BUSINESS ASSOCIATIONS

CAPITAL & CAPITAL MAINTENANCE REGIME (2)

EVA TAM 2023
UNLAWFUL RETURN OF CAPITAL (RECAP)

 Unlawful return of capital will be void under common law

 Cannot be authorised/ratified by shareholders
 If authorised by directors, potential breach of directors’ duties
 Common examples of ‘return of capital’:
 Distributions by way of cash or assets to shareholders
 Reduction of capital
 Buy-back of shares by the company
 Provision of financial assistance for the acquisition of own shares
 CO provides relaxations to the capital maintenance rule
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EVA TAM 2023
DISTRIBUTIONS
 ‘Distribution’ means every description of distribution of a
company’s assets to its members, whether in cash or otherwise
(s290 CO). E.g.:
 Cash dividends
 Distributions in specie
 This section does not cover distributions by :
 Issue of bonus shares
 Redemption or buy-back of shares out of capital or
unrealized profits
 Reduction of share capital
 Distribution of assets to members on winding up

EVA TAM 2023

 Financial assistance permitted under CO 3
DIVIDENDS & DISTRIBUTION IN SPECIE

 s.297 CO allows a company to make certain distributions – actual mechanics

determined by the Articles
 Annual/final dividends – Company in general meeting to declare not exceeding the
amount recommended by Directors (Model Article 73(1))
 Interim dividends – Directors may declare if justified by profits of company (Model
Article 73(2))
 Non-cash dividends/distributions in specie (Model Article 77) e.g. scrip dividend
 Directors to determine arrangements including fixing the value of assets and
payment to adjust rights
 Shareholders to authorise on recommendation by directors
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PROFITS AVAILABLE FOR DISTRIBUTION
 Can only declare dividends out of ‘profits available for distribution’
(s.297 CO; Model Article 73(3))
= accumulated, realised profits - accumulated, realised losses
 Accumulated = not dependent only on the current year’s financial
position
 Realised = Not defined. Guidance in Financial Reporting Standard 18
and HKICPA Accounting Bulletin 4 – “realised profits include both
profits realised in the form of cash or other assets, the ultimate cash
realisation can be assessed with reasonable certainty”
EVA TAM 2023
5
 FINANCIAL STATEMENTS AS
REFERENCE POINTS
 Statutory obligation on company to determine whether
and what amount of distribution can be made by reference
to financial items in financial statements (s302 CO)
 Financial statements for the previous financial year (s304
CO) must be:
 properly prepared
 contains auditor’s report
 laid before company in general meeting or sent to every
member
 Financial items (s290(1) CO)
 Profits, losses, assets and liabilities
 Provisions 6

 Share capital and reserves

EVA TAM 2023
CONSEQUENCES OF UNLAWFUL DISTRIBUTION

 Liabilities of Members (s301 CO)

 Members who knows or has reasonable grounds for believing distribution is unlawful
 If in cash, liable to repay the distribution to company
 If in specie, liable to pay cash equivalent to the value of the asset at the time of
distribution
 Liabilities of Directors (Bairstow v Queens Moat Houses plc [2000] 2 BCLC 531)
 Directors who authorised the payment in breach of duty
 Liable to repay the amount of distribution to company
 Distribution not capable of being ratified by members
 Not allowed to go beyond the financial statements
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
ISSUE OF BONUS SHARES

 Company’s power to allot and issue bonus shares (s170(2)(c) & (d)
CO)
 Bonus shares issued by way of a distribution of profits in lieu of
cash dividends (Model Article 77)
 Bonus shares issued by capitalization of profits (Model Article 79)

 Merely an accounting operation of converting profits into capital

EVA TAM 2023

REDUCTION OF CAPITAL

Shareholders
1. To return
surplus capital
Issued share capital HK$ 2mil
divided into 20,000 shares
2. To write off
accumulated Creditors
Company
losses (e.g. lenders,
1.Amount owed to all suppliers,
creditors is HK$500,000 landlords)

EVA TAM 2023 Assets 9

REDUCTION OF CAPITAL (2)
 Forms of reduction of capital (non-exhaustive):
1. Returning surplus paid-up capital to shareholders
2. Extinguishing or reducing the liability on unpaid shares
3. Cancelling any paid-up share capital that is unrepresented by available
assets
 Reduction of capital permitted (s211 CO)
 Special resolution confirmed by court order
 Special resolution supported by statutory (solvency statement) procedure
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EVA TAM 2023

REDUCTION OF CAPITAL – COURT ORDER

 Members’ special resolution + Petition to court for order (s226(1) CO)

 Creditors entitled to object if the reduction involves (s226(2), s227(1) CO)

 diminution of liability in respect of unpaid share capital; or
 payment to shareholder of paid-up share capital

