Nature of Shares I
Shares are assets and are the subject of property rights. They enjoy the constitutional protection of property and the guarantee against the abolition of private property. Although they are founded on a deemed contract between the members in the constitution (formerly the memorandum and articles of association) they are proprietary in nature. They are the instruments of “ownership” of the company. In the everyday sense, the shareholders are the owners of the company.
Shares are personal “non-real” (non-immovable) property. This classification, which formerly was of importance in relation to succession, has continued relevance in certain contexts, including in the conflicts of law. In essence, shares are intangible rights, classified as “choses in action”. They are rights which are ultimately enforced and given effect by legal action.
Shareholders do not have a direct interest in the assets of the company. This is a fundamental principle of the company law. The company is a separate entity and it owns its assets. The rights of the shareholders are limited to those defined in the constitution/ memorandum and articles of association.
Nature of Shares II
The shareholder’s rights usually comprise of voting and economic rights. He has the right to vote and to participate in the company’s affairs. They are entitled to dividends, if and when declared, and to a share of the proceeds available in winding up if any, if and when the company is wound up.
The shareholder’s obligation to a limited liability company is to pay the amount due on his shares. Company law protects the shareholder from changes in this basic obligation, without his consent. Most shares are paid up on their issue so that the liability is satisfied and fulfilled from the outset. The amount paid up is commonly nominal.It is in this sense that the member’s liability is limited.
Share may be issued (alloted) by the company, on terms by which the nominal amount and any premium due, are unpaid or are not fully paid up. In this event, “calls” are made for the remaining amounts due. The shareholder is obliged to pay calls when due. The shares may usually be forfeited if outstanding calls are not paid. There is usually a lien for calls and other sums due by the shareholder to the company.
Division and Denomination
Shares are measured by reference to a nominal value in Ireland. This is generally one euro, but it need not necessarily be so. They may be denominated in a foreign currency. When the euro replaced the Irish pound as the domestic currency, it required the redenomination of shares from Irish pounds into the euro.
Shares are required to be numbered. The requirement may be dispensed with, if the shares all rank pari passu and are all fully paid up. Shares may be consolidated or subdivided, subject to certain conditions.
Shares are presumed to have equal rights. Share may be divided into different classes by the constitution/ memorandum and articles of association or by the terms of their issue. Equality applies presumptively in the division of dividends and to rights on a winding up. Equality may apply to all shares or within the respective classes of shares, where there are classes.
Economic Nature of Shares I
The shareholders are the owners of the company and are entitled to the residual value of the company. They take the risks and rewards of the business.The value of a company may increase over time. The increase in asset value or the income generating capacity of the company’s trade or business should be reflected in an increased share value/ price.
The equity shareholders may be said to own the company through their ownership of its shares. In effect and indirectly, they own the company’s assets, net of its liabilities. In this sense, the share’s value is its breakup value on a winding up.
Shares are more commonly valued on bases entirely unrelated to the value of the company’s underlying assets and liability. The company may have strong earning capacity. It may have the potential to grow. In this case, the shares in the company may be valued on the basis of its potential future earnings or dividends.
Economic Nature of Shares II
Where profits are not distributed as dividends, they are usually reinvested in the business. From the shareholders’ perspective, a return by way of capital gain should, in theory, be equivalent to a dividend. It may have a relative tax advantage.
The balance sheet will not necessarily bear any relationship to the actual value of the company. The capital of the company as it appears on the balance sheet may be the nominal capital only. The various assets are usually entered at historical cost. Over time the capital balance may increase due to retained profits, which are effectively added to the capital in the balance sheet.
Assets may go up in value, thereby increasing the net value of the share capital. Assets which have increased in value may be revalued with the increase posted to a non-distributable revaluation reserve. The accumulated value of undistributed profits is added to the balance sheet. Equally, losses in asset value and trading losses are subtracted from the balance sheet total.
It is possible to have a myriad of share types, each holding variously defined rights. Most commonly that there is one class of equity shareholder with uniform rights. If the shareholders have different rights, their entitlements are determined by the constitution/ memorandum and articles of association or in some cases, the resolution defining the terms on which the shares are issued.
Where there are multiple share classes, the equity shareholders are the residual owners of the company. Most other classes of owners or investors have limited or defined rights. Those who hold loan capital are creditors only and are entitled to repayment before the payment of capital to shareholders.
Preference shareholders usually have preferential rights to the return of their capital and to a dividend. The equity shareholders share the remaining income and capital after payment of ordinary creditors, debt holders and preference shareholders.
Companies may allot shares of different nominal values and in different currencies. They may allot shares with different share premiums payable on them. A company may allot shares which are redeemable by it. The powers are subject to the general duties of the directors or shareholders who allot the shares.
Without prejudice to any special rights conferred on the holders of existing shares or classes of shares, new shares in a company may be issued with such preferred, deferred or other special rights or restrictions, whether in regard to dividend, voting, return on capital or otherwise, as the company may from time to time by ordinary resolution determine.
