POLICY CONSIDERATIONS BEHIND THE RULES GOVERNING RAISING OF CAPITAL IN CORPORATE FINANCE

By Ninsiima Irene

Advocate and legal consultant with M/s Angualia Busiku & Co. Advocates www.lawyers-uganda.com

Introduction

The raising of the capital of a company is subject to the traditional Common Law rules that are aimed at protecting the interests of the shareholders and the creditors of the company. Some of these rules have been incorporated in the Companies Act.^[1] There are other rules that govern the raising of capital by companies which are found in the Act and are not necessarily derived from Common Law. Where the rule of limited liability operates, the creditors claims are confined to the assets of the company. Consequently, a method of protecting creditors will consist of rules ensuring that a company operates only with an appropriate level of assets, so as to increase the chances that it will be able to meet the claims of the creditors.^[2] This policy is given effect through detailed rules of company law governing the raising and maintenance of capital. These rules have been described as complex and cumbersome.^[3] In this assay, I will discuss these rules clearly illustrating the policy considerations behind them and the circumstances pertaining in Uganda.

What is share capital?

According to Gower,^[4] Capital is a word of many meanings but in company law, it is used in a very restrictive sense. It connotes the value of the assets contributed to the company by those who subscribe for its shares. In other words, capital is the value of what is received rather than the assets themselves, because those assets change form in the course of the business activities of the company. If the company receives cash in exchange for its shares, the directors will turn that cash into other types of assets in order to promote its business, some writers have commented that indeed if they did not, it would be difficult to see why, in most cases, the investors should use the cash to buy shares in the company rather than put the money in a building society or some other interest bearing deposit.^[5]

The value of the assets which the company receives in exchange for its shares may represent less than the total value of the company’s assets. Even where the company has not yet begun to trade, it may have raised money from sources other than in exchange for its shares for example it may have borrowed money from a bank. The value of such loan does not however count as its capital. This is because the aim of the definition of capital of the company is to protect creditors as a class and only assets contributed by shareholders do this effectively.^[6]

Once a company has begun trading and if it has done so profitably, it will have assets which represent the profits made and these too do not count as part of the company’s legal capital however the shareholders will have an interest in them since they may provide a legal basis for payment of dividends. In short, the value of the company’s legal capital and the value of the company’s assets held in the company are not necessarily or even typically equivalent. In the above examples, the value of the total assets is greater than the value of the company’s legal capital, if the company trades unsuccessfully, the value of those assets may fall of course, below the value of its legal capital.^[7] Legal capital is also important in company accounts because it provides a basis of measuring the success of the company from the shareholders point of view or for fixing the distribution of dividends.

Different types of capital can be identified in a company.

• Share Capital

This is the amount contributed by members entitling them to a dividend as a return to the member.

• Nominal capital.

This is the amount of capital that a company proposes to be registered with which will be realised after the shares have been allotted i.e. the maximum amount of share capital that can be realised. S4 of the Act describes nominal capital as the authorized maximum amount of share capital that can be realized.

• Issued capital.

This represents the nominal value of shares availed for subscription and which has been allotted.

• Capital at call.

This represents the issued capital that is not yet paid for.

• Called up capital.

Portion of the issued capital that the company has requested for settlement.  It is the portion of issued capital that the company has requested for settlement from the holder of shares that have not been fully paid for who is entitled to all benefits as if the shares were fully paid provided the Articles of association allow.

• Reserve Capital (S.66)

Reserve capital is a portion of the issued capital which is at call but is not to be called up except in the event of winding up of the company. It is issued only by a company limited by shares or by guarantee.

Raising of capital of a company: A case for private and public companies.

A company will definitely need to raise capital at its initial stage of its business; this is done by way of raising this capital from the persons that have subscribed for shares of the company. Even then, a company may still need to raise more capital in the course of its trading, it may do this by inviting members of the public to come and buy shares in a company through a prospectus. It must be clearly noted that it is only public companies that can issue a prospectus inviting members of the public to buy shares in that company; private companies cannot do this because of the restriction on transferability of shares. S. 29 of the Act^[8] provides that a private company is a company which by its articles restricts the right to transfer its shares and prohibits any invitation to the public to subscribe for any of its shares or debentures.

