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ACCA Applied Skills · Corporate and Business Law (Global) · Capital maintenance and dividend law

Zephyr Ltd, a private company, wishes to reduce its share capital by cancelling shares that are no longer represented by available assets. Under the general principle of capital maintenance, why is a reduction of share capital generally subject to strict rules?

Reduction of share capital is strictly regulated because share capital acts as a cushion for creditors of a limited liability company. Returning it to shareholders without safeguards could leave creditors unpaid, so the law imposes procedures and protections before capital can be reduced.

  1. ABecause share capital is a fund that creditors rely on as security, so it should not be returned to shareholders without safeguardsCorrect
  2. BBecause shareholders are always entitled to veto any change to the company's capital
  3. CBecause only public companies are permitted to hold share capital
  4. DBecause a reduction automatically triggers the company's liquidation

Explanation

The capital maintenance doctrine treats share capital as a buffer for creditors, since members have limited liability. Reductions are therefore regulated to prevent capital being returned to members to the creditors' detriment. The other options misstate the law: there is no automatic liquidation and private companies may hold share capital.

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