the board of directors fixed an amount of money as consideration and then later accepts non-cash consideration from some shareholders. If the directors determine a non-cash consideration only, there is no ‘amount’ to be credited.
Shares are also regarded as paid up ‘other than in cash’ if they are credited as fully or partly paid up as part of an arrangement involving a transfer of property or the provision of services, even if the arrangement also involves an exchange of cash or cheques or other negotiable instruments.59
When previously issued shares are later credited as fully or partly paid up other than for cash, the directors also have to determine the present cash value of the consideration and resolve and certify that it is fair and reasonable to the company and all its existing shareholders and that the present cash value is not less than the amount to be credited in respect of the shares.60 This provision appears to be an important anti-avoidance measure and should be considered as a possible improvement on the proposed regulation in the South African Companies Bill.61

Timing of capital contribution

It is not a requirement that the company should actually receive the consideration before the shares are issued. The person to whom a share was issued, or another person who undertook the liability for the consideration at the time of issue will, however, remain liable to pay the consideration for the issue of the share, despite a subsequent transfer of the share.62 The directors may also have the power to refuse to register the transfer of a share while any liability attaching to it remains outstanding.63

DISTRIBUTIONS

A company may make distributions to shareholders subject to requirements designed to protect creditors and ensure fair treatment of shareholders. Non-compliance with any of these requirements is deemed to constitute unfairly prejudicial conduct towards a shareholder for purposes of the minority oppression remedy.64
Distributions are regulated in general by the inclusion of a definition of ‘distribution’ and by the requirements of the solvency test. However, the solvency test is modified for certain specific kinds of distributions and different procedures and other requirements are prescribed for different kinds of distributions.

Kinds of payments regulated

‘Distribution’ is defined as:
in relation to a distribution by a company to a shareholder:
the direct or indirect transfer of money or property, other than the company’s own shares, to or for the benefit of the shareholder; or the incurring of a debt to or for the benefit of the shareholder – in relation to shares held by that shareholder, and whether by means of a purchase of property, the redemption or other acquisition of shares, a distribution of indebtedness, or by some other means.65
The essence of this definition is that the company must make the distribution in relation to shares held by the shareholder. A distribution requires both an outflow of funds from the company and a corresponding benefit conferred on the shareholder.66 This is comparable to the requirement in the definition of ‘payment’ in South Africa that the payment must be ‘by reason of the shareholding’ of the shareholder.67 The use of the words ‘direct or indirect’ is another feature common to these two definitions. The current South African definition does not expressly include the incurring of a debt, although such an extension has been proposed.68
Apart from this general definition, various other provisions specifically state that a particular transaction is a distribution.69 The cancellation or reduction of a shareholder’s liability in relation to a share will be regarded as a distribution to the shareholder of the amount by which the liability is reduced.70 This will be the case regardless of whether the reduction or cancellation is achieved through an alteration of the company’s constitution, the acquisition of own shares, or the redemption of shares.71 It is interesting to note that in addition to being a distribution, it will also be a dividend, necessitating equal treatment of shareholders.72 The same principle applies to amalgamations between companies resulting in the reduction of shareholder liability, but its ambit is there extended to include shareholders who do not become shareholders of the new company.73

Financial restrictions

The solvency test is set out in section 4. It comprises two elements, namely an equity solvency or liquidity test which is satisfied if the company is able to pay its debts as they become due in the normal course of business,74 and a balance sheet test, which requires the value of the company’s assets to be equal or exceed the value of its liabilities, including contingent liabilities.75
Section 4 contains various prescriptions regarding the application of the balance sheet test, but no further indication as to the interpretation of the liquidity test. In determining whether the balance sheet test is satisfied, the directors must have regard to the most recent financial statements of the company that comply with the Financial Reporting Act 1993, as well as to other circumstances they know of or ought to know of that affect or could affect the value of the assets or liabilities.76 The valuation of contingent liabilities may be determined by having regard to the likelihood of the contingency occurring.77 The directors may deduct the amount of any claim the company can make and which can reasonably be expected to be met, that would reduce or extinguish the contingent liability.78 A director may rely on valuations of assets or estimates of liabilities that are reasonable in the circumstances.79
The solvency test is refined for purposes of section 52, which deals with the power to make distributions, and section 56, which governs the recovery of distributions made in breach of the solvency test.80 Debts, which are to be taken into account in assessing the liquidity of the company, include fixed preferential returns on shares ranking ahead of the shares in respect of which a distribution is made.81 However, debts arising by reason of the authorisation must not be taken into account. 82 It makes sense to disregard debts that arise by reason of the authorisation, as these cannot really be described as debts becoming due in the normal course of business.83 This provision could provide clarity and a similar provision should be considered for South Africa.84
Liabilities include the amount necessary to repay fixed preferential amounts payable on deregistration if the company were to be deregistered at the time of the distribution. 85 If the shares are liable to be redeemed before the date of the distribution, the redemption price must also be counted as a liability.86
The interests of preference shareholders are protected. However, the constitution of the company can expressly provide that the fixed preferential amounts are subject to the power of the directors to make distributions.87 This approach stands in contrast with the current position in South Africa, where the preferential claims of shareholders are not regarded as liabilities.

