Maintenance of Capital, Dividends and Share Buy-Back

A limited company has a bargain with its creditors. Its members risk only the money they put in, and in return the company keeps that money in the business instead of handing it back to them.

The law protects the bargain with a set of rules: capital may not be reduced casually, dividends may not be paid out of capital, a company may not freely buy its own shares or finance others to buy them, and it may not squander its capital on commissions.

Examiners test these rules as lists (the purposes of a reduction, the conditions for a buy-back) and as short problems about a dividend declared in the wrong way.

This topic covers why capital is protected, the rule against reduction and the permitted reductions, the treatment of creditors, the rule against paying dividends out of capital and who declares a dividend, the conditions for a share buy-back, the ban on financial assistance, the rule on commissions and discounts, and the reserve fund of a bank.

Why the law protects capital

A person who lends to or trades with a limited company cannot sue its members for the debt. What he can rely on is the company’s capital.

In Trevor v Whitworth (1887) Lord Watson said that persons who deal with a limited company and give it credit rely on the company trading with a certain amount of capital already paid, and are entitled to assume that none of it has been paid out except in the legitimate course of the company’s business.

Capital may be lost in trading, which no law can prevent, but it may not be handed back to the shareholders. For that reason the syllabus calls capital the creditors’ guarantee fund.

Investors have an interest too. They are entitled to see that the money is applied judiciously to the business. The syllabus gives four rules for preserving capital. They are: no reduction of capital, no dividends out of capital, no buy-back of shares except on conditions, and no commission or discount out of capital. It adds the ban on financial assistance as a related rule.

The rule against reduction of capital

The rule

Section 130(1) of Companies and Allied Matters Act (CAMA) provides: except as authorised by the Act, a company having a share capital shall not reduce its issued share capital.

The rule is much older than the Act, and in Trevor v Whitworth Lord Watson said that it prohibits every transaction between a company and a shareholder by which money already paid in respect of his shares is returned to him, unless the court has sanctioned it.

Permitted reduction (sections 131 and 132)

A company may reduce its share capital if:

1. its articles of association authorise the reduction;
2. it passes a special resolution; and
3. it obtains the confirmation of the Federal High Court (section 132).

May 2017 asked for two of these cases (2 marks). The examiners accepted the three: authorised by the articles, authorised by a special resolution, or permission of the court.

The purposes of a reduction

A company may reduce its share capital in order to:

1. extinguish or reduce the liability on any of its shares in respect of share capital not paid up;
2. cancel any paid-up share capital that is lost or unrepresented by available assets, with or without extinguishing or reducing liability on any shares; or
3. cancel any paid-up share capital that is in excess of the company’s wants.

May 2017 asked for two purposes (4 marks). Whatever the purpose, the company must amend its memorandum to reflect the reduction.

Treatment of creditors

The company must show that it will still be able to pay its creditors. The court will not approve a reduction that makes it impossible for the company to meet its obligations. Section 136 makes it an offence, punishable by a fine, for an officer of the company to:

• wilfully conceal the name of a creditor who is entitled to object to the reduction;
• wilfully misrepresent the nature or amount of a creditor’s debt or claim; or
• aid, abet or be privy to such a concealment or misrepresentation.

Dividends only out of profits

The rule

Section 433 of CAMA forbids the payment of dividends out of capital, because the payment would automatically reduce the capital. A dividend is payable only out of the profits of the company, after due allowance for the company’s tax. The syllabus names the Companies Income Tax Act here, which the Nigeria Tax Act 2025 has replaced, so refer to company tax under the tax law.

Liability of directors (section 433)

• All directors who knowingly pay, or are party to the payment of, a dividend out of capital, or in breach of the Part, are personally liable, jointly and severally, to refund the amount to the company (section 433(1)).
• Those directors may recover the dividend from shareholders who received it knowing that the company had no power to pay it (section 433(2)).
• See also section 105.

Re Exchange Banking Co, Flitcroft’s Case (1882)

For several years the directors made it look as if the company had made profits when it had not. They put debts known to be bad into the balance sheets as assets. On the faith of these reports the shareholders passed resolutions to declare dividends, which the directors paid. In the winding up the liquidator successfully had the directors who were responsible made to repay the sums wrongly paid.

Jessel MR said that the memorandum declares that the company’s capital exists with the safeguards provided by statute, and that the legislature clearly did not intend any of it to be returned to shareholders without the statutory conditions.

