Company Law and Practice (CLP512S)
Unit 14 Capital Maintenance
Capital Maintenance
Introduction
One of the important common law premises on which company law was previously based was that a company
having a share capital initially obtains its funds (capital) by issuing shares to its members; this contributed capital
then constituted the fund to which creditors of the company could look for the satisfaction of their claims, and
accordingly it had to be maintained.
In reality the common law rules regarding capital maintenance provided little protection to creditors, while
totally disregarding the interests of shareholders. The Companies Act 28 of 2004 attempted to address this
situation by including certain legislative provisions aimed at protecting both creditors and shareholders.
In this unit we will learn about the rules of capital maintenance in terms of the common law and how they are
amended by the current legislation
Objectives
Upon completion of this unit you should be able to:
• name the three basic common-law rules aimed at the maintenance of a company’s share capital
• discuss the requirements to be met for a company to acquire its own shares
• state the possible consequences for the directors of a company if the above requirements have not
been met
• compare the acquisition of its own shares by a company with the redemption of preference shares by a
company
• list the requirements to be met for a company to pay dividends to its members
• explain when interest may be paid out of share capital
• formulate the legal rules applicable to a company issuing par value shares at a discount
• formulate the prohibition against financial assistance for the purchase of a company’s own shares
contained in section 44 of the Act
• explain the consequences of a contravention of this prohibition
• apply the contents of this unit to factual scenarios and give appropriate advice
Additional reading
Cilliers H S, Benade M L, Benade M L, Henning J J, Du Plessis J J, Delport P A, D e Koker L, Pretorius J T. (2003).
Entrepreneurial Law. Durban: Butterworths. (Pages 171 - 186)
Haupt, A. and Nkhangweni, J. (2011). Corporate Law for Commerce Students (2nd ed.). Pretoria: Van Schaik.
(Pages 126 - 129)
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1 The Common Law Situation
The basic principle under common law in regard to the maintenance of share capital was
The rule was formulated as follows by Lord Watson in Trevor v Whitworth (1887) 12 App Cas 409 (HL):
“Paid-up capital may be diminished or lost in the course of the company’s trading; that is a
result which no legislation can prevent; but persons who deal with and give credit to a limited
company naturally rely upon the fact that the company is trading with a certain amount of
capital already paid, as well as upon the responsibility of its members for the capital remaining
at call; and they are entitled to assume that no part of the capital which has been paid into the
coffers of the company has subsequently been paid out, except in the legitimate course of
business ”
From this basic principle the following rules regarding capital maintenance were derived:
1) a company may not buy back its own shares;
2) a company may not pay dividends out of capital;
3) a company may not issue par value shares at a discount.
Earlier legislation added a further prohibition to these rules, namely that a company may not give financial
assistance for the purchase of its own shares.
The Companies Act 28 of 2004 contains various provisions regarding share capital. Although in some instances
the common law capital maintenance principle is still supported, the general approach has been to relax these
rules, providing instead for certain measures to protect both shareholders and creditors.
2 Acquisition of Own Shares
The Companies Act now provides that, if it is so authorised in its articles, a company may pass a special resolution
approving the acquisition of its own issued shares. The procedure to be followed is laid down in Section 89 of the
Companies Act.
2.1 Procedure to be followed
The articles of the company must permit it to buy back its shares. If not, the articles must first be amended
accordingly.
If the articles permit the buying back of shares, the shareholders must adopt a special resolution approving the
transaction. The approval can be a general approval, which will be valid until the next annual general meeting
unless revoked by a special resolution before then, or a specific approval for a particular acquisition.
If a company proposes to acquire its own shares, it must distribute an offering circular as prescribed in the
Companies Act to all the shareholders holding shares of the class that it intends to acquire, and also lodge a copy
of the circular with the Registrar.
An offering circular is not required if it is so agreed in the special resolution authorising the acquisition or if the
shares of the company are listed on the Namibian Stock Exchange.
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Shares can be acquired at any consideration, including, in the case of par value shares, at a premium over par
value, and the consideration therefore can be paid out of any reserves, including statutory non-distributable
reserves such as the capital redemption reserve fund and the share premium account.
Shares that are acquired by the company itself will be cancelled and will become authorised but unissued shares,
and the share capital of the company will be reduced by the shares so acquired.
A company may not acquire all its shares and the acquisition of shares must not have the result that the only
issued shares remaining would be redeemable preference shares.
2.2 Protection of creditors
In order to prevent possible prejudice to creditors as a result of the acquisition of shares and resultant reduction
of capital, a company may not make any payment for the acquisition of its own shares unless there are
reasonable grounds for believing that:
▪ the company is, or would after the acquisition, be able to pay its debts as they fall due in the ordinary
course of business (liquidity test); and
▪ the consolidated assets of the company would after the acquisition exceed its consolidated liabilities
(solvency test)
If the above requirements are not met, a creditor may apply to court for an order to compel a shareholder or
former shareholder (who is no longer a shareholder because his/her shares were acquired by the company) to
return the consideration received for his/her shares to the company and to order the company to reissue shares
to that shareholder/s, or any other order that the court thinks fit.
The directors of the company that acquired its own shares without complying with the liquidity and solvency
requirements are jointly and severally liable for any consideration given for the acquisition of such shares, but
they may obtain a court order to compel a shareholder to return the consideration that he/she received. An
action against directors must be instituted within three years after the date of the acquisition.
2.3 Protection of shareholders
The shareholders of a company wishing to acquire its own shares are protected by the requirement that the
acquisition of shares must be authorised by a special resolution. Furthermore, the requirement that an offering
circular must be sent to all shareholders of the class of shares that it wishes to acquire ensures that all
shareholders are granted an equal opportunity to participate.
