Share Capital

CHAPTER 6
SHARE CAPITAL
Chapter objectives
After the completion of this chapter you should be able to understand amongst other things: What is meant by authorised share capital, issued capital and paid up capital of the company; How the company can increase its authorised share capital; Issue of shares at par value; Issue of shares at discount and its exceptions; That consideration for shares issued can either be in cash or in monies worth; That the CA has implemented provisions that are designed to prevent abuses that may arise where shares issued is paid for otherwise than in the form of cash; That shares may be issued at premium and that a share premium account must be maintained by the company in the event shares are issued at premium; That the share capital of a company may be comprised of different classes of shares; That rights of preference shareholders should be provided for in the companys constitution; That the CA as well as Table A have provisions designed to protect class of shareholders against variation of their class rights;

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That as a general rule a company limited by shares cannot return capital to its members otherwise than allowed by law; That this rule is given effect by ss 64, 67 and 365; That this rule is not absolute and is therefore subject to statutory exceptions which include amongst others ss 61, 67(2) and 67A; That a public listed company can buy back its shares provided it complies with the CA, MSEB LR and Part III of the Companies Regulations 1966; That a company can legally implement a capital reduction exercise provided it complies with the necessary rules set out in the CA and Companies (Reduction of Capital) Rules 1972; and That dividend must not be paid out of capital but from profits.

1.1 1.2

Trading companies require capital to carry out their activities. A company limited by shares obtain its capital from a variety of sources but in particular capital is derived from: Issuing and allotting shares in which case this type of capital is called share capital; and Debt financing in which case this type of capital is loan capital;

SHARE CAPITAL 2.1 A company limited by shares must among other things, state in its memorandum of association the amount of share capital with which the company proposes to be registered and the division thereof into shares of fixed amount: s 18 (1) (c).

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2.2

This capital clause in the memorandum is referred to as the authorised share capital of the company.

2.3

The companys authorised share capital represents the maximum value of shares that the company can issue.

2.4 2.5

A company cannot allot shares in excess of its authorised share capital. Any allotment of shares in excess of the companys authorised share capital is void: Bank of Hindustan, China & Japan Ltd v Alison.

2.6

Robert Baxt, Keith Fletcher and Saul Fridman in their book titled Afterman & Baxts Cases and Materials Corporations and Associations, 7th. edition Butterworths have submitted that: Authorised capital sets an upper level on fund-raising, until varied but otherwise is a meaningless figure. A company can have a $ 1,000,000 authorised capital and only five $ 1 shares issued. Worse still, the shares may be partly paid, so that its issued capital is $ 5 but its paid up capital may be only 5 cents.

INCREASING AUTHORISED SHARE CAPITAL 3.1 As we have discussed above in 2.5 a company is not allowed to issue shares in excess to its authorised share capital: Bank of Hindustan, China & Japan Ltd v Alison.

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Share Capital 3.2 Where the need arises that the company is to issue shares in excess of its existing authorised share capital the company must first increase its authorised share capital as is allowed by the CA: s62 (1) (a) 3.3 To increase its authorised share capital the company is required to comply with the procedures set out in s 62. 3.4 S 62 requires that: The companys articles must first allow the company to increase its authorised share capital. For companies that use Table A, this requirement does not pose any problem to the company. This is because article 40(a) of Table A currently allows the company to increase its authorised share capital; The decision to increase the companys authorised share capital must be made by the general meeting. The general meeting must pass an ordinary resolution to that effect; and The company must notify CCM of its intention to increase its registered capital within 14 days after the passing of the ordinary resolution or otherwise the company and its officers shall guilty of an offence against the CA: ss 62 (4) and 62 (5).

NORMINAL/PAR VALUE OF SHARES 4.1 Shares issued by a company limited by shares must have a nominal or par value. This is because the capital clause in the memorandum must state among other things the division share capital into shares of fixed amount

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Share Capital Fully paid up shares 4.2 Shares held by a member will only be considered to be fully paid up when the company receives an amount of money or monies worth that is equivalent to the nominal or par value of that share: Ooregum Gold Mining Co India Ltd v Roper.

Partly paid shares 4.3 So long the company does not receive money or monies worth that is equivalent to the nominal or par value of that share the share held by a member is regarded to be a partly paid up share.

Company rights against members who hold partly paid up shares 4.4 The companys articles normally will provide the company with enforceable rights against members who hold partly paid up shares. These rights can be enforced by the company against the member by way of contract as provided for by s 33 (1). 4.5 Company rights includes among others: The ability of company directors to make a call on that member in respect of any money unpaid on their share. Art 13 Table A; If a call is in fact made but not complied with by that member the company can serve notice to that member informing that member that in the event there is non-payment of the call made the shares in

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Share Capital respect to which the call was made will be liable to be forfeited: Arts 28 and 29 Table A; The company is empowered to resell the forfeited share: Art 31 Table A; The person whose shares have been forfeited shall cease to be a member in respect of those shares: Art 32 Table A; and The company also has a lien on every share not being a fully paid share and is empowered to sell those shares that are subjected to the lien if the company does not receive the amount in respect of which the lien exist: Art 9 and 10 Table A.

PROHIBITION AGAINST ISSUING SHARES AT DISCOUNT 5.1 Where the company issues shares as being fully up when in fact the company has received an amount less than the nominal or par value of the share this issue of shares is termed as an issue of shares at discount: Ooregum Gold Mining Co India Ltd v Roper. 5.2 In the English case of Ooregum Gold Mining Co India Ltd v Roper, Lord Watson construed the then ss 8(5) and s 38(4) of the English Companies Act 1862 that is similar to our current s 18 (1) (c) and s 214 (1) (d) and said: These sections read together indicate the intention of the legislature that every member who takes shares from the company in return for cash either pay or become liable to contribute their full nominal value; and

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If shares are issued against money, any payment to the company less than the nominal amount of the share must, by force of the statute, and notwithstanding any agreement to the contrary, be treated as a payment to account, the member remaining liable to contribute the balance, when duly called for. 5.3 Where shares are issued at a discount, the officers of the company shall be committing an offence against the CA: s 67 (3). This is because s 67 among other things prohibits a company limited by shares from giving financial assistance to those who acquire or subscribe for the companys shares.

