Can I Use a Scheme of Arrangement to Reduce Share Capital in England?

Reducing your company’s share capital is not easy, as there are only a few legal ways to do so. Likewise, the law places significant administrative burdens on company directors. One particular route is through a scheme of arrangement. This article will explain a scheme of arrangement and how you can use it to reduce your company’s share capital in England. 

What is a Scheme of Arrangement?

Schemes of arrangement refer to a court-approved arrangement between a company, its shareholders, and the company’s creditors. Schemes are tools that a company’s key stakeholders can use to restructure or reorder its obligations to its creditors and shareholders. 

While schemes of arrangement are commonly used by companies facing financial difficulties, nothing prevents a perfectly healthy company from using it to reduce its share capital. 

Before we look at the process of using a scheme of arrangement to reduce share capital, we will first consider why a company may want to reduce its capital in the first place. 

Purpose of Reducing Share Capital

Companies reduce their share capital for a variety of reasons, including to:

• create distributable reserves so that the directors can authorise paying more in dividends; 
• redistribute capital back to its shareholders; 
• rebalance the company’s balance sheet so that the equity figure more accurately represents the assets owned; 
• redeem outstanding redeemable shares or buy back ordinary shares; and 
• facilitate a disposal of the company (or a portion of it) through a business sale. 

Reducing Share Capital and Schemes of Arrangement 

The law restricts the ability of a company to reduce its share capital because this value functions as a measure of a company’s assets after accounting for profit and the company’s debts. Since a company cannot easily reduce its share capital, creditors can look at a company’s balance sheet and get a sense of the company’s underlying value. 

However, provided the creditors agree to the company’s proposal to reduce its share capital, the law will not interfere. In fact, by having a company’s creditors agree to the reduction through a scheme of arrangement, the company can complete the reduction when it otherwise might not have. 

Additionally, schemes of arrangement are versatile because they are one of the few ways to facilitate negotiations between a company’s shareholders and its creditors. They are also a common way for insolvent companies to convert a creditors’ debt into equity, effectively wiping out the pre-existing shareholders and making the creditors the new shareholders. 

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Overview of the Process

Regardless of the purpose behind using a scheme of arrangement, the basic steps are the same:

1. court application; 
2. stakeholder negotiation; 
3. voting on the proposal; and
4. obtaining the court’s approval. 

Application to the Court  

A court must approve a scheme for it to have any effect.  Any of the following parties can apply to the court:

• the company (via its directors); 
• the company’s shareholders; 
• any creditors, including any lenders or trade creditors; and
• any administrator or liquidator that has been appointed over the company (where the company is in financial difficulty).

When applying, you must have a legitimate reason to initiate a scheme, such as one of the reasons outlined above. If the court is satisfied with your application, it will notify all relevant parties that it is convening a meeting. The meeting is where the court formally approves (sanctions) the scheme, meaning your shareholders and creditors must agree to a proposal in the negotiation process. 

Negotiations 

Following a successful application, parties will have the opportunity to negotiate with one another on the terms of the scheme. Notably, some parties will have a superior negotiating position compared to others. 

In the negotiation process, each class of creditor typically negotiates on their own behalf and votes as a class. At least 75% of each class that will be affected by the scheme must vote in its favour. Otherwise, the scheme will not progress.

Where a company is not distressed but nonetheless wants to reduce its share capital, directors and shareholders may propose modifications of any outstanding debt owed to the creditors in their favour, for instance, agreeing to pay a higher interest rate. 

Obtaining the Court’s Sanction 

Further, the court must approve the scheme before your company can implement it. While courts have discretion, the following list includes common factors affecting its decision:

• reasonableness of the scheme;
• if the classes of creditors and other stakeholders are appropriately defined;
• if the scheme complies with the relevant laws;
• whether the scheme is necessary; and
• if the company does not have any other conditions it must comply with.

Schemes and Other Methods of Reducing Share Capital 

Schemes are one of three main ways to reduce your company’s share capital. The other three are:

• using the proceeds of an equity raise; 
• applying the company’s profits to the reduction; and 
• using the solvency statement procedure. 

Schemes provide more flexibility than the other options because the creditors play an active role in agreeing to the proposal. 

Key Takeaways 

A scheme of arrangement is a particular process a company (through its directors and shareholders) can follow to reduce its share capital. Crucially, it must obtain the consent of a sufficient number of its creditors and the court’s approval. However, it can be an effective way to reduce a company’s share capital, especially where other options may not be available to the company. 

If you need help reducing your share capital, 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. Visit our membership page or call us today on 0808 196 8584.

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