Methods of issue

There are different ways of inviting the public to subscribe for shares in a company, they include the following:-

(a) Placings.

These take place in the issuing house. A company issues securities, placing them in the issuing house for purposes of the issuing house selling them to its clients. The issuing house (may purchase securities and place them with clients) or may not place them with the clients.  When it purchases the securities, then it ceases to be an agent of the company.

Offers by Tender

This is a new innovation in the developed world by which the company will make a tender to the public for the purchase of its shares. All the shares that have been tendered are sold to the highest bidder.

(b) Rights issue/script issue

The company invites its own shareholders to subscribe for new shares or debentures. As an incentive, such securities are sold at a lower price than what they would normally obtain in the new market.

(c) Bonus issue

Like the rights issue, the bonus issue method is an internal affair of the company concerned. Under this method, instead of the company paying to shareholders a dividend it may have declared, it holds on to those funds by issuing shares to the shareholders.

(d) Offer for sale

The company concerned issues its securities in an issuing house and the issuing house sells them to the public at a higher price. This method has a number of advantages to this company: First the company is not responsible for unsuccessful issue to the public,^[9] second it is the issuing house which bears the responsibility for the prospectus, and third, unlike the method of placings, the company does not pay anything since the issuing house pays itself a commission, the difference of the price at which the sells and the price which it bought.

(e) Direct issue

The company itself deals with the public without an intervention of the issuing house. This method is cumbersome for a number of reasons. First the company has to use a prospectus i.e. legal liability is conferred upon a company, second the company bears a risk of unsuccessful issue and third although it may protect itself against unsuccessful issue by underwriting such issue, the underwriters have to be paid a commission for that issue. The commission must not exceed 10% of the price at which the shares are issued and that there must be authority from the Articles to pay that commission. This means that a company cannot transact with underwriters who demand more than 10% of the price. Again if the Articles authorise more than 10% the company cannot exceed such figure. And such payment must be disclosed in the prospectus.^[10]

Rules governing the raising of capital of a company:  Policy considerations behind these complex and cumbersome rules.

Rules as to disclosure and the prospectus requirements

A company inviting members of the public to subscribe for its shares must disclose all relevant information to the public whose affairs it is inviting to participate. This disclosure is done through a public document called a prospectus. A prospectus is defined under the Act as any prospectus, notice, circular, advertisement, or other invitation, offering to the public for subscription or purchase any shares or debentures of a company.¹¹ The expression “invitation” and “offer” in this context bear unique meanings in the sense that they refer only to cases where application forms are sent out to be completed by potential subscribers for the acceptance or rejection of the company. Consequently when the form is sent out this in effect is an invitation to tender, while the completion and no dispatch of the form constitutes the offer which has to be accepted by the company. The definition in S.2 is very vague and consequently the courts have come up with some guidelines to be employed in determining whether an invitation amounts to a prospectus or not.

Firstly, according to Nash Vs Lynd^[11], for a document to amount to a prospectus, not only must it be delivered but also there must be some publicity with the aim of inducing subscription e.g. if a thief stole the document and publicized the issue of shares which the public purport to buy, the document does not amount to a prospectus.

Secondly, for a document to amount to a prospectus, it must be issued to the public.  What amounts to the Public? The Act seems to indicate that a public means a public whether selected by members or debenture holders of the company concerned or as clients of the person issuing the prospectus or in any other manner.^[12] In Re Government Stocks & other Securities investment Co. Ltd Vs Christopher¹⁴ a company issued a circular in which it offered to acquire shares in another company in return for its own shares. The question was did that circular amount to a prospectus. The court held that where an offer is acceptable only by the shareholders of a company, such an offer is deemed not to be to the public unless the shares are to be issued under renounceable letters or terms.^[13]  Where the shares have been issued at non-renounceable terms, the allottee cannot sell them to a third party.

