ACCA Class notes compiled by Njihia KaburuCAPITAL AND THE FINANCING OF COMPANIES 1. Share capitala) Examine the different meanings of capital. (a)b) Illustrate the difference between various classes of shares. (a)c) Explain the procedure for altering class rights. (a)

MEMBERSThis term denotes a person who has agreed to become a member and whose name has been entered in the register of members. This may occur by: subscription to the memorandum; applying for shares; the presentation to the company of a transfer of shares to the prospective member; applying as a personal representative of a deceased member or a trustee of a bankrupt.

Subscriber sharesSubscribers to the memorandum are assumed to have agreed to become members and on incorporation, their names should be entered into the members’ register. Other persons may acquire shares and become members by;o Applying and being allotted shares.o Presenting to the company for registration a transfer of shares to them.o Applying as personal representatives or trustees of a deceased or

bankrupt member.

Cessation of membership There are eight ways in which one may cease to be a member;

By transferring all shares to another & the transfer is registered. Death of a member. Shares of a bankrupt being registered in trustee’s name. A minor repudiates his shares. Trustee of a bankrupt member disclaims his shares. Company forfeits or accepts the surrender of shares. Company sells the shares in exercise of a lien. Company is dissolved and ceases to exist.

Numbers of members

Public companies have minimum requirement of 2 members with private being one member. However for the single member private companies, there are certain rules; The sole member/director must not be the secretary. The register of members must contain a statement that there’s only

one member and give his address. Articles are automatically amended to provide for quorum of one. All resolutions must be in writing. All contracts between company and sole member must be in writing

unless its in the usual course of business or its on the company’s usual commercial terms.

A written record of all decisions made by the member must be given to the company.

SHARE CAPITALA share is an interest which the shareholder has got in the company which can be measured in terms of money for the purpose of determining his liability to the company in the first place and his interest in the company in the second place i.e. his right to demand dividend. It is a bundle of rights and obligations! (Kaplan)

It’s a transferable form of property, carrying rights and obligations, by which the interest of a member in the company limited by shares is measured (Bpp)

The best definition of the term share is that given by Farwell J. in the case of Borlands Trustee v. Steel [1901] Ch. D 279 stated “a share is the interest of a member in a company measured by a sum of money for the purpose of liability in the first place and of interest in the second and also consisting of a series of mutual covenants entered into by all the shareholders among themselves in accordance with Section 22 of the Companies Act.”

The contract contained in the Articles of Association is one of the original incidents of a share. A share is therefore not a sum of money but an abstract interest measured by a sum of money and made up of various rights contained in a contract of membership.

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ACCA Class notes compiled by Njihia Kaburu

Key points of the definition It’s a form of personal property, carrying rights and obligations. A share is a transferable property. It gives proportionate entitlement to dividends, votes and any return of

capital (interest). Each share must be paid for ‘liability’. Each share must be given a face value and should not be sold below that

value. It’s a form of a bargain (mutual covenants)

A shareholder is a member/owner of the company and therefore has voting rights, depending on the class of shares held.

Types of Sharesa) Preference SharesThese are those shares whose interest rate is fixed, they are given the preference over ordinary shares for the payment of dividend and return of capital at the dissolution of the company. (Kaplan)

They are shares carrying one or more rights such as fixed rate of dividend, or preference claim to any company profits available for distribution. (Bpp)

Muslim companies however, do not issue preference shares because the fixed amount to be paid is considered as riba which is forbidden under sharia law.

They are further classified into the following;Accumulative preference shareDividend earned or to be paid in one year which is not claimed will be carried forward to the next year automatically. If the dividend was fixed at 6% and is not paid in the current year, it’s carried forward and paid at 12% in the next year.

Non-accumulative preference sharesAre shares on which dividend is fixed but will not accumulate.

Redeemable preference sharesAre shares whose dividend is fixed but are issued for a specific period of time. During that period, the company can redeem these shares.

Irredeemable preference sharesAre shares which once issued cannot be redeemed unless the company is dissolved.