Exceptions to the prohibition against issuing shares at discount 5.4 The CA provides two exceptions as to when the company can legally issue shares at discount. 5.5 The exceptions are provided for by s 59 and 58.

S 59 5.6 Section 59 among other things provides that a company can issue shares at a discount: Of a class already issued provided the issue of shares at a discount has been authorized by a resolution passed at a general meeting of shareholders and confirmed by an order of the court; The resolution must set out the maximum rate of discount;

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The shares must be issued within one month of the court order confirming the issue; Moreover, at the date of the issue, in the case of a public company not less than one year should have elapsed since the date on which the company was entitled to commence business; The shares must first be offered to existing shareholders of that class in proportion to the number of shares currently held; and If the above procedures are not duly complied with the company and every officer who is in default shall be guilty of an offence against the CA: s 59(7).

S 58 5.7 S 58 empowers a company to make a payment in the form of commission to a person in consideration of that person taking up shares provided the payment of the commission is no more than ten per cent of the issued value of the shares. 5.8 This section covers the legitimate practice of paying underwriting commissions. The effect of giving this commission is to give a discount to the subscriber. Companies frequently enter into underwriting agreements with stockbrokers or merchant banks whereby the underwriter contracts to place shares and to take up any shares, which are not subscribed for by the public. This increases the chance of success for the company in placing all shares it seeks to issue.

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Share Capital NON-CASH CONSIDERATION FOR SHARES ISSUED 6.1 English cases such as Ooregum Gold Mining Co India Ltd v Roper and Re Wragg Ltd, suggest that as a general principle there is no wrong committed by the company or its officers when the company issues shares in return for property or services provided to the company but provided it is done honestly and not to relieve the subscriber for shares of its bargain.

Non-cash consideration and issue of shares at discount 6.2 There exists a possibility that when shares are issued in return for non-cash consideration such as property or services the shares may be issued at a discount. This is because there is always a possibility that the property or services transferred to the company can be less in value than the nominal value of the shares issued and if so proven the court can refuse to give effect to that transaction: Ooregum Gold Mining Co India Ltd v Roper. 6.3 The possibility of shares being issued at a discount for non-cash consideration is worsen by the fact that currently the CA does not require a valuation to be done before shares are issued in return for non-cash consideration.

Other risks related to shares issued for non-cash consideration 6.4 In addition to the risk that shares issued for non-cash consideration can result in the issue of shares at a discount, there is also the risk that the companys power to issue shares for non-cash consideration can be abused by directors to benefit them selves. Further, if the company were to issue all its shares for non-cash

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Share Capital consideration this would also mean that the company will have no cash in its hand and this can be detrimental to creditors.

Mitigating the risks associated to shares issued for non-cash consideration 6.5 The CA has enacted several provisions that are designed to mitigate the risks referred to in the above 6.4. These include provisions that are designed to ensure among other things that: The company must receive some money for the shares issued. The policy of the Act is to ensure that the issued capital of a company is a meaningful indicator of the fund available to its creditors. Thus, If a company offers shares to the public or where a prospectus has been registered with the Securities Commission, the minimum subscription (5% of the nominal value of the share) must be paid in cash: s 48(1)(b). Further, if s 48(1)(b) is contravened every director of that company who knowingly contravened or authorized the contravention of s 48 (1) (b) shall be guilty of an offence against the CA that is punishable with imprisonment for three years or a fine of RM 1 Million or both: s 48 (6); Directors who issue shares for non cash consideration must use that power honestly to benefit the company, or otherwise they will contravene s 132 (1). Contravening s 132 (1) can result in that director incurring both civil and criminal liability: s132 (3) (a) and (b); The Company must lodge with CCM a return of the allotment of shares, within one month of the company making an allotment of shares: s

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Share Capital 54(1). This return shall include details of any contract that caused the company to allot its shares for consideration otherwise than in cash. Indeed, s 54(3) requires a copy of the contract to be lodged with CCM If the contract is not in writing, particulars of that contract must be lodged under s 54(5). If s 54 is breached, every officer in default is guilty of an offence: s 54(7); an Prior approval of members is required before the company enters into any transaction or arrangement with its director or directors of the holding company or with person connected with such director to acquire or dispose to such a person any non-cash asset of substantial value: s 132 E. S 132 E is discussed in the chapter concerned with corporate governance. Further, prior approval of members is also required before directors can exercise their power to issue shares: s 132 D. S 132 D is discussed in further detail below. 6.6 Further, a listed public company must ensure that it and its subsidiaries shall not issue shares or convertible securities to a director, major shareholder or person connected with any director or major shareholder unless shareholders in a general meeting have approved of the specific allotment to be made to such aforesaid person: Rule 6.11(1) MSEB LR

ISSUE OF SHARES AT PREMIUM 7.1 Shares are issued at premium when the company receives an amount that is in excess of the nominal or par value its shares.

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Share Capital Directors not obliged to issue shares at premium 7.2 There is no duty imposed upon the company directors to issue shares at premium: Hilder v Dexter. Yet, it should be noted that failing to issue shares at premium could result in the company directors to be in breach of s 132 (1).

Share premium account 7.3 Where the company receives a premium (whether in the form of cash or other valuable consideration) a sum equal to that premium must be credited into the share premium account, which is to be treated as paid up capital of the company for the purposes of reduction of share capital: s60 (2). 7.4 Therefore the premium received for shares must be reflected in the share premium account even if the premium is not in the form of cash: s 60(2) and see Head (Henry) & Co Ltd v Ropner Holdings Ltd. 7.5 Where however a company issues shares in consideration for the acquisition of at least 90% of the equity shares in another company, a share premium account does not have to be created even if the shares are issued at a premium: s 60(4).