A prospectus must be dated and must be delivered to the registrar for registration before or on the date of publication and if it contains a statement by an expert, that expert’s written consent must accompany the prospectus.¹⁶ If these requirements are contravened, the company and any officer responsible for that prospectus are liable to a fine not exceeding shs 100/= per each day the default continues. The mandatory registration makes the document a public document and it is deemed genuine for evidential purposes.

The prospectus must  also disclose matters that the Act specifies that include among others:- the number of founders and management or deferred shares and the interests thereof in the company property and profits, the names, addresses and description of the directors, their share qualification and their remunerations, the minimum subscription to be raised by the company, certain particulars of contracts relating to property acquired or to be acquired by the company, the auditors, the different classes of shares, the voting rights in respect of capital and the dividend attached to various classes of shares and a report by the company’s auditors showing its assets and liabilities, profits and losses of the company including its subsidiary, and dividends paid during each of the financial years preceding the issue of the prospectus.^[14]

The legal regulation of statements made in the prospectus for the purpose of advertising securities for purchase and sale is aimed at effecting full disclosure of the company’s affairs to the investing public. It is evident from the prospectus provisions that their purpose is to ensure that the company provides to the public the essential minimum information about its position when it is launched into the world, and that whenever it offers its securities to the public it fully and fairly discloses the relevant facts so that the risk of investment can be assessed.

Liability imposed for  a defective prospectus

Both civil and criminal liabilities lie against the company and/or its officers for non-compliance with the statutory provisions as well as misstatements in the documents. This is aimed at ensuring that the company and its officers do not mislead the public when they issue a prospectus, the company and its officers must therefore take care that the information contained in the prospectus does not contain untrue statements. a) Criminal liability.

1. 46 provides that where a prospectus issued includes any untrue statement, any person who authorised its issue is liable on conviction to imprisonment for a term not exceeding 2 years or to a fine not exceeding 10,000/= or both. The only way such a person can escape liability is to prove that at the time the statement was issued, they reasonably believed that the statement was true. b) Civil liability under the Act.

Civil liability for the defective prospectus exists under both the Act and common law.

Under the Companies Act, s.45 provides that if a prospectus contains false or untrue statements, the civil liability will be borne by the persons responsible for its issue to pay compensation to all those persons who rely on it to subscribe for shares. The compensation will be for any loss or damages those persons have suffered by reason of relying on such a false statement. The persons that will be held liable include the directors of the company at the time of issue, any other person who authorised himself to be indicated as a director in the company at the time of issue, promoters of the company and any other person that authorised the issue. The only way such person can escape liability is to prove that although they had authorised to be named as directors, they withdrew their consent before the prospectus was issued or that it was issued without their knowledge or consent or that after the issue when they became aware of the defect in it, they withdrew their consent and gave notice of the false statement to the public.

1. c) Civil liability at common law.

Damages for misrepresentation

At  common law, an aggrieved subscriber can institute an action for deceit or misrepresentation which entitles him to damages for misrepresentation. Damages are equivalent to the loss suffered and inconveniences.  This remedy has got limitations and therefore before the court can entertain such an action, the plaintiff must show that the false statement was a statement of fact not an opinion and that there was actually a false statement in the prospectus not an omission to include a statement.

Action for rescission of contract

At common law an aggrieved subscriber who has suffered loss or damage because of the defective prospectus can also institute an action for rescission of the contract. This way he will seek to put the contract to an end. This remedy has also got limitations and therefore before the court can entertain such an action, the plaintiff must show that;- He indicated his intention to rescind the contract immediately after discovering the defects in the prospectus. In this case he must not have done anything showing that after the discovery of the defect, he was still willing to continue with the contract and actually did acts that amounted to affirmation of the contract. For example If he had applied for shares on the basis of a defective prospectus, he must show that he immediately returned them on acquisition of this knowledge, did not attend meeting, sell his shares to a third party or receive dividends in respect of those shares etc. secondly that he took steps to bring his action before any winding up proceedings had commenced in respect to the company.

