BUSINESS LAW

LARGE GROUP 2

Welcome to the 2nd Large Group, which as you can see from the slide is on Equity

Finance.

Hopefully, as with last week, you all found the Student Guide so you’ve got

everything handy. As I did last week I’ll try and remember to refer you to the Student

Guide as I go, but also do ask me if you’re lost and not sure where we are.

So starting at the very beginning with our little introduction section on the Student

Guide.

Just to remind you what you did last year in Business Law 1. In Business Law 1 you

looked at the two different ways of funding a company and you will know from what

you did last year that companies are funded in two different ways.

Let me see if you know the answer. Can you tell me what are the two different ways

companies are funded. One answer is on the slide in front of you.

Yes, debt and equity finance.

So equity finance, as we’ll be focusing on today, is basically company finance via

investment through the shareholders.

Debt finance is the other method which is basically where companies borrow

sometimes from banks, sometimes from other equity investors, but it’s more formal

debt borrowing rather than funding in the way that shareholders fund.

Let’s have a look at the Outcomes for this session. We’ve already sort of covered the

first one.

1. Explain the difference between equity and debt finance.

We will look at debt finance in a few weeks, I think that’s in Large Group 5, so we will

come onto debt finance in a few weeks’ time.

2. Explain what is meant by share capital and the different categories of share

capital.

3. Identify and differentiate between different classes of shares.

Again, I think we did some of that in Business Law 1, but we’ll build on that

knowledge today.

4. Identify and explain the key principles relating to the allotment and issue of shares

and explain how that works.

We will be looking at that in a lot more detail in Workshop 2.

5. Identify the rights of shareholders in relation to payment of dividends and transfer

of shares.

That’s what we’re going to be covering today.

Moving onto shares and share capital and doing a bit of revision.
Primarily then we talked about debt finance already. This is bank borrowing and also

borrowing from investors. And that’s what we’re going to come onto in a few weeks’

time.

Equity finance then kind of selling shares. For private companies it’s quite difficult to

find a market for your shares because obviously they can’t kind of advertise

themselves on an open market. So private companies if it’s a small family business

those shares will be owned by family members or private investors that have been

brought in.

But of course, remember that public companies have access to a much wider market

because they can list their shares on the stock exchanges. And generally, not

always, but generally we see that public company shares are considerably more

expensive than private company shares.

Let me click onto this slide so that we can see those different sources of funds

coming into our company there.

Remember that shareholders own a proportion of the assets of the company so

when you’re a shareholder you own a little slice of that company. And, of course, it’s

proportionate so I’m sure you already know a 10% shareholder has got significant

more power than 2% shareholder.

So shareholders have a right to vote, a right to be paid dividends if one is declared,

so sometimes they’re not declared. And when the company is wound up

shareholders have a right to claim any surplus assets, so when the company is

dissolved and if there’s anything left after everybody else has been paid those assets

go to the shareholders, again in proportion to their ownership.

So just having a look at the Student Guide, you’ve got Activity 1.

This is back to Jumbo Gym. We’ve seen this case study a couple of times last week

and also last year.

I’ll give you a couple of minutes to read through Activity 1 and have a little think

about the answers. You’ve got 3 questions there. I’d like you to leave question 4 for a

moment. I’ll just ask you to answer in a couple of minutes.

Activity 1

Let’s have a little go through these questions then.

Activity 1 we’ve got Kai and Patrick. When the company was set up they each

subscribed for one £1 ordinary share each. Subsequently when the assets of the

partnership were transferred to the company it issued them with 999 additional £1

ordinary shares each. They’ve both paid the full amount for their shares.

Question 1:

What was the issue shared capital when the company was set up?
Let’s have some answers in the Chatbox.

We have two suggestions here for £2.

The question what was the issued share capital when the company was set up?

You two are both correct. Well done. Let’s have a look at why.

So if you look back to the facts, Kai and Patrick each subscribed for one £1 share

each. So when the company was set up they each invested £1 totally £2. So the

issued share capital at the moment the company was set up was £2.

Question 2:

What is the issued share capital now?

£2,000, because each of them have their £1 share, then they each bought 999 £1

shares. Add them altogether you’ve got £2,000 worth of issued share capital.

Question 3:

What is the amount of the paid up share capital?

So the amount of the paid up share capital is also £2,000. It does say that they’ve

both paid in full for their share allocation. And in fact, remember under Model Article

21 all shares issued after the initial share issues must be fully paid. So they’re not

actually allowed to partly pay for their shares.

So the answer to question 3 is £2,000 because the shares have been fully paid.

They’ve been fully paid because they have to be fully paid under Model Article 21.

A student asks could I explain why it’s £2,000 for question 2.

Since the initial allotment of one £1 share each, each of the two shareholders then

bought an additional 999 £1 shares each and that’s why the whole lot adds up to

£2,000.

