Law of Business Organization Capital Maintenance Doctrine

Question: Discuss about the Law of Business Organizationfor Capital Maintenance Doctrine. Answer: The Capital Maintenance Doctrine The capital maintenance doctrine signifies that a limited company is required to keep its capital reserve intact in the best interest of the creditors of the company. The creditors contribute to the capital reserve of the company and their contribution indicates the fact that they are entitled to the repayment of that capital. The reduction in the company capital can reduce the liability of the members and subsequently, the position of the creditors is at risk. The retaining of the capital by the company acts as a guarantee that the creditors shall not be prejudiced. The origin of the doctrine can be traced back in the 19th century. The doctrine was embedded in England and has been enacted through the Companies Act 1985 that has been modified in the Company Act 2006. The Australian legislation has many similarities with the legal framework of several nations such as The United States and The United Kingdom. The capital maintenance doctrine was adopted in the Australian Corporate law after being influenced by the universal application of the principle in the legislation of overseas nations. The doctrine was established in the landmark case of Trevor v. Whitworth where the company bought its own shares and at the time of liquidation of the company, one of its shareholders approached the court for the amount he owed to the company. The court established the rule that the shareholder must be paid and that a company is not permitted to buy its own shares. It was further held in the Aveling Barfords case that when a company winds up, the shareholders of a company should be paid after the payment of the creditors. The capital maintenance rules stipulates: capital reduction; financial assistance; share buy-backs; dividends. The Company Act 2006 states that a company making distributions out of its capital reserves is unlawful. The capital maintenance rules have been incorporated in the Corporations Act 2001 under section 256 A that enables a company to reduce its share capital and buy-back the shares in the best interests of the creditors and the shareholders of the company. The Act stipulates that a company must address any risks involved in its transactions and disclose before the creditors all relevant information to retain a fair balance between the company and its shareholders. The statutory provisions relating to the doctrine have been reformed in the year 1980 in the UK to meet the modern business necessities. The provisions were relaxed to the extent that the company was permitted to buy back or redeem its own shares. In 1998, Australia, the Corporation Act 2001 relaxed the capital maintenance rules under section 256 B where the company was allowed to reduce its capital with due authorization of law. Section 257 A enables the court to buy-back its own shares after the approval of the shareholder and ensuring that the company is able to make payments to its creditors. However, the capital maintenance rules have been subjected to criticisms as it involves time-consuming processes and is expensive. The capital maintenance regime requires further modifications to provide more effective creditor protection.