The mandatory minimum subscription requirement

The Act also stipulates stringent rules in relation to the Minimum Subscription. It provides that no allotment shall be made of any shares in a company offered to the public for the subscription unless the minimum subscription has been subscribed and the sum payable on application for the amount so stated has been paid and received by the company.^[15] Minimum subscription refers to that amount of capital stated in the prospectus which in the opinion of the directors must be raised by the issue of the share capital in order to provide for the purchase price of any property purchased or to be purchased which is to be defrayed in whole or in part out of the proceeds of the issue, any preliminary expenses payable by the company, and any commission so payable to any person in consideration of his or her agreeing to subscribe for, or of his or her procuring or agreeing to procure subscriptions for any shares in the company;  the repayment of any monies borrowed by the company in respect of any of the foregoing matters and working capital .

Each subscriber must pay at least not less than 5 percent of the nominal value of the share.^[16] Where the minimum subscription is not raised, on the expiration of sixty days after the issue of the prospectus, all money received by the company from the applicants must be repaid to them and if this is not done within seventy five days after the issue of the prospectus, the directors of the company are jointly and severally liable to repay that money with interest at the rate of five percent per year. However a director is not liable if he proves that the default in the repayment was not due to any misconduct or negligence on his part.

The mandatory requirement that a company must not go ahead to allot shares if the minimum subscription has not been raised, paid for and received by the company is  aimed at preventing the company from getting underway until it has   raised the capital needed to carryout the objects in which it has invited the public to participate. Apart from the aforementioned, the mandatory rule on minimum subscription is very important in terms of creditor protection. The requirement that a company must raise a minimum amount of legal capital before it allots and issues shares is important in terms of creditor protection because at the stage of allotment the company acquires a legal entitlement to the consideration promised in exchange for the shares, so the creditors will be guaranteed that there will be sufficient funds not less than the stated minimum subscription to which they will look to for purposes of repayment of their debts.

However as seen, the minimum capital requirement by definition operates when the company is issuing capital, this is not adequate and sufficient to protect creditors because creditors need their protection not only at this stage but also when the company becomes insolvent. A minimum capital requirement at the time of issue does not guarantee any particular level of assets being available for the creditors at this later date since no legal rule can protect a company against unsuccessful trading as was stated by the House of Lords in Trevor V Whiteworth^[17] that;-

“…paid up capital may be diminished or lost in the course of the company’s trading; that is a result which no legislature can prevent…”

The mandatory rule relating to authorized capital

The memorandum of a company limited by shares must state the total amount of the share capital and the division of the share capital into shares of a fixed amount.^[18] The amount stated in the memorandum is known as the company’s authorized share capital/ nominal share capital. The significance of the authorized share capital clause is that it specifies the maximum number of shares that can be allotted at any time and thus a limit on the power of allotment. This rule is aimed at protecting the interests of the shareholders. Authorised share capital operates to restrict the further issue of shares which may dilute existing shareholders interests.^[19] The directors cannot issue more than the amount of the company’s authorized capital without returning to the shareholders for approval of an increase in the authorized amount.²³ Authorised capital is also said to protect the interests of creditors because this is the amount of capital that the company implicitly warrants it has available to pay creditors and when providing credit to the company, the creditors will refer to the authorised capital as this is the potential maximum capital the company can issue and to the paid up capital as this is the amount that cannot be returned or distributed amongst shareholders hence ensuring that there is a cushion against insolvency.^[20]

This concept of authorized capital has been criticized by Gower as a concept that sounds important but which fulfils no identifiable creditor protection role.^[21] According to Gower,^[22] the requirement of authorized capital has more to do with relations between directors and shareholders than with creditors’ relations. It has been noted that the above protection is only illusory as the authorised share capital is no longer a relevant concept in today’s business environment because the existence of the authorised share capital does not mean that a company will indeed issue all the shares it is authorised to issue. In fact, in reality, many companies have a much larger authorised share capital than its issued capital and have no obligation to increase the issued capital up to the authorised capital to meet solvency requirements. Thus, the purported protection to creditors afforded by the authorised share capital principle is illusory and misleading. Secondly that the authorised share capital is not an appropriate indicator of the company’s ability to repay debt even if all the shares have been issued and fully paid up, the amount so received from the issue is a historical figure and does not reflect the actual worth of the company which may change as the company continues its business and operations.²⁷