Who declares the dividend

In a company the directors recommend a dividend and the general meeting declares it. The meeting may declare a dividend but may not declare more than the directors recommend. The question in November 2017 tests this. Fresh Foods Plc made a net profit of ₦2 million, but it had ₦20 million of trading losses accumulated over the past ten years.

The board did not recommend a dividend and wanted to plough the profit back. The shareholders passed a resolution at the annual general meeting (AGM) approving a dividend, and threatened to remove the directors if they refused to pay. The examiners held that:

• because the board did not recommend payment and it was not on the agenda, the resolution was illegal, null, void and of no effect;
• the directors should not give way, because if they paid they would be personally liable to refund; and
• the threat to remove the directors was unjustifiable.

The accumulated losses are an extra reason not to pay. The capital of the company would be eaten into by paying a dividend while the losses were not made good.

Acquisition of own shares: the share buy-back

Why the old rule was strict

The law at first did not allow a company to buy its own shares. The reason is that it can reduce capital. If the company paid more than the price of the existing shares, it would increase the value of the remaining shares, and if it paid less, it would dilute them.

The conditions today (sections 184 and 185)

CAMA now allows a company to acquire its own shares, including redeemable shares, if:

1. its articles permit it;
2. the purchase is authorised by a special resolution of the shareholders;
3. within seven days of the special resolution the company publishes it in two national newspapers;
4. only fully paid-up shares are bought;
5. the terms of purchase provide for payment, and the payment is made from the company’s distributable profits (section 185);
6. within 15 days after the publication, the directors file a statutory declaration of solvency with the Corporate Affairs Commission (CAC) that the company can pay its debts as they fall due after the purchase;
7. within six weeks of the publications, creditors and dissenting shareholders may apply to court to cancel the resolution; and
8. the company may proceed only on the order of the court, where applicable.

From whom shares may be bought back (section 186)

The repealed 2004 Act limited the reasons for which a company could buy its own shares to settling a debt or claim, eliminating fractional shares, complying with an agreement to buy an officer’s or employee’s shares, satisfying a dissenting shareholder’s claim, and complying with a court order. Section 186 of CAMA 2020 instead lists the persons from whom, or the means by which, a company may buy back its shares:

1. the existing shareholders or security holders on a proportionate basis;
2. the existing shareholders in a manner permitted by a scheme of arrangement sanctioned by the court;
3. the open market; and
4. the purchase of securities issued to employees under a stock option or similar scheme.

Because the purchase must be paid for out of profits and not capital, the syllabus treats this as the third rule on the maintenance of capital.

Prohibition of financial assistance

It is unlawful for a company to give financial assistance, directly or indirectly, to a person who intends to acquire its own shares. Under section 183, financial assistance means a gift, a guarantee, any form of security or indemnity, a loan or any form of credit, or any other financial assistance given by a company whose net assets are reduced by up to 50% by it, or which has no net assets.

The reason is that the company’s money would be used to buy its own shares, which has the same effect on capital as a buy-back that does not comply with the conditions.

Commissions, discounts and allowances

Section 155(1) prohibits a company from applying any of its shares or capital money in payment of any commission, discount or allowance to a person for subscribing, or agreeing to subscribe, for shares in the company, or for procuring or agreeing to procure subscriptions. The exceptions in sections 155(2) and 156 allow:

1. any brokerage or agency fees agreed with a broker or agent of the company for services in those capacities;
2. commission for subscribing or procuring subscriptions, if the articles authorise it;
3. a commission that does not exceed 10% of the price of the shares or the rate authorised by the articles, whichever is lower;
4. the rate of commission on shares offered to the public being disclosed in the prospectus;
5. for shares not offered to the public, the rate being disclosed in a statement in lieu of prospectus, or a statement in the prescribed form delivered to the CAC; and
6. the number of shares on which commission is to be paid being disclosed in the same way.

If the company fails to deliver the required document to the CAC, the company and each officer in default pay a daily penalty set by the CAC.

The reserve fund of a bank

May 2017 asked about a bank that planned to distribute all its profits as dividends. Under section 16 of the Banks and Other Financial Institutions Act, every licensed bank must, out of its annual net profits and before declaring dividends, transfer to its reserve fund at least 30% where the reserve fund is less than its paid-up capital, or at least 15% where the reserve fund equals or exceeds the paid-up capital.

The penalty for non-compliance is ₦500,000. The bank in the question had paid-up capital less than its reserve, so the 15% rate applies, but it still had to transfer before paying any dividend.

