Considerations for QAHC directors when using a capital reduction to facilitate a distribution

Under English company law, a company may reduce its share capital “in any way”, but will typically do so by reducing either (i) the number of shares in issue, (ii) the nominal value of those shares, or (iii) one of the company’s reserves (such as the share premium reserve). In each case, the reduction frees up capital for distribution, as the amounts realised can either be paid directly to shareholders or credited to the profit and loss account.

Carrying out a capital reduction

As a capital reduction diminishes the resources available to creditors, the proper procedure must be followed. In summary, a company can reduce its share capital through a special resolution of its shareholders, but that resolution must be supported either by a court order confirming the reduction or (for private companies only) a solvency statement given by its directors. As obtaining a court order is more costly and time-consuming, directors will often be keen to explore the solvency statement route. However, where they seek to use a solvency statement, directors of QAHCs need to bear in mind certain corporate considerations alongside the applicable regulatory and tax considerations.

Key considerations

A solvency statement is a written statement signed by all of the directors of the company, in which they confirm their opinion that (a) as at the date of the statement, there is no ground on which the company could then be found to be unable to pay (or otherwise discharge) its debts; and (b) if there is no intention to wind up the company within 12 months, that it will be able to pay (or otherwise discharge) its debts as they fall due during the year immediately following the date of the statement. Each director therefore needs to be comfortable that this is the case.

The phrase “no ground” does not mean the Company must be able to pay its debts no matter what. It means the directors have no grounds at the time the statement is made for doubting that the company will be able to pay debts in full. For example, once they have identified a liability, the directors may recognise a range of estimates for that liability, then fix their best estimate lower than the upper end of that range.

However, the directors need to consider carefully the financial position of the company and the effect of the capital reduction. The state of the market generally may also influence the directors' consideration of solvency. In particular:

• they must actually form the opinions set out in the statement. If they do not (or could not reasonably), the statement will be invalid;
• they must take into account all the company’s liabilities (including any contingent or prospective liabilities) and then consider what assets are available to satisfy these contingent liabilities and, in a non-technical sense, what provision has been made for them. Redeemable preference shares that are treated for accounting purposes as liabilities should be treated as prospective liabilities;
• when considering available assets, they can take contingent assets (such as future receivables) into account. They must then decide how much weight to give these assets and ask themselves how certain it is that any contingent assets will be received or paid and how dependent the company is on those assets; and
• they must consider what supporting documentation is available to support their opinion. They should review the latest statutory and management accounts and check that there has not been any material change or other material issue affecting the financial position or solvency of the company since the date of those accounts.

The City of London Law Society has published a memorandum of practical steps directors can take before making a solvency statement. These steps include:

• recording information relied on to show that the directors had reasonable grounds for their opinions and that they exercised reasonable care, skill and diligence in forming such opinions, addressing any uncertainties regarding the company’s liabilities or the resources available to meet them;
• considering different factors such as potential external threats to the company's business model and the likelihood of such threats occurring; and
• obtaining reports from independent third parties.

The consequences of getting it wrong

If the directors make and deliver a solvency statement without having reasonable grounds for the opinions expressed in it, a criminal offence is committed by every director who is in default, punishable by a fine and/or up to two years’ imprisonment. Directors might also incur civil liability for breach of statutory duty, misfeasance or negligent misstatement. While a director could consider obtaining an indemnity from an appropriate interested party (e.g. the company’s parent company) in relation to their potential civil liability, this would not relieve them of their criminal liability.