One of the issues we are frequently faced with when carrying out due diligence on a company, whether it’s for restructuring, mergers and acquisitions or lending, is the invalid increase in the number of shares within a company. Many companies make the mistake of completing only part of the allotment process or simply adding the new number of shares to the next confirmation statement (or even the annual return), deeming these share increases as invalid. This can often be time consuming and difficult to rectify. The process to validly increase the number of shares within a company should therefore be properly considered, and there are a range of matters which must be reviewed before this process occurs.
Articles of Association and statute
The starting point would be to review your articles of association to see what requirements are set out within these to answer some key questions.
Do they contain a restriction on the number of shares that can be issued and if so, has that limit been reached? Articles of association adopted before the implementation of the Companies Act 2006 (2006 Act) automatically included an authorised share capital limit and articles adopted after implementation of the 2006 Act may have an authorised limit, although many do not. If the limit has been reached the directors and shareholders will need to decide whether to increase or remove the limit before the allotment.
Do the articles provide the directors with a general authority to allot additional shares in the company and, if so, is there a period in which that allotment is to be used or does the authority need to be renewed? Is the company able to rely upon the general statutory powers for directors to allot?
Do the articles provide existing shareholders with pre-emption rights so that any additional shares the directors are proposing to allot must first be offered in a prescribed manner? If the articles are silent on this point, has the statutory provision within the 2006 Act been dis-applied? If not, the existing shareholders will need to give consent to the allotment.
The directors and shareholders should then consider any shareholder agreement there might be (investor agreement or similar), as these may contain restrictions or requirements on the allotment of further shares in the company.
Once the above have been considered and the process ascertained then the allotment process itself can be started. This is likely to involve board minutes, shareholder resolutions, the notice of allotment at Companies House in the prescribed form and finally, the write up of the company’s statutory registers and the issue of share certificates.
Can invalid share increases be rectified?
In order to rectify an error, the company needs to attempt to correct the position retrospectively which, depending on the length of time since the increase in the share capital, can be difficult and time consuming. Alternatively, on a share sale it means that the buyers are likely to want the sellers to give warranties as to the number of shares in issue and their validity. Warranties are of course something that sellers should be looking to avoid, especially where it could have been avoided by following the correct procedure or, as a last resort, rectified as quickly as possible after the event if it comes to light that the correct procedure was not followed or the correct filings were not made.