Reduction of share capital: the solvency statement
We are seeing a trend of client companies seeking to reduce their share capital using the solvency statement procedure introduced by the Companies Act…
We are seeing a trend of client companies seeking to reduce their share capital using the solvency statement procedure introduced by the Companies Act 2006. We thought it would be useful to provide a refresher of the simplified process for reducing share capital by way of a solvency statement and the considerations which directors must make when they provide the statement.
Why reduce share capital?
There are various commercial reasons for reducing share capital, such as:
- to return surplus capital to shareholders which is no longer required by the company
- to eliminate losses of the company to allow it (for example) to declare dividends to shareholders
- an alternative to a share buy back where the company does not have sufficient distributable reserves
- to reorganise and simplify group structures
How may a company reduce its share capital?
The Companies Act 2006 prescribes two ways for a company to reduce its share capital, both of which require a resolution of at least 75% of the eligible members of the company (special resolution), which are:
- by special resolution with the confirmation of the court; and
- by special resolution supported by a solvency statement of the directors.
The solvency statement procedure is only available to private companies. The company must not be prohibited from reducing its share capital by its articles of association.
What is a solvency statement?
A solvency statement is a statement in writing by all of the directors which states that, as regards the company's situation at the date of the statement:
- there are no grounds on which the company could be found to be unable to pay or otherwise discharge its debts; and
- the company will be able to pay its debts as they fall due during the 12 months immediately following the date of the statement, or, if it is intended to commence the winding up of the company within 12 months of the date of the statement, that the company will be able to pay or discharge its debts in full within 12 months of the commencement of the winding up.
The statement should not be made more than 15 days before the date of the passing of the shareholder resolution.
Are there any sanctions on directors for providing solvency statements without having reasonable grounds for the opinions contained in it?
The Companies Act 2006 states that if the directors make a statement of solvency without having reasonable grounds for the opinions expressed in it, an offence is committed by every director who is in default which can lead to imprisonment and/or a fine. It is therefore important that directors are aware of the financial status of the company so they can make a considered decision whether or not to provide the solvency statement.
What must the directors consider before they provide the statement?
- The directors should consider carefully the financial position of the company and the effect of the reduction of capital.
- They should take account of projections (including prospective and contingent liabilities) of the company for at least the next 12 months.
- The Company Law Committee of the Law Society has issued a memorandum highlighting practical steps that directors can take before they make a statement of solvency to reduce the risk of committing an offence under the Companies Act 2006, including:
- to consider potential threats to the company's business model such as the potential insolvency of suppliers and loss of customers;
- although it is not necessary under the Companies Act 2006, to obtain advice from independent third parties, such as accountants or auditors; and
- to keep a record of the information which they have considered to show that they have exercised reasonable care, skill and diligence.
When will the court procedure be appropriate?
As stated above, the solvency statement procedure is only available to private companies.
The procedure may not always be the appropriate method for carrying out a reduction of capital in private companies, particularly when all of the directors are not willing to sign the solvency statement or the directors would prefer the comfort of obtaining court approval if there is the possibility of an objection to the reduction from creditors.
The solvency statement procedure for reducing share capital introduced for private companies under the Companies Act 2006 is a simpler and more cost efficient procedure for private companies seeking to reduce share capital than the court approved procedure. Directors who provide solvency statements should do so only after taking into account all of the company's liabilities for the following 12 months otherwise they run the risk of committing an offence.
If your company is considering carrying out a reduction of capital, or you are a director who is being asked to provide a solvency statement, and you require further advice, please contact Anna Kerrane in the corporate department at email@example.com or 0161 214 0523.