Prohibition against issuing shares at a discount to their par value

As well as stating the total amount of the authorized share capital, the memorandum must also state the division of the share capital into shares of a fixed amount. The stated fixed amount of each share is known as the nominal or par value of the share.^[23] The basic common law rule, now reflected in section 59 of the Companies Act cap 110, is that shares may not be issued at a discount to their par value. In Ooregum Gold Mining Co. of India V Roper²⁹, the directors sought to issue shares at a discount. It was held that shares are not to be issued at a discount and whoever takes shares in return for cash must either pay or become liable to pay the full nominal value of those shares. The ‘par value’ is a notional capital amount associated with each share. It need bear no resemblance to their market value. The phrase fixed amount was considered in the case of Re Scandinavian Bank Group Plc^[24]where it was held that although it had to be a monetary amount, it did not have to be an amount which was capable of being paid in legal tender.

This prohibition against issuing shares at a discount to their par value can be rationalised as providing creditors with protection against a form of misrepresentation. The company’s capital is recorded in its public documents i.e. in the authorised capital clause in the memorandum. Would-be creditors may view these documents and be misled if the assets have never actually been contributed to the company. Considerations of this sort are clearly apparent in the reasoning of at least some members of the House of Lords in Ooregum Gold Mining Company of India V Roper.³¹ In laying down the rule that a company may not allot shares for less than par, Lord Halsbury stated:

‘The capital is fixed and certain, and every creditor of the company is entitled to look to that capital as his security.’

According to Lord Harlsbury therefore, every creditor of the company is entitled to look to a fixed and certain amount of capital as his security and a company should not be allowed to mislead potential shareholders and creditors about the amount of its real capital.

The rule makes it easier for investors to find out how much capital has been subscribed to the company.  Even where shares are issued for non cash consideration, there must be a valuation of those shares. Shares may be issued for cash and or non-cash consideration. Where shares are issued for non-cash consideration, the concern is whether the consideration received for the shares is adequate. One of the ways to deal with the issue of ‘inadequacy of non cash consideration’ is by requiring the prior valuation of the non-monetary consideration.  However it has been noted that in so far as the Companies Act is concerned adequacy of consideration should be dealt with by way of director’s duties. Common law as well as the Companies Act require company directors to act in the best interest of the company.^[25] A director who issues company shares for inadequate consideration contravenes this duty and can be made accountable to the company for this contravention. An investor therefore can be sure that the value stated in the company’s accounts has actually been contributed by the allottee. Of course both creditors and potential shareholders can take comfort from the fact that the amount raised is subject to extensive rules regarding maintenance of capital so that it cannot be freely withdrawn from the company and paid back to its existing shareholders.

However the companies Act authorizes issue of shares at a discount subject to certain conditions. S. 59 of the Act provides that a company may issue shares at a discount of a class already issued except that;- the issue of the shares at a discount must be authorised by resolution passed in a general meeting of the company and must be sanctioned by court, the resolution must specify the maximum rate of discount at which the shares are to be issued, the resolution can only be made after the company has already been in business for more than a year and the shares to be issued at a discount must be issued within one month after the court has sanctioned the issue. This rule does not only protect creditors of the company but the shareholders as well, the rule protects existing shareholders from directors who propose to devalue their interest in the company by issuing shares to new shareholders too cheaply.^[26]

However, Gower, has criticized this rule in as far as creditor protection is concerned, he says that it is doubtful whether this rule protects creditors since creditors will always benefit if the legal capital of the company is increased, no matter what the impact of that increase on the existing shareholders caused by the issue of more shares at a discount. The rule has further been criticized in as far as it presupposes that nominal value may mislead investors to believe that the company guarantees that the value of the investment in the company’s shares is to be always equivalent to the share’s nominal or par value.  That in reality, an informed investor does not rely on the shares’ nominal/par value when deciding whether to invest in the company’s shares. Instead, reliance is placed on other financial indicators which will include the NTA (Net Tangible Asset) per share and on the company’s business reputation, its net worth and its cash flow besides the amount contributed by its shareholders.

