Summer Snow: Business&Company Law

1. Introduction

Mirza plc was incorporated in London in 1944 as a road haulage company and has an authorized capital of £200,000 and net assets of £320,000. In this report I will be discussing the share premium account and revaluation reserves. I shall be addressing the reasons why a company may wish to purchase or redeem its own shares. Additionally, I will be identifying how to revise balance sheet after the shares are redeemed. In particular, I will be analyzing the steps a public company must take to redenominate the nominal value of shares from one currency to another. I will conclude by reviewing Mirza plc current conditions to advise the directors on the matters I discussed.

Enquiries Regarding Mirza Plc

2.1 Share Premium Account & Revaluation Reserves

2.1.1 Definition of Share Premium

“A company may, without any special powers in its articles, issue its shares for a consideration (cash or assets) which is more than the nominal value of the shares. The excess is called ‘premium'.”

2.1.2 Definition of Share Premium Account

“Company Act 2006 Section 610 states that a sum equivalent to the premium must be transferred into a special account known as the ‘Share Premium Account'. This amount also has to be specified in the company's balance sheet under a separate sub-heading.”

2.1.3 Three Purposes for Share Premium Account can be used

“The share premium account is treated as a capital account and cannot be used to pay a dividend; nor can it be reduced in any other way without leave of the courts except where it is applied in:

paying up new shares of the company to be issued to members as fully paid-up bonus shares; or
writing off expenses or the commission paid or discount allowed on, an issue of those shares (i.e., shares to underwriters at a discount). This means that the company can use the premium obtained from a particular issue of shares only to write off expenses etc incurred in respect of that issue;
providing for any premium payable by the company on the acquisition of its own shares if certain conditions set out in sections 687 (4) and 692 (3) are satisfied.”

2.1.4 A Special Situation of Share Premium

“There may be a situation where a company issues shares in exchange for shares in another company as part of an arrangement providing for the acquisition or merger of the two companies. Then if the shares received by the issuing company represent assets exceeding their nominal value, the issuing company can choose to treat the premium as merger reserves, or if it satisfies section 612 as profits. To treat the surplus as profits, the issuing company must be able to secure 90 percent of the equity shares of the merged company or, if such shares were divided into classes, then 90 percent of the shares of each class (s. 613). The issuing company is allowed to write down the shares received at their nominal value in the assets section of its balance sheet, thus ignoring the premium element of the shares. The provisions of sections 612 and 613 permit the use of ‘merger accounting' under SSAP 23.”

2.1.5 Definition of Revaluation Reserves

Revaluation reserve is an accounting term used when a company has to enter a line item on their balance sheet due to a revaluation performed on an asset. This line item is used when the revaluation finds the current and probable future value of the asset is higher than the recorded historic cost of the same asset.

A revaluation reserves fall under the category of supplementary capital, in that it does not reflect ordinary business results. Because of this revaluation, reserves typically are not counted as capital that can be leveraged for financial institution's, such as a bank's, contractual provisions.

2.1.6 Purposes for Revaluation Reserves can be used

“In determining whether the company has distributable profits, the company must satisfy the realized profits test. This test provides that the ‘profits available for distribution' will be the company's accumulated realized profits (revenue and capital) in so far as they have not been previously utilized by a distribution or capitalization, less its accumulated realized losses (revenue and capital) in so far as they have not been previously written off in a reduction or reorganization of capital. Realized profits are the amount by which the revenue from sale then there is a realized loss for that financial year. Unrealized profits cannot be used to declare a dividend or to pay up debentures or amounts unpaid on issued shares (s. 849); but they may be used for paying up bonus shares (s. 280 (2)). Unrealized profits arise where the assets appreciate in value and the new value is recorded in the accounts. They will be shown in the accounts as revaluation reserves. If there is an overall decrease in the book value of the company's assets, this unrealized loss will be shown in the accounts as a debit balance in the revaluation reserves.”

Purchase or Redemption of Own Shares

2.2.1 Purchase of Shares

“Section 690 allows a company to purchase its own shares (including any redeemable shares) as long as the company pays for the shares in full at the time of the purchase. This section is subject to any provision in the company's articles restricting or prohibiting the company from purchasing its shares. The shares must be fully paid up before they can be purchased; and the effect of the purchase should not leave the company only with redeemable shares or, in the case of a public company, shares held as treasury shares. In addition, the company must obtain authority from its members to make the purchase. Members' authority is given by resolution. The type of resolution which members must pass depends on whether the purchase is an off-market purchase or a market purchase.”