Timing for application of the financial restrictions

Before it authorises a distribution, the board has to consider the financial position of the company and be satisfied that it will be solvent and liquid immediately after making the distribution.89 At this stage, the directors who support the distribution must sign a solvency certificate.90 However, if the board subsequently ceases to be satisfied that the company will satisfy the test, the distribution is deemed not to have been authorised.91 Although an enquiry must be made at the time of authorisation, the board’s view of the solvency and liquidity of the company at the time the distribution is actually made is decisive. The initial satisfaction of the board is relevant with respect to the question of authorisation only.
The recoverability of a distribution from shareholders and directors depends on the actual solvency and liquidity of the company at the time of the distribution, not when it is authorised.92
The formulation of the solvency test facilitates this distinction between its application in determining whether a distribution has been authorised and in establishing the recoverability of a distribution. This perspective can be useful in reforming the position in South Africa.93

Status of claim in respect of authorised but unpaid distributions

Although the Act expressly regulates the enforceability of repurchase contracts,94 it does not address the status of a claim in respect of an authorised but unpaid distribution. The authors of Morison’s Company and Securities Law argue that the authorisation of a distribution does not create a debt and that the common-law principle, that the declaration of a dividend created a debt recoverable by a shareholder, no longer applies.

Authorisation

Any distribution to shareholders must be authorised by the board of directors.96 The board must authorise a distribution only if it is satisfied on reasonable grounds that immediately after the distribution, the company will satisfy the solvency test.97 The directors voting in favour of a distribution have to sign a certificate stating that in their opinion the company will satisfy the solvency test and setting out the grounds for that opinion.98
If after the authorisation of a distribution but before it is made, the board is no longer satisfied that the company will comply with the solvency test, the distribution is deemed not to have been authorised.99

Liability for distributions made in contravention of the Act.

Section 56 provides for the recovery of distributions made in breach of the solvency test. If the company did not actually satisfy the test immediately after the distribution was made the distribution can, in principle, be recovered from the shareholder.100 In order to retain the distribution, a shareholder must satisfy three conjunctive requirements.101 First, the shareholder must have received the distribution in good faith and without knowledge of the company’s failure to satisfy the solvency test.102 Secondly, the shareholder must have altered her position in reliance on the validity of the distribution.103 Thirdly, it must be unfair to require repayment in full or at all.104
The authors of Morison’s Company and Securities Law point out that these requirements are similar to those for resisting the repayment of voidable preferences and suggest that judgments dealing with voidable preferences may provide guidance on their interpretation.105
Directors are liable for non-compliance with the solvency test 106 and for non-compliance with the procedural requirements.107 They are, however, liable only to the extent that the distribution cannot be recovered from the shareholders.108 A director can be liable on one of the following bases:
failing to take reasonable steps to ensure that the proper procedure is followed109
signing of a solvency certificate when reasonable grounds for believing that the company would satisfy the test did not exist110
failing to take reasonable steps to prevent a distribution after no longer being satisfied that the company would satisfy the solvency test.111

DIVIDENDS AND OTHER PAYMENTS TO SHAREHOLDERS

The significance of regarding a distribution as a dividend is to provide for the proportionate treatment of shareholders.112 Dividends paid to members of a specific class must be proportionate to their shareholding or alternatively, proportionate to the consideration paid to the company in satisfaction of the liability of the shareholder under the constitution of the company or under the terms of issue of the share.113 A shareholder may waive his or her entitlement to a dividend.114
A ‘dividend’ is defined as ‘any distribution other than a distribution to which section 59 or section 76 applies’.115 Thus, it is any distribution except an acquisition of shares and the provision of financial assistance for the acquisition of shares. Since redemptions are distributions under sections 69 to 75, the question arises whether redemptions are ‘dividends’. It is expressly provided that the redemption of shares at the option of a shareholder or on a fixed date is not regarded as a distribution for purposes of section 52 or as a dividend for purposes of section 53.116 The position regarding redemption at the option of a company is not clear. Although it is expressly stated that in a redemption at the option of the company the solvency test of section 52 must be complied with,117 nothing is said about section 53. At first glance, it may appear that a redemption at the option of a company should be regarded as a dividend. However, since non-pro rata redemptions are expressly allowed, it is unlikely that redemptions qualify as dividends, which are by definition proportionate.
Shareholders of a company may agree to accept an issue of shares wholly or partly in lieu of a proposed dividend or proposed future dividends. 118 All shareholders must be treated proportionately. Since shares will be issued, the requirements of section 47 regarding consideration must also be satisfied.

