Learning Outcomes
After studying this article, you will be able to explain the legal requirements for allotting and transferring shares in a company, including the authority needed for directors to issue shares, the operation of statutory pre-emption rights, and the procedures for valid share transfers. You will also understand the rules for share buybacks and the principle of capital maintenance, enabling you to answer SQE1-style questions on these topics.
SQE1 Syllabus
For SQE1, you are required to understand the legal framework and procedures for allotting and transferring shares in private and public companies. Focus your revision on:
- the authority required for directors to allot shares and the relevant Companies Act 2006 provisions
- the operation and disapplication of statutory pre-emption rights
- the process and restrictions for transferring shares, including directors’ discretion and stamp duty
- the legal requirements and procedures for share buybacks, including funding and approvals
- the principle of capital maintenance and its impact on share transactions
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What statutory authority must directors have to allot new shares in a private company with more than one class of shares?
- What are statutory pre-emption rights, and when do they apply to a share allotment?
- What is the usual process for transferring shares in a private company, and what role do the directors play?
- How can a private company lawfully buy back its own shares, and what are the funding options?
- What is the principle of capital maintenance, and why is it relevant to share allotments and buybacks?
Introduction
The allotment and transfer of shares are central to company finance and ownership. For SQE1, you must know the statutory rules and procedures that govern how new shares are issued, how existing shares are transferred, and how companies can buy back their own shares. These processes affect control, capital structure, and the rights of shareholders.
Authority to Allot Shares
Before a company can issue new shares, the directors must have the proper authority. The Companies Act 2006 sets out the requirements for directors’ authority to allot shares.
Key Term: authority to allot shares The legal power given to directors to issue new shares, either by the company’s articles or by an ordinary resolution of the shareholders.
In a private company with only one class of shares, directors usually have automatic authority to allot shares unless the articles restrict them. In companies with more than one class of shares or in public companies, directors need express authority, either in the articles or by an ordinary resolution of the shareholders (s. 551 CA 2006). The authority must specify the maximum amount of shares and the period (not exceeding five years).
Worked Example 1.1
A private company with two classes of shares wants to issue new ordinary shares. The articles are silent on allotment. What must the directors do?
Answer: The directors must obtain authority from the shareholders by passing an ordinary resolution specifying the maximum number of shares and the period of authority.
Statutory Pre-emption Rights
When a company proposes to allot new equity shares for cash, existing shareholders have statutory pre-emption rights under the Companies Act 2006.
Key Term: pre-emption rights The right of existing shareholders to be offered new shares first, in proportion to their existing holdings, before the shares are offered to others.
These rights apply to ordinary shares issued for cash (s. 561 CA 2006). The company must offer the shares to existing shareholders on the same or more favourable terms, giving at least 14 days to accept. Pre-emption rights can be disapplied by a special resolution or by a provision in the articles.
Key Term: equity securities Ordinary shares or rights to subscribe for, or convert into, ordinary shares.
Worked Example 1.2
A company with 10,000 ordinary shares wants to issue 2,000 new shares for cash. What must it do if pre-emption rights apply?
Answer: The company must offer each shareholder the right to buy a proportion of the new shares (e.g., a 10% shareholder can buy 200 shares) before offering them to outsiders.
Payment and Valuation for New Shares
Shares must not be issued at a discount to their nominal value (s. 580 CA 2006). Payment can be in cash or in assets of a verifiable value. If non-cash consideration is used, an independent valuation may be required, especially for public companies.
Key Term: nominal value The face value of a share as set out in the company’s constitution, not necessarily its market value.
The Process of Share Transfer
Transferring shares means an existing shareholder sells or gifts their shares to another person. The process is governed by the Companies Act 2006 and the company’s articles.
Key Term: share transfer The process by which ownership of existing shares passes from one person to another, usually by a stock transfer form.
The usual steps are:
- The transferor and transferee complete a stock transfer form.
