Principles Of Corporate Finance Law

Principles Of Corporate Finance Law

Principles of Corporate Finance Law

Second Edition

EilÍs Ferran

and

Look Chan Ho

Great Clarendon Street, Oxford, OX2 6DP,

United Kingdom Oxford University Press is a department of the University of

Oxford.

It furthers the University’s objective of excellence in research, scholarship, and

education by publishing worldwide. Oxford is a registered trade mark of Oxford

University Press in the UK and in certain other countries © E Ferran and L C Ho

2014

The moral rights of the authors have been asserted

Second edition published in 2014

Impression: 1

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, without the prior

permission in writing of Oxford University Press, or as expressly permitted by

law, by licence or under terms agreed with the appropriate reprographics rights

organization. Enquiries concerning reproduction outside the scope of the above

should be sent to the Rights Department, Oxford University Press, at the address

above You must not circulate this work in any other form and you must impose

this same condition on any acquirer Crown copyright material is reproduced

under Class Licence

Number C01P0000148 with the permission of OPSI

and the Queen’s Printer for Scotland Published in the United States of America

by Oxford University Press

198 Madison Avenue, New York, NY 10016, United States of America British

Library Cataloguing in Publication Data

Data available Library of Congress Control Number: 2013949382

ISBN 978–0–19–967134–2 (Hbk)

978–0–19–967135–9 (Pbk) Printed in Great Britain by

CPI Group (UK) Ltd, Croydon, CR0 4YY

Links to third party websites are provided by Oxford in good faith and for

information only. Oxford disclaims any responsibility for the materials

contained in any third party website referenced in this work.

Preface

In the period since the previous edition, the financial markets have experienced

an unprecedented degree of strain. Whilst banks and other financial institutions

have been at the eye of the storm, their problems have had repercussions for the

financing of the ordinary commercial companies as well. Deficiencies in the

legal and regulatory framework governing corporate finance have been exposed,

leading to a multiplicity of private lawsuits and to wide-ranging regulatory

reforms.

In other words, there has been much to do in producing this new edition. I am

especially grateful to my co-author Look Chan Ho for coming on board and

taking responsibility for chapters 11 and 12. I am also grateful to numerous

Cambridge LLM Corporate Finance students for their feedback on draft

chapters, and to Demetrio Maltese (LLM, 2012-13) for specific research

assistance. I would like also to record my gratitude to the trustees of the JM

Keynes Fellowship in Financial Economics, Cambridge University, for funding

to support the research.

The manuscript was delivered to the publishers in August 2013 and reflects

our knowledge and understanding of the law, regulation and practice at that

time. We have been able, however, to include brief references to significant

developments that occurred during the period between delivery of the

manuscript and the final proofs.

The professionalism and dedication of the editors and others at OUP have

been much appreciated.

EVF,

November 2013

The law and practice of debt finance respond to and thus develop from financial

crisis. Two financial crises this book has now spanned. The original version of

the book, entitled Company Law and Corporate Finance, was published just

after the Asian financial crisis, and this edition is to be published when the world

economy is beginning to recover from the global economic crisis.

As an admirer of the book since its inception as Company Law and

Corporate Finance, I am delighted to be able to contribute to two chapters in the

book relating to debt financing.

I am most grateful to Professor Ferran for all her kindness and echo her

comments about OUP.

Look Chan Ho

London

November 2013

Contents

Table of Cases

Table of Legislation

List of Abbreviations

I. OVERVIEW

1. The Regulatory Framework

Scope of the Book

Types of Company Limited by Shares

The Regulatory Framework for Corporate Finance

Legislation

Internal constitutional instruments

Case law

Codes and guidelines

2. Use and Abuse of the Corporate Form as a Vehicle for Raising Finance

and Managing Financial Risk

Issues Considered in this Chapter

Distinctive Features of the Company Limited by Shares

Separate legal personality

Piercing the veil of incorporation

Limited liability

Promotion of entrepreneurial activity

Passive investment

Portfolio diversification

Cost of capital

Transferability of shares

Tort liabilities

The Corporate Group

The recognition of corporate groups in company law

The definition of the corporate group for accounting purposes

The definition of the corporate group for other purposes

Substantive company law and the corporate group: a general overview

Insolvency within a corporate group

Alternatives to piercing the veil: agency

Alternatives to piercing the veil: contractual guarantees

Alternatives to piercing the veil: tort claims against other companies

Alternatives to piercing the veil: Insolvency Act 1986

Is the law on corporate groups deficient?

