The solvency statement procedure for reductions of share capital by private companies was introduced as a simplified alternative to the more complex and involved process of applying to the court.
Reasons for a reduction in share capital
Where a private company reduces its share capital, the reserve arising from the reduction can usually be treated as realised profit and is distributable immediately. This can be useful for the following reasons:
- As a way to create distributable reserves and thereby enable the company to pay dividends
- To return excess capital to the shareholders
- To simplify the capital structure of the company by eliminating certain classes of shares which have no valuable rights attached to them.
The share premium account and capital redemption reserve
A company wishing to pay a dividend must have adequate distributable reserves; where this is not the case, a reduction of capital from the share premium account or capital redemption reserve may provide the solution.
For the purposes of a reduction, the share premium account and the capital redemption reserve are treated as part of the company’s share capital. This means that when reduced, the share premium account and the capital redemption reserve can create a reserve which is capable of being used to make distributions to shareholders.
What is involved?
The procedure to be followed and supporting paper work to achieve a reduction of share capital are relatively straight forward. The procedure involves two key steps:
- A solvency statement in a prescribed format signed by all of the directors of the company (see below); and
- The approval of the shareholders of the company by special resolution, which must be passed within 15 days of the date of the solvency statement.
The solvency statement
All of the directors of the company need to consider very carefully the financial position of the company and the effect of the reduction before signing the solvency statement. This consideration needs to take account of projections (including prospective and contingent liabilities) for at least the next 12 months, although it would be prudent for the directors to give the statement with regard to the next 15 months as this will assist the directors in showing that they have exercised reasonable care, skill and diligence in forming the opinion in the solvency statement.
Other relevant factors will include the financial health of the company, the relative size of the reduction and amounts owing to creditors. In all cases, the directors should review the latest management accounts to check there has not been any material change or another material issue affecting the financial position or solvency of the company since those accounts.
If the directors of the company make a solvency statement without having reasonable grounds for the opinions expressed in it then that could lead to a director being guilty of an offence and liable to imprisonment or a fine (or both). The directors should therefore take accounting and legal advice before signing a solvency statement to ensure they are considering all the relevant factors.