BUSI1104 / BUSI1120

Business Law

Lecture 14
Financing the company
 Financing the company

Today’s lecture

After the lecture (and reading) you will be able to:

1. Distinguish sources of finance for the company

2. For company:
a) Explain the nature of different types of shares and the procedure for their issue;
b) Illustrate the difference between various classes of shares;
c) Examine the effect of issuing shares at either a discount, or at a premium;
d) Explain the doctrine of capital maintenance;
e) Explain the rules governing the distribution of dividends;
f) Define companies’ borrowing powers;
g) Explain the meaning of loan capital and debenture;
h) Distinguish loan capital from share capital, and explain the different rights held by
shareholders and debenture holders;
i) Explain the concept of fixed and floating charges and the procedures for registering
them.
 Financing the company

Financing the
company

Shares (or share capital)

• Buyers become members
• Rights & liabilities conferred by CA and constitution

Loans (or loan capital)

• Lenders are NOT members of the company
• Rights conferred by agreement and CA
 Financing the company
Share capital
• Definition
A share is the interest of a
shareholder in the company
measured by a sum of money, for
the purpose of liability in the first
place, and of interest in the
second. A share is an interest
measured by a sum of money and
made up of various rights.’
Borland’s Trustees v. Steel
Brothers & Co. Ltd. (1901)
Borland’s Trustee v Steel Bros & Co Ltd (1901)
A share is:
1. The shareholders’ financial stake in the co
• Liability to contribute capital & ‘right’ to
income from company
2. The shareholders’ interest in the company as
an association
• Rights as members,
• incl. voting rights in general meeting & other
rights conferred by CA & constitution
3. Rights as owners of a species of property
• As property of shareholder, shares can be
bought, sold, charged, etc.
 Financing the company

Share capital
• Definition Liability
• To pay the amount of
capital agreed with the
company
• usually fully paid
when the share is
issued

Rights
• Can only be enforced by
legal action, so known
as a ‘chose/ thing in
action’
• Transfer shares;
• Meetings;
• Dividends;
• Accounts.
 Financing the company

Share capital
Classes of share
Ordinary shares (standard / default shares)
1. Ordinary shares Articles may specify classes of shares with different rights
Rank behind
Rank behind preference
Typically carry preference shareholders
No right to
most of the shareholders in the
fixed dividend
voting rights in payment of repayment of
dividends capital on
winding up
(usually 1 share 1
vote) but may co may pay
include shares dividend out of dividend rates
with no voting distributable depends on last in line in
rights or multiple profits distributable winding up
voting rights (see BUT at directors' profits
slide on class discretion
rights)
 Financing the company

Share capital
Classes of share
Preference shares
1. Ordinary shares (a hybrid of equity & loan capital)
2. Preference shares
Preference
Preference May be
Have over
over cumulativ
limited ordinary May be
ordinary e or non-
voting shares in redeemed
shares in cumulativ
rights winding
dividend e
up

Vote usually Dividends

limited to usually fixed, co may
issues provided But still repurchase
concerning company behind the Example
rights of pref have creditors preference
shareholders distributable shares
only profits
 Financing the company

Share capital
Classes of share
1.Ordinary shares
2.Preference shares
• Exercise Eric holds 100 preference shares of £1 each, carrying a preference dividend of
10%
In year one, the dividend cannot be paid (no profits)
What difference would it make to the dividend he receives in year two if his
shares are cumulative?

If cumulative?
If non-cumulative?
 Financing the company

Share capital
Classes of share
Allotment & issue

Shares are allotted Shares are issued

when the company when the investor’s
agrees to issue the name is registered in
shares to that the company’s
investor register of shares
 Financing the company

Share capital
Classes of share
Allotment & issue
Capital requirement

Private company Public company

•no minimum capital •must have a nominal
requirements value of allotted share
capital of at least
£50,000
•at least a quarter of this
must be paid up
 Financing the company

Share capital
Classes of share
Allotment & issue The Articles of Association may specify classes of
Capital requirement (ordinary) shares with different rights
Class rights

Example of use of class rights

• Alphabet, the parent company of Google, has three types of shares: Class A
shares: 1 vote/share; Class B shares: 10 votes/share; and Class C shares: no
voting rights.
• Founders Page and Brin’s control of Class B shares gives them 51.1 percent of
shareholder voting power.