3 Payment of Dividends
A common-law rule that also entrenched the principle of capital maintenance was that dividends may not be
paid out of share capital. This common law rule has now been replaced by section 96 of the Companies Act,
which allows a company to make payments to its shareholders if the provisions of that section are complied with
and the payment is authorised in the articles.
The term “'payment” includes any direct or indirect payment of money or transfer of property to the shareholder
by virtue of the shareholder’s shareholding in the company, but does not include a payment made to the
shareholder in another capacity (for example as creditor of the company).
Section 96 of the Companies Act requires that there must be a reasonable belief that the company is, or would
after the payment, be able to pay its debts as they fall due in the ordinary course of business (liquidity test) and
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Unit 14 Capital Maintenance
that the consolidated assets of the company would after the payment exceed its consolidated liabilities (solvency
test). The shareholder will be liable to the company for any payment made in contravention of this section.
Section 96 of the Companies Act does not require that the payment be authorised by a special resolution and an
ordinary resolution will therefore suffice. Any payment, even if it meets the requirements of Section 96, must
however still be authorised in the articles of the company, and a company is accordingly at liberty to provide for
stricter requirements.
4 The Payment of Interest on Shares Out of Share Capital
Section 85 of the Companies Act provides that where shares are issued to finance construction works or the
acquisition of plant which cannot produce profits for a lengthy period, the company may, subject to the
stipulated statutory requirements, pay interest on share capital during this period.
Such interest payments must be authorised by the articles or by a special resolution of the company and
approved by the Minister of Trade and Industry and may not exceed the rate of 10% per annum.
5 Issue of Par value Shares at a Discount
The final common law rule on the maintenance of share capital was that a company was not permitted to issue
shares at a discount, in other words at a price below their par value.
Section 87 of the Companies Act now permits the issue of par value shares at a discount under the following
conditions:
▪ the shares which are issued at a discount must be of a class already issued by the company;
▪ at least one year must have elapsed since the date on which the company became entitled to
commence business or since the date of the first issue of that class of shares;
▪ the issue must be authorised by a special resolution specifying the maximum rate of discount at which
the shares are to be issued;
▪ the issue must be sanctioned by the court; and
▪ the shares must be issued within one month after the date of the court's sanction or within such
extended time as the court may allow.
6 Financial Assistance for Purchase or Subscription of Own Shares
The common law prohibition of the purchase by a company of its own shares was extended with a statutory
prohibition contained in section 44 of the Act. In terms of this section a company is prohibited from giving,
whether directly or indirectly and whether by means of a loan, guarantee, the provision of security or otherwise,
any financial assistance for the purpose of, or in connection with, a purchase or subscription made or to be made
by any person of, or for any shares of the company or where the company is a subsidiary company, of its holding
company.
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6.1 Exemptions
The following transactions are exempted from the prohibition against financial assistance contained in section 44
of the Companies Act:
▪ the lending of money in the ordinary course of business by a company whose main business is the
lending of money;
▪ the provision (under a scheme in force for the time being) of money for the subscription or purchase of
shares to be held by trustees for the benefit of employees (including salaried directors) of the company;
▪ the making of loans by a company to its employees (other than directors) to enable them to purchase or
subscribe to shares in the company on their own behalf; and
▪ the provision of financial assistance by the company for acquisition of shares in the company if prior
approval for the particular transaction has been obtained by means of a special resolution at a general
meeting of a company and if there are reasonable grounds for believing that the company is both
solvent and liquid.
The effect of these exemptions is that a company IS PERMITTED to give financial assistance for the purchase of its
own shares, provided that the transaction falls within the exempted categories.
6.2 Approval by Special Resolution
The Companies Act lays down very precise requirements that need to be met before a company can provide
financial assistance for the acquisition of its shares, namely prior approval for the particular transaction. The
shareholders of a company wishing to give financial assistance for the acquisition of its shares are protected by
the requirement that such acquisition must be authorised by a special resolution passed before such assistance is
given. The special resolution can furthermore only refer to the particular intended transaction.
This means that financial assistance given without the necessary approval will be void and cannot subsequently
be ratified. A general approval will similarly be void.
Creditors of a company intending to provide financial assistance for the purchase of its shares are protected by
the requirement that the company must be both solvent and liquid at the time such assistance is given. Section
44(3) of the Act provides that every director or officer of a company that provides financial assistance contrary to
the prohibition (or any person who at the time that the assistance was provided was a director of the company)
commits an offence and is liable for a fine of up to N$4000 or imprisonment of up to 1 year, or both.
Summary
In this unit you learned that the common law rules regarding the maintenance by a company of its share
capital have been considerably amended by the legislature.
In general, companies are now permitted to purchase their own shares, pay dividends out of capital, issue par
value shares at a discount and provide financial assistance for the purchase of their shares, provided certain
statutory requirements have been met. These requirements relate mainly to protection of shareholders
(transactions often require authorisation by special resolution) and protection of creditors (the company must
be solvent and liquid).
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References
Cilliers H S, Benade M L, Benade M L, Henning J J, Du Plessis J J, Delport P A, de Koker L, Pretorius J T. (2003).
Entrepreneurial Law. Durban: Butterworths
Davies, D., Cassim,F, H.I, Geach, W., Mongalo,T., Butler, D., Loubser, A., Coetzee,L., Burdette, D. (2014).
Companies and other Business Structures in South Africa (3rd ed.). Cape Town: Oxford University Press
Deport, P. (2011). The New Companies Act Manual. Durban: Lexis Nexis.
Haupt, A. and Nkhangweni, J. (2011). Corporate Law for Commerce Students (2nd ed.). Pretoria: Van Schaik.
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