Application of the share premium account 7.6 Section 60(3) provides that the company can apply its share premium account for the following purposes: Paying up unissued shares to be issued to members of the company as fully paid bonus shares; Paying up in whole or in part the balance unpaid on shares previously issued to members of the company;

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Share Capital Paying dividends if such dividends are satisfied by the issue of shares to members of the company; In the case of a company which carries on insurance business in Malaysia by appropriation or transfer to any statutory fund established and maintained pursuant to any law of Malaysia relating to insurance; Writing off preliminary expenses of the company or the expenses of, or the commission or brokerage paid or discount allowed, on any duty, fee or tax payable on or in connection with, any issue of shares of the company; or In providing for the premium payable on redemption of redeemable preference shares. 7.7 Further, with effect as from 1 November 1998, a public listed company that purchases its own shares in accordance with s 67A can use its share premium account to provide consideration for the purchase of its own shares: s 67A (3).

Rights of the member if any in regards to premium paid 7.8 As we have discussed above in 7.3 premiums received are to be regarded as part of the paid up capital of the company and therefore premium cannot be returned to the shareholders other than by way of the procedure provided by s 64: s 60(2). Thus, it is not possible to pay a dividend out of the premiums that a company has received for its shares: Re Hume Industries (FE) Ltd. Section 64 will be discussed below. 7.9 Shareholders who have paid premium on their shares have no right to the return of their premiums ahead of other shareholders in a winding up at least in absence of specific provision in the terms of issue, any surplus remaining after the return of the nominal amount of shares is distributable on a rateable basis: Re Driffield Gas Light Co.

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7.10

Further, it has been held Supreme Court of Victoria that a shareholder who has not paid the full amount of the premium is not liable as a contributory in a winding up to pay the unpaid part of the premium. This is because the court held that the unpaid amount of premium was not an amount unpaid on the shares within the meaning of s 214(1)(d): Niemann v Smedley.

7.11

In the recent Court of Appeal case of Chloride Eastern Industries Pte Ltd v Premium Vegetables Oils Sdn Bhd, the Court of Appeal held that when a company redeems its redeemable preference shares the company is prohibited from redeeming the preference shares at a lesser value than the aggregate amount subscribed. Therefore, where a subscriber of shares has paid premium to the company at the time he or she subscribed for the redeemable preference shares and the company later redeems those shares that shareholder will be entitled to a return of his or her premium paid.

SHARES A DEFINATION 8.1 In return for the capital provided to the company by the shareholder the shareholder will receive shares. 8.2 In the English case of Borlands Trustee v Steel Bros & Co, Farwell J defined a share as follows: A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of mutual covenants entered into by all the shareholders inter se in accordance with s 33. The contract contained in the articles of association is one of the original incidents of the share.

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Share Capital 8.3 Further, the CA also provides among other things, that shares in the company shall be a movable property transferable in the manner provided by the articles: s98.

CLASSES OF SHARES 9.1 Table A empowers company directors to issue shares. Further, the shares issued can carry with different rights: Art 2 Table A. 9.2 When the company issues shares with different rights the company is said to have issued different classes of shares. 9.3 Rights attached to shares may differ in regards to: 9.4 Entitlement to dividends; Priority in relation to payment of dividend; Voting rights; Priority in the repayment of capital; and Right to surplus assets upon winding up

In Malaysia it is common for a company limited by shares to issue preference and ordinary /equity shares. They represent different classes of shares as they have different rights.

ORDINARY/EQUITY SHARES 10.1 The CA states that any share that is not a preference share is an equity share: s4.

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10.2

In contrast with preference share ordinary share do not carry with it the right to: Fix dividends; Cumulative dividends;

10.3

Further, dividends are only to be paid to the ordinary shareholders after preference shareholders have been paid.

10.4

Ordinary shareholders in contrast with preference shareholders have the right to vote and to participate beyond a specified amount in any distribution whether by way of dividend, or redemption, in a wind up, or otherwise: s 4.

PREFERENCE SHARE 11.1 The CA defines a preference share to include a share by whatever name called, which does not entitle the holder thereof to the right to vote at a general meeting or to any right to participate beyond a specified amount in any distribution whether by way of dividend, or redemption, in a wind up, or otherwise: s4.

VOTING RIGHTS OF PREFERENCE SHAREHOLDERS 12.1 As we have discussed above in 11.1 a preference share does not carry with it the right to vote at a general meeting: s4.

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Share Capital 12.2 Despite this general restriction, the companys articles may provide that a preference shareholder may have the right to vote in limited circumstances as set out s 148(2). 12.3 The companys articles can therefore provide preference shareholders with the limited right to vote where: Preferential dividend or any part thereof remains unpaid; A class meeting of preference shareholders is held to vary rights attached to the preference shares; or A resolution is to be passed to wind up the company.

RIGHTS OF PREFERENCE SHAREHOLDERS MUST BE SET OUT IN THE M&A 13.1 The CA requires that the rights of preference shareholders in respect to: Repayment of capital; Participation in surplus assets and profits; Cumulative or non-cumulative dividends; Voting; and Priority of payment of capital and dividends in relation to other shares or other classes of preference shares be set out in the companys M&A: s 66(1). 13.2 Contravening this provision can result in the company and its defaulting officers to be guilty of an offence against the CA that is punishable with a fine of RM 2000: s 66(2).

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Share Capital Purpose of s 66 13.3 Section 66 is designed to enable the prospective and existing preference shareholders to easily ascertain the rights attaching to their shares. 13.4 Further, the section also seeks to ensure that the rights attached to preference shares are more entrenched than they would be if contained in a resolution of the company or board of directors.

Civil consequence for contravening s 66 13.5 13.6 The section does not specify the civil consequences for contravening this section. Further, nothing in the section suggests that rights provided to preference shareholders other than by way of the companys memorandum and articles are invalidated. 13.7 Apart from setting out the rights of preference shareholders in the companys M&A, preference shareholders rights may also be provided for by a separate contract that is entered between the company and the preference shareholder or those rights may be stipulated in a resolution. 13.8 Therefore, the CA provides that every resolution or agreement which effectively binds any class of shareholders whether agreed to by all the members of that class or not must unless otherwise stated by the CA must be lodged with CCM within one month after the passing of that resolution or the making of that contract: s 154(1) (b). 13.8.1 Therefore it is submitted that rights of preference shareholders that are not provided for by the companys memorandum and articles continue to be valid but

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Share Capital the onus is upon the preference shareholder to prove them. 13.9 Further, the common law has past held that preference shareholders may still be entitled to the benefit of an alleged right even if that right is omitted from the companys memorandum and articles by way of presumption. 13.10 The English case of Webb v Earle, illustrates the application of this presumption. In this case the company issued participating preference shares, but the companys articles made no mention whether the shares were cumulative or not. Sometime later the company once again issued preference shares but this time the company expressly stated that the latter issue of preference shares were cumulative. The court held that the first issue of preference shares was presumed to be cumulative even though this was not expressly stated. 13.11 Cases such as Webb v Earle may no longer be of importance in Malaysia given what was said by Tan Ah Tah J, in Re Hume Industries (FE) Ltd, He said that: The presumption is that the rights set out in the memorandum and articles are exhaustive.

