Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law
| Date | 01 May 2000 |
| Author | John Armour |
| DOI | http://doi.org/10.1111/1468-2230.00268 |
| Published date | 01 May 2000 |
Share Capital and Creditor Protection: Efficient Rules
for a Modern Company Law
John Armour*
This article examines the case for rules of company law which regulate the raising
and maintenance of share capital by companies. The enquiry has practical
relevance because the content of company law is currently under review, and the
rules relating to share capital have been singled out for particular attention. The
existing rules, which apply generally, are commonly rationalised as a means of
protecting corporate creditors. The analysis considers whether such rules can be
understood as responses to failures in the markets for corporate credit. It suggests
that whilst the current rules are unlikely, on the whole, to be justified in terms of
efficiency, a case may be made for a framework within which companies may `opt
in’ to customised restrictions on dealings in their share capital.
Introduction
A number of provisions of the Companies Act 1985 regulate dealings with
corporate share capital.1These are commonly thought to be unduly complex,2and
to lack coherence.3Some have questioned whether their existence is justified.4The
provisions have been identified as a ‘key issue’ for reform under the ongoing
Company Law Review.5This article seeks to elucidate the function of these rules,
and to investigate their role – if any – in a ‘modern company law’.
A common rationalisation of the share capital provisions is that they protect
corporate creditors from the abuse of limited liability by shareholders.6The idea
that creditors need such protection is of course used to explain a wide range of
company and insolvency law doctrines. Yet a principle of ‘creditor protection’ per
se tells us little about the extent to which such rules are required. By itself, it fails
to have regard to the consequences for other stakeholder groups, or the economy
more generally.
ßThe Modern Law Review Limited 2000 (MLR 63:3, May). Published by Blackwell Publishers,
108 Cowley Road, Oxford OX4 1JF and 350 Main Street, Malden, MA 02148, USA. 355
* School of Law, University of Nottingham and ESRC Centre for Business Research, University of
Cambridge.
I thank Brian Cheffins, Simon Deakin, Eilı´s Ferran, Dan Prentice, Chris Riley, Adrian Walters and two
anonymous referees for helpful comments and suggestions on earlier versions. I am also grateful for
comments received following presentations to the SPTL’s Company Law Section at the annual conference
in Leeds, September 1999, and to a University of Cambridge Centre for Corporate and Commercial Law
Seminar in November 1999. The usual disclaimers apply.
1 Companies Act 1985, Parts IV, V and VIII.
2 eg L.S. Sealy, Company Law and Commercial Reality (London: Sweet & Maxwell, 1984) 8–16; J.H.
Farrar and B.M. Hannigan, Farrar’s Company Law, 4th ed (London: Butterworths, 1998) 180.
3egRe Scandinavian Bank Group plc [1988] Ch 87, 101 per Harman J.
4 B.R. Cheffins, Company Law: Theory, Structure and Operation (Oxford: OUP, 1997) 528–533. See
generally B. Manning, Legal Capital, 2nd ed (Mineola, NY: Foundation Press, 1982).
5 Department of Trade and Industry, Modern Company Law for a Competitive Economy (London: DTI
1998) 6; Company Law Review Steering Group, The Strategic Framework (London: DTI, 1999) 19.
6 eg Company Law Review Steering Group, Company Formation and Capital Maintenance (London:
DTI, 1999) 22.
Economic analysis offers a way of making questions involving difficult trade-
offs, such as the extent to which creditors should be protected, more tractable. This
mode of reasoning has become increasingly prominent in UK company law
debates, informing a number of academic contributions,7and even featuring in a
recent Consultation Paper by the Law Commissions.8Furthermore, the Company
Law Review Steering Group (CLRSG)’s Strategic Framework document expresses
a commitment to ‘competitiveness’ and ‘efficiency’, and promises reforms that
will ‘maximise wealth and welfare as a whole’.9In the wake of these
developments, the present enquiry asks what light economic analysis can shed
on the following question: to what extent should the law relating to share capital
seek to protect creditors?
The content is structured as follows. The opening section develops an evaluative
framework, building on the ‘goals’ set out in the Strategic Framework. This is
applied in the next three sections, which investigate respectively: (i) how laws
which ‘protect’ creditors might – in theory – enhance efficiency; (ii) how the law
relating to share capital can be seen as a means of protecting creditors; and (iii)
whether the current law is in fact likely to enhance efficiency. It then concludes
with some general observations about the CLRSG’s preliminary suggestions for
reform. At the outset, it should be emphasised that the continuing evolution of the
Company Law Review, along with a relatively limited academic literature on share
capital,10 imply that this contribution is only preliminary.
The goals of a modern company law
The starting-point for the analysis is taken from the three ‘guiding principles’ for
the reform of company law, set out in the Strategic Framework document.11 The
first is entitled ‘facilitation of transactions’, and intones that a key role for law in
the corporate arena is the support and enhancement of market-led contractual
solutions. The Review adopts a ‘presumption against prescription’, suggesting that
the merit of regulation must henceforth be demonstrated in terms of its ‘costs and
benefits’.12 The second guiding principle is entitled ‘accessibility: ease of use and
identification of the law’.13 Its aim is that the law should entail ‘minimum
complexity and maximum accessibility.’ The third principle suggests that the
allocation of responsibility for enforcement of a particular rule be chosen with
sensitivity.14
These guiding principles are presumably intended to provide a basic
methodology for the assessment of current company law and the development of
7 For an overview, see B.R. Cheffins, ‘Using Theory to Study Law: A Company Law Perspective’,
(1999) 58 CLJ 197, and sources cited therein.
8 The Law Commissions, Company Directors: Regulating Conflicts of Interests and Formulating a
Statement of Duties, LCCP 153, SLCDP 105 (London: TSO, 1998) Part III. See also The Law
Commissions, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of
Duties, Law Com 261, Scot Law Com 173 (London: TSO, 1999) 13–31.
9 n 5 above, 8–9.
10 Outstanding exceptions include E. Ferran, Company Law and Corporate Finance (Oxford: OUP,
1999) 279–454, and in the US context, Manning, n 4 above. From an economic perspective, see G.P.
Miller, ‘Das Kapital: Solvency Regulation of the American Business Enterprise’, University of
Chicago Working Paper in Law & Economics (2d) No 32, April 1995; Cheffins, n 4 above, 521–537.
11 n 5 above, 15–17.
12 ibid 16.
13 ibid.
14 ibid 17. The third principle is accorded considerably less detailed treatment than the first two.
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