Company Law Bill [HL]

It might be helpful if I outlined what Sections 171 to 177 do, and why the Government have decided to retain them, before I move on to consider the provisions amended by Clause 571. Sections 171 to 177 of the 1985 Act relax, for private companies, the rule that shares may only be redeemed or purchased out of distributable profits. A private company may redeem or purchase shares out of capital, provided that any distributable profits and proceeds of a new issue of shares are used up first, before any payment is charged to capital, and a special resolution of the company’s members is passed, to which provisions publicity requirements are attached and a right of creditors or members to object to court. These provisions were introduced in 1981 to provide a means for private companies to redeem or purchase shares out of capital, without the necessity to obtain a court order approving a reduction of capital under Section 135 of the 1985 Act. The absence of any court involvement, save where there are objectors under Section 176, means that this mechanism can provide a quicker and less expensive route for capital reductions for private companies than Section 135 of the 1985 Act. However, Sections 171 to 177 impose a large number of detailed procedural requirements on companies. The Company Law Review considered that, as the new solvency statement procedure for capital reductions by private companies provided a less onerous procedure for such reductions of capital, the provisions of Section 171 to 177 would be rendered unnecessary—that point has been made. The recommendation to repeal Sections 171 to 177 of the 1985 Act was subsequently endorsed in the 2002 White Paper. Shortly prior to the introduction of the Bill, we were contacted by a firm of City solicitors who expressed concern that the Government intended to repeal these provisions, as it was considered that they were still of use to companies notwithstanding the introduction of the new solvency statement procedure for capital reductions. In particular, it was considered that there might be circumstances in which a company may purchase shares out of capital under Section 171 which may not be possible under the simplified reduction of capital procedure for private companies that is provided in Clause 562. We understand that private companies regularly make purchases of shares out of capital and that Sections 171 to 177 of the 1985 Act have proved to be useful in a number of circumstances. These circumstances include buying out shareholders seeking an exit where there are no external purchasers in circumstances in which the company would have insufficient distributable profits to effect the purchase. The provisions have also been useful as a means of distributing surplus cash to shareholders in circumstances in which a company has surplus cash but no distributable profits, as can arise, for example, through the application of accounting principles. It was also pointed out that the provisions are useful where the price paid for the shares exceeds the nominal value of the shares—for example, where each £1 share is bought back for £1,000. While the provisions of Section 135 of the 1985 Act, as amended by the Bill, would not prohibit the return to a shareholder of an amount which exceeds the nominal value of the shares where the company has capital in excess of the company’s wants, which includes share premium account and the capital redemption reserve, it seems that, in the absence of such reserves, Section 135 would not permit a payment to shareholders in excess of the nominal value of the shares. In such a case, there is simply not enough share capital to reduce to fund the exercise. However, the position under Section 171 is different. The section permits a company to make a payment out of ““capital”” in respect of a purchase of own shares. ““Capital”” for these purposes includes the amount of any capital redemption reserve, share premium account or fully paid share capital of the company, but it crucially also includes any amount representing unrealised profits of the company for the time being standing to the credit of any revaluation reserve maintained by the company. At this juncture I should add that we have discussed this matter with the Law Society, which concurs with the view that the repeal of the provisions of Sections 171 to 177 would remove a facility not covered by the Bill provisions relating to reductions of share capital that private companies find useful. One of the objectives of the Bill is to facilitate the operation of private companies; the removal of an existing, often used and uncontroversial mechanism for a purchase of shares out of capital by such companies is at odds with this objective. In the circumstances, we have decided to retain these provisions. I hope that this explains our change of position and why we have concluded that our original decision should be amended. Turning to the clause stand part debate on Clause 571, I should explain that this clause amends subsection (4) of Section 173 of the 1985 Act and inserts new Section 177A into that Act. Section 173 is concerned with the conditions that must be satisfied before a private company may make a payment out of capital in respect of a purchase or redemption of own shares. The directors must have made a full inquiry into the affairs and prospects of the company and must confirm that, as regards the company’s situation immediately after the date on which the payment out of capital is made, there will be no grounds on which the company could then be found unable to pay its debts, and that, as regards the company’s prospects for the year immediately following that date, the company will be able to continue to carry on business as a going concern and to pay its debts as they fall due in the year immediately following the date on which the payment out of capital is made. These provisions are unchanged by the Bill. Subsection (4) of Section 173 provides that, in forming their opinion on the company’s solvency and prospects, the directors must take into account the same liabilities, including contingent and prospective liabilities, as would be relevant to the question of whether a company is unable to pay its debts under Section 122 of the Insolvency Act 1986. Consistent with the approach taken in respect of reductions of capital using the new solvency statement procedure, where a private company limited by shares makes a payment out of capital pursuant to the statutory scheme in Sections 171 to 177, it will in future have to take account of all contingent and prospective liabilities, not just those relevant to the purposes of Section 122 of the Insolvency Act. This change is achieved by the amendments to Section 173(4) of the 1985 Act set out in subsection (1) of Clause 571. As a purchase or redemption of shares out of capital will affect a company’s subscribed capital, companies will also in future be required to give notice of this alteration to the Registrar of Companies under new Section 177A, which is inserted into the 1985 Act by Clause 571. That notice must be accompanied by a statement of capital. Where a company fails to comply with the procedural requirements for notice contained in new Section 177A, the company and every officer of the company who is in default commits an offence. If the Committee accepts that Sections 171 to 177 of the 1985 Act are useful to companies—and that is what we have been told—it also makes sense to update the provisions to ensure that they fit with similar provisions in the Bill, in particular the new solvency statement procedure for capital reductions. That is what Clause 571 does. In the circumstances, I hope that the Committee will agree that the clause should stand part of the Bill.