Participative preference shares Are shares where the dividend is fixed but once all the shareholders and creditors are paid, they can participate in the residual profit of the company together with the ordinary shareholder.

The dividend of preference shareholders is fixed but the following points should be remembered as regards to priority; Payment of dividend is entirely at the discretion of the directors

and if the directors decide to transfer the whole profit made by the company to reserve capital, then nobody can question the decision.

Payment of dividend to preference shareholders only becomes due once the dividend has been recommended and approved and the date of payment is due.

If the dividend was not declared and the company goes into liquidation, even preference shareholders will not be paid.

If it was declared before the company went into liquidation and was not paid, then the right will not be lost.

b) Ordinary shares (equity)Equity is the residual interest in assets of the company after deducting all its liabilities. issued ordinary share capital plus reserves, statutory or otherwise, which represents investment in the company by the ordinary shareholders. Equity share capital is however the company’s issued share capital less capital which carries preferential rights.

Ordinary shares are shares which entitle the holders to the remaining divisible profits (residual) after prior interests have been satisfied. These are the most common types of shares. The rate of dividend to be

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ACCA Class notes compiled by Njihia Kaburupaid is not fixed, but normally, such shares carry full voting rights which enable the shareholders to attend the meetings, appoint directors and auditors of the company etc.

c) Deferred sharesThese are few in number and are issued to the founders of the company. Amount of dividend is not fixed and the shareholders are the last people to be paid. These people normally are directors of the company and if the company makes a huge profit, they may decide to pay themselves dividend at a higher percentage than the rest of the shareholders.

Share Capital TerminologyAuthorized share capitalThis refers to the type, class, number and amount of the shares which a company may issue, as empowered by its memorandum of association. Also called nominal share capital or registered share capital.

Issued share capitalThis refers to the type, class, number and amount of the shares held by the shareholders. A company needs not issue all its shares at once, if it retains part of it, its then called unissued share capital.

Called up share capitalThe amount which the company has required shareholders to pay on the issued shares, now or in future.

Paid up share capitalAmount that shareholders have paid on the shares issued after call-up.

CLASS RIGHTSThese are the special rights attached to each class of shares such as dividend rights, distribution of capital on winding up, voting etc. These rights may be allocated to a particular class of shares by the Articles of Association or may be created by a shareholder agreement. Any share with different rights is grouped with other shares carrying identical rights to form a class.

Although the Companies Act recognizes the existence of class of shareholders, it does not define the term ‘class’ the best definition is found in the case ofSovereign Life Assurance Co. v. Dodd (1892) 2 QB 573In that case Bowen L.J. stated as follows: “The word Class is vague it must be confined to those persons whose rights are not dissimilar as to make it impossible for them to concert together with a view to their common interest.”

How can they be varied?Variation of class rights is an alteration in the position of shareholders with regard to those rights and duties which they have by virtue of their shares. They grant rights to specific groups of shares only. To ensure that those rights are not amended by a majority vote of other shareholders, the law has established a procedure for alteration of these rights. The procedure for variation is two-fold; If the Articles of Association provide an alteration procedure, this

must be strictly followed. If no procedures are provided for, variation needs an extra-ordinary

resolution or written consent of 75% in nominal value of the class-Section 63- Companies Act.

Minority protectionUnder section 633 of CA, the holders of 15% of the nominal value of that class, who did not consent to the variation, may ask the court to cancel the variation within 21 days of the passing of the resolution.

The court may confirm or cancel the variation. However, it will only cancel the variation if the petitioner proves it is unfairly prejudicial.

The courts however will create a distinction between;o A variation that affects the value, enjoyment or power derived from

the rights.o A variation that changes the rights themselves.

The courts will only intervene in the latter case;

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ACCA Class notes compiled by Njihia KaburuWhite v Bristol Aeroplane Co (1953)Bonus issue is not a variation of class rights, even though its effect may be to dilute the voting rights of the existing shareholders.