A company may not issue bearer instruments. Bearer instruments transfer title to shares and securities by delivery. Formerly, they could be issued. If a company purports to issue bearer instruments, then there is a debt due by the company to the purported subscriber.
Preference Shares I
Companies may create different classes of shares. The most common class of are usually designated as “ordinary” shares. Preference shares are those with some element of preference, whether for dividend and/or repayment of capital in a winding up. The terms of the preference will depend on the constitution/ memorandum and articles of association or the terms of issue.
Preference shareholders are usually entitled to a fixed percentage dividend (related to their nominal capital value) from the distributable profits available, in priority to the entitlement of ordinary shareholders to a dividend. If there are insufficient profits available, the question arises as to whether they have priority in later years for arrears of the preference dividend, before a dividend on the ordinary shares may be paid.
There is a presumption that the preference shares are to be cumulative. If the shares are clearly defined as cumulative preference shares, the arrears must be paid as soon as distributable profits are available. The issues are ultimately a matter of interpretation of the company constitution.
Preference Shares II
Dividends on shares may be paid out of distributable profits only. The terms of the preference will determine whether the dividend may or must be paid, when there are distributable profits. Even if the terms are such that the dividend is paid only if declared, it will usually retain cumulative preference rights over the ordinary shares. In other cases, there may be no entitlement to a preference dividend, unless a dividend is declared.
There is a presumption that the preference dividend should be paid from reserves in priority to ordinary dividends, where the reserves are created by the transfer of profits that would have been available for distribution.
It is presumed that the preferential rights exhaust the entitlement of the preference shareholders in relation to dividends from profits. Some cases have applied a presumption that the preference shareholders may participate in the distribution of surplus assets on a winding up, after payment of capital. Other cases presume that preference rights are exhausted, both as to capital as well as income.
In a winding up, it is a question of interpretation of the constitution/ articles, as to whether any arrears of the preferential dividend are to be paid. The regulations/ articles should define the position precisely. Commonly the preference shareholder’s rights are limited to repayment of their nominal value with arrears of the preferenece dividend. It is presumed that arrears of dividends are to be paid in a winding up, in the case of cumulative dividends.
In some cases, it may be provided that the preference shareholders are entitled to participate in the distributable surplus available on a winding up, notwithstanding that they could have been used for payment of an ordinary dividend on the ordinary shares.
Loan capital refers to long-term debt. There may be formal debt capital by way of bonds or debenture capital. Registered debt capital or debenture stock may be issued in much the same way as shares. A register of debenture holders is required in this case.
A debenture may refer to a formal transferable debt instrument secured by a fixed and floating charge over all of the company’s assets. The expression “debenture” may refer to secured or unsecured debt instruments. It may also refer to a floating charge, granted to a single lender, such as a bank. A debenture in this sense may be secured over the assets of the company. Alternatively, it may be wholly unsecured.
Debenture stock has many of the characteristics of shares. It is effectively transferable debt. It is not usually found in smaller scale private companies.
In the case of smaller scale companies, the promoters may invest by way of long-term loans. This would not usually be formalised as debenture stock. The subscribers may secure their loans by way of security over the company’s assets. The 2014 Act provides for unfavourable consequences in the case of loans by directors to the company unless they are formally documented.
Power Balance in Companies
Default company law provides that the board of directors controls and manages the company. Another body of persons, the shareholders in general meeting, appoint the directors under default provisions. They are in effect, the owners of the company. Often in private companies, the directors and shareholders are the same persons.
Company law allows considerable flexibility in determining the balance of rights between the directors and the shareholders. In practice, the vast majority of small companies use the default constitution or have used standard articles of association with minimal modifications and modernisations, provided by company formation agents.
Historically, the model memorandum and articles largely assumed a divergence between the shareholders / investors and the directors / controllers. The Companies Act, 2014 sought to change this assumption and provides default terms which are based on the model of a private limited company, without a dichotomy between the shareholders as owners and the directors as managers.
It is possible to alter the default provisions and tailor them to the requirements of the particular business of the company. This is often done in combination with a shareholders’ agreement.
The memorandum and articles of association were filed upon formation of a company. They are public documents and are available at the CRO or online. Under Companies Act, 2014, the constitution is a public document and is available online. It is typically shorter than memoranda and articles of association, reflecting the fact that most matters formerly provided in common form articles are provided for by the default positions in the 2014 Act.
The default constitutional rules / articles of associations set out detailed rules for the management of the company. They set out much of the “nuts and bolts” of how a company is managed and controlled. This includes the procedures for meetings of the shareholders and directors. They set out the balance of power and rights between the directors and the shareholders. They specify the rights of the shareholders. There may be different classes of shareholders with different types of right and entitlements.
