What is the Doctrine of Maintenance of Share Capital in England?

As a shareholder and director in a small or medium-sized company, you may have come across references to the doctrine of maintenance of share capital. This doctrine is relevant when you attempt to reduce the size of your share capital. The doctrine of maintenance of share capital refers to a general rule of company law that your company cannot normally return the capital its shareholders have invested. This article will explain the basic principles of what the doctrine of maintenance means and what practical effects it might have on your company. It will also provide an overview of the exceptions to this general rule of UK company law. 

Share Capital

A company’s capital refers to all the valuable assets it owns and can use to make a profit. In the context of share capital, this refers to the assets, usually cash, the shareholders have transferred to your company in exchange for their shares. 

Once anyone transfers cash or any other valuable asset to your company in exchange for shares, your company cannot return the value of the shareholder’s investment, even if the shareholder demands it. This is the basis for what lawyers call the doctrine of maintenance of share capital. 

Purpose of the Doctrine 

As a company owner, you benefit from the principle of limited liability unless you commit fraud or serious misconduct. This means that your company’s creditors cannot come after your shareholders if your company cannot meet its obligations. 

Therefore, the doctrine aims to protect your company’s creditors, such as its bank lenders and trade suppliers.

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Effect of the Doctrine on the Balance Sheet 

The doctrine comforts creditors knowing that the information the company has supplied in its most recent accounts has not substantially changed from year to year. The law requires all companies to make their balance sheets available to the public for inspection at the end of their accounting periods, so anyone who might do business with your company can see the value of its share capital. 

This is because your company’s share capital should “balance out” the bottom half of the balance sheet in relation to the top half. You measure the value of your shareholders’ investment in your company as the amount of:

• their paid-up shares;
• plus any profits; or 
• less any losses incurred during the accounting period.

There are also other specific accounting treatments applied. 

The effect of the doctrine means creditors can treat the called-up share capital figure as a reserve. In the event of financial difficulty, the creditors have a sense of the minimum they can claim from your company. 

An Example 

It is helpful to look at a hypothetical balance sheet to make sense of how this doctrine works t in practice. 

Below is the balance sheet of an imaginary company YouCo Ltd for its financial years 2022 and 2021. 

 The top half of the balance sheet reflects the value of the business at the net asset figure*. The bottom half** represents the value of the shareholders’ investments in the company. 

We can conclude that the business has taken the initial value invested by the shareholders (£200,000) and used it to generate an additional £140,000 in value. From this amount, YouCo’s creditors know that there is at least £200,000 in value that it can use to pay off YouCo’s debts. 

Return of Capital vs Dividends

However, despite the effect of the doctrine on the balance sheet of a company such as yours, you can still pay your shareholders dividends when you make a profit. This is because the law distinguishes between a return of capital and the distributions out of the realised profits. Dividends are the most common form of distributions out of realised profits. Therefore, you can only return capital to shareholders when the money comes from the business profits. This is an exception to the doctrine of maintenance rule. 

Your company’s directors must ensure they abide by several essential laws regulating their powers to declare a dividend. If they break these rules, the law will state that they have made an unlawful distribution. This can result in various penalties and entitle your company to claw back the unlawful amount from your directors. 

Other Exceptions to the Doctrine 

Other prominent exceptions to the doctrine include what we commonly hear as “share buybacks”, such as when the company is:

• purchasing outstanding shares from shareholders; or
• redeeming redeemable shares. 

As a company, you can also reduce share capital, such as if you want to increase your distributable reserves. 

Finally, when a company is wound up, provided you have paid all your creditors, shareholders are entitled to any remaining proceeds from selling the company’s assets. 

A fuller extent of these other exceptions is beyond the scope of this article. 

Key Takeaways 

The doctrine of maintenance of share capital restricts the ability of a shareholder to demand a return on the value of the money they transferred to your company in exchange for shares. This doctrine exists to protect a company’s creditors. An individual intending to do business with a company can refer to the company’s most recent balance statement filed as part of their annual reports and determine the value of the share capital.

In some cases, other factors can adjust the value of your company’s share capital, such as any share premium account. There are exceptions to the doctrine, such as the ability of directors to declare a dividend out of the company’s profits. 

If you need help with the doctrine of maintenance of share capital for your business, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us at 0808 196 8584 or visit our membership page.

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