We’ll do question 4 in a second.

Let’s move on and look at classes of shares. This is section 1.2 in the Student Guide.

Most smaller companies, if you think about your average family owned company,

they will only have ordinary shares because there’s no real need for them to have

fancy shares with lots of different rights attaching to them. But the larger the

company the more you’ll see that actually have they have significant amounts of

different classes of shares. And we’ve been looking in Workshop 1 at Tesco this

week, you’ll see that Tesco has a significant amount of different classes of shares

and sometimes it’s quite mindboggling.

So you did look at classes of shares in Business Law 1, so this is a little bit of

revision.
Let’s have a go at question 4 for Activity 1.

Question 4:

List three other classes of shares.

So let’s see what you can all come up with. See if we can have some suggestions.

We’ve got preference shares. Redeemable share. Treasury shares. I think that’s a

decent list.

Preference shares – can anyone remember what are the rights of a preference share

in broad terms?

[Chatbox response]

A student said a preference to the annual dividend. A student is suggesting they give

you limited voting rights.

So firstly to say that the rights of these shares are what they are. Not every

preference share is going to look the same as the next one because when the

company creates them they decide what are we going to put into these shares, what

kind of limitations are we going to give, what kind of preferences are we going to

give.
But if we’re talking generally then generally what you see with a preference share is

preferential rights over things like capital and dividends. So you can see on the slide

those are the normal rights that shareholders have but if you have a preferential

share you might be front of the queue. So on a winding up or when there’s only a

small amount of profit to share out on a dividend, preferential shareholders come

first.

They sometimes do have limited voting rights and actually what we tend to see is the

preferential shareholders are big investment companies and they don’t necessarily

what to go to shareholder meetings and vote on resolutions. That’s not why they’re

here. They’re here to make money. So actually we tend to see that the holders of

preferential shares are big investment institutions.

Redeemable shares, can anyone remember broadly what is a redeemable share?

A student has said are they what a shareholder has that a company will honour at a

later date. Sort of. Think about the name redeemable.

Basically, redeemable shares are issued with an agreement that the company will

buy them back on a fixed date. So they’re almost like short term share issue. So they

might be bought back next year on the 1st of December, something like that, and

sometimes with a pre-agreed price as well.

The third type of shares – treasury shares. These are shares which the company has

bought back but they have not cancelled them, so they’re put in a kind of
metaphorical treasury. So shares that are bought back but they haven’t been

cancelled.

I mentioned at the beginning of this bit that bigger companies tend to have lots of

different classes of shares. And just on that it’s worth mentioning Facebook as an

interesting example. So Facebook has lots of different types of shares as you would

imagine for such a huge company, now called Meta, but I’m sure you know what I’m

talking about.

So they have class A and class B shares as an example. The class A shares are

issued to investors and those investors are given one vote per share.

The class B shares give that person 10 votes per share. Guess who owns the class

B shares at Facebook – it’s Mark Zuckerberg.

So quite interesting, so the general every day investors get one vote per share. Mark

Zuckerberg has class B shares and they give him 10 votes per share.

So you can see how companies use the shares to really control power and the flow

of cash within a company. So as the company becomes more and more

sophisticated, so you will see increasingly sophisticated different types of shares

doing different types of things.

Let’s move onto allotment and issue of shares. This is part 2 in your Student Guide.
I’ll put the next slide up for you.

When a company is set up the first shareholders called the subscribers to the

memorandum, they’re the first shareholders and they agree to take those first

shares. And that’s what we call the initial share capital.

There’s no minimum share capital for a private company, so a private company can

actually be set up with a share capital of £1 or less.

Can anyone remember what the minimum prescribed amount of share capital is for a

public company. You might have looked at this in Business Law 1.

£50,000.

So unlike private companies which can have £1 or less when they start off, public

companies have to have a minimum of £50,000 as their minimum prescribed share

capital.

The other thing to remind you of before we get started on this section is that

companies formed under the 2006 Companies Act and later have no maximum

amount of shares, so they can issue as many shares as they want.

So for example, Tesco has issued something around the 7.5 billion share mark. So

that gives you an idea that they can just keep going.
Companies incorporated before the 2006 Act and who haven’t changed their articles

are still limited in terms of the amount of issued share capital they can allot.

Once the company is set up and it’s got that minimum share capital issued then

there are three ways that an investor can become a shareholder to the company:

 Allotment - which we’re about to look at – where the investor buys new shares

from the company.

 Transfer – where you buy shares from an existing shareholder.

 Transmission.

Transmission happens essentially by operation of law. So if the existing shareholder

dies, for example, then you might be left those shares in a will.

So allotment - which we’re about to look at – when you buy shares from the

company.

Transfer – when you buy shares from an existing shareholder.

Transmission – where you acquire those shares by operation of law.

So we’re going to start with allotment.

