Beware! The dangers of issuing shares at a discount

23rd June 2021

Beware! The dangers of issuing shares at a discount

Section 580 of the Companies Act 2006 (CA 2006)

Section 580 CA 2006 contains a general prohibition that a company cannot allot shares at a discount.

The question to consider is, why is this option (which may be a tactical move to raise money quickly for a company) considered unlawful?

Allotting shares

Directors of a private limited company, which has only one class of shares, generally have the power to allot further shares of that same class (unless there is a restriction in the company’s articles of association). Where the directors of a private limited company want to issue shares of different classes, then the directors must seek authority for doing so from the company’s articles of association, or, by way of an ordinary resolution of the shareholders.

Newly allotted shares must have a fixed nominal value, and once allotted, the nominal value of those shares constitutes the company’s share capital.

Shares can be paid for in money, or, monies worth (which includes good-will and know-how), and they can be issued part-paid (or nil-paid), which means the shareholder has paid the company only a percentage of the value of the shares but is liable to pay the full value of the shares to the company when called on.

Maintenance of capital

It is a fundamental rule that the share capital of a company belongs to the company itself and not to the shareholders. The principle of capital maintenance precludes the return of capital to shareholders, prior to the winding up of the business, save for some specific and narrow exemptions. The main aim of capital maintenance is to preserve the capital in a company for the ultimate benefit of the company’s creditors.

One of the main provisions of the capital maintenance regime can be found in section 830 CA 2006, which provides that a company may only make distributions to its members (i.e. shareholders) out of distributable profits. This prevents shareholders from withdrawing their capital investment in a company should it run into financial difficulty, which in turn, would reduce the possible value of a creditor’s claim.

Another key statutory provision relating to the doctrine of capital maintenance, and the subject of this article, is section 580 CA 2006 (the general prohibition about allotting shares at a discount to their nominal value).

Allotting shares at a discount

As a result of section 580 CA 2006, an allotment of paid-up shares for less than the nominal value will be void, and contravention of this section will result in the allottee being liable to pay an amount equal to the discount (together with interest) back to the company.

This regime is largely designed to protect creditors. In theory, a creditor should be able to review a company’s statement of capital to check whether their capital assets will cover their liabilities. If shares are allotted at a discount the share capital figure will not accurately reflect the real position.

Take for example a company that has ordinary shares with a fixed nominal value of £1. If that company then sells 500 shares at a discount of 50p, the statement of capital will show a share capital value of £500 for those shares, as it is calculated using the fixed nominal value, but the reality is the company’s capital will only have increased by £250. That is, in short, the reason parliament saw fit to legislate to make it unlawful for a company to allot shares at a discount.

Final thoughts

At a time when most companies are suffering the financial impacts from Covid-19, and may wish to issue discounted shares to encourage investment and boost their balance sheet, this provision may feel like an overly stringent one too many. Important to note, is that the Government temporarily suspended wrongful trading provisions in an attempt to encourage businesses to continue to trade and incur additional debt, so why was a temporary suspension not afforded for this section under the Companies Act?

With that being said, none of the above is to say that shares must be fully paid for on a fresh allotment. Companies can allot shares where only a portion, or, in fact, none of the nominal value has been paid for by the allottee. The Court of Appeal made it very clear in their recent decision in the case of Chalcot Training Ltd v Ralph, that where the shareholder remains liable for the full amount of the nominal value, shares will not be considered to have been issued at a discount.

If you need any advice regarding your business or the impact that Covid-19 is having on your operations, then please do get in touch with Elizabeth Clazie on 01473 298187, elizabeth.clazie@gotelee.co.uk or Max Harnden on 01473 298139, max.harnden@gotelee.co.uk.

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