Shareholders and Share Capital for SQE1

Business Law and Practice > Shareholders and Share Capital

Most students confuse unfair prejudice with derivative claims and lose 40% of the marks. The difference is stark: one remedy targets wrongs to you personally; the other targets wrongs to the company itself. Master this distinction, and you've cracked the highest-scoring section of shareholder law in SQE1.

What are Shareholders and Share Capital in SQE1?

A shareholder (member) holds shares in the company. Shares represent proportionate ownership and confer rights and obligations. Share capital is the total nominal value of issued shares. Capital maintenance rules protect creditors by restricting how and when capital can be returned to shareholders.

SQE1 tests:

• The nature and scope of shareholder rights
• Limitations on return of capital
• Remedies for unfair treatment (unfair prejudice, derivative claims, winding up)
• Pre-emption rights and allotment procedures
• Dividend rules

Key Principles for SQE1

• Share rights: A share is a bundle of rights:

• Voting right - right to vote at shareholder meetings (usually one vote per share unless articles provide otherwise)

• Dividend right - right to a share of declared profits (not automatic; depends on articles and availability of profits)

• Return of capital - right to a share of remaining assets on winding up (after creditors paid)

• Right to information - right to financial statements and other company information

• Classes of shares: Companies may issue different share classes with different rights. Common classes:

• Ordinary shares - full voting and dividend rights; the default

• Preference shares - preferential dividend (fixed rate) and return of capital, but often reduced or no voting rights

• Redeemable shares - shares the company can buy back at its option

• Allotment of shares (s.549 CA 2006): Directors need authorisation (by articles or shareholder resolution) to allot shares. Without authorisation, allotment is void. Authorisation typically states: which directors can allot, maximum number, and term (up to 5 years usually).

• Pre-emption rights (s.561 CA 2006): When shares are allotted for cash, existing shareholders have a right of pre-emption: they must be offered new shares pro-rata before they can be offered to outsiders. Pre-emption protects against dilution. Shareholders can waive pre-emption (by ordinary resolution) or the company's articles may exclude it.

• Issue at discount (s.580 CA 2006): Shares must not be issued at less than their nominal value (par value). Issuing at discount is unlawful and unenforceable. This is a capital maintenance rule protecting creditors.

• Capital maintenance doctrine: The company cannot return capital to shareholders except through:

• Dividends (from distributable profits)

• Reduction of capital (with special resolution and court/solvency statement)

• Redemption/repurchase (from distributable profits or capital, subject to requirements)

The company cannot simply pay back capital willy-nilly. This protects creditors who rely on capital as security.

• Distributable profits (s.830 CA 2006): A company can only pay dividends from accumulated, realised profits less accumulated losses. The test is quantitative: are there profits available? Dividends must be paid from accounts and approved by directors. Payment of dividends from capital is unlawful.

• Reduction of share capital (ss.641-644 CA 2006): The company may reduce capital by special resolution (75% shareholder approval) if:

• Court approves (expensive and slow), OR

• Directors make a solvency statement (quicker: statement that company will remain able to pay debts for 12 months post-reduction)

• Unfair prejudice remedy (s.994 CA 2006): A member can apply to court for relief if the company's affairs are being or have been conducted in a manner unfairly prejudicial to their interests as member. Common scenarios: exclusion from management, denial of dividends, disproportionate share dilution, oppressive conduct.

The court has broad powers: order share purchase, dividend declaration, director removal, or wind up the company. The test is whether the member's legitimate expectations as shareholder have been violated.

• Derivative claim (ss.260-264 CA 2006): A shareholder can sue on behalf of the company for wrongs done to the company (not the shareholder personally). Common scenarios: director breach of duty, misappropriation of assets, fraud. Permission to continue the claim requires: rational person would expect the company to pursue it, and it's not an abuse of process.