As you can see on the slides, shares are allotted when a person has agreed to buy

them and is entitled to be entered on the register. Shares are issued when that

person is actually entered on the register.

The reason that we focused on this on the slide is because actually we tend to use

the word “allot” and “issue” interchangeable and they’re not quite the same. They

are sort of the same and most people will know what you mean, but if we’re being

very technical and detailed we can see on the slide they’re not quite the same.

So allotted you’ve agreed to buy them but you actually haven’t yet bought them.

Issued, when you have bought them and you are actually entered on the register.

So the process in order is that the shares are allotted to you and then they’re issued

to you.

We’re going to move onto the Student Guide subheading 2.1 – looking at directors’

power to allot.

So in terms of an allotment then issue, it’s the company that allots the shares and as

the directors run the company the decision is made by the directors and they act on

the company’s behalf.

When a company decides to allot shares the people or companies who want to buy

those shares will actually apply to buy them. So you can see on the slide there’s an
application by the prospective shareholders and if we’re thinking about this in

contract law terms that application is essentially an offer to buy.

The next bit of the process then is the directors must approve the application, which

is basically acceptance of the offer. And as I’m sure you remember, offer plus

acceptance equals hopefully a binding contract if you have all your other elements

there.

How does that actually happen?

Well, again you see on the slide how do the director actually approve the application.

They have to pass a resolution to approve the application. They will also then

resolve to allot the shares. And the third resolution they will resolve to authorise the

preparation an execution of the share certificates.

Finally – this point isn’t on the slide - they will need to issue the shares by actually

entering the shareholder on the register.

So that’s the process in broad terms.

You will remember that one of the Outcomes was to understand the procedure of

allotment, so that’s what we’re starting to get into. So you can see we’ve got this

offer and acceptance situation and some formal resolutions by the Board of Director

to actually agree to do the allotment.

So that’s the kind of headline.

Now in fact, the process is quite complicated in terms of whether or not the directors

can actually proceed with the allotment.

So we’re not moving on in the Student Guide – we’re still at 2.1 - but I’m going to

show you the next slide and start explaining the things that the directors have to

check before they can actually proceed to allot and register the new shareholder.

There’s a lot going on on this slide. We’re going to take our time to talk it through.

Basically, there are three things that if we’re advising a client, for example, whether

or not they can do an allotment. You can see the three blue boxes on the slide.

Those are the three steps that we need to go through in order. So we’ll go through

these slowly and I’ll explain each one in turn.

The first step is to check whether there is a restriction on the allotment of shares.

What does that actually mean? A restriction?

Essentially, what we’re checking is to see if there are any shares that can actually be

allotted. Do we have enough shares to allot, that is what restriction is really about.
As I said a few minutes ago, more modern companies, so companies incorporated

since the 2006 Act don’t need to worry about this because they can issue as many

shares as they want.

If it was an earlier company then you need to think about whether or not to amend

the articles, to make sure that you do actually have enough shares to allot.

So let’s assume there is no restriction and generally what we’ll see is that this is a

newer company incorporated under the 2006 Act. There’s no restriction on the

number of shares that can be issued and so the directors can move on to checking

point number 2, which is whether they have authority.

So before we come onto the points on the slide, just to give you a couple of headline

points, why do we need to check that the directors have authority?

Well, the starting point is actually section 549 in the Companies Act. And the general

principle there says that the directors of a company must not exercise any power to

allot shares unless authorised.

The question then is do they have authority?

This is depends on the sorts of shares that they have.

So let’s have a look at 2.1.1 in your Student Guide. You can see that ties up with that

black box number 1.

Section 550 of the Companies Act says that if the company that we’re dealing with

only has one class of share and there’s nothing to say otherwise in the articles then

the directors will automatically have authority to allot.

So if you’re a small company usually if it’s section 550 the company has one class of

shares, there’s nothing else in the articles to say there’s any limit on the directors’

authority, section 550 automatically grants the directors and says yes, you have

power to allot.

Section 551, as you will imagine, companies that have more than one class of share,

so Tesco, for example, and other companies that might have redeemable shares and

preference shares, et cetera, they need to be given authority. The directors there

need to be given authority either by way of an ordinary resolution or by amending the

articles, so what we call a special article, a new article. And that article will

essentially give the directors authority to allot.

It's worth noting, just to really emphasise this point, that if the company that you’re

dealing with has unamended model articles and more than one class of share the

directors will not have authority to allot.

So really the golden rule is if the company you’re dealing with has more than one

class of share you need to work out how to give the directors power to allot.
The third blue box, the third step, if you like, is assuming that there’s no restrictions,

they’ve got plenty of shares to allot, assuming that your directors have authority

either under 550 or 551, the third thing to think about is pre-emption rights, and this

is this idea that the existing shareholders have first right of refusal over any

allotment.

