Hong Kong Companies Ordinance: Reduction of capital

The Companies Ordinance (Cap 622) (CO) introduced a company-led court-free process for reduction of share capital in 2014.[1]  This followed in the wake of the removal of the requirement for companies to have an authorised capital, which in turn followed a trend globally of removing restrictions in the handling of company capital that has swept up major common law countries such as the UK and Australia.[2]

The court-free process simplified the procedures for reducing share capital and provided for a significantly more flexible, faster and comparatively much more inexpensive alternative to a court-sanctioned process.  As a consequence the process is now much more available to companies and shareholders seeking to improve group structures and benefit from deal structuring options.

What are the main drivers for Reducing Share Capital?

There are a number of reasons why a company might want to reduce its share capital:

  • Reduce liability: the most common reason is to reduce the number of shares to a more manageable level and so to reduce liability
  • To eliminate losses: as a company can only pay a dividend from distributable profits, eliminating accumulated losses which would otherwise prevent these payments being made
  • To return surplus capital: if a company has a surplus of cash or assets, these may be paid directly to shareholders by cancelling the shares issued to them
  • To support share buy-back or redemption: if a company wants to buy back or redeem shares out of its distributable profits, it may carry out a reduction of share capital in order to create enough distributable profits to do so
  • Some companies also do this as a way to reorganise or simplify their group structures

The result of capital reduction is that the number of shares in the company will decrease by the reduction amount. However, the company’s market value won’t change – there will simply be fewer shares available to trade.

Key Elements of the Company Sanctioned Process

  • Each of the directors must make a solvency statement
  • Board approval
  • Shareholder approval
  • Publication of notice (providing notice at large)
  • Final filings at the Companies Registry

The Solvency Statement

The process hinges on the ability of the directors to make a statement as to the solvency of the company and accordingly its ability to effect the reduction of capital.  It is a uniform solvency statement that applies not only to the court-free process for reduction of share capital but also to share buy-backs out of capital.

Very briefly, the solvency statement must be in prescribed form and, amongst other requirements, each director must form the opinion that immediately after the transaction there will be no ground on which the company could be found to be unable to pay its debts.  In forming their opinion, the directors must inquire into the company’s state of affairs and prospects and take into account all the liabilities of the company (including contingent and prospective liabilities).

It is a criminal offence for a director to make a solvency statement without having reasonable grounds for such opinion. A director may be liable for a fine of up to HKD150,000 and imprisonment of up to 2 years.

Board and Shareholder Approval

The proposed capital reduction must be approved by the directors of the company within 15 days of the date of the solvency statement(s) and then the shareholders of the company must pass a special resolution approving the reduction of share capital.

Requirement to Provide Public Notice and Commencement of Registry Process

Public notices must then be published in the Government Gazette, in one specified Chinese newspaper and in one specified English newspaper at which time certain forms (including the solvency statements) must be filed with the Companies Registry.

The provision of public notice is intended to give any creditor or non-approving shareholder of the relevant company an opportunity to object by filing an application to the court for cancellation of the resolution.

Finalisation of the Process

If all goes well, a return setting out the share capital of the relevant company must be filed with the Companies Registry no earlier than 5 weeks and no later than 7 weeks after the date of the special resolution. The reduction of share capital takes effect from the date on which such return is registered by the Companies Registry.

[1] Part 5 Sections 203 to 273 of the CO.

[2] Note that the CO, when introduced retained the existing court-sanctioned process for reduction of share capital, so the CO provides two distinct paths to the reduction of capital.