REFORMING CAPITAL MAINTENANCE LAW: THE COMPANIES (AMENDMENT) ACT 2005
|(2007) 19 SAcLJ 295
|01 December 2007
|01 December 2007
The Companies (Amendment) Act 2005 has reformed the law on capital maintenance substantially. It has, inter alia, enabled a company that satisfies the requisite solvency tests to reduce capital, engage in financial assistance and share buyback. This article analyses the salient features of these reforms and their doctrinal implications, in particular the doctrine of capital maintenance and solvency tests. It argues that whilst the reforms have reduced compliance costs, the failure to bring the solvency-based reforms to their logical conclusion has made Singapore law’s on capital maintenance incoherent. It recommends that Singapore should follow New Zealand and abolish the capital maintenance doctrine.
1 The Companies (Amendment) Act 2005 (“Amendment Act”) was passed by Singapore’s Parliament on 16 May 2005 and came into operation on 30 January 2006.1 It gave effect to several recommendations of the Company Legislation and Regulatory Framework Committee (“CLRFC”),2 which includes abolishing the par value and authorised capital, liberalising the rules of capital maintenance, allowing shares repurchased by companies to be kept as treasury shares and providing for a new method of amalgamation for companies. Those reforms have reduced the costs of running companies in Singapore and made Singapore’s company law more competitive and flexible.
2 This article discusses the reforms of the capital maintenance rules and rules related thereto by the Amendment Act. It does not seek to summarise the new statutory provisions. Rather its purpose is to analyse their salient features and those aspects that may cause difficulties in interpretation in future, and the doctrinal implications of the reforms. We should not lose sight of the latter, even as we plough through the very complex and technical provisions in the Amendment Act. The main argument is that the reforms have rendered Singapore’s law on capital maintenance doctrinally unsatisfactory. This is not to say that the reforms are unsound. On the contrary, it will be argued that the reforms do not go far enough and that Singapore should follow New Zealand and abolish the capital maintenance doctrine.
3 With a simple statement, “Shares of a company have no par or nominal value”,3 the Amendment Act implemented recommendation 2.18 of the CLRFC report. In so abolishing the par value, long regarded as important by the company laws of the Commonwealth countries, we follow the lead taken by countries such as New Zealand4 and Australia.5 In UK, the Company Law Review Steering Group would have recommended abolishing par value shares but for the restrictions imposed by the Second EU Company Law Directive.6
4 Any amount in the share premium account and capital redemption reserve before 30 January 2006, the date when par value was abolished, became part of the company’s share capital.7 Authorised capital was also abolished and provisions relating to it in the memorandum of any company are deemed to be deleted.8 Henceforth, generally there will
now be only two items of share capital reflected in a company’s balance sheet: issued capital and paid-up capital. They will be measured against the amount of capital issued and actually paid up respectively, not the par value of shares.
5 Generally, the above reforms have been well received.9 One of the benefits of the reforms is to simplify the rules on capital both for professionals and businessmen. At the initial stage, however, accountants and lawyers will have to grapple with the transitional provisions and learn to reason without resorting to the familiar concept of par value. This may prove difficult for some who have become so used to the concept. It is therefore useful to recount briefly the shortcomings of the par value regime, which have been comprehensively and convincingly canvassed elsewhere.10
6 Concepts of capital based on par value are outdated and are no longer relied on by investors and creditors in assessing a company’s underlying value. In practice, other measures such as earning per share, net tangible asset backing and other financial ratios are used. But par value is not just something that is or has become useless. It may mislead unsophisticated investors into thinking that it has some relevance to the intrinsic value of a company’s shares. Next, the rule that a company cannot issue shares at a discount to par value11 prevents a company from raising new funds when the market value of its shares has fallen below par value. Indeed, the case for the abolition of par value is so overwhelming that even its birthplace for common law jurisdictions was minded to abolish it but for the restraints imposed by the Second EU Company Law Directive.12
7 At the heart of the reforms to the capital maintenance doctrine is the solvency statement of directors.13 Put simply, if a solvency statement is made and other relevant requirements are met, a company is allowed to reduce its capital without court sanction,14 redeem its preference shares out of capital,15 and give financial assistance without having to comply with the traditional white-wash procedure.16 For purpose of analysis, it is necessary to set out the definition of the solvency tests, found in s 7A, in some detail.
8 A solvency statement consists of the opinions of the directors on four solvency tests: first, as regards the company’s situation at the date of the statement, there is no ground to think that the company could not then pay its debts;17 secondly, if it is intended to commence winding up of the company within the period of twelve months after the date of the statement, the company will be able to pay its debts in full within the period of twelve months after the commencement of the winding up;18 thirdly, if it is not intended so to commence winding up, the company will be able to pay its debts as they fall due during the period of twelve months after the date of the statement;19 and fourthly, the value of the company’s assets is not less than that of its liabilities and will remain so after the proposed capital reduction, redemption or giving of financial assistance, whichever is relevant.20
9 The second solvency test may seem to be a test on cash flow solvency. That is incorrect. Prima facie, what the test requires to be satisfied is that if the company were wound up its assets should exceed its liabilities. This is a test on balance sheet solvency, but it differs from the familiar balance sheet test which if not satisfied would give the court
jurisdiction to make a winding up order on the ground that the company is insolvent.21 It is rather more similar to the test for a declaration of solvency under s 293(1), which if made by directors will enable the company’s liquidation to proceed as a solvent liquidation under the members’ control. Commenting on the English equivalent of Singapore’s s 293(1),22 Professor Goode has said that it is “technically possible for the directors properly to file a declaration of solvency”23 even though at that time the company is unable to pay its debts both on a cash flow and balance sheet basis. Transposing this comment to the second solvency test, the test does not require that the company should be balance sheet solvent at the time when it was wound up; what is required is that the company should be able to pay its debts in full within twelve months after it is wound up. However, in practice it is highly unlikely that a reasonable forecast may be made on the second matter without the first matter being satisfied.24
10 In summary, a solvency statement requires directors to state in their opinion that the company is cash flow solvent at the date of the statement and will remain so for twelve months thereafter (first and third solvency tests), that the company will be balance sheet solvent before and after the proposed transaction (fourth solvency test), and that if the company were wound up within twelve months after the date of the statement, it will be balance sheet solvent, at the latest, within a further twelve months after the commencement of winding up (second solvency test). This is a very complicated battery of tests. It is submitted that, in practice, directors would be well advised not to make a solvency statement unless they can be reasonably certain of the following: that the company is cash flow and balance sheet solvent at the date of the statement and will remain so for twelve months thereafter.
11 Although this is still early days, it can be seen that a s 7A solvency statement is not only complex but also imposes onerous demands on directors. It requires the directors to not only assess the company’s current financial position, including valuing its assets and estimating its contingent and prospective liabilities, but also a forecast on those matters
for the next twelve months. The amount of work that will be involved in that task will depend on many factors, including the state of the companies’ financial records, the state of the economy and industry that the company is in, the nature of its business, assets and liabilities and accounting standards. It can well be anticipated that it may prove difficult for some directors, especially independent directors, to make a solvency statement, especially since negligence may expose them to a criminal charge.25
12 The doctrinal implications of the introduction of solvency tests into capital maintenance law will be dealt with in a later section. This section is only concerned with the more technical issues in relation to the solvency statement. At the outset, it is necessary to appreciate that solvency tests are used widely in the Companies Act (Cap 50, 2006 Rev.Ed.) (“Companies Act”). In addition to the solvency statement found in s 7A, there is another in relation to two new mechanisms of amalgamation introduced by the Amendment Act.26 Further, there is...
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