So we’re going to have a go at Activity 2 and then we’ll talk a little bit more about

what exactly are pre-emption rights.

Have a look at Activity 2 in your Student Guide. This is Kai and Patrick again from

Jumbo Gym. I’ll give you a couple of moments to read that through and have a little

think.

Activity 2

So this is just understanding the rationale of pre-emption rights and what they’re

there for.

So we’ve got Kai and Patrick. The company has an issued share capital of 2,000

ordinary shares. They each own 50%. They now need to raise finance and they’re

going to issue a further 2,000 ordinary to two new shareholders.

Question 1:

What percentage of the shares do Kai and Patrick now own after they’ve made that

new allotment?
25%. So their 50% has gone down to 25% because of the new shareholders.

How does that change the balance of power? If we had to be more specific than just

talking about percentages how would we explain to a client how their power has

changed? What can they no longer do?

It’s all to do with the resolutions. So what percentage do you need to achieve for an

ordinary resolution?

So you need 50%. So if you hit 50% you can pass an ordinary resolution. They need

more than 50%, so majority. So neither of them could have actually had power in

terms of ordinary resolution because they didn’t have more than 50%. They only

have 50%.

But what kind of resolution could they have blocked?

A special resolution.

So they both had power before to block special resolutions because they had 50%

they obviously had that quite significant power. Now they’ve only got 25% each

they’re not going to be able to block a special resolution. So they have lost a

significant amount of authority.

And that’s the reason why we have pre-emption because the existing shareholders
need to know that their investment is safe. These two, Kai and Patrick, were in quite

a significant position of power being able to impact special resolutions. Now they

don’t have that power they may no longer want to invest in their company. So that’s

the whole idea of pre-emption is preserving or giving the existing shareholders

anyway the opportunity to preserve their power base.

So let’s have a little look at pre-emption and then we’ll come onto disapplication. So

let’s just spend a bit more time on pre-emption.

So how can pre-emption rights actually arise?

Let me just pull up this next slide here.

Primarily pre-emptions rights arise under statute. So section 561 of the Companies

Act, what we call statutory pre-emption rights on an allotment of new shares.

So what section 561 is saying in very broad terms is if the company is making an

allotment of new shares you must offer those shares to the existing shareholders

first.

Pre-emption rights can arise from the articles and you can also find them in

shareholders agreement. But those types of pre-emption rights tend to relate to

share transfer, so where you’ve got shares being transferred between existing

shareholders then we often see control of that process through the articles or

through a shareholder agreement.

And of course that’s up to the company then. They’re amending their articles to

control who can actually come into this company.

So in terms of this Large Group and what we’re focusing on right now we’re focusing

on statutory pre-emption rights, section 561, which apply on allotment of new shares.

You’ll see from the slide then that statutory pre-emption applies to something defined

as equity securities, that’s the language used in statute.

And equity securities at its most basic definition is ordinary shares.

For example then, if the company wanted to allot new preference shares they would

not fall within the definition of equity securities and you don’t have to worry about

pre-emption.

So what must directors do?

Well, this is the middle of the slide. So they must offer the new shares to existing

shareholders in the same proportions.

So for Kai and Patrick, for example, the new share allotment should have been

issued to them in that 50% split because otherwise the whole process of pre-emption

is a bit pointless because it’s obviously about preserving the existing power base.
The second bullet point, the directors must offer the shares to existing shareholders

on the same terms as they are thinking of offering them to the new shareholder. So

not cheaper and not more expensive, basically.

Finally, the offer must be kept open for 14 days.

If you want the section number for that 14 days it’s section 562.

So if the existing shareholder either declines that offer within the 14 days or they

allow the 14 days to expire then – and only then - can you offer your shares to the

new shareholder.

So let’s move onto disapplication.

Why do you think you might want to disapply pre-emption? Has anyone got any

idea? Why do you think you might not want to go through that process that we can

see on the slide?

It is long and drawn out. That is one of the key problems. If you’re a company that

needs quite a swift cash injection hanging around for 14 days is not a good idea. You

might have an investor lined up, they’ve got the cash ready, they’re ready go to but

now you’ve got to hang around for 14 days. So that’s one reason you might not want

to go through it.
Can anyone think of any other reasons? Think about the Wagtales case study, and

this new lady called Milly. Why might you sometimes want to bring a new person in

as a shareholder?

So new knowledge, new expertise. Well done. That’s also a kind of real motivating

factor. If you feel like your company’s maybe a bit stale, you’ve had the same people

there for a while and actually you need a new injection, new life, new energy, new

expertise, you might really what to actually bring in a new shareholder. And if you

have to constantly offer the shares to the existing shareholders then they all get

snapped up, it’s obviously really difficult to do that.