Bushell v. Faith (1970)

• A clause in the articles provides enhanced voting rights on a resolution for the
director whose removal is sought (3 votes per share for a director sought to be
removed)
• HELD: this special voting rights is valid.
 Financing the company

Share capital
Classes of share
Allotment & issue • In accordance with the articles, or
Capital requirement Class rights can be varied • If three-quarters in value of the
shares of that class either consent
Class rights in writing OR pass a special
• Variation of class resolution at a separate meeting of
rights those shareholders.

• Company has 1000 class A shares held by A.

Examp • Company also has 1000 class B shares, held by A, B,
le: C, D and E equally (therefore 20% for each of them).
• Each of class B shares carries 2 votes.
• Company wishes to amend to reduce the voting
rights of class B shares to 1 vote per share.
• If A, B and C vote to pass the resolution, will it take
effect? (bear in mind that the amendment requires
special resolution, i.e. the approval of 75% of the
shareholders of class B shares)
 Financing the company

Share capital
Classes of share
Allotment & issue
Capital requirement Generally, any new shares must be offered to existing
Class rights shareholders first
Pre-emption rights (pre-emption rights)

BUT subject to exceptions:

Private company can exclude pre- Public company can also dis-apply pre-
emption rights by adding a provision to emption rights by special resolution
the articles by special resolution (Listing Rules may apply though)
 Financing the company

Share capital
Classes of share
Allotment & issue
Capital requirement
Class rights
Pre-emption rights Issue of shares at a premium Issue of shares at a discount
Issue of shares Shares can be issued at a Company is forbidden from
• at a premium/ premium; issuing shares at a discount
discount
E.g. a share with a nominal E.g. a share with a nominal
value of £1 could be allotted value of £1 must not be
for £1.20 or £2 or £5 if allotted for less than £1.
investors are willing to pay
that amount;
Any amount received by
company as share premium
must be kept in a share
premium account
 Financing the company

Share capital
Non-cash consideration: property as consideration for issue of
Classes of share
shares
Allotment & issue
Capital requirement
Class rights For private companies
Pre-emption rights • Re Wragg Ltd. (1897): the court will accept
Issue of shares the board’s valuation unless reached
• at a premium/ dishonestly/ fraudulently.
discount
• Non-cash
consideration
For public companies
• Usually, any non-cash consideration must be
valued by an independent expert
• Undertaking for future personal services is
banned as consideration for shares
• Re Bradford Investments plc (1991): No
valuation, so court ordered repayment of the
issue price
 Financing the company

Share capital
Classes of share
Allotment & issue
Capital requirement Origins in 19th century common law, but strengthened by
Class rights 2nd EU Company Law Directive
Pre-emption rights
Issue of shares
Capital maintenance Clearly, as the company’s capital contributed by shares is
intended to offer some protection to creditors, there are
restrictions on handing the capital back to members

e.g. a company not permitted to acquire its own shares

except as provided in CA 2006
 Financing the company

Share capital
Classes of share
A company may not make a distribution to
Allotment & issue members except out of distributable profit
Capital requirement
Class rights
BUT no rule that profits have to be Dividends are only payable when the
Pre-emption rights distributed company has ‘declared’ a dividend
Issue of shares
Capital maintenance Should not reduce the
Dividend company’s net assets Breach  payment
Accumulated profits
below the value of its unlawful
• Payment out of share capital
profit
Director concerned liable to repay
dividends: Bairstow v. Queens Moat
Houses (2001), Re Exchange Banking
Co (1882)

Member who knew/has reasonable

grounds for believing – liable to repay
 Financing the company

Share capital
Classes of share
Allotment & issue
STAGE 1
Capital requirement
The directors recommend an amount of the company’s profits to be distributed to the
Class rights shareholders by way of dividend.
Pre-emption rights
Issue of shares
Capital maintenance Procedure for the distribution of profits by way of dividends
Dividend
STAGE 2
• Payment out of Shareholders cannot declare an amount which is
The company (shareholders) will ‘declare’
This resolution cannot be passed until the directorsthe dividend by passing an ordinary resolution.
profit have made the recommendation
greater than that recommended by directors (can
substitute a smaller amount).
• Procedure for
payment

STAGE 3
The directors pay out the dividend, taking into account different class rights
A dividend once declared becomes a debt owed by the company to the shareholders.
 Financing the company

Share capital
Classes of share
Allotment & issue
Capital requirement
Class rights
Pre-emption rights
Issue of shares Sarah purchases 500 £1 shares in Dodgy Property Ltd. Explain to her:
Capital maintenance 1. If she can pay for them by transferring ownership of her car worth £400 to
Dividend the company? Would your answer be different if Dodgy Property were a
Review public company?