Greenhalgh v Arderne Cinemas Ltd (1950)The sub-division of shares is not a variation of class rights.

ISSUING/ ALLOTING SHARESAllotment: this is the allocatiqon to a person of a certain number of shares under a contract of allotment. Once allotted, his details are entered in the members register and the holder becomes a member of the company i.e. he acquires an unconditional right to be entered in the register (s738). This happens when the board considers and formally resolves to allot the shares. If directors impose a condition, the shares only become fully allotted on meeting the condition.

Issue: this happens at a later stage when the allotee receives a letter of allotment or share certificate issued by the company as evidence of his title.

There are two basic methods of issuing shares;

Bonus issueIn order to capitalize some reserves, new fully paid shares may be offered to existing shareholders in proportion to the shareholdings. These don’t raise any new funds. Articles usually give powers to directors to apply reserves to paying up unisued shares and allotting them to as bonus shares to members.

It’s also called capitalization issue or scrip issue. They require an ordinary resolution. Further, sufficient authorized capital must be available to make the issue; if not it must eb increased.

Rights issue

This is a right given to a shareholder to subscribe for further shares in the company, usually pro rata to his/her existing holding in the company’s shares. If a company proposes to allot shares, these new shares are first offered to existing shareholders in proportion to the shareholdings. They raise new funds.

The offer must be made in writing, specifying a period of not less than 21 days within which to accept. Shares are usually offered at discount to market value and not at discount to nominal value.

Authority to issue sharesThe directors need authority in order to allot shares. These may be given; By articles By passing an ordinary resolution. Signed copy must be sent to

registrar in 15 days.

The authority must state; The maximum number of shares to be allotted. The expiry date for the authority (max 5 years).

Directors may have been given general authority to allot without further reference to a general meeting. However, a general meeting must be called if; No authority has been given in advance. Authority is subject to certain conditions. Authority has lapsed/ has been used up.

The directors of a private company with only one class of shares may allot shares of that class without further authority unless prohibited by the articles. S550.

If the directors have allotted shares without authority, the allotment will be valid but the directors are punishable by fine.

Issues at Discount

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ACCA Class notes compiled by Njihia KaburuAs a general rule, shares cannot be issued at a discount on their nominal value s580. It’s only in rights issue where shares are issued at discount but also then, discount from the market price and not their nominal value. If this rule is breached, the issue is still valid, but the allotee must pay-up the discount plus interest.

However, the company may issue partly paid up shares, with public having minimum of 25% set. Further, the price is to be paid with money or money’s worth, including goodwill and know-how. The company may in alternate accept a non-cash consideration, if it’s of sufficient value. Debentures can however be issued at discount if they don’t have the immediate right to convert to shares.

Issue at premiumShares can however be issued at premium i.e. higher price than the nominal value. This may be paid in the form of cash or some other assets. Section 610 requires that such premiums be deposited to a share premium account, which can only be used for; Writing off expenses of the issue of those shares. Writing off any commission issued on the sale of those shares. Issuing bonus shares.

Private companiesFor these, shares are not issued to the public. Any person wishing to purchase shares applies directly to the company directors, after which they are allotted and issued. They may issue shares for non-cash consideration. However, in such cases, independent valuation must be done, and the valuer’s report is final.

The courts will only interfere with the valuation if there is fraud or the consideration is ‘illusory, past or patently inadequate’.

Public companiesThere are additional rules in the companies act in respect of issue of shares as follows; S584- subscribers to the memorandum must pay cash for their

subscription shares.

S585- payment of shares must not be in the form of work or services.

S586- shares cannot be allotted until at least one quarter of their nominal value and the whole of any premium have been paid.

S587- Non-cash consideration must be received within 5 years. Non-cash consideration must be independently valued and reported

on by a person qualified to be the company auditor.

COMPILED BY:Francis Njihia Kaburu. IMIS (Dip.), LL.B (Hons.), LL.M (cont).

Lecturer, Oshwal College.

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