The rule relating to restrictions on payment of commission, prohibition of payment of certain commissions and discounts

A company may pay a commission to any person in consideration of his or her subscribing or agreeing to subscribe for any shares in the company or for procuring or agreeing to procure subscriptions. However the payment of the commission must be authorized by the articles, the commission paid or agreed to be paid must not exceed 10% of the price at which the shares are issued or the amount authorized by the articles whichever is the less, and the amount of the commission to be paid must be disclosed in the prospectus in case of public companies and in case of shares not offered to the public for subscription, in the statement in lieu of a prospectus.^[27] Such commission may include commission payable to underwriters. Upon the formation of a company, the promoters, where appropriate ensure that the shares offered to the public are underwritten. However, where an existing company is desirous of raising capital, it is the director’s duty to ensure that new shares are underwritten. The aim of underwriting is to ensure that the issue of shares is successful. Underwriting is a form of insurance against possible poor reception of the issue by the public. In the words of Cotton LJ in Re Licensed Victuallers Mutual Trading Association^[28]

“an underwriting agreement means an agreement entered into before the shares are brought before the public, that in the event of the public not taking the whole of them, or the number mentioned in the agreement, the underwriter will, for an agreed commission, take an allotment of such part of the shares as the public has not applied for.”

Except as provided above, a company is prohibited from paying any other commission, discount or allowance to any person in consideration for share subscription.^[29] The rationale for this rule is that if corporate transactions such as the giving of discounts and payment of commissions are left unregulated, this would have the effect of reducing the company’s share capital and this can be detrimental to the company’s creditors.

Prohibition against a company repurchasing its own shares

It is illegal for a company to acquire/ repurchase its own shares except as provided by law. Thus a company cannot use its own capital to buy its own shares as was held in the case of Trevor V Whiteworth^[30] that it is ultra vires for a company to purchase its own shares even if the memorandum gives express authority to do so. In that case a company went into liquidation and a former shareholder claimed from the company the balance of the price of his shares which he had sold before liquidation and which had not been wholly paid for. The claim was disallowed. Lord Watson indicated that the intention of the legislature in restricting the power of limited companies to reduce the amount of their capital as stated in the memorandum is to protect the interests of the creditors. Additionally that the effect of the restriction is to prevent transactions between the company and shareholder by which money already paid to the company in respect of shares is returned to him save where the court has sanctioned this. Allowing a company to buy its own shares amounts to a return of capital to the shareholder and is misleading as far as the capital yardstick of the company is concerned. However there are exceptions to this rule though they specifically don’t arise as a result from the company raising capital for example under the alternative remedy to the rule in Foss V Harbottle³⁸in s.211 of the Companies Act where the court may allow a company to buy shares from an aggrieved oppressed shareholder, where the company is allowed to redeem its redeemable preference shares^[31]and forfeiture of shares.^[32]

Prohibition on a company giving financial assistance for the acquisition of its own shares or those of its holding company

A company must not give financial assistance for the acquisition of its own shares. S. 56 provides that it shall not be lawful for a company to give whether directly of indirectly any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of any shares in the company or its holding company. Examples of such instances include the following;- A company lending money to A so that to put A in funds so that he can buy shares from the existing members, A company lending to C money so that C can repay a loan provided earlier by C’s bank which C has already used to buy shares in the company, A company buys a piece of land from D knowing that D will use that same purchase price he receives to pay for shares in the company that he already agreed to buy. If a company acts in contravention of this section, the company and every officer of the company who is in default are liable to a fine not exceeding twenty thousand shillings.