2. If she can take action if the company does not declare a dividend?
 Financing the company

Share capital
Classes of share MultiSoft plc was incorporated in 2005. Its memorandum states that it has an
authorized share capital of £2 million. Since then, it has allotted and issued
Allotment & issue
1.2 million shares, all with a nominal value of £1.50. The terms of all
Capital requirement allotments to date have provided that shares can be partly paid for with a
Class rights minimum of 90 pence payable at allotment and the remainder due when
Pre-emption rights called for. Of the 1.2 million shares, 500,000 have 90 pence paid up, 400,000
Issue of shares have £1.20 paid up, and the remainder are fully paid up. The company calls
Capital maintenance
for 10 pence per share on all unpaid shares, but not all the members pay the
called-for amount. Based on the information provided, calculate Multisoft’s:
Dividend
1. issued share capital
Review
2. unissued share capital
3. paid-up capital
4. called-up capital
5. uncalled capital.

(Answer in appendix)
 Financing the company

Share capital
Loan capital

Loan capital
Money required to run a business which is raised from loans
 Financing the company

Loan capital
Debenture
Debenture
when company’s assets used as loan security

includes deben Single debenture:

ture stock, loan to the
bonds and any company from Company to
other securities any person or create a trust
as written organisation,
of a company, with control
evidence of a usually a bank
whether or not over company’s
secured loan to
constituting a Debenture stock: assets to
the company
charge on the offered to the protect
assets of public through creditors
the company. the Stock
CA, s.738* Exchange

No precise legal definition of the term! Levy v. Abercorris Slate & Slab Co. (1887)
 Financing the company

Loan capital
Debenture Chargeable assets
Charges property of the company which is security for debentures
• Fixed & floating
charges
Floating charge charge on
Fixed charge charge attached
the assets for the time being
to a particular asset to the
of a going concern, remains
value of the loan
dormant until crystallised
Characteristics of floating charges
Re Yorkshire
Characteristics of fixed charge
Woolcombers Association Ltd.
(1903)
The assets
The company within the class
Attaches to a Restricts the Charge is over a can continue subject to the
specific asset company’s class of assets business and charge will
Like a mortgage
such as land or power to deal present and dispose assets in change as the
premises with that asset future the course of company
that business conducts
business
 Financing the company

Loan capital National Westminster Bank plc v. Spectrum

Debenture Plus Ltd (2005)
Charges Charge is a floating charge if borrower had
• Fixed & floating ability to continue to deal with the charged
charges assets
• Cystallisation Facts: S granted a charge over all present and
future book debts and other debts to the bank to
Events causing secure an overdraft
crystallisation
• Debenture stated S must pay proceeds of
Crystallisation Liquidation of the collection into specified account, but did not
The process whereby a company restrict how the account could be used
floating charge is • Was the charge fixed or floating?
converted into a fixed The company ceases
charge trading • HELD: the charge was a floating charge as S still
had the ability to continue to deal with the
Company fails to pay the
debenture holder
charged assets

Any other event specified

in the charge
 Financing the company

Loan capital
Debenture
Charges
• Fixed & floating
charges
• Cystallisation
• Priority

1. Fixed charge ranks before floating charge

2. As between the same type of charge, priority is governed by the order of

creation
• i.e., between several floating charges, the charge created first in time prevails
 Financing the company

Loan capital
Debenture
Charges
• Fixed & floating
charges
• Cystallisation All charges created by Consequences
• Priority the company are for non-
• Registration registrable registration

• Period for registration is 21 • If charge is not registered

days starting with day after
charge created;
• BUT registration is not
mandatory – no criminal
sanction for non-
registration
within 21 days, then it is void
• BUT the debt remains valid,
indeed the money advanced
against the charge becomes
immediately repayable
Next: loan capital review
 Financing the company

Loan capital Shares Debentures

Debenture
Purpose?
Charges
Review Member or creditor?

Voting rights?
 
Transferable?

Issued at a discount?

Returns?

Redemption?

Rank in winding-up?
 
 Financing the company

Share capital & Loan

capital
Debenture
Charges
Conclusion

1. Two ways of raising finance – equity (share) & loan

2. Types of equity & loan capitals

3. Rules associated by both

Appendix
 Financing the company

Share capital
• Exercise

Eric holds 100 preference shares of £1 each, carrying a preference dividend of

10%
In year one, the dividend cannot be paid (no profits)
What difference would it make to the dividend he receives in year two if his
shares are cumulative?