SHARE REPURCHASES

The acquisition by a company of its own shares is specifically regulated by sections 58 to 67 of the Act, while section 107 and sections 110 to 112 also apply to repurchases.
6.1 Power to acquire shares
Various provisions of the Act regulate the repurchase by a company of its own shares. Section 58 provides that a company may acquire its own shares in accordance with sections 59 to 66, section 107, and sections 110 to 112, ‘but not otherwise’. A repurchase in compliance with a court order such as an order made under the minority oppression remedy119 is also possible, although not covered in s 58.120
Sections 59 to 66 provide for four different types of share repurchases that can be initiated by a company, namely:
a pro rata offer to all shareholders
a selective offer direct to some shareholders
an on-market purchase with prior notice to shareholders
an on-market purchase not subject to prior notice to shareholders.
The first three of these types of repurchase involve an offer made by the company to shareholders.125 Regardless of the type of repurchase, compliance with section 52, which sets out the solvency test as it applies to distributions, is required. Sections 60, 63 and 65 set out the procedure for the different types of repurchase.126
Section 107 provides for the repurchase of shares by a company with the agreement of all ‘entitled persons’. 127 The authorisation and procedural requirements do not apply,128 but the directors have to be satisfied on reasonable grounds and sign a certificate to the effect that the company will satisfy the solvency test.

