Things You Should Know About The Reduction Of Share Capital Process

June 5, 2024

The term “reduction in share capital” is used in the closing of a business, which means that a company’s shareholder’s equity is reduced. Shares may also be bought back, which are referred to as share buybacks, occurs through share cancellation, repurchase, or tender offers.

Very often firms decide to undertake the process of share capital reduction because of strategic transformations of their business. Frequently, this process generates the situation when companies have issued share capital that is greater than required for the best business execution and growth. Nonetheless, there are other than few other factors, which encourage companies to cut their share capital.

As for the bootstrappers who are knowledgeable about the Hong Kong business scenario, they can use the court free capital process to reduce the capital, which in effect increases the utility of capital exceeding requirements.

Content Outline

As a result of capital reduction, the number of shares in the company drops by the prescribed amount. On the other hand, market capitalization will remain the same for the company even after the restructuring. However, the float, which refers to the number of shares that are in circulation and floating around among investors, will be reduced instead.

When such instances occur in which a company’s profits come down or it loses revenue that can never be recovered, capital reduction measures may be introduced. This type of conduct entails various techniques, actually cash flows in the direction of sponsors for the terminated shares. But, in many cases, shareholders do not have the chance to feel the weight of these maneuverers because of the limited impact on them.

The companies seeking to minimize their stock equity must follow a list of actions.

Most jurisdictions call for the sending of notice first to lenders for the resolution of the capital reduction.
Next, the company has to organize a procedure to apply for help in the reduction of its share capital not earlier than three months after the initial notice.
The share capital is to be paid to shareholders not earlier than three months from the entry of a decrease in the commercial register.

Hong Kong Companies Ordinance

In Hong Kong, a court-free procedure for reducing a company’s capital is specified in the new Companies Ordinance (Cap. 622).

The procedure without court requires the director to present proof of company solvency for a reduction of capital. That is a route, that is quicker and cheaper as compared to the court-sanctioned process where the company is clearly able to finance its operations independently.

The prescribed procedure and criteria for the reduction of share capital process can be found in sections 215 to 225 of the Companies Ordinance.

The company is implementing various types of reduction including :

Lowering the liability of any shares connected with the shares issued but not paid up.
Canceling the share capital where it is not covered by the available assets.
Returning any share capital that is already paid in an amount that is more than the company wants.

The limitation of the company’s share capital will be subject to any restrictions on it that are included in the articles (so as to prohibit or restrict the reduction thereof). For the company to reduce its shares, the articles of the company should have such a rule and the revision of the company’s articles is required prior to the reduction.

Also, note that if this implies that the company can only offer redeemable shares, any further reduction in capital, which is the amount of equity the company has, will be impossible.

Here are the top three key factors of capital reduction and why it is easier to implement in Hong Kong compared with most other places as well.

1. It is convenient in Hong Kong

For the most part, in the various countries in the world, share capital had to be reduced by means of courts, which is also usually lengthy. Such reductions of capital necessarily complicate the issue of deciding the timing of these reductions, since the company’s structure and financial state change frequently.

These are the several concepts why a business may need to avert capital:

Giving up excess capital to shareholders.
Departing from or decreasing capital contributed which is not used anymore.
Reserve formation through the capital reduction process

Hong Kong authorities understood how heavy this process can be and that is why, in 2014 the Hong Kong government came out with Cap 622 of the Companies Ordinance of Hong Kong SAR (the “CO”), by which ease of doing business became simplified.

This decision served as a reform attempt in accordance with international standards by conceding more room to businesses to decide on the terms of their share capital. The reduction of share capital under the former CO could only arise through a special resolution which was adopted by the shareholders and further later confirmed by the court.

The updated Companies Ordinance deliberately states that the company capital diminution process can be done by way of an alternative court-free procedure the solvency requirement of which is applicant company-specific substance test. A courtless process like this simplifies the procedures for using the excess capital more efficiently. This approach not only saves time but is also cheaper when compared to more technical court-based protocols.

It is intended for situations where a company is well off. Moreover, in this context, both companies’ directors can classify their companies’ solvency and how it is supposed to be in the future.

The new ruling is that the implementation of the solvency statement is not obligated to attach the auditors’ report. This results in companies having the ability to carry out corporate restructuring exercises with ease.