PROTECTION AGAINST VARIATION OF CLASS RIGHTS 14.1 Where different classes of shares have been issued, an important issue that arises is how do we protect class rights from being varied or abrogated. 14.2 It will be noted that both the CA as well as Table A have provisions that are geared towards the protecting of class rights.

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Share Capital What corporate actions constitute variation of class rights? 14.3 The protection afforded by the CA and companys articles is discussed below only applies can when there is a variation of class rights.

Variation of class rights in accordance to the common law 14.4 In common law a variation of class rights only occurs when the strict legal rights attached to the class of shares are varied. Variation of class rights does not occur when the economic value attached to those share are affected by corporate actions: Greenhalgh v Arderne Cinemas Ltd. 14.5 In the English case of Greenhalgh v Arderne Cinemas Ltd, a company issued 21,000 preference shares of 10s each and 31,000 ordinary shares of 10s each. The companys articles provided the holders of each class of shares with one vote per share. Further, the companys articles also provided that the company also had the power to subdivide its existing shares. When the company fell into financial difficulties it entered into an agreement with Greenhalgh by which he lent it 11,000 secured by a debenture. He was also issued with 10s ordinary shares subdivided into 2s shares. Each 2s share was to have the same voting rights as the issued ordinary 10s shares. After differences arose between the parties, the company resolved at a general meeting to subdivide all existing 10s shares into 2s shares ranking equally with the subdivided shares held by Greenhalgh. The effect of this was to diminish the proportion of votes, which Greenhalgh previously had and it also meant that he no longer held sufficient shares to block the passing of special resolutions. Greenhalgh argued that the voting rights attached to his shares were varied without the consent of the holders of those shares as required by the articles. It was held that the voting rights were not varied.

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Share Capital Lord Greene MR said that: Instead of Greenhalgh finding himself in a position of control, he finds himself in a position where the control has gone, and to that extent his rights are affected as a matter of business. As a matter of law, I am quite unable to hold that, as a result of the transaction, the rights are varied; they remain what they always were a right to have one vote per share pari passu with the ordinary shares for the time being issued which include the new 2s ordinary shares resulting from the subdivision.

Variation of class rights in accordance to the CA 14.6 The CA provides that an allotment of preference shares ranking equally with existing preference shares to be a variation of rights of the holders of existing preference shares: s 65(5). This is so unless at the time the existing preference shares were allotted, the memorandum or articles authorized a later issue of equal rank: s 65(6). In such a case the holders of preference shares know all along that their rights may be subject to the equal rights of later preference shareholders. This is reinforced in Table A, art 5, which provides that an issue of shares of any class with rights ranking equally with existing shares of that class is deemed to be a variation of rights of the holders of the existing shares. 14.7 Further, the CA also provides that any alteration to the modification of rights clause shall also be deemed to be a variation of class rights: s 67(7).

Protection afforded by the CA against variation of class rights 14.8 As we have discussed above in 13.1, the CA requires the rights of preference

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Share Capital shareholders to be set out in the company's memorandum and articles: s66. 14.9 Further, in 13.4 it was also submitted the purpose of section 66 is to entrenched the rights of the preference shareholder.

Entrenching class rights by inserting class rights in the memorandum 14.10 Class rights that are provided for by the companys memorandum are capable of entrenchment. This is because class rights provided for by the companys memorandum cannot be altered: ss 21(1A) and s 21(1B). 14.11 Where the companys memorandum or articles provide for class rights and that right has been contravened the member whose rights have been contravened can proceed against the company with a personal cause of action based on the s 33 contract. Further, that member can also petition for a remedy under s 181.

Protection afforded by the Articles against variation of class rights 14.12 Where class rights are provided for in the company's articles then alternation of class rights must be in accordance to the procedure prescribed by the company's articles. 14.13 If the company observes Table A as its articles, then attention must be given to art 4. Class rights cannot be altered by any other means except by complying with prescribed procedure as set out in the articles: Crumpton v Morrine Hall Pty Ltd.

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Share Capital 14.14 It is submitted that should the companys articles not prescribe a procedure for the variation of class rights that are provided for in the companys articles then the company cannot proceed with variation class rights.

Variation or Modification of rights clause in the companys articles 14.15 The clause in companys articles that sets out the procedure that must be followed in the event the company wants to vary class rights is called a variation or modification of rights clause. 14.16 Art.4 of Table A is a variation or modification of rights clause. 14.17 Art 4 of Table A provides that before the company can proceed with a proposed variation of class rights the company must: First convene a class of shareholders meeting. That meeting is to be attended by the holders that class of shares whose rights are to be varied; and In that meeting the holders of three quarters of the issued shares of that class must give their consent in writing or pass a special resolution consenting to the proposed variation.

S 65 14.18 The CA provides additional protection to holders of a class of shares whose rights have been altered in accordance to the variation or modification of rights clause.

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Share Capital 14.19 S 65 provides among other things that where a variation or modification of rights clause exists in the companys memorandum or articles, and class rights have been varied in accordance with that modification of rights clause, the holders of not less than ten per cent of the issued shares of that class whose rights have been varied or abrogated can, within one month after the variation or abrogation, apply to the court to set aside the proposed variation or abrogation. 14.20 Where an application is made pursuant to s 65 (1) the purported variation or abrogation of class rights will have no effect until confirmed by the court. 14.21 The right to complain to the courts is also extended to those who had actually voted for the variation in the first place: s 65(2).