So there are quite a few commercial reasons why companies would not want to go

through pre-emption. They might want to move quickly, they might want to bring in

new blood, new expertise. They might not really like the existing shareholders. You

know there’s all sorts of commercial reasons. So what we often see is that directors

actually wanting to disapply pre-emption so they don’t have to go through that

process.

So under section 569, you can see that referenced on the slide, a private company

with one class of shares can vote to disapply pre-emption using a special resolution

or by amending their articles. So if you amend your articles you can basically say

we’re not going to do pre-emption any more, or you can pass a special resolution to

disapply pre-emption for this particular allotment.

Or as you can see on the slide, you can disapply pre-emption indefinitely with your

special resolution.

So there’s quite a few ways around it.

There are other ways of disapplying pre-emption but for the purpose of this course

we’re going to focus on section 569. So one class of share company a special

resolution can be passed either to amend the articles or to disapply pre-emption

either temporarily or permanently.

Let’s move onto price and payment. This is section 2.2 in your Student Guide.

So when the company allots shares it’s got to make that commercial decision as to

how much to sell the shares for. When the shares are first issued they’re normally

issued at nominal base value which normally we see as £1, and that’s because

generally when a company first starts it has very little value. It’s an untried, untested

company and most investors are going to be reluctant to pay a premium for shares.

In effect, it’s very much an investment in an idea.

But, of course, as the company expands and hopefully becomes more successful the

directors can charge a premium and that is a commercial decision as to what is a

reasonable market price.

If you sell your shares too cheaply then that could be a breach of duty so it’s very

important for the directors to get that price right so they’re not underselling the

shares.

So looking at issuing at a premium, this is 2.2.1 in your Student Guide, as I

mentioned then, shares can be issued for more than their nominal value, so the

nominal value is usually £1. We often invariably see shares selling and trading for a

lot higher than that nominal value.

The difference between the nominal value and the market value is what we call the

premium.

Issuing at a discount, so this is the next heading in your Student Guide.

Section 580, quite clearly really, you’re not allowed to issue shares for less than their

nominal value.

So section 582 says that shares can be paid for in money, which is what we

generally see, or what it calls monies worth, so that might be a non-cash asset, for

example, equipment. And we see that quite often when we’re incorporating a pre-

existing business.

So earlier in this Large Group, so Activity 1, when we were looking at Jumbo Gym

transferring from a partnership to a limited company we saw that Kai and Patrick
were transferring the assets of the business to that new company in return for

shares. So that’s that method of payment in action.

Shares in a private company, but not a public company, can also be issued in

exchange for services being provided.

In terms of directors’ duties I’ve already mentioned that you’ve got to be really careful

as a director when you’re setting that price that you’re not under-selling the shares

because obviously you’re doing the company a disservice, so particular section 172

of the Companies Act, making sure that when you’re doing the allotment you’re

promoting the success of the company.

So you’ve got an Activity in your Student Guide - Activity 3, which looks at the

Howard Smith v Ampol case, a 1974 case. You looked at this in Business Law 1, but

just have another look at it. So you’ve got a small extract from the facts of the case

and you need to have a little think about why the directors of Miller might have been

in breach of duty.

So quite complicated facts. We’ve got Ampol control, they’ve got 55% of the shares

in Miller already but they want to actually takeover Miller. Howard Smith makes a

rival bid, which Miller’s directors actually favour, but they knew Ampol would put the

kibosh on that, they would stop that takeover. So in order to promote their own

interests the Miller directors issued £10.5 million worth of new shares which reduced

Ampol’s holding which would mean they could defeat the Ampol bid.
How would we explain why the directors of Miller might have been in breach of duty

there?

Let’s build on the student’s stance. So he’s saying issuing shares for the purpose of

defeating a bid, not for raising cash.

How are the directors supposed to behave, what’s supposed to motivate them?

So they’ve got an ulterior purpose, so it’s sort of an abuse of power. And remember,

they’re supposed to be promoting the interests of the company.

So they’re really in breach of 171 and 172 here. They’re not using the directors’

duties for a proper purpose. In that they’re not behaving in a way that promotes the

company’s best interests. Actually, they’re using their powers in a way that’s

potentially harmful to the company. And if you can remember the case it was all

about preserving their own positions as directors.

So that’s just a good example of directors’ duties.

Hopefully that makes a bit more sense.

So directors’ duties in the context of price and payment. Don’t forget then directors

are bound by those duties to act in the best interests of the company promoting the

success of the company and that obviously feeds into how they’re pricing those

shares, remembering that the shares are a critical source of cash for the company.
Let’s move onto part 3. So we’re looking at shareholder rights in relation to their

investment. So we’re looking at this now from the other side. So far we’ve been

looking at allotment, et cetera, from the company side, now we’re looking at it from

the shareholder side.

Just under heading 3 if you’re following this in your Student Guide.