2.2.2 Redemption of Shares

“Section 684 permits a company, if authorized by its articles (prior authorization to issue redeemable shares is not necessary if the company is a private company), to issue shares which are to be redeemed at a fixed date or at the option of either the company or the shareholder. To ensure that the company will never find itself in a situation where it has no member left, redeemable shares can only be issued if the company already has in existence issued shares which are non-redeemable. The shares must be fully paid up before they can be redeemed and the articles must set out the terms of redemption (e.g., the time of redemption and the payment on redemption).”

2.2.3 Two Reasons to Purchase or Redeem Own Shares

“A market purchase of its own shares by a public company may be affected as a means of using surplus cash advantageously, particularly where redeemable shares are listed at below their redemption price; also to re-arrange the company's capital (e.g., by purchasing non-redeemable preference shares to reduce gearing).”

2.2.3.1 Explanation to Reason One

To purchase or redeem company's own shares when the share price is too low is an efficient way to protect a company's reputation. If the share price is too low, it will have a negative effect on operation of a company. Moreover, shareholders may lose confidence to the company because of the low share price; customers may suspect the quality of products from the company, which could decrease the sales revenue and market share of the company. Therefore, the company purchases or redeems its own shares to support the share price and maintain the company's reputation. Meanwhile, shareholders will pay more attentions to the operation of the company and customers will be confident to the products again with the increasing share price.

2.2.3.2 Explanation to Reason Two

To purchase or redeem company's own shares is a useful method to re-arrange the company's capital. When a public company purchases or redeems its own shares, the capital is to be fully utilized and the earnings per share are enhanced as well.

2.3 Premium to be written off to Share Premium Account

According to the Company Act 2006 Section 687 (4) and Section 692 (3) permits that if the redeemable shares were issued at a premium, any premium payable on their redemption may be paid out of the proceeds of a fresh issue of shares made for the purposes of the redemption, up to an amount equal to-

(a) the aggregate of the premiums received by the company on the issue of the shares redeemed, or

(b) the current amount of the company's share premium account (including any sum transferred to that account in respect of premiums on the new shares),

whichever is the less.

Section 692 (4) permits that the amount of the company's share premium account is reduced by a sum corresponding (or by sums in the aggregate corresponding) to the amount of any payment made under subsection (3).

2.4 The Entire Premium CANNOT be written off to the Share Premium Account

As I mentioned in 2.3, only “the lower of (a) and (b) can be deducted from the share premium account. The unrelieved balance has to be deducted from distributable profits.”

Therefore, in this case, (a) the aggregate of the premiums received by the company on the issue of the shares redeemed is £2,500 and (b) the current amount of the company's share premium account is £10,500, that is to say, only £2,500 can be written off to the share premium account.

2.5 The Revised Balance Sheet after the Shares are Redeemed

Revised Balance Sheet of Mirza plc

FIXED ASSETS	￡	￡
Premises		200,000
Fixtures		20,000
		220,000
CURRENT ASSETS
Stock	30,000
Debtors	40,000
Cash in hand ①	61,500
	131,500
CURRENT LIABILITIES
Creditors	40,000
		91,500
Net assets		311,500

Financed by
CAPITAL
Ordinary shares of ￡1 each ②		205,000
Share premium account ③		9,000
Capital redemption reserve ④		3,500
Revaluation reserves		30,000
Profit & Loss ⑤		54,000
Creditors-amounts falling due after more
than one year:
5% debentures of ￡1 each		10,000
Net asset ⑥		311,500

The directors wish to redeem all the redeemable shares for £15,000 and issue 5,000 new shares of £1 each for £6,500, so cash in hand will be reduced by £15,000 and then increased by £6,500 (i.e., £70,000-£15,000+£6,500=£61,500).
The directors issue 5,000 new shares of £1 each for £6,500, so ordinary shares will be increased by £5,000 (i.e., £200,000+£5,000=£205,000).
(ⅰ) Premium received on original issue £2,500

(ⅱ) Current amount in share premium account (including £1,500

premium received on the new shares) £10,500

The lower of (ⅰ) and (ⅱ) can be deducted from the share premium account (i.e.,£2,500). The unrelieved balance (£1,500) has to be deducted from profits. (i.e., £10,000+£1,500-£2,500=£9,000)