The rationale behind this rule is that if financial assistance was permitted, it would militate against shareholder and creditor protection.  Financial assistance can prejudice the creditors’ interests by reducing the company net assets therefore adversely affecting its ability to repay creditors.^[33] The origin of this rule is traceable in the House of Lords decision in the case of Trevor V Whitworth⁴² in which the rule was laid down making it unlawful for a company to use its assets to purchase its own shares. In this case the memorandum of association of a company did not authorise the company to purchase its own shares, however the company’s articles contained a provision that any share may be purchased by the company from any person willing to sell it and at any price not exceeding the then market value thereof, as the board thinks reasonable. When the company went into liquidation in 1884, a claim was brought against it by the executors of Whitworth, a deceased shareholder, for the balance of the price of his shares sold by the executors to the company in 1880. The liquidators sought to determine whether the claim should be allowed. In formulating the rule, it is clear from the reasoning of the HOL that they took the view that it should be anchored firmly within the realms of creditor protection and, as such, arose as an inevitable consequence of the limited liability principal. Lord Herschell, surveying the nature of the limited liability company and the statutory provisions then governing reduction of capital explained that the company’s capital:

“ may no doubt be diminished by expenditure upon and reasonably incidental to all the objects specified in the memorandum. Apart of it may be lost in carrying on the business operations authorised. Of this all, persons trusting the company are aware, and take the risk. But I think they have a right to rely and were intended by the legislature to have a right to rely, on the capital remaining undiminished by any expenditure outside the limits or by the return of any part of it to the shareholders…”

Lord Watson agreed noting that;

“ those  who extend credit to the company rely on the fact that it is trading with a certain sum of capital already paid and they are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out except in the legitimate course of its business.”

The house of lords therefore was primarily concerned with protecting the company’s capital for the benefit of its creditors while recognizing that this objective is always subject , of course, to its diminution through the risks associated with ordinary trading.

It has further been noted that if a company is allowed to give financial assistance for the purchase of its shares, such an arrangement would appear to offend the spirit and the letter of the law which prohibits a company from purchasing its own shares and that this kind of practice would be open to grave abuse.^[34] However, this rule has been criticized and there is a consensus opinion that the prohibition is drawn far too widely and as a consequence, it renders unlawful what would otherwise be harmless and profitable commercial transactions for companies.^[35]

However, there are exceptions to this rule/ instances where the company may give financial assistance for example where the lending of the money is part of the ordinary business of the company and where the company gives loans to persons with in the employment of the company other than the directors with a view to enabling those persons to subscribe for fully paid up share in the company for their beneficial interest.

Rules on application of premiums received on issue of shares

Where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares has to be transferred to a share premium account. This sum is regarded as paid-up share capital of the company. The share premium account can only  be applied by the company for specific activities such as  in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares, in writing off the preliminary expenses of the company; or the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company, or in providing for the premium payable on redemption of any redeemable preference shares or of any debentures of the company.  The fact that the money on the premium account is regarded as part of the company’s legal capital means that it is subject to the rules on the maintenance of capital. The company’s ‘legal capital’ account must be distinguished from the company’s retained profit/earning account that remains distributable to the company’s shareholders. The company’s paid up capital   is subject to strict rules on maintenance and any proposed reduction of this account otherwise than that permitted by the law is treated as an illegal reduction of the company’s paid up capital. This restriction ensures that creditors’ interests are safeguarded.^[36]

Equal subscription price rule

This is to the effect that shares in the same series shall have the same rights and privileges and the same consideration shall be paid for shares issued with the same terms at the same time. This anti discrimination rule is ostensibly fair, as corporate governance considerations would dictate that all shareholders be treated equally. However, price discrimination would yield the maximum return for the issuing company if different shareholders like employees, strategic investors and financial investors are willing to pay different prices for shares issued in the same tranche^[37].

Conclusion

The rules of company law that relate to the raising and maintenance of share capital are commonly rationalised as being an attempt to protect corporate creditors on the one part and the shareholders on another. Creditors are provided with protection by company law against the abuse of limited liability. Shareholders are protected from any act that may affect the value of their shares. The relevant provisions are generally thought to be unduly complex, and to lack coherence. Some have argued that their very existence is unjustified and in fact certain jurisdictions have modified some of these rules by legislation or totally abolished their application.^[38]Nonetheless these rules are very important in terms of shareholder and creditor protection.