The capital maintenance doctrine refers to a legal principle whereby a company is not supposed to engage in activities that will result to a reduction of its capital. One of these activities is providing financial assistance to other companies. Section 256A of the corporation act prohibits this action if it would result to the inability of the company to meet its financial obligations, which includes financial its daily liabilities and paying off its debts. Other activities include share capital reductions, self-acquisition schemes and share buybacks.
This principle of capital maintenance doctrine is not new, and it has existed more than a century ago (Armour, 2000). For instance, in 1887, a precedent was established in the case of Trevor v Whitworth, where the court was of the opinion that a company cannot engage in activities that will lead to a reduction of its capital, and this is basically because it will be breaching the expectations of its shareholders, who have invested in the company.
Through this ruling, the court was denoting that the aim of capital maintenance doctrine is to protect money belonging to shareholders from getting lost or wasted. Furthermore, another precedent was established in Ooregum Gold Mining v Roper, where the court ruled that the intention of a capital maintenance doctrine is to promote the principle of a limited liability, and this is because it will protect the capital a shareholder invests in the company, which acts as a security in case the company defaults on its creditors (Hanrahan, Ramsay and Stapledon 2013). Shareholders normally have a limited liability to the extent of the value of shares they hold within a company (Borg 2015). Basing on the principles established in these case laws, it is possible to assert that the capital maintenance doctrine has two important functions and benefits, which are protecting the investments of a shareholder, and protecting the interests of creditors, whereby, if the company fails to pay their money, their will be sufficient resources that can be confiscated for purposes of recovering back their money. Creditors cannot recover their debts from the personal property of shareholders, and this is because their liability is limited.
However, the law allows companies to engage in activities that may lead to a reduction of their capital in some circumstances. For instance, the directors of a company can reduce the capital of the organization in case they want to return capital to investors. This is a precedent established in the 1966 case of Fowlers Vocola Manufacturing Company. Section 256A of the 2001 Corporation Act allows a company to engage in activities that would result to a reduction of their capital if is aimed at protecting the interests of creditors and shareholders (Armour, 2000). For example, if these activities are aimed at protecting the company from becoming insolvent, then it is acceptable for the directors of the organization to reduce its capital.
However, section 256B denotes that this action can only be acceptable if the capital reductions will not make the company to be insolvent, or the liabilities to become more than the resources and assets the company has (Hannigan, 2015). Moreover, s257B of the 2001 Corporation Act identifies the kind of Buybacks that are acceptable, and they include equal access schemes, which give equal opportunity for shareholders to sale off their shares; employee share schemes, which allows the employees of the organization to sale their shares to the organization.
Finally, section 254 of the corporation act allows the company to reduce its capital, if the process is allowed by shareholders. This normally requires a unanimous resolution from the shareholders of the company.
Armour, J., 2000. Share capital and creditor protection: Efficient rules for a modern company law. The Modern Law Review, pp.355-378.
Borg, D.J., 2015. The acquisition of own shares by limited liability companies.
Hanrahan, P.F., Ramsay, I. and Stapledon, G.P., 2013. Commercial applications of company law.
Hannigan, B., 2015. Company law. Oxford University Press,.