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

Zeta Ltd, a private company, has issued redeemable shares. Its directors wish to redeem them. Which of the following describes the general rule on the source of funds for a redemption or buyback that is consistent with capital maintenance principles?

Redemption or buyback is normally funded from distributable profits or the proceeds of a fresh issue of shares made for that purpose. This protects creditors by preventing the company's permanent capital from being returned to shareholders in the ordinary course.

  1. AIt must be paid out of distributable profits or the proceeds of a fresh issue of shares made for the purposeCorrect
  2. BIt must always be paid out of the share premium account
  3. CIt must be paid out of any funds the company holds, including borrowed money, with no restrictions
  4. DIt must be paid out of the company's undistributable reserves

Explanation

The general capital maintenance rule is that shares are redeemed or bought back out of distributable profits or the proceeds of a new share issue made for that purpose. Using share premium or undistributable reserves would reduce the capital cushion protecting creditors, and unrestricted use of any funds would defeat the rule.

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