As you know and as we saw from one of the first slides, shareholders are given quite

a lot of rights and powers when they invest in the company. Of course, they’re

owners and they have rights to vote and things like that.

One thing to mention is this concept of limited liability.

So limited liability means that when you invest in a company as an investor, as a

shareholder your liability is limited to the value of the paid up shares that you’ve

invested in. So if you’ve invested £1,000 in X Company Ltd and X Company Ltd

goes bust you may lose your £1,000 but that’s it, it’s limited.

Don’t get limited liability muddled up with separate legal personality, which they can

get intertwined a little bit. So separate legal personality is that the company is

essentially treated as a separate person, so companies can be employers, they can

enter into contracts in their own name, et cetera.

Limited liability is the liability of the shareholders being limited to the value of their

investment. You know you’re not going to lose more than the amount you invested.

How do shareholders get a return on their investment?

Two ways:

Dividends if they’re declared and they might not be. If you get paid a dividend then

we call that an income return, so you are earning money via kind of income, earnings

of the company, which become earnings of you. So that’s regarded as income.

The second way that shareholders make a return on their investment is through

capital return. So this may be that you buy your shares for £1 in 2020 and you sell

them in 2025 for £30, and that is a capital return. So the actual asset itself, the share

value itself has gone up.

So just make that differentiation in your head between income return - which is

dividends. And capital return where the underlying asset - the share, has increased

in value.

Let’s have a look at rights to dividends - heading 3.1 in the Student Guide.

Of course, one of the key motivations in investing in shares is that you may receive a

dividend. Dividends are paid from the profits of the company so it follows logically

that if the company is not doing well or not profitable then you may not get a
dividend. And, of course, the more shares that you own the more dividends you will

get. So it goes in proportion to how much you’ve invested.

So if you have 100 shares in a company and they declare a dividend of £1 per share

obviously you’re going to get £100 in dividends.

In terms of the types of dividend you can see on the slide there are two different

types of dividend, interim and final.

As you can see, interim – paid during the company’s financial year. That means

before the annual accounts have been drawn up. So we looked at the accounts last

week and the interim dividend is paid before those accounts are finalised. Final

dividends are paid at the end of the financial year after the annual accounts have

been prepared.

So the directors decide. You don’t have a right to a dividend, the directors do decide.

The process is governed by Model Article 30. And in terms of that process then the

directors have to hold a board meeting. They recommend a payment of a dividend

and the shareholders will then approve that dividend.

In terms of interim dividends they don’t have to go through that procedure. So you

can see that on the slide. The procedure, the Model Article 30 procedure where it’s

very formal and you have to go through the board meeting and get approval by the

shareholders only relates to that final dividend. The interim dividend they can just

pay it.
However, they have to be careful. They can’t just hand out cash. They’ve got to

make sure that there is what’s called enough distributable profit and they’re bound to

do that.

So how do they work out if there’s enough distributable profit?

Of course they have to look in the accounts.

So let’s have a look at the accounts to see where we would look. You’ve got

Wagtales’ accounts set out in your Student Guide. They’re also on the slide here.

So the reason that we really kind of emphasise this is because it’s quite tempting to

think we’ll go to the profit and loss account and have a look at the net profit for the

year. But actually, slightly counterintuitively we go to the balance sheet and we have

a look at the bottom of the balance sheet in what’s called the profit and loss reserve.

So make note of that. So you can see there profit and loss reserve for Wagtales is

2.9 million. So when the directors of Wagtales are considering – and we’ve seen this

week that they make quite juicy dividend payments. I think the recent one was £1

million. So we can see there’s plenty of profit in that profit and loss reserve for them

to be making pretty good dividend payments.

For those of you who are wondering, why do we look in the profit and loss reserve at

the bottom of the balance sheet, remember that’s the overall pot of profit from all of
the years, so it’s what we call accumulated and realised profits that’s sort of put in

this metaphorical pot.

The problem with using just this year’s net profit figure is that it is only looking at this

year’s net profit. So you might have had a bad year, you might have actually had a

loss making year, but there might be plenty of cash in the profit and loss reserve

from previous years. So just be very clear in your mind this word distributable profit is

looking at all of the profit that the company’s made that’s kind of kept in this

metaphorical profit pot and we’re not looking at just this year’s net profit.

I mentioned earlier that directors must be really careful, so even with an interim

dividend payment they don’t have to get shareholders’ approval, they have to be

really careful that they have got enough cash to actually make these dividend

payments. If they authorise payments when there is insufficient distributable profits

then they might be personally liable.

So if directors declare dividends where there’s insufficient distributable profits then

those directors might be personally liable.

Likewise, shareholders who receive a dividend where they either know or think that

it’s not properly authorised payment might have to repay the dividend.

I’ve got an astonishing example here for you of unauthorised dividend payment. So

Domino’s Pizza they announced in 2016 that they’d been paying interim dividends,

so these are not the ones that need to be authorised. They language they used was
that they’d been paying them regrettably otherwise than in accordance with the Act.

