What is meant by a Reduction of Capital?

What is a Reduction of Capital?

The majority of companies have a share capital, which is the money invested into the company by its shareholders in exchange for shares.

It is possible for a company to reduce its share capital by reducing (or cancelling) its share capital (a “Reduction”). A Reduction can be the first step which affords a company the opportunity to carry out other useful processes, because the share capital that is cancelled will generally be:

1. Used to create a distributable reserve
2. Paid directly to shareholders.

Creating (or increasing) distributable reserves is the most common reason for a Reduction, as it can allow a company to carry out other corporate actions such as a demerger or share buyback. For an overview of the demerger process carried out via a Reduction, please see: https://www.ts-p.co.uk/insights/demerger-by-way-of-share-capital-reduction/

Alternatively, a company may simply have surplus share capital, which is better returned to the shareholders. It is important to note that this is a different process from a share buyback (mentioned above), which is a contract between the company and one or several of its shareholders. For an overview of the share buyback process, please see: https://www.ts-p.co.uk/insights/what-are-the-key-considerations-when-it-comes-to-share-buy-backs/

What is the Solvency Procedure?

 A Reduction can take place via two procedures:

1. A court approved reduction
2. A solvency statement reduction.

This articles focuses on the solvency statement Reduction as this is the most common method.

The solvency statement Reduction procedure does not require the approval of the court. Instead, every director of the Company must sign a solvency statement.

The wording of a solvency statement (the “Statement”) is prescribed by the Companies Act 2006, however, the practical meaning of this wording is that the directors must consider that the Company:

• Can currently pay (or otherwise discharge) its debts as and when they fall due
• Will be able to continue to pay its debts as they fall due for the 12 months following the date of the Statement.

This requires careful consideration on the part of the directors, who must ensure that they are able to justify their opinion given in the Statement on objectively reasonable grounds. The approach taken in forming this opinion will generally include seeking the advice of the company’s accountant in order to evaluate the company’s assets as against any actual or potential liabilities which may arise.

What is the process?

Both types of Reduction are undertaking pursuant to very precise procedures governed by the Companies Act 2006. These procedures are detailed and must be followed in order for the Reduction to be valid; however, we have set out a brief overview of the solvency statement Reduction below:

1. The company must hold a board meeting to approve the circulation of a special resolution to its shareholders. The special resolution may be passed either at a general meeting of the shareholders or via a written shareholder resolution
2. The shareholders must pass this special resolution approving the Reduction.  A special resolution must be approved by 75% or more of the shareholders in order to pass
3. The special resolution must be supported by a solvency statement made by the directors of the company (as set out above), which must be made available to the shareholders
4. The Statement must be made by the directors not more than 15 days before the date on which the special resolution is passed
5. Within 15 days of the special resolution being passed, a copy of the following must be filed at Companies House (with the Reduction not taking effect until this is done):

a) A statement of capital of the Company

b) The special resolution

c) The Statement

d) A statement from the directors confirming that their Statement was made not more than 15 days before the resolution was passed and provided to the shareholders.

If you require any assistance in implementing a Reduction, please get in touch.