A company may distribute its assets to its shareholders for an array of reasons, including as a return on investments, to support its ongoing operations, or when it ceases operations. In Kenya, the distribution of a company’s assets is mainly regulated by the Companies Act, 2015 (the Companies Act) and the Insolvency Act, 2015 (the Insolvency Act) together with the regulations made thereunder. There are also sector-specific laws governing the distribution of assets in regulated industries like banking, insurance, capital markets, retirement benefits and telecommunications. The existing regulatory framework seeks to protect creditors and minority shareholders and to guarantee the equal treatment of shareholders.
There are various ways of distributing the assets of a company, including via liquidation, dividend in specie, distribution in specie and share buyback. We discuss these options below.
Distribution upon Liquidation
Liquidation or “winding up” is a procedure under which the assets of a company are realised and distributed to creditors in a statutory order of priority pursuant to procedures under the Insolvency Act. In the event of any surplus, distribution is made to the company’s shareholders.
Section 381 of the Insolvency Act contemplates two types of liquidation, being voluntary liquidation and liquidation by the Court. Voluntary liquidation may be initiated by the members or creditors of the company in accordance with the provisions of the Insolvency Act.
A members’ voluntary liquidation is deemed to have commenced after the passing of the special resolution by the members of the company after which the company ceases to carry on its business, except in so far as may be necessary for its beneficial liquidation.
Where a company is to be liquidated through a members’ voluntary liquidation, the directors are required to convene a directors’ meeting and make a statutory declaration (commonly known as a declaration of solvency), in the standard form prescribed under the Insolvency Act, to the effect that they have made a full inquiry into the company’s affairs, and that having done so, they have formed the opinion that the company will be able to pay its debts in full, together with interest at the official rate, within such period (not exceeding twelve (12) months from the commencement of the liquidation) as may be specified in the declaration.
It is important to note that the statutory declaration by directors has to be made within five (5) weeks before the date of passing the resolution or on the date of the resolution but before the passing of the resolution. The declaration must include the latest statement of the company’s assets and liabilities, in the standard form prescribed under the Insolvency Act, at the latest practicable date before the declaration is made. The declaration is also to be lodged with the Registrar of Companies within fourteen (14) days after the date of the resolution.
Creditors play no part in a member’s voluntary liquidation since the assumption is that their debts will be paid in full. The Registrar of Companies dissolves the company after three (3) months from the date of receipt of the final accounts of the company by removing the company’s name from the Register of Companies.
Section 406 of the Insolvency Act outlines the process of initiating a creditors’ voluntary liquidation. A creditors’ voluntary liquidation is commenced by the directors convening a general meeting of members to pass a special resolution to wind up an insolvent company and appoint a liquidator. Thereafter, the directors must also convene a meeting of creditors within fourteen (14) days of members passing the resolution to wind up the company.
The Second Schedule to the Insolvency Act sets out the priority of claims in an insolvency as first, second or third priority claims. The claims which take first priority are the expenses of administration or liquidation. Second are the company debts, as listed in the Second Schedule, to the extent that they remain unpaid. The third priority claims relate to the tax obligations incurred by the company under the Income Tax Act (Cap. 470) Laws of Kenya as well as the Excise Duty Act, 2015.
Once priority claims have been settled, secured creditors holding fixed and floating charges will rank ahead of unsecured creditors. Shareholders are the last to be paid to the extent of the capital they contributed to the company.
Dividend in specie
A dividend in specie, is a dividend which is to be satisfied otherwise than in cash. The dividend can be a transfer of company shares, physical assets, assignment of a debt or the transfer of the benefit of convertible debentures. A company will typically declare a dividend of a specified amount which it will satisfy by transferring a non-cash asset of equivalent value to its shareholders.
A company is generally permitted to undertake a dividend in specie, as provided under section 485 (3) of the Companies Act, unless explicitly prohibited by its articles. A company’s articles will more often than not authorise a company, subject to approval by its shareholders, to declare a dividend of a specified amount and for such amount to be satisfied by the transfer of non-cash assets of equivalent value to its shareholders.
It is important to note that distributions can only be made out of profits or capital available for this purpose as stipulated in section 486 of the Companies Act.
Distribution in specie
Also known as distribution in kind, this involves circumstances where a company identifies a non-cash asset that it wishes to transfer to a shareholder or sister company (for example, as part of an intra-group reorganisation). The transfer is known as a distribution in specie but there is no requirement to declare a dividend.
Whereas a dividend is typically described in a company’s articles as a “distribution payable in respect of a share”, a distribution in specie is a “distribution consisting of or including, or treated as arising in consequence of, the sale, transfer or other disposition by a company of a non-cash asset”. Therefore, since the provisions in a company’s articles only apply to dividends, shareholder approval is not generally required for a distribution in specie.
Although a distribution in specie is flexible for the directors of a company since it does not involve shareholder approval, this method of distribution has certain limitations. Specifically, a company may not distribute assets in specie if the value of the proposed assets exceeds what it can distribute to its shareholders. Where a company distributes assets of a higher value than it should, this may result in legal issues for the company and the recipient of the asset. It may be viewed as an unlawful return of capital, as the distribution exceeded the distributable value. Where a shareholder knowingly receives assets categorized as an unlawful distribution, they may be expected to either return the asset back to the company or pay the value of the asset.
It is important to note that section 486 of the Companies Act provides that distributions can only be made out of profits of a company available for distribution or capital. Therefore, before opting for distribution in specie as a mode of asset distribution, the company should ensure that it has sufficient distributable profits.
Share Buyback
A share buyback is a purchase by a company of its own shares from a shareholder. Companies typically repurchase their own shares from the market in instances where they want to consolidate ownership of the company, increase share prices or reduce the cost of capital. Share buybacks by private limited companies are governed by Part XVI of the Companies Act.
A limited company undertaking a share buyback must comply with the provisions of the Companies Act, failing which the transaction would be declared void. Further, the failure constitutes an offence by the company and every officer in default. The officer in default is liable to fines as prescribed in the Companies Act.
A company is permitted to repurchase its own shares, provided that it is not restricted or prohibited from doing so in its articles and subject to complying with the procedural requirements set out in the Companies Act. Under the Companies Act, a limited company may not purchase its own shares unless they are fully paid.
Further, section 449 (2) provides that a limited company may purchase its own shares only out of distributable profits of the company or the proceeds of a fresh issue of shares made for the purpose of financing the purchase. A private limited company may however purchase its own shares out of capital as provided under section 449 (1) of the Companies Act. Under section 484 of the Companies Act, a company that agrees to purchase its own shares is not liable in damages for failing to redeem or purchase any of the shares.
A share buyback is a viable option only where the company’s capital or distributable reserves are sufficient to cover the cost of the shares. Payment of the shares may be made through a non-cash asset.
Conclusion
The foregoing is a synopsis of the various ways a company may distribute its assets in order to achieve its desired objective considering the structure, unique needs of the company, prevailing laws and other considerations.
It is important to note that each method of distribution is subject to legal and tax implications, such as payment of income tax, stamp duty and capital gains tax. Therefore, a company should obtain legal and tax advice before embarking on the distribution of its assets.