So they hadn’t been following the Act. And the amount of interim dividend payments

that they’d made which they shouldn’t have made amounted to £51.7 million, which

is obviously quite a lot of money, so big problem for them.

The final thing on dividends before we move on.

Remember the concept which you’ll have looked at in Business Law 1, this idea of

the maintenance of share capital. So we never see a dividend payment from capital

because of that concept of maintenance of share capital. All dividend payments must

come from distributable profits and we look in the profit and loss reserve to establish

whether there is enough distributable profits.

We’re going to move onto share transfer.

So share transfer is 3.2 in the Student Guide.

What I explained a while ago in this Large Group was that there were three ways of

acquiring shares. The main that we’ve looked at is allotment, where the company

itself is selling new shares to shareholders and we’ve seen that that process is very

tightly controlled by statute, in particular pre-emption.

The second way that you can acquire shares is by transfer and essentially a transfer

is when an existing shareholder sells you their shares. So they’re not being sold by

the company, they are being sold by an existing shareholder.

So this process of transfer is not really controlled at all by statute. In fact, the statute

says almost nothing about transfer, unlike allotment, which is very tightly controlled.

So if we want to know whether or not shareholders are allowed to transfer their

shares we have look at the company article to see if the company has decided itself

whether or not they want to restrict that process.

So we’re going to check the articles and then we know whether or not they can

actually go ahead with the transfer.

So looking at the Student Guide you’ll see at 3.2.1 it talks about capital growth. One

of the main reasons why existing shareholders want to sell their shares is to make

money, so that idea of capital growth. So we did talk about capital growth a few

minutes ago so hopefully you’ve got the right idea on capital growth.

Let’s have a look at Activity 4.

Activity 4 you’ve got 3 different years, 2015, 2019 and 2020 dealing with this

company X Co Ltd. And you’re asked to have a think about what the nominal value is

and what the market value is of those shares at each of those points in time.

I’m going to give you 5 minutes to have a look at Activity 4 and then we’ll chat it

through together.
Activity 4

Let’s start with 2015. We’ve got X Ltd. They’ve issued 100,000 ordinary shares at £1

each. Selima, one of their shareholders has bought 10,000 of those shares for £1

each, she’s paid in full.

So what was the nominal value of the shares if we look at this question from the

whole company. What was the nominal value of the whole company shares in 2015?

So one share is worth £1. If we look at all of the 100,000 shares what is the total

nominal value of all of the shares?

£100,000.

So what was the nominal value of the shares in 2015, one share is worth £1, so

100,000 of them is of course worth a £100,000.

What’s the market value of the shares in that same year?

One share is worth £1, so if you were to buy all of the 100,000 shares the market

value would be £100,000. Or if you were to buy Selima’s 10,000 shares from her she

would just get that £10,000. So the point in relation to 2015 is that the nominal value

and the market value are exactly the same because it’s a new company. There is no

“market” because nobody knows anything about this company and they don’t know

whether it’s going to be successful.

So let’s move onto 2019. A few years later they’re expanding, they’ve got a new

director. The shares are now worth £1.20. They can’t offer their shares to the public

and of course they’ve got to then offer them internally, so they’re not seeing the

same rise in value that you would see for a public company because of this lack of

market.

So what’s the nominal value of these shares then?

So we’re still with our £1 par value or nominal value, and if we look at all of them it’s

the same as before, 100,000 shares times the £1 par value, so 100,000 if you’re

looking at all of the shares.

So if they sold all 100,000 of their shares what’s the market value of that sale?

£120,000. So between 2015 and 2019, 4 years, the market value of all of the shares

has gone up from 100,000 to £120,000. This company is becoming successful.

So the third option 2022, they’ve become really very successful. They’ve now re-

registered as a public company. They’ve been able to join the alternative investment

market so this is basically a public market for trading shares and the shares start

trading at £2 per share. What’s the nominal value then of the shares in 2022?

We’ve slightly split here, we’ve got some of you going for the £1 or the 100,000. One

student went for £2, I was wondering if anyone would. In fact they’re still what they
were, so they never change because that’s what they were when the company was

first incorporated.

So the nominal or par value in 2022 is still £1 per share or of course the £100,000 if

you’re putting them altogether.

What’s the market value if we sell all of the shares?

It’s 200,000. So we’ve seen a real dramatic increase in that capital growth.

So really differentiate this from income, which is what we were just looking at.

Dividend payments tightly controlled by the directors. We’re looking at whether

there’s distributable profit there to distribute out. That’s income. What we’re looking

at here is capital growth. So our investor, Selima, has gone from having shares that

were worth £1 to shares that are now worth £2. So she’s seen good capital growth in

her shares. She’s doubling her investment.