ENSURING THAT DIRECTORS POWER TO ISSUE SHARES IS NOT ABUSED 15.1 The CA and the SCA have enacted several provisions that are designed to ensure that directors do not abuse their power to issue shares as is provided to them by the companys articles: Art 2 Table A. That when directors issue shares it must serve the interest of the company alone and that the power to issue shares must be used for its proper purpose or otherwise the directors may contravene s 132(1) and incur civil and criminal liability as provided for by s 132 (3); That prior approval of members is required before directors issue shares or otherwise the shares issued shall be void: s 132 D; That prior approval of members is also required where the company enters into any transaction or arrangement with its director or directors of the
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Share Capital holding company or with person connected with such director to acquire or dispose to such a person any non-cash assets of substantial value: s 132 E; That new shares issued must first be offered to existing shareholders in proportion to their existing shareholding or otherwise the existing shareholder can sue the company for breach of contract: s 59 (4) in the case of shares issued at a discount and Art 41 Table A;

DOCTRINE OF CAPITAL MAINTENANCE AND ITS RELATIONSHIP WITH THE ISSUED CAPITAL OF THE COMPANY The rational for maintaining the doctrine of capital maintenance 16.1 The common law prohibits a company limited by shares from returning its issued capital to its members unless otherwise allowed by the law. 16.2 The English House of Lords first expressed this rule in 1887 in the case of Trevor v Whitworth, which required the House of Lords to decide whether a company empowered by the companys articles could purchase back its own shares from a member. The House of Lords held that a company had no power to purchase its own shares even if its articles permitted such an acquisition as it was against the doctrine of capital maintenance. 16.3 The doctrine of capital maintenance is justified upon the basis that it seeks protect the interest of creditors who have dealing with a limited company.

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Share Capital STAUTORY ENACTMENT OF THE DOCTRINE OF CAPITAL MAINTANCE 17.1 The CA includes provisions that are designed to implement and enforce the common law doctrine of capital maintenance. They include: S67; S 64; and S365

S 67 17.2 This provision imposes 5 distinct prohibitions upon a company limited by shares Accordingly it provides that as a general rule a company limited by shares cannot: Provide direct or indirect financial assistance to anyone who purchases or subscribes for the companys shares; A holding company cannot give direct or indirect financial assistance to a subsidiary that purchases or subscribes for the shares of the holding company; Deal with its own shares; Purchase its own shares; and Lend money on the security of its own shares. 17.3 Where any of the above prohibitions are contravened it is not the company that is not punished but instead the officers of the company shall be punished: s 67(3).

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Share Capital 17.4 Further, the officer who is convicted under s 67 (3) may be ordered to pay compensation to the company or any person who has suffered loss as a result of the contravention: s 67(4). 17.5 A contract that is entered into in contravention of this provision is not void: s 67 (6). See also Lori (M) Sdn Bhd (Interim Receiver) v Arab Malaysian Finance Bhd. 17.6 As the opening words of s 67 reads as follows Except as is otherwise expressly provided therefore the above prohibitions set out in 17.2, are subject to exceptions that are provided for by the CA. 17.7 The majority of cases that have been litigated before our courts involve the selfpurchase prohibition and the financial assistance prohibition.

SELF PURCHASE PROHIBITION 18.1 In Mookapillai & Anor v Liquidator, Sri Saringgit Sdn Bhd & Ors, the Federal Court did not allow the company to purchase back its shares from the minority shareholders as it was against s 67 and it also amounted to illegal reduction of capital. See also Trevor v Whitworth.

EXCEPTIONS TO THE SELF-PURCHASE PROHIBITION 19.1 The Act currently provides for 4 exceptions to the self purchase prohibition. They include Redeeming redeemable preference shares in accordance to s 61;

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Share Capital Shares purchased in accordance to s 67A; Shares purchased in accordance to s 181 (2) (c). This is discussed in the chapter of meeting and membership rights Redeeming shares for purposes of cancellation under s 64.

REDEMMABLE PREFERENCE SHARE 20.1 As a general rule a limited company cannot buy back its shares: Mookpillai v Liquidator, Sri Saringgit Sdn Bhd and s 67(1).

Issuing redeemable preference shares 20.2 The CA does however provide that a company having share capital, if authorized by its article can issue redeemable preference shares, which the company may later redeem in accordance to the manner set out by its articles: s 61(1). 20.3 Normally the companys articles will provide the company with an option to redeem its redeemable preference shares. The companys articles can also provide a fixed date as to when the company will redeem its redeemable preference shares. Further, the companys articles may also provide the holders of the redeemable preference shares with the right to serve notice on the company requiring the company to redeem its redeemable preference shares: Chloride Eastern Industries Pte Ltd v Premium Vegetables Oils Sdn Bhd.

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Share Capital Funds for redemption 20.4 Redeemable preference shares can only be redeemed provided they are fully paid up and the funds for redemption must be derived from: Profits otherwise available for dividends; or Proceeds from a fresh issue of shares made for the purposes of the redemption: ss 61(3)(a) and 61(3) (b). 20.5 Redemption of redeemable preference share shall not be taken as reducing the amount of the companys authorized share capital: s 61 (2).

Capital redemption reserve 20.6 Where the company redeems the shares out of profits, a sum equal to the nominal value of the shares redeemed must be transferred to a capital redemption reserve which is treated as if it were paid up capital of the company: s 61(5). This means that capital redemption reserve is cannot be reduced provided it proposed reduction is done of the in accordance to s 64. 20.7 The capital redemption reserve may however be used by the company in paying up un-issued shares that will then be issued to members of the company as fully paid bonus shares: s 61(7).

Redemption of shares must be at aggregate value paid at time of subscription 20.8 In the recent Court of Appeal case of Chloride Eastern Industries Pte Ltd v Premium Vegetables Oils Sdn Bhd, the Court of Appeal had to decide among other things, at what value was the respondent required to redeem its redeemable preference shares. It was argued for the respondent company that the respondent
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Share Capital company was only required to pay the par value of the shares which was only 10 cents per share whilst it was argued for the appellant company that the redemption value included the par value of the shares and its premium which was 90 cents. The Court of Appeal found in favour of the appellant company as it held that redemption value of shares for the purposes of s 61 must be at aggregate value paid to the company at time of subscription, which meant that this value included premium if any paid at time of subscription.