The directors wish to redeem all the redeemable shares, that is to say, redeemable shares will be reduced by £10,000, so no redeemable shares will be left (shares redeemed will be cancelled). Capital Redemption Reserve of £10,000 will be set up to replace the capital which is cancelled; and then the directors issue 5,000 new shares of £1 each for £6,500, so Capital Redemption Reserve will be reduced by £6,500 (i.e., £10,000-£6,500=£3,500).
Any premium payable by the company to a shareholder on the acquisition of his shares has to be paid out of distributable profits (s. 692 (2) (b)). In this case, the redeemable shares were issued at a premium of £2500, so profits will be reduced by £2,500. The amount to be transferred from distributable profits to capital redemption reserve to replace the issued share capital which is diminished by the redemption is the difference between the nominal value of the shares redeemed and the aggregate amount of the new issue of shares (s. 733 (3)). In this case, as I solved in ④, capital redemption reserve is £3,500, so profits will be reduced by £3,500 as well. (i.e., £60,000-£2,500-£3,500=£54,000).
The directors wish to redeem all the redeemable shares for £15,000, so net assets will be reduced by £15,000; and for the purpose of the redemption issue 5,000 shares of £1 each for £6,500, so net assets will be increased by £6,500 as well. (i.e., £320,000-£15,000+£6,500=£311,500)
1. Redenomination

2.6.1 Definition of Redenomination

Redenomination is the process whereby a country's currency is recalibrated due to significant inflation and currency devaluation. Certain currencies have been redenominated a number of times over the last century for various reasons.

2.6.2 Three Steps of Redenomination

“Section 622 allows a company to redenominate the par value of its shares from one currency to another (this is subject to any restriction in the company's articles) by members passing an ordinary resolution (s. 622). The ordinary resolution must specify the spot rate used for converting the nominal value of the shares from son currency to another; and the redenomination must take effect within 28 days after the resolution is passed; otherwise the resolution will lapse. In the Mirza plc conditions, the calculation of the new par value has to be as follows: Step1-take the aggregate of the old nominal value of all the affected shares (or shares of that class); Step 2-translate that amount into the euros at the rate of exchange specified in the affected shares (or shares of the class). Where the redenomination will leave the par value in a fractional amount of the euros, the Mirza plc may want to obtain the share values in whole units of the euros. It can do this by capitalizing any distributable reserves it has in order to increase the nominal value of the affected shares, or it may reduce its capital by using the procedure under section 626. Section 626 allows a company which redenominated some or all of its shares to reduce part of its share capital by special resolution (there is no need to obtain the courts' permission for this or for its directors to make a statement of solvency under section 641). The special resolution must be passed within three months of the ordinary resolution effecting the redenomination; but the amount by which the share capital is reduced must not exceed 10% of the nominal value of the Mirza plc's share capital immediately after the reduction. The company must then transfer the amount by which the share capital is reduced as a result of redenomination into a new non-distributable reserve, called “the redenomination reserve” (s. 628). This reserve can only be used to pay for fully paid bonus shares (s. 268 (2)). Notice of a reduction of capital under section 626, together with a copy of the relevant resolutions and a statement of capital, must be filed with the Registrar within 15 days. The reduction is not effective until these documents are registered. The Mirza plc must also file with the Registrar within 15 days a statement by the directors confirming that the reduction in capital does not exceed the 10% ceiling; otherwise there would be a default fine on both the company and its directors.”

3. Conclusion

In conclusion, I have assessed the share premium account and revaluation reserves, redemption or purchase of own shares, the conditions must be satisfied when premium to be written off to the share premium account, the entire premium cannot be written off to the share premium account, the revised balance sheet of Mirza plc after shares are redeemed and redenomination. Mirza plc would have ordinary shares of £205,000 and net assets of£311,500 if the directors redeem all the redeemable shares for £15,000 and issue 5,000 new shares of £1 each for £6,500.

(2575 words)

References

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. pp. 101-102.

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. p. 145.

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. pp. 125-126.

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. pp. 127-128.

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. p. 133.

De Freitas, J. D. (2009) Company law. Castlevale Limited, London. pp. 96-97.

http://w ww.completeformations.co.uk/companyfaqs/shareholde rs/share_prem ium.html16/11/2008