3. Capital Structure—Fundamental Legal, Accounting, and Financing

Considerations

Scope of this Chapter

Share Capital Terminology

Accounting for an Allotment of Ordinary Shares

Characteristics of Ordinary Shares (Common Equity)

Dividends

Capital gains and risk

Voting rights

Common equity and financial regulation

Debt Finance Terminology

Characteristics of Simple Debt

Interest

Capital gain and risk

Control

Hybrid Securities in Outline

Valuation of Securities

Shares

Net asset value

Dividend valuation

Free cash flow valuation

Debt securities

Cost of capital

Capital Structure

Sources of Corporate Finance in the UK

Bank lending and its importance for SMEs

Sources of External Equity for SMEs and the Role of Venture Capital

Capital Markets: A Funding Source for Large Companies

Efficient Capital Markets

Measuring and assessing financial performance: company accounts

Statutory financial disclosure framework for UK companies: an overview

Additional financial disclosure framework under FCA Disclosure and

Transparency Rules

Additional financial disclosure framework for other publicly traded

companies

II. LEGAL CAPITAL

4. Formation of Share Capital

Scope of this Part

Minimum Price of Individual Shares: Par Values

Minimum Capital

Denomination of minimum capital

Is any valuable purpose served by minimum capital requirements?

Allotted, Issued, and Equity Share Capital

Allotted share capital

Authority to allot shares

Registration of allotment and return of allotments

Issued share capital and issued shares

Equity share capital

Payment for Shares

Introduction

Paid up share capital

Called up share capital

Cash consideration for shares

Shares must not be issued at a discount

The no-discount rule and convertible securities

The no-discount rule and underwriting commissions

Regulation of non-cash consideration for shares

Public companies must not accept an undertaking to do work or perform

services as consideration for shares

Public companies must not accept undertakings to be performed in the

future as consideration for their shares

Valuation of non-cash consideration for shares in a public company

Takeover exemption

Mergers exemption

Relaxation of the independent valuation requirement by the 2006

amending Directive

Liability of subsequent holders

Relief from liability

Criminal liability for breach of rules relating to payment for shares

Share Premiums

Determining the issue price

Treatment of share premiums

Permissible uses for share premiums

Bonus issues

Expenses and commissions on an issue of shares

Share premiums and non-cash consideration

Group reconstruction relief

Merger relief

Statutory reliefs and accounting requirements

Importance of group reconstruction and merger relief

Other reliefs

Other Capital Contributions

Stock

5. Share Allotments

Scope of this Chapter

Regulating Share Issuance Activity: Striking a Balance

The Case for Special Protection of Shareholders’ Interests

Wealth transfers

Protection against dilution

Distortion of market for corporate control or other unconstitutional

behaviour by directors

Abuse of majority shareholder power

Shaping a balanced policy response

Shareholder Empowerment under the Companies Act 2006

Private company with a single class of shares

Authorization by company

Statutory Pre-emption Rights under the Companies Act 2006

Pre-emption rights in relation to ‘allotments’ of ‘equity securities’:

definitions

The operation of the statutory pre-emption rights procedure

Consequences of non-compliance with statutory rights

Shareholders who do not take up (or sell) subscription rights

When statutory pre-emption rights do not apply

Vendor placings

Cashbox structures

Disapplication of Pre-emption Rights: All Companies

Disapplications for the purposes of making a rights issue or open offer

Timing

Tractions

Overseas shareholders

Open offers

Disapplications for placings

Disapplication or Exclusion of Pre-emption Rights: Private Companies

Other Formalities in Relation to Share Allotments

6. Classes of Shares

Scope of this Chapter

The Legal Nature of a Share

Financial Incidents of Shares: Capital and Dividends

What financial entitlements do investors in shares acquire? The position of

holders of ordinary shares

Default capital rights of ordinary shares

Default dividend rights of ordinary shares

What financial entitlements do investors in shares acquire? The position of

holders of preference shares

Default capital rights of preference shares

Default dividend rights of preference shares

Enfranchisement when preferential dividends are in arrears

Payment of accumulated unpaid cumulative preferential dividends

What financial entitlements do investors in shares acquire? The position of

holders of redeemable shares

Incidents of Shares: Transferability

Incidents of Shares: Voting Rights

The Juridical Nature of the Relationship Between a Company and Its

Registered Shareholders

Variation of Rights Attaching to Shares

Provision for entrenchment

Identifying a class of shares

Golden shares

Rights conditional on holding a specified percentage shareholding

Shares with different par values

Shares on which different amounts have been paid up

When class distinctions matter

Variation of class rights

What is a right attached to a class of shares for this purpose?

What is a ‘variation’ of a right attached to a class of shares?