The consequences of the company failing to redeem Its shares when served notice 20.9 As we have discussed above in 20.3 the companys articles may also provide the holders of redeemable preference shares with the right to serve notice to the company requiring the company to redeem its shares. The issue therefore is whether the company is bound to redeem the shares should notice be served on the company. 20.10 In the Singaporean case of UOB Venture Investment Ltd v Tong Guan Garden Holdings Pte Ltd, Selvam J, took the view that where notice has served to the company in accordance to the companys articles and there is failure on the part of the company to redeem the shares this would give rise to a breach of the s 33 contract. 20.11 Further, this case also suggested that if the company defaults on its obligation to redeem, a preference shareholder has three options against the company. They include seeking an order specific performance against the company, seeking damages at common law against the company and or applying for an order to wind- up of the company.

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Share Capital SHARE BUY BACK BY LISTED COMPANIES: S 67A 21.1 Effective as of 1 September 1997 a public listed company if authorized by its articles can now apply to the Exchange buy back its shares. 21.2 The rules that governed this buy back is sourced from: The CA: s 67A; Part III A Company Regulations 1966; and Chapter 12 of the MSEB LR.

Pre-requisites for share buy back by listed public company 21.3 Before a public listed company applies to purchase its shares as provided by s 67A, the company (presumably its directors) must do among other things, the following: Ensure that the company is solvent at the date of the purchase and will not become insolvent by incurring the debts involved in the obligation to pay for its shares so purchased: s 67A(2)(a); Ensure that the purchase of shares by the company is done in good faith and in the interests of the company: s 67A(2)(c); Obtain prior authorisation from its members by way of an ordinary resolution: Para 12.03 MSEB LR; Make the necessary declaration as is set out in Regulation 18 A Part III A Company Regulations 1966, and lodge a copy of the declaration with CCM, the Exchange and SC. See also Paras 12.12 and 12.13 MSEB LR;

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Share Capital Ensure that the listed company does not purchase its own shares or hold any of its own shares as treasury shares if this results in the aggregate of the shares purchased or held exceeding 10% of the its issued and paid up capital: Para 12.09 MSEB LR, and Ensure that the necessary announcements and timelines provided for by Chapter 12 of the MSEB LR are duly complied with;

When a listed company cannot buy back its shares 21.4 Even if assuming the above pre-conditions have been satisfied the MSEB LR provides two situations when a listed company is not allowed to buy back its shares. 21.5 Accordingly the MSEB LR provides that a listed company cannot buy back its shares if buying back its shares will result in: The listed company being in breach of paragraph 8.15(1) MSEB LR: Para 12.14 MSEB LR; or The buy back will cause the issued and paid-up share capital of the company to fall below the prescribed minimum provided under paragraph 3.04 MSEB LR: 12.15 MSEB LR.

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Share Capital On market trade 21.6 The share buy back must be made through the stock exchange in accordance to the relevant rules of the stock exchange: s 67A (2).

Funding for the purposes of share buy back 21.7 The company is permitted to apply its share premium account to pay for the shares that it has purchased: s 67A(3). Further, the company can also use its retained profits to do so: Para 12.10 MSEB LR.

Treasury shares 21.8 The shares purchased may either be cancelled or retained as treasury shares or part of the shares may be retained as treasury shares and part may be cancelled: s 67(3A). The shares cancelled pursuant to this provision will not be deemed to be a reduction of share capital: s 67A(5). 21.9 That the rights (such as voting rights and dividend) attached to the treasury shares are suspended while they are retained as treasury shares: S67A (3C).

Share dividend 21.10 Treasury shares can either be distributed to the shareholders as dividends, in which case the dividend will be called share dividend. 21.11 Where the share dividend is distributed, the cost of the shares on the original purchase shall be applied in the reduction of either the share premium account or the funds otherwise available for distribution as dividend or both: s 67A(3D).

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Share Capital Resale of treasury shares 21.12 Treasury shares can be resold on the stock exchange or cancelled: s 67A(3B). 21.13 Chapter 12 of the MSEB LR set outs the rules that must be complied with in the event the listed company resells its shares. 21.14 The rules provides among other things for the resale price and for notification of resale. 21.15 When reselling its shares the listed company and its directors must ensure that they duly comply with Part IX of the Securities Industry Act 1983.

Cancelling shares 21.16 The CA empowers the listed company to cancel shares bought back: s 67 A (3A).

21.17 The MSEB LR requires that the company give the Exchange, immediate notification as to its intention to cancel shares.

Capital redemption reserve 21.18 Where shares bought back are cancelled, the issued capital of the company shall be diminished by shares so cancelled and the amount by which the companys issued capital is diminished shall be transferred to the capital redemption reserve: s 67A(3E).Further, the CA provides that the capital redemption reserve can be applied in paying up unissued shares of the company to be issued to members of the company as fully paid bonus share: s 67 A(4).

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Share Capital Consequence of not complying with the CA 21.19 The CA provides that, where S 67 A is contravened the company, every officer of the company and any other person or individual who is in default shall be guilty of an offence against the CA, which is punishable with imprisonment for five years or a fine of RM100,000 or both: s 67A(7).

THE PROHIBITION AGAINST THE GIVING FINANCIAL ASSISTANCE TO THOSE WHO SUBSCRIBE OR PURCHASE COMPANY SHARES The rationale for this prohibition 22.1 The prohibition supports the proposition that those who wish to buy or subscribe to the shares of the company must do so entirely by using their own resources, for if it were otherwise, a company may dissipate its own assets and return capital to its members to the detriment of its creditors: Datuk Tan Leng Teck v Sarjana Sdn Bhd & Ors .

What constitutes the giving of financial assistance? 22.2 Section 67(1) provides examples of financial assistance. Accordingly it provides that financial assistance may take the form of the company whose shares are being purchased or subscribed providing a loan, guarantee or the provision of security however the examples provided there in are by no means exhaustive. 22.3 The CA does not define the term financial assistance. This omission therefore allows the courts to decide which transactions constitute financial assistance and which do not.