The £10 he is entitled to is carried forward to Y2. If there are sufficient

profits, then he will receive £20 dividend in Y2.
If non-cumulative, then he would not receive £10 lost in Y1.
 Finance

Share capital Sarah purchases 500 £1 shares in Dodgy 2. If she can take action if the company
• Review Property Ltd. Explain to her: does not declare a dividend?
1.If she can pay for them by transferring
ownership of her car worth £400 to the Dividends are only payable when the
company? Would your answer be company has ‘declared’ a dividend.
different if Dodgy Property were a public No English case law exists in which a
company? shareholder has forced a company to
declare a dividend even when the
Cannot issue shares at a discount (s.552); company is making handsome profits!
BUT depends how the car is valued by
the board?
As Dodgy is private company, court will
accept their valuation unless dishonest or
fraudulent (Re Wragg Ltd);
If Dodgy is public company, any non-
cash consideration must be valued by an
independent expert (s.593);
Consequences for non-compliance are
severe (Re Bradford Investments plc)!
 Finance
An initial point worth making is that
Share capital MultiSoft was incorporated prior to the
passing of the Companies Act 2006.
• Review Accordingly, its memorandum is likely to
state information that is not required to be
stated under the CA 2006. For example,
the 2006 Act does not require companies to
state their authorized capital. However,
companies incorporated prior to the
passing of the 2006 Act that still retain
their authorized capital within their
memoranda will still be bound by the
stated amount.
Issued share capital
Whereas the authorized share capital was
the maximum nominal value of shares that
could be allotted, the nominal value of
shares that actually has been allotted is
known as the issued share capital.
MultiSoft has issued 1.2 million shares with
a nominal value of £1.50 each. Accordingly,
MultiSoft’s issued share capital is £1.8
million.
Unissued share capital
A company’s unissued share capital is the
difference between its authorized capital
and its issued capital. MultiSoft has an
authorized capital of £2 million and an
issued share capital of £1.8 million.
Accordingly, its unissued share capital is
£200,000.
With the abolition of the requirement to
state the authorized share capital, the
concept of unissued share capital has also
been abolished, unless (as is the case here)
the company was incorporated prior to the
passing of the 2006 Act and states in its
memorandum what its authorized capital
is.
 Finance

Share capital Paid-up capital Called-up capital

• Review Shareholders may not be required to If shares are not fully paid for, the company can call for any
pay fully for their shares upon outstanding amounts to be paid, or instalments may have become
allotment. For example, in our set of due. The paid-up share capital plus the amount called for constitutes
facts, purchasers of shares need only the company’s called-up share capital.
pay a minimum of 90 pence upon
MultiSoft has a paid-up share capital of £1,380,000. It calls for 10
allotment. The combined total of the
pence to be paid on all unpaid shares. As 300,000 shares have been
nominal share capital that has been
fully paid for, there are 900,000 unpaid shares. 900,000 multiplied
paid is known as the paid-up share
by £0.10 equals £90,000. It should be noted that this £90,000
capital. This is calculated by working
forms part of the called-up share capital, irrespective of whether
out how much has actually be paid on
everyone actually does pay the amount called up. Accordingly, the
the shares:
fact that some members do not contribute the amount called for,
1. 500,000 shares have 90 pence does not affect the called-up capital.
paid up = £450,000
Adding this £90,000 to the paid-up capital results in MultiSoft
2. 400,000 shares have £1.20 paid having a called-up capital of £1,470,000.
up = £480,000
3. The remainder (300,000 shares)
Uncalled capital
are fully paid up (£1.50) = £450,000
The difference between the company’s issue capital and its called-up
Adding these figures together tells us
capital is known as the uncalled share capital (that is, the amount
that the MultiSoft’s paid-up share
that the company can call on). As MultiSoft’s issued share capital is
capital is £1,380,000.
£1.8 million and its called-up capital is £1,470,000, it follows that
its uncalled capital is £330,000.
 Finance

Loan capital   Shares Debentures

• Review
Purpose? Provide finance to company Provide finance to company
 
Member or creditor? Member Creditor
 
Voting rights? Yes No
 
Transferable? Yes Yes
 
Issued at a discount? No Yes
 
Returns? Dividends payable only out of Interests must be paid when due
distributable profits  
 
Redemption? Yes. Statutory restrictions. No restrictions
 
Rank in winding-up? Last to be paid when winding up Debts paid before shareholders