Constitution is Binding
The constitution binds all shareholders and the company as if it was a contract between them. When a person becomes a shareholder, he becomes bound to the constitution / memorandum and articles. Shareholders or members can enforce the rights and obligations in the constitution in legal proceedings against each other and the company. Equally, the company may enforce the terms of the constitution against the member.
Shareholders may only enforce the provisions in the constitution / memorandum and articles that relate to them in their capacity as shareholders. Other non-shareholder related matters are not enforceable and should not be included. The rules should relate to the mechanics and running of the company and the consequent rights and obligations of the shareholders and the company.
The constitution / articles of association can be altered or varied by special resolution. A special resolution is one passed by 75% of those attending a meeting of the shareholders. Some matters may be entrenched in the constitution / memorandum so that they cannot be changed if no mechanism for amendment applies.
Alterations to Constitution
Although 75% of the shareholders may generally, by special resolution amend and change the constitution, they must act when they do so in good faith and for the benefit of the company as a whole. They must believe honestly that the alterations are in the company’s interests. They cannot use the power to expropriate the minorities’ interest in the company, in whole or in part.
The shareholders are entitled to be selfish and vote in their own interest to a great extent. If however, the alteration is a blatant device for some other purpose and is not for the benefit of the company as a whole, then the alteration may be set aside. If this can be shown, it may be possible to challenge the alteration in court. An alteration may be set aside where the majority changes the constitution for the effective objective of expropriating the minority.
Where the alteration varies the special rights of a particular class of shareholder, a separate vote of that class is required. A 75% majority of that class is required. 10% of the shareholders of the class can apply to the court for an order to set aside the variation, on the basis that it is unfairly prejudicial to them.
Variation of Rights / Class Rights
The are protections against variation of the rights of shareholders by directors or by the majority of shareholders. In the absence of protections, the majority could use its power to change the constitution/ memorandum and articles of association to the detriment of the minority. The allotment/ issuing of further shares of the same class in itself is declared by standard constitution/ articles not to be a variation or abrogation of existing share rights. However, there are circumstances in which the issue of further shares constitutes a breach of duty.
Where the constitution/ memorandum of association contains a procedure for the variation of rights with the consent of the shareholders or a class of shareholders, the rights may be varied with the consent of the shareholders or of that class, given by a special resolution passed by the shareholders or that class in accordance with the procedure. The minority who dissent may apply to the court for an order cancelling the variation.
Where the class rights are not contained in the constitution and there is no procedure for variation, the Companies Act allows their variation by special resolution ( three-quarters) of the holders of the share capital or by a special resolution of the class of shareholders. If rights are varied accordingly, the holder of not less than 10% of them, may apply to the court to cancel the variation. This must be done within 28 days. Dissenting shareholders only may apply.
The court may hear the application and disallow the variation if it is satisfied that the variation would unfairly prejudice the shareholders concerned. A copy of the court’s order must be filed in the CRO.
Where the share rights are entrenched in the constitution / memorandum, relate to any matter other than the reduction of capital or the authority to issue shares, and there is no procedure for the variation in the constitution, then the consent of all members is required to variation. If there is a procedure in the constitution, then that procedure applies.
References and Sources
Companies Act 2014 (Irish Statute Book)
Companies Act 2014: An Annotation (2015) Conroy
Law of Companies 4th Ed. (2016) Courtney
Keane on Company Law 5th Ed. (2016) Hutchinson
Other Irish Sources
Tables of Origins & Destinations Companies Act 2014 (2016) Bloomsbury
Introduction to Irish Company Law 4th Ed. (2015) Callanan
Bloomsbury’s Guide to the Companies Act 2015 Courtney & Ors
Company Law in Ireland 2nd Ed. (2015) Thuillier
Pre-2014 Legislation Editions
Modern Irish Company Law 2nd Ed. (2001) Ellis
Cases & Materials Company Law 2nd Ed. (1998) Forde
Company Law 4th Ed. (2008) Forde & Kennedy
Corporations & Partnerships in Ireland (2010) Lynch-Fannon & Cuddihy
Companies Acts 1963-2012 (2012) MacCann & Courtney
Constitutional Rights of Companies (2007) O’Neill
Court Applications Under the Companies Act (2013) Samad
Company Law – Nutshell 3rd Ed. (2013) McConville
Questions & Answers on Company Law (2008) McGrath, N & Murphy
Make That Grade Irish Company Law 5th Ed. (2015) Murphy
Company Law BELR Series (2015) O’Mahony
Companies Act 2006 (UK) (Legilsation.gov.uk)
Statute books Blackstone’s statutes on company law (OUP)
Gower Principles of Modern Company Law 10th Ed. (2016) P. and S. Worthington
Company Law in Context 2nd Ed. (2012) D Kershaw
Company Law (9th Ed.) OUP (2016) J Lowry and A Dignam
Cases and Materials in Company law 11th Ed (2016) Sealy and Worthington
UK Practitioners Services
Tolley’s Company Law Handbook
Palmer’s Company Law