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22.4

For instance in Utama Wardley & Anor v Leggan Laut Development Sdn Bhd & Ors, the company gave a negative pledge to a bank which was financing a purchaser to acquire shares in the company. For the purpose of the negative pledge, the company deposited the title deeds to its land with the bank. The court held that the negative pledge and the deposit of title deeds by the company was not by way of security but instead it was merely an assurance by the company that it would not encumber its assets without prior consent of the bank. In the circumstances the court held that the negative pledge and the deposit of title deeds did not constitute the giving of financial assistance.

22.5

In Datuk Tan Leng Teck v Sarjana Sdn Bhd & Ors, Augustine Paul JC as he was then, said that: The giving of financial assistance means making a provision in money or moneys worth to which a shareholder was not already entitled in his capacity as a shareholder.

22.6

In the English case of Belmont Finance Corp Ltd v Williams Furniture Ltd, the English Court of Appeal held that financial assistance clearly extended to a case where a company purchased property from a person at an inflated price with the sole purpose of enabling that person to purchase the companys shares.

22.7

In Chung Khiaw Bank Ltd v Hotel Rasa Sayang Sdn Bhd, the respondent hotel company had provided a third party security over its land in favour of the appellant bank for advancing a loan to a third party. The third party then used the proceeds of that loan to acquire shares in the respondent hotel company. The Supreme Court held that this transaction was in contravention of s 67.

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Share Capital Financial assistance must come from the target company 22.8 It must be pointed out that the financial assistance must come from the company whose shares are being purchased or subscribed: Cheah Theam Swee & Anor v Overseas Union Bank Ltd & Ors. Thus, where assistance is provided for by another legal entity without any assistance from the target company (the company whose shares are to be subscribed or purchased) this transaction should not contravene s 67.

Exceptions to the financial assistance prohibition 22.9 Section 67(2) provides three exceptions to the financial assistance prohibition. They include the: Lending of money by a company whose ordinary business is to lend money and the lending is in the ordinary course of its business: s 67(2)(a); Provision of money by a company for the purchase of or subscription for fully paid shares in the company in accordance with a scheme, by trustees for shares to be held by or for the benefit of employees of the company: s 67(2)(b). It is to be noted under this exception a director who is an employee may also enjoy the benefit of this exception; and The giving of financial assistance by a company to persons, other than directors, for the purchase of fully paid shares in the company or holding company to be held by themselves by way of beneficial ownership: s 67(2)(c).

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Share Capital REDUCING THE PAID UP CAPITAL OR ISSUED CAPITAL OF A COMPANY: S64 23.1 As we have discussed above 16.1 the paid up share capital of a limited company cannot be returned to members otherwise than by the means allowed by the law. This rule exists to protect creditors interest in that it assures the creditor who has given credit to the company that the companys paid up capital will act as a creditors reserve.

Examples of illegal return of capital to members 23.2 Therefore, a company limited by shares company has no power to refund to its members the money that they paid for their shares: N.Sinnasamy v Hup Aik Omnibus Co. A company limited by shares cannot covert equity capital into a loan and purport to repay it: Merchant Credit Pte Ltd v Industrial & Commercial Realty Co Ltd. A share buy-back by the company unless allowed by the CA also constitutes an illegal return of capital to members: Mookapillai & Anor v Liquidator, Sri Saringgit Sdn Bhd & Ors. 23.3 23.4 The above transactions constitute an illegal return of capital to members. Further, the authors of The Annotated Statutes of Malaysia, Companies, Vol 2 , MLJ have also submitted at p 155 that: A company also cannot reduce capital that appears in the companys accounts, viz the issued and paid up capital, the share premium account and the capital redemption reserve.

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Share Capital Rational for the enactment of s 64 23.5 The CA does however recognise that they may arise situations where there is indeed a good reason for the company to reduce its share capital. At the same time the CA also recognises the fact that unregulated return of capital can result in unfair treatment of the company creditors and shareholders. 23.6 Given these concerns the reduction of the companys capital is therefore regulated by s 64 and by the Companies (Reduction of capital) Rules 1972.

Conditions that must be satisfied before the company can implement its capital reduction exercise. 23.7 The CA provides that before a limited company can reduce its paid-up capital the following procedures must be complied with: That the companys constitution must allow for the reduction of capital. In the case of a company that observe Table A; attention must be given art 42 Table A; That the proposed reduction of capital must be approved by the general meeting by way of special resolution; and That before the company implements its proposed capital reduction exercise the company must first obtain the courts confirmation in regards to that exercise: s64 (1).

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Share Capital Manner in which the company can reduce its paid up capital 23.8 S 64 (1) provides that the company can among other ways reduce its share capital by: Extinguishing or reducing the liability on any of its shares in respect of share capital not paid up: s 64(1) (a); Cancelling any paid up share capital that is lost or is not represented by available assets: s 64(1)(b); and Paying off any paid up share capital that in excess of its needs: S 64(1) (c).

Factors that will be considered by the court when confirming proposed reduction 23.9 The court is not under a duty to confirm a proposed capital reduction exercise. Instead the CA provides the court with discretionary power to do so. 23.10 The authors of The Annotated Statutes of Malaysia, Companies, Vol 2, MLJ have submitted at p 156 that: When the court is asked to confirm a reduction, it has a two-fold function: first, to consider whether the creditors-present and future-would be prejudiced, second, to ensure that the reduction is fair among the members inter se. The court should also consider public interest.

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Share Capital Reduction of capital and variation of class rights 23.11 A proposed reduction in the companys capital can result in the company having to: Cancel shares as in the case where the company reduces its capital because of the situation set out in s 64(1) (b), or Having to return capital to existing shareholders and cancelling their shares because of the situation set out in s 64(1) (c). 23.12 Where a companys capital is comprised of various classes of shares the holders of a class of shares may complain that the proposed capital reduction exercise is not fair to them, as they have not been treated fairly by the company. 23.13 In the Australian case of Re Fowlers Vacola Manufacturing Co Ltd, the preference shareholders of the company complained among things, that the company had treated them unfairly in the proposed capital reduction exercise. The preference shareholders alleged unfairness on the part of the company because the company proposed to reduce its capital, which was in excess of the companys needs by only returning an amount of money to its ordinary shareholders. It must be pointed out that the companys articles provided among other things that preference shareholders were entitled to priority over ordinary shareholders in a winding up in respect of a repayment of capital and payment of arrears of dividends. However, there was no reference in the articles to preference shareholders rights in a reduction of capital exercise. 23.14 The court held that proposed reduction of capital exercise was unfair to the preference shareholders and therefore it did not confirm reduction of capital exercise.