Variation of rights by enhancement

The procedure for variation of class rights

Voting to alter class rights—a fettered power?

Statutory protection of minorities in a class of shareholders

Class rights and reduction of capital

Class rights and redemption of shares/share buy-backs

7. Maintenance and Reduction of Capital

Protection of Creditors’ Interests: Introduction

Questioning the value of the legal capital doctrine

The Development of the Maintenance of Capital Regime in the UK

Application of the common law rule prohibiting the return of capital to

shareholders

An unlawful return of capital is ultra vires

The doctrinal test for distinguishing between genuine transactions and

disguised distributions

Gratuitous dispositions to third parties and directors’ duties

Reduction of Capital under the Statutory Procedures

Why reduce capital?

Forms of reduction of capital sanctioned by the Companies Act 2006

Limitation on the use of solvency statement reduction of capital

procedure

The Court Approval Procedure

Special resolution of the shareholders

The oversight of the court in respect of creditors’ interests

The oversight of the court in respect of shareholders’ interests

General powers of the court

Registration

Where allotted capital is reduced below the authorized minimum

Effect of a court-approved reduction of capital

Reduction of Capital under the Solvency Statement Procedure: Private

Companies Only

Special resolution of the shareholders and class consents

Solvency statement

Contents of solvency statement

Sanctions in respect of false solvency statements

Registration requirements relating to the solvency statement procedure

Effect of a reduction of capital under the solvency statement procedure

Reductions of Capital and Schemes of Arrangement: Two Case Studies

Re Uniq

Cape Group

Exceptional Reduction of Capital Procedures

Reduction of capital following redenomination of shares

Reduction of capital pursuant to an order of the court

Reduction of capital in respect of forfeited or acquired shares

8. Share Buy-backs and Redeemable Shares

Introduction

Arguments For and Against Allowing Companies Share Buy￾back/Redeemable Share Issuance Powers

To attract external investors

To facilitate exit

To structure a temporary loss of control

To return value to shareholders

To address principal-agent concerns

To give information signals

To achieve a target capital structure

To expand the range of financing options

To buy back redeemable shares at a discounted price

To facilitate the organization of employee share schemes

To achieve an informal reduction of capital

To defend against a takeover or to deal with dissident shareholders

To stabilize the share price

Consideration by Review Bodies

The European Dimension

Excessive Deregulation?

General Statutory Rule in the Companies Act 2006 Against a Company

Acquiring Its Own Shares

Share Buy-backs—Authorizations Required by the Companies Act 2006

Market purchase

Ordinary or special resolution?

Off-market purchase

Significance of procedural requirements

Other Statutory Restrictions on the Terms and Manner of Buy-backs

Accounting for a Share Buy-back

Treasury Shares

Buy-back of Own Shares Out of Capital or from Cash: Private Companies

Only

Statutory Modification of Contractual Matters Relating to Share Buy-backs

FCA Regulatory Requirements Relating to Share Buy-backs

Takeover Code Implications of Share Buy-backs

The Authorizations Required for an Issue of Redeemable Shares

Other Requirements of the Companies Act 2006 Relating to Redemption of

Redeemable Shares

Class Rights Issues Relating to Share Buy-backs and Redeemable Shares

Share Buy-backs and Redeemable Shares and Protection of Minorities

9. Distributions to Shareholders

Investor Expectations

Determinants of Dividend Policy

Dividend policy and market value

Dividend policy, information asymmetries, and signalling

Dividend policy, principal-agent problems and agency costs

Regulation of Dividend Policy Decisions

An overview of the regulatory response to agency problems relating to

shareholders

An introduction to the regulatory response to agency problems in relation

to creditors

Statutory Regulation of Distributions

What is a ‘distribution’?

Profits available for distribution

Additional requirement for public companies

Relevant accounts

Choice of accounting regulatory framework

Accounting profits and profits available for distribution

Generally accepted principles with respect to the determination of realized

profits or losses

Dividend payment procedure

Unlawful Distributions

When is a distribution unlawful?

Other restrictions on dividends

Liability consequences of unlawful dividends

Directors’ liability

Shareholder liability

Directors’ claims against recipient shareholders

Other Issues

Scrip dividends

Dividend reinvestment plans

Intra-group distributions

Intra-group transactions and principles of realization

Intra-group transfers of assets at an undervalue

Further Reform?

10. Financial Assistance

Prohibition on the Giving of Financial Assistance—Some Preliminary Issues

What is ‘financial assistance’ law?

Legislative history

Who is protected by the ban?

Why is the Giving of Financial Assistance Banned?