So let’s have a look at the procedure for transfer of shares.

This slide is just giving us all the answers, so we have talked through these figures.

I’ll leave that there for a moment if anyone wants to copy anything down.

We’re moving onto procedure for transfer. So this is 3.2.2 in the Student Guide.

We’ve got quite a lot of detail on this slide as well.

The first thing to remember is this is not really controlled by the statute, this is pretty

much controlled by general law and procedure and the articles if the company has

got some controls that they wanted to put on transfer.

So in terms of the procedure, section 770, so we do have some statutory controls.

Section 770 of the Companies Act says that a company may not register a transfer

unless a proper instrument of transfer has been delivered to it. That’s section 770.

So the company must have a proper instrument of transfer before they can register

the transfer.

So looking at the slide what we see is the seller of the shares completes and signs a

stock transfer form. And I’m not sure if you’ll have seen a stock transfer form but it’s

basically got how many shares, the price, the buyer, the seller. So it’s got those basic

sales terms on it. So they fill all that in, sign it and they give that to the buyer along

with their share certificate, which is their own certificate of title.

If the shares are sold for more than £1,000 the buyer has to pay tax. So you can see

there buyer pays stamp duty which is currently at 0.5% on the value of the transfer.

So tax is paid. The buyer then sends the stock transfer form and the share certificate

to the company. The company must issue the new share certificate within 2 months.

Remember the share certificate is the document of title. And they should enter the

new shareholder’s name on the register of members again within 2 months. And they

should also tell Companies House that that they have a new shareholding
arrangement. So however many shares have been transferred that needs to be

updated in the Companies House records.

Moving onto restrictions on the rights of transfer. This is just underneath on the slide.

So generally, as I said, shares are transferred in accordance with the company’s

articles.

This is on the final page of your Student Guide. You’ll see there is a small typo. So if

you look at heading 3.2.3 you will say it says “Transmission of Shares”, that should

say Transfer of Shares. And we’re going to go through that bit.

So at the heading 3.2.3 “Transmission of Shares” should say “Transfer of Shares”.

Looking at non-statutory pre-emption rights, so remember what I’ve said before.

Transfer is not really controlled particularly much by the statute, it’s very much a

private matter. So the company itself may have got restrictions in its own articles or

in a shareholder agreement, which is a private contract and they may have decided

to limit who can buy shares in the company or how that transfer is going to happen.

And we do actually see this quite often, particularly with small family companies

where the family doesn’t necessarily want new shareholders coming in. They want to

keep it within the family so you may well see in these small private companies they

do have non-statutory pre-emption within their articles controlling who can actually

buy shares.
So that’s the first restriction on transfer.

The second restriction on transfer can be through the directors who do actually have

a right to refuse to register a transfer.

So this comes from Model Article 26(5). The directors have a right to refuse to

register the transfer of shares.

Just to temper that slightly, remember that the directors must be acting in the

interests of the company. So remember those directors’ duties. So when they’re

deciding whether or not to register a transfer they’ve got to remember that they’re

acting in the best interests of the company if they are refusing to register a transfer.

They may have decided, for example, that this new shareholder is not a good fit for

the company in some way, maybe they doubt that they’re a bona fide investor. So

they must tell the transferee that they refusing to register the transfer and give them

a reason. And they must do that within 2 months of when the transfer has gone

through. So within 2 months they must tell them that they are refusing to register

them and why.

Listed public companies are not permitted restrictions on registering. So under the

listing rules for public companies they must have freely transferrable shares so then

there are no rights for the directors in listed public companies to refuse to register.
Why?

Because those shares must be freely marketable. They are listed on a market, they

must be freely marketable.

So the very final heading just to finish up is at 3.2.4 in the Student Guide looking at

transmission. So we talked a little bit earlier about the difference. You can see

Activity 5 there. What is the difference between transfer and transmission?

So somebody said transmission is a kind of common way of receiving shares via

transmission, but basically operation of law is through death and receiving them

under a will.

Can anyone think of any other ways that you might receive shares via transmission,

so via operation of law, apart from death?

So bankruptcy. If the owner of the shares has become bankrupt then as part of that

kind of reorganisation of assets their shares may be transferred, if you like, or

transmitted to a new shareholder.

And the third way that we see transmission is if a shareholder becomes a patient

under the Mental Health Act, then their shares may be transmitted to a new

shareholder.
So basically the difference between the two is that transmission is almost a forced

transfer of ownership by operation of law. So death, bankruptcy or if the shareholder

becomes a patient under the Mental Health Act.

There are very few controls on transmission so there isn’t really that much to say on

transmission.

So we’ve finished a little bit early but we have covered all of our Outcomes and we

will obviously go through some of these quite complicated processes in Workshop 2.

In particular we’re going to have a look at allotment in Workshop.

You are free to go and thanks very much for your input.