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Share Capital Little J, said that: Bearing in mind the priority given in winding up I should have thought in the circumstances of this case fairness called for at least equality in treatment of the classes. 23.15 Therefore it is submitted that fair treatment of the various classes of shareholders in a proposed capital reduction exercise at the very least requires the company to observe the rights accorded to that class of shareholders in a winding up. 23.16 Further, in the English case of House of Fraser PLC v ACGE Investments Ltd, the House of Lords held that where the rights accorded to a class of shareholders in a winding up is observed in a capital reduction exercise there is no need to hold a separate class meeting as is required when there is a variation of class rights. Here the company in a proposed capital reduction exercise wanted to return capital to the preference shareholders. The companys articles provided that preference shareholders had priority on a return of capital or otherwise. The preference shareholders complained that before this could be done a separate class meeting was required. 23.17 The House of Lords held that no separate class meeting was necessary. The return of capital to preference shareholders in this case was merely a satisfaction of their rights and did not involve a variation or abrogation of their right. 23.18 According to the Australian view when rights accorded to a class of shareholders in a winding up as provided for by the companys articles is not observed this does not amount a variation of class rights as the right has not been varied or abrogated:Re Fowlers Vacola Manufacturing Co Ltd.

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Share Capital PROHIBITION AGAINST PAYING DIVIDENDS FROM CAPITAL: S365 24.1 Dividends must be paid from profits only and not from the companys capital: s 365(1) and see also Art.100 Table A. 24.2 The prohibition that dividends should not be paid from capital ensures that capital of the company is therefore maintained for benefit of ITS creditors.

Contravening s 365(1) 24.3 Wilful contravention of s 365(1) can result in that company director or manger to be imprisoned for a term not exceeding 10 years and to pay a fine of RM 50,000 or both: s 365(2) (a). 24.4 Further, that company director or manger shall also be liable to the creditors of the company for the amount of debts equal the amount paid in contravention of s 365(1): s 365(2) (b). 24.5 A director who allows a dividend to be paid from capital commits a breach of duty by misapplying company funds. Such a director may be made liable to replace the money paid out: Re Exchange Banking, Flitcrofts Case. 24.6 Members who receive dividends knowing that there are no profits available for the payment of dividends will be required to refund those dividends, at least if they wish to maintain a derivative action against the directors: Towers v African Tug Co.

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Share Capital Directors powers in regards to dividends 24.7 The companys articles usually provide that the company in general meeting may declare dividends, but no dividends shall exceed the amount recommended by the directors: Art 98 Table A. 24.8 This article therefore indirectly allows the company directors to control the amount of dividend that is to be paid by the company. Further, the company directors may also chose not to recommend the payment of any dividend. 24.9 The English case of Burland v Earle, illustrates to us that the courts will adopt a cautious approach when asked to interfere with company directors recommendation as to the amount to be paid as dividends. 24.10 This does not however mean that the court will not interfere when there is a need to. Such a need may arise where it can be shown that the non-recommendation of dividend or the amount recommended to be paid as dividend is contrary to s 181: Re SQ Wong Holdings (Pte) Ltd, Sanford v Sanford Courier Service Pty Ltd and Chiew Sze Sun & Anor v Cast Iron Products Sdn Bhd & Ors.

The effect of validly declaring dividends 24.11 Once a dividend is declared in accordance to the companys articles it becomes a debt that the member can contractually enforce against the company: BSN Commercial Bank (M) Bhd v River View Properties Sdn Bhd. 24.12 Further, although it is a debt it shall not bear interest against the company: Art100 Table A.

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Share Capital 24.13 The CA also provides that although a declared dividend is a debt due from the company to the member, the sum will not be payable to the member in the case of competition between the member and creditors in a winding up: s 214(1) (g). 24.14 The debt is immediately payable unless it is stipulated in the declaration that dividend is will be payable at a later date and the declaration once made cannot be revoked or cancelled nor can dividend be reduced: Marra Development Ltd v BW Rofe Pty Ltd.

Interim dividend 24.15 Table A allows for the payment of interim dividend: Art 99. 24.16 The declaration of interim dividend does not create a debt unlike the declaration of final dividend and it can also be revoked: Marra Development Ltd v BW Rofe Pty Ltd.

Profit and the payment of dividend 24.17 Profit for the purposes of s 365 need only exist at the time dividend is declared and not after it has been declared or for that matter at the time dividends is paid: Marra Development Ltd v BW Rofe Pty Ltd

Common law definition of profit for the purposes of dividend 24.18 The CA does not define profit for the purposes of s 365. Thus, attention must be given to the common law to determine what constitutes profits for the purposes of dividends.

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24.19 The common law has among other things held that: The profit that is to declare as dividend must be the profit of the company that is declaring the dividend: Industrial Equity Ltd v Blackburn; That dividend may be paid even if the total assets of the company are less than the original capital subscribed by the shareholder provided the company makes a profit on its revenue account: Lee v Neuchatel Asphalte Co; Revenue profits need not be paid out as dividends in the year that they are earned. They may be carried forward or transferred to a reserve, unless the articles provide otherwise: Re Hume Industries (FE) Ltd; A company need not apply its revenue profit to make up for depreciation of assets or accumulated losses before it declares dividend: Lee v Neuchatel Asphalte Co and see Verner v General & Commercial Investment Trust; A company can pay out dividend even when there is no revenue profit provided that there has been an increase in the value of its capital assets (capital profit) however in this respect the capital of the company must be intact: Marra Development Ltd v BW Rofe Pty Ltd; Unrealised profits resulting from a revaluation of assets can be distributed as dividend but its revaluation must be independently done and it must be done in good faith: Dimbula Valley (Ceylon) Tea Co Ltd Laurie.

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