TABLE OF CONTENTS
SUMMARY
ACKNOWLEDGEMENTS
TABLE OF CONTENTS
CHAPTER 1 INTRODUCTION
1 INTRODUCTION
2 THEORETICAL ISSUES
2.1 The relevance of share capital
2.2 Legal and economic roles of share capital
2.3 Creditor protection
2.4 Share-capital related conflict situations
3 OVERVIEW OF THE REGULATION OF DISTRIBUTIONS
3.1 The capital maintenance doctrine
3.2 Solvency and Liquidity
4 METHODOLOGY
4.1 Need for this study
4.2 Scope and motivation of comparative study
4.3 Specific issues considered
5 REFERENCE TECHNIQUES
CHAPTER 2 ENGLAND
1 INTRODUCTION
2 STRUCTURE OF SHARE CAPITAL
2.1 Authorised capital
2.2 Minimum share capital
2.3 Kinds of shares
2.4 Share capital and reserve accounts
2.5 The variation of share capital
2.6 Formal reduction of capital
2.7 Serious loss of capital
3 CAPITAL CONTRIBUTIONS
3.1 Size of the capital contribution
3.2 Form of capital contribution
3.3 The regulation of non-cash capital contributions
3.4 Timing of capital contribution
4 DISTRIBUTIONS
5 DIVIDENDS AND OTHER PAYMENTS TO SHAREHOLDERS
5.1 Kinds of payments regulated
5.2 Financial Restrictions
5.3 Timing for the application of the financial restrictions
5.4 Status of claim in respect of authorised but unpaid distributions
5.5 Authorisation
5.6 Liability for distributions made in contravention of the Act
6 SHARE REPURCHASES
6.1 Power to acquire shares
6.2 Financial restrictions for repurchases
6.3 Procedure and other requirements
6.4 Liability for unlawful repurchases
6.5 Enforceability of repurchase agreements
6.6 The status of repurchased shares
6.7 Repurchases through subsidiaries
6.8 Redemption of shares
7 EVALUATION AND CONCLUSION
CHAPTER 3 NEW ZEALAND
1 INTRODUCTION
2 STRUCTURE OF SHARE CAPITAL
3 CAPITAL CONTRIBUTIONS
3.1 Size of capital contribution
3.2 Form of capital contribution
3.3 The regulation of non-cash capital contributions
3.4 Timing of capital contribution
4 DISTRIBUTIONS
4.1 Kinds of payments regulated
4.2 Financial restrictions
4.3 Timing for application of the financial restrictions
4.4 Status of claim in respect of authorised but unpaid distributions
4.5 Authorisation
4.6 Liability for distributions made in contravention of the Act.
5 DIVIDENDS AND OTHER PAYMENTS TO SHAREHOLDERS
6 SHARE REPURCHASES
6.1 Power to acquire shares
6.2 Financial restrictions
6.3 Procedure
6.4 Liability for unlawful repurchase
6.5 Enforceability of contracts for the acquisition of own shares
6.6 The status of repurchased shares
6.7 Purchases through subsidiaries
6.8 Redemption of shares
7 EVALUATION AND CONCLUSION
CHAPTER 4 UNITED STATES OF AMERICA
1 INTRODUCTION
2 DELAWARE
2.1 Introduction
2.2 Structure of share capital
2.3 Capital contributions
2.4 Distributions
2.5 Dividends
2.6 Share repurchases
2.7 Evaluation and conclusions on Delaware
3 CALIFORNIA
3.1 Introduction
3.2 Structure of share capital
3.3 Capital contribution
3.4 Distributions
3.5 Dividends
3.6 Share repurchases
3.7 Evaluation and conclusions on California
4 THE MODEL BUSINESS CORPORATION ACT
4.1 Introduction
4.2 Share Capital Structure
4.3 Capital contributions
4.4 Distributions
4.5 Dividends
4.6 Share repurchases
4.7 Evaluation and conclusions on the MBCA
5 EVALUATION AND CONCLUSION
CHAPTER 5 SOUTH AFRICA
1 INTRODUCTION
1.1 Overview of the development of share capital and distribution rules
2 STRUCTURE OF SHARE CAPITAL
2.1 Authorised capital
2.2 Minimum share capital
2.3 Kinds of shares
2.3.1 Comparison of par and no par value shares
2.3.2 Evaluation of dual system of shares
2.4 Share capital and reserve accounts
2.5 The variation of share capital
2.6 The reduction of issued capital
2.7 Loss of capital
2.8 Capital structure under the Companies Bill
2.9 Evaluation of capital structure
3 CAPITAL CONTRIBUTIONS
3.1 Size of capital contribution
3.2 Form of capital contribution
3.3 The regulation of non-cash capital contributions
3.4 Timing of capital contribution
3.5 The regulation of commissions
3.6 Capital contributions under the Companies Bill
3.7 Evaluation of capital contribution
4 DISTRIBUTIONS
4.1 Financial restrictions for distributions
4.2 The time for application of the financial restrictions
4.3 Distributions under the Companies Bill
4.4 Evaluation of distributions in general
5 DIVIDENDS AND OTHER PAYMENTS TO SHAREHOLDERS
5.1 Kinds of payments regulated
5.2 Financial restrictions
5.3 Timing for the application of the financial restrictions
5.4 Status of claim in respect of authorised but unpaid distributions
5.5 Authorisation
5.6 Liability for distributions made in contravention of the Act
5.7 Payment of interest on capital
5.8 Dividends and other payments under the Companies Bill
5.9 Evaluation of dividends and other payments
6 SHARE REPURCHASES
6.1 Power to acquire shares
6.2 Financial restrictions for repurchases
6.3 Procedure and other requirements
6.4 Liability for unlawful repurchases
6.5 Enforceability of contracts for the acquisition of own shares
6.6 The status of repurchased shares
6.7 Acquisitions by a subsidiary
6.8 The redemption of shares
6.9 Acquisition of own shares under the Companies Bill
6.10 Evaluation of repurchases
CHAPTER 6 CONCLUSION
1 INTRODUCTION
2 STRUCTURE OF SHARE CAPITAL
2.1 Authorised capital
2.2 Minimum share capital
2.3 Kinds of shares
2.4 Share capital and reserve accounts
2.5 The variation of share capital
2.6 The reduction of issued capital
2.7 Loss of capital
3 CAPITAL CONTRIBUTIONS
3.1 Size of capital contribution
3.2 Form of capital contribution
3.3 The regulation of non-cash capital contributions
3.4 Timing of capital contribution
3.5 The regulation of commissions
4 DISTRIBUTIONS
4.1 Financial restrictions for distributions
5 DIVIDENDS AND OTHER PAYMENTS BY REASON OF SHAREHOLDING
6 SHARE REPURCHASES
6.1 Power to acquire shares
6.2 Financial restrictions for repurchases
6.3 Procedure and other requirements
6.4 Liability for unlawful repurchases
6.5 Enforceability of contracts for the acquisition of own shares
6.6 The status of repurchased shares
6.7 Acquisitions by a subsidiary
6.8 The redemption of shares
7 CONCLUSIONS AND KEY RECOMMENDATIONS
8 PROPOSED PROVISIONS
8.1 Kinds of shares
8.2 Authorised capital
8.3 Variation of share capital
8.4 Minimum issued capital
8.5 Protection against dilution of shareholder interests.
8.6 Consideration for shares
8.7 Capitalisation shares
8.8 Definition of distribution
8.9 Making of distributions
8.10 Solvency and liquidity test
8.11 Liability for distributions in violation of solvency and liquidity test
8.12 Regulation of dividends
8.13 Definition of acquisition
8.14 Power to acquire shares
9 FINAL ANALYSIS
BIBLIOGRAPHY
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