Equity – shareholder issues in private companies

Understanding the legal framework surrounding shareholder issues in private companies is crucial to buy-out practitioners. Here, in an extract from The UK LBO Manual, a recently-published guide to structuring buy-outs in the United Kingdom, Charlie Geffen, Head of Private Equity at international law firm Ashurst, outlines issues surrounding income, capital and voting rights.

This section relates to private limited companies. Some additional restrictions apply to public limited companies, whether or not their shares are publicly traded.

Whilst this section principally applies to companies incorporated in England and Wales, the position for companies incorporated in Scotland and Northern Ireland will not usually be substantially different.

References to the ‘Act’ are to the Companies Act 1985 and the Companies Act 1989, which together form the principal statutory regime governing companies incorporated in the United Kingdom.


Dividends can only be paid out of distributable reserves.

How are distributable reserves determined (e.g. can management accounts be used)?
The relevant accounts for determining whether a dividend can be lawfully paid will normally be the last audited annual accounts, but subsequent interim accounts may be used instead where the proposed dividend would be unlawful if reference were made only to the company's last audited accounts. For example, the last annual accounts might show an asset which has subsequently been sold and a profit realised. Interim accounts will be required to show the realised profit, but only if the last annual accounts do not show sufficient reserves available for distribution. If interim accounts are used, an auditors' report is not needed but the accounts must be properly prepared so as to enable a reasonable judgement to be made as to whether the proposed dividend is lawful or not. Additional provisions apply to a plc.

Who declares dividends?
This is governed by the company's articles of association. Most articles authorise the company to declare dividends by ordinary resolution of shareholders in general meeting, but this must not exceed the amount recommended by the directors. The directors are authorised by resolution of the board to pay interim dividends if they are satisfied that this is justified by the profits of the company available for distribution.

If dividends are not paid, what is the right of the shareholders?
The declaration of dividends is at the discretion of the company in general meeting and there is no right for a shareholder to receive a minimum distribution unless otherwise stated in the articles or required pursuant to a contractual arrangement between the shareholders and the company, such as a shareholders' agreement – which would often be the case in a private equity transaction.

Even if a company's articles specifically provide that a class of share carries a right to a dividend, in the absence of specific provision to the contrary, the shareholder has no absolute right to the dividend unless and until it is declared. For this reason, articles will sometimes provide (especially in relation to preference shares) that the dividend becomes automatically payable without the need for further authorisation either by the directors or shareholders

Once a dividend has been recommended by the board of directors and approved by the shareholders, it becomes a debt due from the company which a shareholder can sue to recover if unpaid. This is not the case in relation to an interim dividend declared by the board of directors. The interim dividend will only become a debt when it is actually paid. A resolution declaring such an interim dividend may be revoked prior to actual payment of it, as no debt is created.

Can shares have fixed rights to dividends tied to issue price/share premium or a percentage of profits?
Yes, if specified in the articles of association. However, under English common law, in the absence of a provision to the contrary in the articles, dividends are declared and paid according to the nominal value of shares (i.e. irrespective of the amount paid up on any share, including any premium).

What are the tax consequences of paying a dividend?
There is no need for a UK company to deduct or withhold any amount for or an account of tax from dividends it pays. A UK company will not get a tax deduction for paying a dividend (unlike interest), but UK corporations will not pay tax on dividends received. Other shareholders will, subject to their personal circumstances and the availability of any reliefs, pay tax on dividends. It is possible in certain jurisdictions for a corporate investor holding a specified percentage of a company's ordinary share capital or voting rights to get a foreign tax credit for the underlying UK corporation tax paid by a company in respect of the profits from which the dividend is paid.

Can late dividends attract interest?
No. However, the articles can provide for further sums to be paid akin to interest. These further sums will be treated as further dividends to be paid out of distributable reserves.


Can shares have differential rights on the return of capital (e.g. preference shares first, then ordinary shares)?
Yes. The general rule is that all shares rank equally as to capital and dividend unless the company's articles of association expressly provide otherwise. However, a company's articles will almost always differentiate between these rights where the company's share capital is divided into more than one class of share.

Can return of capital rights be tied to share premium rather than just issue price?
Yes, if the articles so provide.


Is it possible to have non-voting shares?
Yes, if the articles of association provide for this. Where a class of share does not have voting rights, it will normally be provided that the holders do not have the right either to receive notice of or to attend shareholder meetings of the company.

Even if shares are non-voting, the holders are nevertheless members of the company and have an interest as such which will entitle them, for example, to minority protection rights and will afford them protection against the variation of their class rights.

Can shares have differential votes?
Yes, if so provided in the articles of association. For example, preference shares normally carry no right to vote, except on a resolution for the winding-up of the company, on a proposed modification of the rights attached to the preference shares, if a cumulative dividend is in arrears for a specified period or if banking covenants are breached.

Are weighted voting rights allowed and effective (for instance, if the company is ‘in trouble’ could the institutions expect to be able to take absolute control)?
The extent of voting rights attached to shares is governed by the company's articles. In the absence of specific provision to the contrary, a shareholder has one vote per voting share. The articles may provide that voting rights are enhanced in certain situations as mentioned above.

What are the various matters which require shareholder approval and what are the majorities necessary for them?
Statute (principally the Act) provides that certain business of the company must be conducted by shareholders in general meeting. With the exception of such business, a company's articles will determine what business is assigned to the board of directors of a company or to its shareholders.

There are four categories of shareholder resolution, each with different majority and notice requirements.

  • (i) Ordinary resolutions: formal decisions of the shareholders in general meeting are taken by ordinary resolution unless statute, or the company's memorandum or articles, requires a special, extraordinary or elective resolution. An ordinary resolution requires a simple majority of those voting in person or by proxy. Business conducted by members at the annual general meeting is usually considered by ordinary resolution – for example, the declaration of a dividend, consideration of accounts, election of directors and the appointment of auditors.
  • (ii) Special and (iii) extraordinary resolutions: these require that 75 per cent of those voting must vote in favour (but each has different notice requirements). Statute requires a special resolution in a variety of situations, normally where some constitutional change (for example altering the objects or articles of a company) or some other fundamental issue (such as a reduction of capital) is involved. Extraordinary resolutions are required in relation to certain aspects of winding up a company.
  • (iv) Elective resolutions: these require the unanimous approval of all the members of a company who are entitled to attend and vote at a general meeting (and not just those who actually attend). They are used if a private company wishes to vary the application of certain statutory regulatory requirements, so as, for example, to dispense with the need to hold annual general meetings and to lay accounts before a general meeting. Where a company has issued shares of more than one class, the Act provides that rights attaching to any class of share can only be varied if the holders of three-quarters in nominal value of the issued shares of that class consent in writing, or by an extraordinary resolution passed at a separate general meeting of the holders of shares of that class. This requirement can, in certain specific circumstances, be varied in the articles of association of the Company. In addition to this statutory requirement ,if class rights are to be varied, further requirements may be imposed by contract, for example under the terms of a shareholders' agreement, and this is usually the case in private equity transactions in respect of shares held by the institutional investor(s).


The preceding article was extracted from The UK LBO Manual, a 160-page practical guide to structuring and completing private equity-backed buy-outs in the United Kingdom written and researched by international law firm Ashurst and published by Private Equity International. For more information click here or call +44 20 7566 5437.