• Key distinction: Unfair prejudice vs derivative claim: Unfair prejudice is where the member is wronged (e.g., excluded from dividends). Derivative claim is where the company is wronged (e.g., director diverted an asset). This distinction is tested repeatedly in SQE1—get it wrong and the entire answer collapses. Examiners deliberately set scenarios where both claims could superficially apply; your job is to isolate which one actually fits.

• Just and equitable winding up (IA 1986, s.122(1)(g)): Court can wind up a company if it is just and equitable to do so. Common grounds: deadlock between members, loss of substratum (company's purpose impossible), breach of member's legitimate expectations. This overlaps with corporate insolvency law and is a remedy of last resort.

Exam tip

When you see a shareholder problem, first ask: Is the shareholder personally wronged or is the company wronged? If the shareholder lost money or was excluded, it is likely unfair prejudice. If assets left the company without authority (e.g., director theft), it is likely a derivative claim. This single question routes 90% of exam scenarios to the right answer.

How This Appears in SQE1 Questions

For example, a question might describe a minority shareholder who is excluded from the board and told no dividends will be paid, while majority shareholders take dividends. You'd analyse whether unfair prejudice applies (legitimate expectation of participation and dividends) and distinguish from a derivative claim (which would apply if the company itself suffered loss from director misappropriation).

SQE1 typically presents scenarios where:

• A minority shareholder is unfairly treated and seeks a remedy - which remedy? (Identify unfair prejudice or derivative claim)
• Share capital rules are breached (e.g., issue at discount, dividend from capital) - is it lawful?
• Pre-emption rights are overlooked - what is the effect?
• A director has misappropriated company funds - what remedy does the shareholder have? (Derivative claim)
• Members are deadlocked - can the company be wound up? (Just and equitable)

A critical trap: confusing unfair prejudice (s.994) with derivative claim (ss.260-264). Unfair prejudice is shareholder's personal grievance; derivative claim is on behalf of the company. The wrong scenario gives the wrong answer.

Another trap: assuming dividends can be paid from capital or from unrealised profits. Dividends must come from distributable (realised accumulated) profits.

You should also be aware of how company formation and the memorandum and articles define shareholder rights at the outset—understanding this context is essential for identifying when those rights have been breached or when remedies apply.

Common Mistakes Students Make

• Confusing unfair prejudice with derivative claims. Unfair prejudice is where the shareholder is wronged directly (wrong to shareholder). Derivative claim is where the company is wronged (wrong to company). Choose the correct remedy.
• Forgetting pre-emption rights. When shares are allotted for cash, pre-emption rights apply automatically (unless excluded by articles or waived). Breach allows shareholders to challenge.
• Assuming dividends can be paid from capital. Dividends must come from distributable (realised accumulated) profits. Paying dividends from capital breaches s.830.
• Overlooking just and equitable winding up. Where members are deadlocked or legitimate expectations are violated, winding up is a remedy.
• Misunderstanding share issue at discount. Shares cannot be issued below nominal value (par). This is a capital maintenance rule; breach is unlawful.

Quick Summary

• Unfair prejudice (s.994): member's personal grievance; derives from legitimate expectations (exclusion, dividend denial)
• Derivative claim (ss.260-264): shareholder sues on company's behalf for wrongs to company (director breach, misappropriation)
• Pre-emption rights (s.561): automatic when shares allotted for cash; can be waived by ordinary resolution
• Dividends (s.830): must come from distributable (realised, accumulated) profits; payment from capital is unlawful
• Capital maintenance: return of capital only via dividends, redemption/repurchase, or reduction (s.641-644)
• Just and equitable winding up: remedy for deadlock, loss of substratum, breach of legitimate expectations

Want to test this now? Try a few SQE1-style questions below before moving on.

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Related Topics

• SQE1 Business Law and Practice: Complete Guide
• Company Management and Decision-Making
• Directors' Duties and Liabilities
• Company Formation and Constitution
• Corporate Insolvency

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