Working through the figures

Is this a lawful dividend?

Timing a buy-back

A company passes the special resolution on 1 March. It must publish in two national newspapers by 8 March. If it publishes on 5 March, the directors must file the declaration of solvency within 15 days, by 20 March. Creditors and dissenting shareholders may apply to court within six weeks of the publications, that is, until about 16 April. The company proceeds only after that time, or on the court’s order, where it applies.

Commission on shares

Shares are offered to the public at ₦100 each. The articles authorise a commission of 15%. The commission may not exceed 10% of the price or the articles’ rate, whichever is lower, so the maximum is ₦10 a share. The rate must be stated in the prospectus.

A bank’s reserve

A bank has net profits of ₦100m, paid-up capital of ₦50m and a reserve fund of ₦20m. Because the reserve is less than the paid-up capital, it must transfer at least 30%, that is ₦30m, before any dividend. If the reserve fund were ₦50m or more, the rate would be 15%, that is ₦15m.

Four rules compared

Worked problems

Problem 1: Fresh Foods Plc

1. The issues. Who has power to declare a dividend, and whether a dividend can be paid where past losses have not been made good.
2. The rule. The directors recommend and the general meeting declares, but it cannot declare more than the directors recommend. A dividend may be paid only out of profits (section 433).
3. The application. The directors recommended no dividend and it was not on the agenda, so the resolution is illegal and void. There are also heavy accumulated losses.
4. Advice. The directors should refuse, because if they pay they will be personally liable to refund the amount. The shareholders should not remove the directors on this ground.

Problem 2: false profits

1. The rule. Dividends may be paid only out of profits. Directors who knowingly pay a dividend out of capital are personally liable to refund it jointly and severally (section 433(1)).
2. The case. In Flitcroft’s Case the liquidator made the directors repay dividends paid on the faith of false balance sheets.
3. Advice. The liquidator may apply to make the directors refund. The directors may in turn recover from shareholders who took the dividend knowing the company had no power to pay it (section 433(2)).

Problem 3: a reduction of capital

1. The rule. A reduction is allowed only as the Act permits (section 130).
2. The purpose. Cancelling paid-up capital that is lost or unrepresented by available assets is a permitted purpose.
3. The steps. Check that the articles authorise a reduction, pass a special resolution, apply to the Federal High Court for confirmation, protect creditors, and amend the memorandum.
4. Creditors. The court will not confirm a reduction that leaves the company unable to meet its obligations, and an officer who conceals a creditor commits an offence (section 136).

Questions that have been asked on this topic, and how to answer them

Common mistakes in the exam

• Saying a company may reduce its capital by ordinary resolution. It needs the articles, a special resolution and court confirmation.
• Forgetting that the memorandum must be amended after a reduction.
• Saying the general meeting can declare a larger dividend than the directors recommend. It cannot.
• Saying that only the company can recover an illegal dividend. The directors are personally liable and may recover from shareholders who knew.
• Mixing up the buy-back periods: seven days for publication, 15 days for the declaration, six weeks for objections.
• Saying a buy-back may be paid from capital. It must come from distributable profits.
• Saying commission is unlimited. It is capped at 10% or the articles’ rate, whichever is lower, and must be disclosed.
• Forgetting that a bank must transfer to its reserve fund before it declares a dividend.

Quick revision

• Capital is the creditors’ guarantee fund (Trevor v Whitworth). No reduction except under the Act (s.130).
• Reduction: articles, special resolution, court confirmation (ss.131, 132). Purposes: unpaid liability, lost capital, excess capital. Amend the memorandum. Creditors protected (s.136).
• Dividends only out of profits (s.433). Directors liable to refund, jointly and severally, and may recover from knowing shareholders. Flitcroft’s Case. The meeting cannot declare more than recommended.
• Buy-back: articles, special resolution, publication in two papers in 7 days, fully paid shares, paid from distributable profits, declaration of solvency in 15 days, six weeks for objections, court order where applicable. From shareholders proportionately, under a scheme, on the open market, or from employees (s.186).
• Financial assistance: unlawful if net assets are reduced by up to 50% or there are none (s.183).
• Commission: 10% or the articles’ rate, whichever is lower, disclosed (ss.155, 156).
• Banks: transfer 30% (or 15%) to the reserve fund before dividends. Penalty ₦500,000.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Section A style: multiple choice

Section B style: written questions

Model answers

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