Besides, the new regime bypasses the obstacles of the limitation of capital amount with the court’s decision and its refusal of reduction.

2. Uniform solvency test

A uniform solvency test, which would be used in the new Companies Ordinance, was designed. This procedure serves as a prerequisite for all companies, who want to diminish their authorized capital undergoing this due process. It also applies in the case where a company decides to repurchase its own shares; and shareholding for acquisition of its own shares.

For the purpose of passing the solvency test, such procedures should be followed:

Immediately after the transaction, the assets of the company shall be subject to any one creditor’s claim until it is proved that the company could not be found unable to pay its debts.
The liquidity stress test requires that after 12 months, the company should be able to repay all its debts whether 12 months after the transaction or if the company has to start the wind-down process immediately. Also, the company should be able to pay its debts within 12 months of the wind-up if it is to start the process of winding up at any time.

For the solvency statement, directors would have to sign and having jointly stated that the company, as per the solvency test requirement.

The Director is required to review the company’s status for certain purposes and consider all types of its liabilities, including contingent and prospective in forming an opinion. Moreover, a person who makes a solvency submission without any reasonable ground for the matter expressed within it is guilty of the criminal act.

It is not necessary to provide auditors’ reports either, as the Government assumes that directors may be performing relatively the same tasks as the auditors would as regards proving the solvency of the company.

To be more precise, the test will help to improve the details given in a conceptualized solvency statement. All the administrators have to sign it and it is their responsibility. Every criterion should be met in that case, but the failure to do so can have serious consequences in the form of legal proceedings.

3. Practical implications

One of the best measures that company directors can apply before the start of any capital reduction procedure is paying all the required attention to all the obligations first.

Share capital reduction, inherently, may be quite difficult and complex. With the longer stay of the solvency test under the CO, there will be an increased risk of the director’s civil and crime responsibility.

Directors’ attention needs to focus on such points if implementing a share capital reduction project is supposed to be a good decision for both the company and its shareholders:

Do we have the reasons for saving the current enormous amount of capital?

This refers to any particular trade conditions for the domestic or foreign operations of the company such as licensing requirements with the partners, agreements, or any other historical reason.

Does the company have to continue with these stipulations and continue the great amounts of capital?
What sum does the company need to pay back to shareholders and how much capital does the company need to reduce?

The auditor’s opinion is not compulsory now, yet it’s a good idea to acquire certified accountants’ opinions concerning the ongoing financial standing of the business as well as the influence of share capital reduction on the company.

Along with these, the directors should also think about obstructing the process of reduced share capital once the audited financial statements are available. This will maintain the consistency of variation between the starting time of the enactment and the resolution date.

Also, remember that in the case of some non-standard variations, a court-supervised process might still be used. For instance, there can be instances where shareholders’ objections are guarded or where there is divided opinion involving directors regarding the company’s solvency status.

Consequently, the entity must recognize that the passing of the special resolution may be challenged by a non-approving lender or shareholder within five weeks with regard to the court’s annulment of the resolution. If it does, the court will pass an order to either confess or reject the resolution.

There are also cases when the necessities for companies are mentioned, including the decrease of the share capital, with other options due to the update of the revised company.

Companies may also opt to implement restructuring by an amalgamation by way of court-free proceedings. However, when the option for capital restructuring is chosen, directors have to make sure that they are well-thought-out in their mind while deciding for the restructuring.

Shareholders or creditors that are involved have to be proposed with proper details that would be the basis for the extraordinary resolution on the share capital reduction process.

Without introducing any chances for prejudice and for the creditors to have interests against the debtor, it has to be a top priority for the directors. Another major responsibility involves ensuring capital restructuring rationality and fair treatment for all investors and creditors.

Lastly, the directors’ resolution approving the reduction of share capital should be explicitly phrased stating the factors considered and the reason for coming to the conclusion of the solvency statement.

Conclusion

Certainly, the company was able to drastically change the reduction of share capital procedure, and this procedure of share capital reduction without the court hearing should definitely be taken into account if you want to decrease share capital.

Since the Hong Kong authorities have worked to make the process of moving more seamless, make sure you consider these tips before you take a step that could result in serious consequences.

In case you need some advice about the share capital reduction contact us at FastLane Group as our expert team is ready to guide you through the whole process.