Reduction in Share Capital

Question: Analysis and Summary of Presentation Reduction in Share Capital. Answer: Introduction Capital reduction, or the reduction of share capital of a company, is the process through which, the shareholder equity of a company is decreased through the use of prescribed methods (Dagwell, Wines and Lambert, 2015). Capital reduction helps in increasing the shareholder value and at the same time, it helps in producing a more efficient capital structure (Nanda, 2015). In the following parts, a summary on the various aspects of capital reduction have been highlighted. Moreover, the issues relating to the capital reduction have also been stated. Capital Reduction In Trevor v Whitworth (1887) 12 App Cas 409, it was held that the company should never reduce its capital (Cassidy, 2006). However, since then, certain exceptions have been developed for this rule. The Corporations Act, 2001 restricts the ability of any company to reduce its share capital or the funds of the shareholders, before such a company is wound up. However, the Act provides, for some circumstances or particular situations the provisions for early reduction of share capital, or for the cancellation of shares (Company Secretarial Services Pty Ltd, 2017a). The act also mandates the reasons for which the capital reduction can be undertaken, and these are: Ensuring fairness between shareholders, Minimizing the risk of leading the company into insolvency, For the disclosure of material information by the company (Company Secretarial Services Pty Ltd, 2017b). The capital reduction has its share of benefits and restrictions. The former include increase value of shareholder; creation of distributable reserves, as a result realized profits; reduction in accumulated profits, thus increasing the distributable reserves; return of surplus share capital; facilitating a redemption or buy-back of shares; and distribution of assets to shareholders (Spetch, 2014). The restrictions relate to the adherence of provisions of the Corporations Act, 2001 and for the prescribed purposes. One of the modes for capital reduction is share cancellation. So, in order to reduce the share capital, the shares have to be cancelled. Though, unlike buy back, under capital reduction, the bought shares have to be compulsorily cancelled. Capital reduction can be either of the two: Equal reduction: which has to be applied in same proportion of shares, as well as, for the same terms, for each of the shareholders In any other case, it can be a selective reduction (Company Secretarial Services Pty Ltd, 2017a). For the capital reduction, the provisions of Corporations Act have to be strictly adhered to, or else legal issues may arise for which penalties may be applied, in addition of sentencing, as a result of the breach of legal provisions. The capital reduction of shares is allowed only when it is reasonable and fair for the shareholders as whole, it is not prejudicial to the ability of the company to repay its creditors, and the same has been approved under section 256C of the Corporations Act, 2001 by shareholders (Australian Government, 2013). The breach of this section attract penalty of 100 penalty units, in addition to imprison of two years (Australasian Legal Information Institute, 2017). It can also be achieved through section 245J to 254K pertaining to the redemption of redeemable preference shares; or section 257A pertaining to the share buy-backs; or section 258A-258F relating to other prescribed share capital reduction- for instance cancellation of forfeited shares (ASIC, 2014). For 258A and 258C, the penalty is of 400 penalty units or else an imprisonment for 4 years; for 257A and 258B, it is 100 penalty units or else an imprisonment for 2 years (Australasian Legal Information Institute, 2017). A company can be reduce its capital and give the financial assistance only when the procedure of law is complied strictly. The reduction of share capital also needs the approval of the members and also has to be disclosed fully. In case the capital reduction leaves the company insolvent, the corporation act makes the directors personally liable for it. In Fowlers Vacola Manufacturing Company Ltd [1966] VR 97, it was held that if the company decides to return the capital, it has to be done in a fair and equitable manner only (Cassidy, 2006). Conclusion To sum up the entire discussion, capital reduction is a manner of reducing the share capital of the company. Through capital reduction, the shareholder value can be increased and an efficient capital structure can be presented. The modes of capital reduction include cancellation, buy-back, and redemption of shares. However, buy-back may not necessarily result in the reduction of capital, if the bought back shares are not cancelled. Capital reduction could be either equal or selective. Further, while reducing the capital of the company, the applicable provisions of the Corporations Act have to be strictly followed. A non-compliance of these provisions may lead to penalty, as well as, sentencing, on the basis of the breach of particular section. Capital reduction also helps in increasing the realized profits of the company. Though, the purpose of capital reduction is restricted through the Corporations Act. References ASIC. (2014) Reduction in share capital. [Online] ASIC. Available from: https://asic.gov.au/for-business/running-a-company/shares/reduction-in-share-capital/ [Accessed on: 31/03/2017] Australian Government. (2013) Corporations Act 2001. [Online] Australian Government. Available from: https://www.legislation.gov.au/Details/C2013C00605 [Accessed on: 31/03/2017] Australasian Legal Information Institute. (2017) Corporations Act 2001 - Schedule 3. [Online] Australasian Legal Information Institute. Available from: https://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/sch3.html [Accessed on: 31/03/17] Cassidy, J. (2006) Concise Corporations Law. 5th ed. NSW: The Federation Press. Company Secretarial Services Pty Ltd. (2017a) Cancellation of Shares. [Online] Company Secretarial Services Pty Ltd. Available from: https://www.companysecretary.com.au/board_briefings/CancelShares.pdf [Accessed on: 31/03/2017] Company Secretarial Services Pty Ltd. (2017b) Return of Capital. [Online] Company Secretarial Services Pty Ltd. Available from: https://www.companysecretary.com.au/board_briefings/CancelShares.pdf [Accessed on: 31/03/2017] Dagwell, R., Wines, G., and Lambert, C. (2015) Corporate Accounting in Australia. NSW: Pearson Australia. Nanda, D.S. (2015) Reduction in share capital: Analysis. [Online] Corporate Law Reporter. Available from: https://corporatelawreporter.com/2015/02/23/reduction-share-capital-analysis/ [Accessed on: 31/03/2017] Spetch, A. (2014) Reductions of capital: What are they and what can they be used for?. [Online] DWF. Available from: https://www.dwf.law/news-events/legal-updates/2014/11/reductions-of-capital-what-are-they-and-what-can-they-be-used-for/ [Accessed on: 31/03/2017]