Capital Reductions – A practical guide
What is a Capital Reduction?
A reduction in share capital occurs when a company returns to shareholders some or all of the money originally paid for their shares, or when shares are cancelled for no consideration. This process reduces the company’s issued share capital and is governed by Division 1 of Part 2J.1 of the Corporations Act 2001 (Cth) (Corporations Act).
A reduction of capital is distinct from a share buy-back or redemption of redeemable preference shares.
Why would I want to reduce the capital in my company?
A reduction in capital can be useful when undertaking financial or capital restructuring, and can be used as part of a simplification of your capital table, succession and tax planning.
How is Share Capital Reduced
A company is generally prohibited from reducing its issued share capital because this would prejudice the rights of creditors.However a company may reduce its share capital if:
The reduction is fair and reasonable to the shareholders of the company as a whole;
It does not materially prejudice the company’s ability to pay its debts; and
It is approved by company’s shareholders in accordance with the Corporations Act.
A reduction also includes cancelling shares for no consideration, in which case the requirement about not prejudicing the company’s ability to pay its debts does not apply.
Types of Capital Reductions
1. Equal Reduction
An equal reduction applies to all ordinary shareholders on the same terms, in proportion to the number of shares they hold. This type of capital reduction must be approved by an ordinary resolution (although there is an exception if the company has a constitution which requires a special resolution).
2. Selective Reduction
A selective reduction applies only to certain shareholders and requires stricter approval, including either:
A special resolution with voting exclusions; or
Agreement by all ordinary shareholders.
Selective reductions may be used in restructures, shareholder exits, or where only certain classes of shareholders are affected.
Steps for Reducing Share Capital
ASIC sets out mandatory steps companies must follow when undertaking any capital reduction:
Notify ASIC before sending the meeting notice to shareholders via lodgement of an ASIC Form 2560.
Notify shareholders about the proposed reduction by sending them the notice of the meeting and information about the cancellation.
Hold the shareholders’ meeting (the resolution must be the type outlined above for the type of reduction and your company’s constitution).
(Selective Reduction Only) Notify ASIC about the resolution passing within 14 days via lodgement of an ASIC Form 2205.
Effect the reduction of share capital. For selective reductions, this can only occur 14 days after lodging the ASIC Form 2205.
Notify ASIC of the capital reduction via lodgement of an ASIC Form 484 within 28 days after the reduction.
Capital Reduction vs Share Buy Back
Although both capital reductions and share buy‑backs involve returning value to shareholders, they are distinct corporate actions.
A capital reduction involves reducing the company’s share capital, either by returning capital to shareholders or cancelling shares. By contrast, a share buy‑back involves a company purchasing its own shares, with those shares typically being cancelled.
The choice between a capital reduction and a share buy‑back will depend on the company’s structure, commercial objectives and tax considerations.
Important Considerations
When contemplating a capital reduction, companies should consider:
Potential impacts on creditors and ongoing solvency;
Whether the reduction is fair and reasonable for all shareholders;
The public nature of documents lodged with ASIC;
Whether alternative mechanisms - such a share buy-back - may be more appropriate depending on taxation and commercial outcomes.
How we can assist
Our team can assist you managing the any of the above processes from start to finish to minimise risk and achieve a smooth outcome.
If would like advice on capital reductions, please contact:
Paul Gray
Principal
T 03 5225 5231 | M 0414 195 886
Epgray@ha.legal
Hugo Le Clerc
Senior Associate
T: 03 5225 5213 | M: 0438 089 334
E: hleclerc@ha.legal
Jemimah Fitzgerald
Lawyer
T 03 5225 5219
E jfitzgerald@ha.legal
Prepared with the assistance of Charlotte Newman.
