Protecting Creditors: Share Capital Maintenance in Corporate Law
Doctrine of Maintenance of Share Capital
The doctrine or principle was developed primarily to protect the company’s creditors.
- Creditors have the right to be assured that the company’s capital is applied solely for the purpose of operating the business of the company.
Key Case Law on Creditor Protection
Re Exchange Banking Co – Jessel MR
The creditor lends money to the company based on the promise that the capital will only be used for business purposes. Because of this, the creditor has the right to expect the company to keep its capital and not give it back to the shareholders.
Prohibitions under the Maintenance Doctrine (MoC)
The Doctrine prohibits:
- Lending money on the security of their own shares.
- Giving financial assistance to purchase own shares.
- Purchasing own shares.
- Reducing its capital except as provided by the Act.
- Paying dividend out of capital.
(Refer to Section 123 of the relevant Companies Act.)
Financial Assistance: Making or Giving a Loan
This occurs where a company gives financial assistance (FA) for the purpose of acquiring shares in it, often in the form of a loan.
- If the loan is not repaid, the company loses part of its issued capital.
- The effect is the same as the company purchasing its own shares, which is generally prohibited.
Case Study: Selangor United Rubber Estate Ltd v Craddock
C wanted to take control of SURE Ltd by buying most of its shares. He asked Bank Contanglo to make the bid for the shares on his behalf. To finance this, C made the Board of Directors (BOD) of SURE Ltd lend money to Woodstock, a company he owned. Woodstock then lent that money to C. C used this money to pay Bank Contanglo, who then bought the shares in SURE Ltd for him.
Held: This was a breach of company law (CA) because it involved unlawful financial assistance by the company to help someone buy its own shares.
Statutory References for Financial Assistance
- Section 123(3): Penalty clause.
- Section 124: Effect of the transaction.
- Section 125: Exceptions to the prohibition.
- Section 123(1): Covers both Financial Assistance (FA) and Share Buy Back (SBB).
Share Buy Back (SBB)
Section 123(1)(a) and (b) prohibits a company from acquiring its own shares by share buy back.
Why is Share Buy Back Prohibited?
- It is a return of capital to shareholders, which usually requires court approval.
- It could harm creditors by reducing the company’s available funds.
- It might allow current directors and top management to keep control unfairly.
- It could be used to manipulate the share price.
Case Study: Mookapillai v Liquidator, Sri Saringgit Sdn Bhd
An agreement was made between majority and minority shareholders for the company to buy the minority’s shares at a set price. Held: This was not allowed because Section 67 of the Companies Act clearly bans a company from buying its own shares or helping anyone else to do so, directly or indirectly.
Case Study: Trevor v Whitworth
The executors of W (a deceased shareholder) sold his shares back to the company, to be paid in two installments. Before the second payment was made, the company went into liquidation. The executors then claimed the unpaid amount from the liquidator, T.
Although the company’s Articles of Association allowed it to buy its own shares, the court held that a company cannot legally purchase its own shares even if its articles state otherwise.
Lord Watson’s Principle on Capital
Lord Watson stated that creditors “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.” This means they can assume that any money invested in the company hasn’t been taken out, except for normal business purposes.
Subsidiary Acquiring Holding Company Shares
The doctrine prohibits the purchase of shares in a holding company by its subsidiary.
- Section 123(1)(b) confirms that a subsidiary cannot own shares in its holding company, as this transaction is treated as the holding company effectively buying its own shares.
Exceptions and Solvency Requirements
Statutory Exceptions
- Section 127 provides exceptions for Share Buy Back (SBB).
- Section 125 provides exceptions for Financial Assistance.
Solvency Test
Section 112 mandates a Solvency Test for certain capital transactions.
Effect of Prohibited Transactions
In Datuk Tan Leng Teck v Sarjana Sdn Bhd & Ors, the court confirmed that the transaction remains valid and enforceable because the section itself allows it, even if it goes against the prohibition. This was further confirmed by the Federal Court in Lori (M) Bhd v Arab-M’sian Finance Bhd.