Capital reduction refers to the process by which a company decreases its share capital, either by cancelling shares or by repurchasing them. This strategic move can be driven by various motivations, such as optimising the capital structure, returning surplus funds to shareholders, or eliminating accumulated losses.

Legal Framework in Hong Kong

The Companies Ordinance (Cap. 622) governs capital reduction in Hong Kong.

Both private companies limited by shares (LTD) and public limited companies (PLC) follow the procedures outlined in this ordinance.

Typically, the procedures involve obtaining board approval, holding a shareholder general meeting, filing relevant documentation with the Registrar of Companies, and ensuring solvency compliance.

Introduced in 2014, the company-led court-free process simplifies capital reduction by removing the requirement for an authorised capital, aligning Hong Kong with global trends seen in jurisdictions like the UK and Australia.

Types of Capital Reduction in Hong Kong

There are 2 options for companies in Hong Kong to reduce their share capital: the court-free method and the court-sanctioned method.

Court-Free Method

The court-free method is preferred for its speed and cost-effectiveness. However, it can only be used if the company is solvent, there are no creditor objections, and the reduction meets the criteria.

• Company Solvency: The company must be solvent, capable of paying its debts as they fall due. Directors need to provide a written solvency statement confirming this.
• No Creditor Objections: Creditors must not object to the reduction. If objections arise, the court-sanctioned method becomes necessary.
• Reduction Criteria Met: The reduction must comply with the criteria outlined in the Companies Ordinance (Cap. 622), including not leaving only redeemable shares and ensuring fairness and equity to all shareholders.

Steps in Court-Free Method

The main steps involved in the court-free procedure for reducing capital, as outlined under the Companies Ordinance are as follows:

1. All directors must sign a solvency statement on Form NSC17 to support the proposed capital reduction (section 216).
2. The company must pass a special resolution within 15 days after the solvency statement is signed (sections 215 to 217) and submit this special resolution to the Registrar of Companies within 15 days for official registration.
3. The company is required to publish a notice with the relevant details in the Gazette and either publish a similar notice in a newspaper or directly notify creditors in writing. These notices must be issued within the statutory deadlines. The Form NSC17 must also be submitted to the Registrar no later than the day when the Gazette notice, the creditors’ notice, or the written notice to creditors is issued, whichever occurs first (section 218).
4. Creditors or members who did not approve the resolution have the right to apply to the court to cancel the resolution within five weeks after it has been passed (sections 220 to 222).
5. If no court application is made, the company must file a return of the capital reduction using Form NSC19 with the Registrar after the five-week period but within seven weeks (section 224). If a court order is required, this must be filed within 15 days after the court confirms the resolution or the legal proceedings conclude without a decision from the court (section 225).
6. The reduction in share capital becomes effective once Form NSC19 is registered by the Registrar (section 215).

Court-Sanctioned Method

This method is employed when the court-free method can not be applied. It involves a court application and is necessary under certain conditions:

• Insolvency: If the company is not solvent, a court order can still facilitate capital reduction.
• Creditor Objections: If creditors object to the court-free method, the court-sanctioned method allows for judicial review and potential approval with adjustments.
• Complex Scenarios: For reductions involving intricate details or conflicts with shareholder rights, court oversight might be required.

Steps in the Court-Sanctioned Method

1. Preparation of Petition
   • Prepare a petition outlining the reasons for reduction and seeking court approval.
2. Court Hearing
   • Present the case at a hearing where objecting parties can also present their arguments. The court decides whether to approve the reduction.
3. Order from the Court
   • If approved, the court issues an order specifying the reduction details.
4. Finalisation with Registrar of Companies
   • File the court order and other required documents with the Registrar of Companies for registration.

Reasons for Capital Reduction

There are several reasons why reducing share capital might be useful.

Optimising Capital Structure: Reducing excess capital can enhance financial efficiency by streamlining the company’s capital structure.

Returning Capital to Shareholders: Surplus capital or distributable reserves can be returned to shareholders, often more tax-efficient than paying dividends.

Eliminating Accumulated Losses: Capital reduction can clean up a company’s balance sheet by eliminating accumulated losses, facilitating future dividend payments.

Enhancing Shareholder Value: Capital reduction can boost share value and positively influence market perception.

Additional Benefits

• Reduces running costs as certain fees are calculated on the total shareholding.
• Can simplify complex capital structures, making the company more appealing to investors.
• Acts as a signal of confidence in the company’s future prospects.

However, capital reduction must be carefully managed to avoid adverse effects, such as negative market perception or complications with creditors.

HKWJ Tax Law can help

In summary, capital reduction is a vital tool for companies looking to optimise their capital structure, return surplus funds to shareholders, or eliminate accumulated losses.

The choice between the court-free and court-sanctioned methods depends on the company’s solvency and specific circumstances.

Strategic planning and professional advice are crucial for successful capital reduction.

For tailored advice on capital reduction and other corporate finance matters, contact our experts at HKWJ Tax Law and Partners.

We will guide you through the legal and procedural complexities, ensuring your company’s financial health and stability.