 Court needs to settle a list of creditors (s227(2) CO)

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EVA TAM 2023
REDUCTION OF CAPITAL – COURT ORDER (2)

 Court would take into account, amongst others, the following before
deciding whether to make a confirmation order:
 if creditor’s consent has been obtained, or the creditor’s debt/claim has
been discharged, determined or secured (s229(2) CO);
 whether all members have been treated equitably;
 whether members have passed the special resolution as an informed
choice (i.e. reasons for the reduction properly put to the members, and
must be supported by evidence).
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REDUCTION OF CAPITAL – COURT ORDER (3)

 If the court makes a confirmation order, within 15 days after court order, the
company needs to deliver to the Companies Registrar:
 office copy of the order;
 minute stating certain information on share capital of the company after the
reduction; and
 a return in specified form
(s230(1) – (3) CO)
 The reduction takes effect on registration (s230(4) CO)
13

EVA TAM 2023

REDUCTION OF CAPITAL – STATUTORY PROCEDURE
 Members’ special resolution (s215(1) CO)
 Solvency statement from all directors (s216 CO)
 Publish notice in Gazette (s218(1) CO) & make the special resolution and
solvency statement available for inspection (s219(2) CO)
 Application to court by dissenting members (who voted against or abstained
from voting) or creditors (s220(1) & (2) CO) court order (s222 CO) (Fok
Lai Lor Nora v Fok Ying Tung Ming Yuan Development Co Ltd [2020] 3 HKC
221)
 Reduction effective on registration of return (see s215(2) and Note to ss224
& 225 CO) 14
EVA TAM 2023
SOLVENCY STATEMENT
What is it? (s206 CO)
Statement by a director forming the
opinion that the company satisfies the
solvency test in relation to the
transaction
After considering the company’s state
of affairs, prospects and liabilities
(incl. contingent and prospective
EVA TAM 2023
liabilities)
Solvency test (s205 CO)
Cash flow test:
• immediately after the transaction,
no ground on which company
cannot pay its debts; and
• 12 months after the transaction,
company can pay its debts as they
become due
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SOLVENCY STATEMENT (2)
 Timing - Special resolution must be passed
within 15 days after date of solvency statement
(s216(2) CO)

 The solvency statement is also needed for

certain other share capital transactions (to be
explained below)

EVA TAM 2023 16

CONSEQUENCES OF NON-COMPLIANCE

 Consequences of contravention (s212(1) CO)

 Company and its responsible persons commit an offence
 Maximum fine of HK$1.25 million and imprisonment of up to 5
years
 In addition to the common law position that the unlawful return
of capital is void

EVA TAM 2023 17

REDEMPTION OF SHARES

 General prohibition on acquisition of own shares (s267(1) CO)

 Redeemable shares (s2(1) (definition), ss234-235 CO)
 Company’s Articles may prohibit or restrict issue or authorise issue
 Cannot issue redeemable shares if no other type of shares
 Directors may be authorised to determine terms, conditions &
manner of redemption in Articles or by members’ ordinary resolution
 Otherwise, terms and conditions & manner of redemption must be
set out in the Articles 18

EVA TAM 2023

SHARE BUY-BACKS

 Share buy-backs (formerly ‘share repurchase’) – unlisted companies

(ss236(1)(b) and 244 CO)
 Company’s Articles may prohibit or restrict share buy-back
 Cannot buy back own shares if only redeemable shares left after buy-
back
 May also buy back own shares under a contract authorised in
advance by members’ special resolution

EVA TAM 2023 19

REDEMPTION AND SHARE BUY-BACKS

 Out of distributable profits (s257(2)(a) CO)

 Out of proceeds of fresh issue of shares for the purpose (s257(2)(b) CO)
 Out of capital (s257(2)(c) CO)
 Members’ special resolution (s258 CO)
 Solvency statement from all directors (s259 CO)
 Publish notice in Gazette (s261 CO) & make the special resolution and solvency
statement available for inspection (s262 CO)
 Application to court by dissenting members (who voted against or abstained
from voting) or creditors (s263 CO) court order (s265 CO) 20

EVAShares
TAM 2023 redeemed or bought back are cancelled (s269 CO)
PROHIBITION ON FINANCIAL ASSISTANCE

 General prohibition on financial assistance for acquisition of own shares

(s275 CO)
 Types of ‘financial assistance’ (s274(1) CO)
 gift;
 guarantee, security, indemnity (other than an indemnity in respect of its
own neglect or default), release or waiver;
 loan (or novation or assignment of rights under a loan agreement); or
 any other financial assistance given by a company the net assets of which
EVA TAM 2023 are reduced to a material extent or which has no net assets 21
PROHIBITION
ON FINANCIAL
ASSISTANCE (2)
 Prior/
Contemporaneous
financial
assistance (s275(1)
CO)