- If the consideration exceeds £1,000, stamp duty is paid.
- The form and share certificate are sent to the company.
- The directors decide whether to register the transfer (they may have discretion under the articles).
- If approved, the transferee is entered in the register of members and issued a new share certificate.
Key Term: directors’ discretion on transfers The power of directors, often set out in the articles, to refuse to register a share transfer, usually to protect the company’s ownership structure.
Worked Example 1.3
A shareholder in a private company wants to transfer shares to an outsider. The articles give directors absolute discretion to refuse transfers. What can happen?
Answer: The directors can refuse to register the transfer for any reason, provided they act in good faith and follow the articles.
Restrictions on Share Transfers
Private companies often restrict share transfers to keep control within a chosen group. Common restrictions include:
- Directors’ approval required for any transfer
- Pre-emption rights on transfers (shares must be offered to other shareholders first)
- Prohibitions on transfers to competitors or non-family members
These restrictions must be set out in the articles to be effective.
Share Buybacks
A company may buy back its own shares in certain circumstances, subject to strict statutory procedures.
Key Term: share buyback The purchase by a company of its own shares from shareholders, reducing the number of shares in issue.
Key Term: buyback from profits A share buyback funded from the company’s distributable profits or the proceeds of a new share issue.
Key Term: buyback from capital A share buyback funded from the company’s capital, allowed for private companies if strict procedures are followed.
Buybacks can be funded from distributable profits, the proceeds of a fresh issue of shares, or, for private companies, in some cases from capital.
Key Term: buyback from profits A share buyback funded from the company’s distributable profits or the proceeds of a new share issue.
Key Term: buyback from capital A share buyback funded from the company’s capital, allowed for private companies if strict procedures are followed.
To buy back shares, the company must:
- Check the articles allow buybacks
- Enter into a buyback contract, approved by an ordinary resolution of shareholders
- Ensure the shares are fully paid
- Fund the buyback from profits, a fresh issue, or, if from capital, follow the additional procedure (including a directors’ solvency statement, auditor’s report, and special resolution)
- File the required forms and update the register of members
Worked Example 1.4
A private company wants to buy back 1,000 shares from a retiring shareholder. It has sufficient distributable profits. What approvals are needed?
Answer: The company must enter into a buyback contract, have it approved by an ordinary resolution of shareholders, and fund the buyback from profits. The shares must be fully paid.
Capital Maintenance
The law requires that a company’s share capital is maintained and not returned to shareholders except as permitted by statute.
Key Term: capital maintenance The principle that a company must preserve its share capital for the benefit of creditors and cannot return capital to shareholders except as allowed by law.
This principle underpins the rules on share allotment, transfer, and buybacks. Shares cannot be issued at a discount, and buybacks are only allowed in specific circumstances to protect creditors.
Exam Warning
The procedures for share allotment, transfer, and buybacks are highly technical. Failing to follow the correct process can result in invalid transactions or personal liability for directors. Always check the company’s articles and the relevant statutory requirements.
Revision Tip
For SQE1, focus on the statutory steps for each process: authority to allot, pre-emption rights, transfer procedures, and buyback approvals. Practice applying these steps to short scenarios.
Key Point Checklist
This article has covered the following key knowledge points:
- Directors must have authority to allot shares, either from the articles or by ordinary resolution.
- Statutory pre-emption rights protect existing shareholders when new shares are issued for cash.
- Shares must not be issued at a discount to nominal value.
- Share transfers require a stock transfer form, possible stamp duty, and directors’ approval if the articles allow.
- Private companies can restrict share transfers in their articles.
- Share buybacks require strict compliance with statutory procedures and shareholder approval.
- The principle of capital maintenance limits how and when capital can be returned to shareholders.
Key Terms and Concepts
- authority to allot shares
- pre-emption rights
- equity securities
- nominal value
- share transfer
- directors’ discretion on transfers
- share buyback
- buyback from profits
- buyback from capital
- capital maintenance