EVA TAM 2023 22

PROHIBITION ON FINANCIAL ASSISTANCE (3)

 Post-acquisition financial assistance (s275(2) CO)

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EVA TAM 2023

 TIMING & NATURE OF FINANCIAL ASSISTANCE

 Illustration 1 (s275(1) CO) – prior/contemporaneous financial assistance

Purchaser

1. Acquisition of shares
2. Provision of loan for
acquisition of shares
Target Company

Subsidiary
EVA TAM 2023 24
 TIMING & NATURE OF FINANCIAL ASSISTANCE (2)

 Illustration II (s275(1) CO) – prior/contemporaneous financial assistance

Purchaser
Bank
2. Provision of loan for
1. Acquisition of shares acquisition of shares

Target Company

3. Provision of guarantee
for the loan

Subsidiary
EVA TAM 2023 25
 TIMING & NATURE OF FINANCIAL ASSISTANCE (3)
 Illustration III (s275(2) CO) – post-acquisition financial assistance
2. Provision of loan for
acquisition of shares
Purchaser
Bank
1. Acquisition of 4. Repayment of the
shares bank loan
3.
Provision Target Company
of loan

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Subsidiary 26
FINANCIAL ASSISTANCE –
GENERAL EXCEPTIONS

 General exceptions (s277 CO)

 lawful dividends
 distribution in a winding up
 bonus shares
 permitted reduction of capital
 permitted redemption or buy-back of
own shares
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EVA TAM 2023

 FINANCIAL ASSISTANCE –
‘PRINCIPAL PURPOSE’ EXCEPTION
 ‘Principal purpose’ exception (s278 CO)
 If principal purpose is not of acquisition of
shares or reducing or discharging liability
incurred for the share acquisition or if the
purpose of giving financial assistance is
only an incidental part of some larger
purpose; and
 Assistance given in good faith in the
interests of the company
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EVA TAM 2023

BRADY v BRADY – REORGANIZATION

Before After Jack

Bob
Jack Bob

Motoreal
Brady Activista

Brady
Athersmith Thomsons
Thomsons
Athersmith
Haulage Drinks
business business Drinks
EVA TAM 2023
Haulage business 29
business
BRADY v BRADY – REORGANIZATION STEPS

Bob to transfer shares in Brady

Jack to Motoreal Bob

Motoreal issued loan stock

Motoreal representing equalisation amount Activista

Brady Brady to transfer shares

in Thomson to Activista

Athersmith Thomsons

EVA TAM 2023

Haulage business Drinks business 30
BRADY v BRADY – REORGANIZATION STEPS (2)
After completion of share transfers
Jack Bob
Loan stock representing
Motoreal equalisation amount
Activista

Brady

Transfer assets to Thomsons

Athersmith redeem the loan stock

EVA TAM 2023 Haulage business Drinks business 31

FINANCIAL ASSISTANCE –
‘PRINCIPAL PURPOSE’ EXCEPTION
 Brady v Brady [1989] AC 755
 Bob challenged the equalisation amount and argued that the whole
transaction would violate financial assistance rules; Jack sought specific
performance
 Jack’s argument – purpose of provision of financial assistance was to
resolve deadlock in a family business
 What was the House of Lords’ interpretation of ‘purpose’?
 ‘Purpose’ vs ‘reason/motive’; ‘larger’ is not the same thing as ‘more
important’ 32
EVA TAM 2023
FINANCIAL ASSISTANCE –
STATUTORY ‘WHITEWASH’ PROCEDURES
 Less than 5% of shareholders’ funds utilised (s283 CO):
 Board resolution
 company should give the assistance
 giving of assistance is in the best interests of the company
 terms and conditions of the assistance are fair and reasonable to the company
 Solvency statement by directors who voted in favour of resolution
 With unanimous members’ approval (s284 CO):
 Board resolution
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 Solvency statement by directors who voted in favour of resolution
EVA TAM 2023
FINANCIAL ASSISTANCE –
STATUTORY ‘WHITEWASH’ PROCEDURES (2)
 With only members’ ordinary resolution (s285 CO):
 Board resolution
 Solvency statement by directors who voted in favour of resolution
 Additional protection (additional requirement of 5% shareholding)
 Court application (s286 CO):
 giving of assistance is neither in the best interests of the company nor of
benefit to the members not receiving the assistance
 terms and conditions of the assistance are not fair and reasonable to the
company and the members not receiving the assistance
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 Court order (s288 CO)

EVA TAM 2023
CONSEQUENCES FOR NON-COMPLIANCE

 Criminal liability (s275(4) CO)

 Validity of financial assistance and contract not affected (s276 CO)

 Civil liability arising out of directors’ breach of their duties

EVA TAM 2023 35

Real life examples:
- Financial news
- Facts of cases