[plus others categories not relevant for our purposes].
So from this we can take that a CIC limited by shares could lawfully issue shares to a defined class of persons provided they were already supporters or members or employees of the company.
So far so good. We then turn to look at the second obstacle. That derives from Financial Services and Markets Act 2000, specifically section 21 and the Financial Promotions Order 2005 made under it. This paternalistic piece of legislation is designed to prevent unscrupulous promoters of investments from taking advantage of unsophisticated investors by making it an offence to promote investments unless, either they have been approved by an FCA regulated advisor, or one of the exemptions applies. As we saw above, the issue of shares in a cooperative or community benefit society benefits from a complete exemption in Schedule 1 paragraph 14(3)(c). However, there is no such explicit exemption for shares in a community interest company. It is difficult to see a justification for this apparent disparity, since both legal formats are regulated and should have an asset lock in place, both formats are equally capable of being used to fulfil the social investment purpose.
So we must then turn to look at other possible exemptions that might be helpful in issuing shares to supporter members. The one which is likely to be most helpful is in Article 52. This applies to an offer of shares or debentures to an identified group of persons who, when the financial promotion is made might reasonably be regarded as having an existing and common interest with each other and the company.
Article 52 states—(1) “Common interest group”, in relation to a company, means an identified group of persons who at the time the communication is made might reasonably be regarded as having an existing and common interest with each other and that company in—
(a) the affairs of the company; and
(b) what is done with the proceeds arising from any investment to which the communication relates.
(2) If the requirements of paragraphs (3) and either (4) or (5) are met, the financial promotion restriction does not apply to any communication which—
(a) is a non-real time communication or a solicited real time communication [a real time communication is defined as a ‘personal visit, telephone conversation or other interactive dialogue’];
(b) is made only to persons who are members of a common interest group of a company, or may reasonably be regarded as directed only at such persons; and
(c) relates to investments falling within paragraph 14 or 15 of Schedule 1 which are issued, or to be issued, by that company [which includes the issue of shares in a corporation].
The relevant conditions in paragraphs (3), (4) and (5) can be summarised as follows:
(3) the communication must be accompanied by an indication—
(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that every statement of fact or opinion included in the communication is true and not misleading given the form and context in which it appears;
(b) that the directors of the company (or its promoters named in the communication) have not limited their liability with respect to the communication; and
(c) that any person who is in any doubt about the investment to which the communication relates should consult an authorised person specialising in advising on investments of the kind in question.
(4) The requirements of this paragraph are that the communication is accompanied by an indication—
(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that any person belonging to the common interest group (and his professional advisers) can have access, at all reasonable times, to all the information that he or they would reasonably require, and reasonably expect to find, for the purpose of making an informed assessment of the assets and liabilities, financial position, profits and losses and prospects of the company and of the rights attaching to the investments in question; and
(b) describing the means by which such information can be accessed [e.g. on a website]
(5) The requirements of this paragraph are that the communication is accompanied by an indication that any person considering subscribing for the investments in question should regard any subscription as made primarily to assist the furtherance of the company’s objectives (other than any purely financial objectives) and only secondarily, if at all, as an investment. [emphasis added].
Furthermore the communication must satisfy additional criteria:
The communication must accompanied by an indication that:
– it is directed at persons who are members of the common interest group and that any investment or activity to which it relates is available only to such persons;
– that it must not be acted upon by persons who are not members of the common interest group;
– proper systems and procedures are in place to prevent recipients other than members of the common interest group engaging in the investment activity to which the communication relates with the person directing the communication, a close relative of his or a member of the same group
Paragraph 8 further restricts the definition of a common interest group for the avoidance of doubt: Persons are not to be regarded as being in a common interest group just because
(a) they will have such an interest if they become members or creditors of the company;
(b) they all carry on a particular trade or profession; or
(c) they are persons with whom the company has an existing business relationship, whether by being its clients, customers, contractors, suppliers or otherwise.
From this we can take it that, subject to complying the various formalities outlined above, the CIC could proceed to issue shares to a group of people who already have some form of engagement or commitment to a common cause. There is of course quite an onerous responsibility on the board of directors to comply with the specific requirements. We return to this point below.
The third obstacle is then how could the attractiveness of the ‘withdrawable share capital’, which is unique to cooperatives and community benefit societies, be replicated? This allows investors to ask for their original stake back. Controls normally exist in the governing document to stop all investors withdrawing at once and for the board to set limits and timetable for withdrawals. Company law does not have an exact equivalent to this concept, however, its nearest equivalent would be ‘redeemable shares’. Section 684 of the Companies Act allows a private limited company to issue redeemable shares, unless its Articles of Association provide otherwise. The shares can be redeemed by the company at their nominal value (i.e. the amount paid for them, rather than the market value) at some stated future date. It would be possible for the Articles to set out the mechanism for determining this date at the board’s discretion. Model Article 22 for private limited companies contains helpful wording: “The company may issue shares which are to be redeemed, or are liable to be redeemed at the option of the company or the holder, and the directors may determine the terms, conditions and manner of redemption of any such shares.” There are two conditions which must be satisfied (a) there must normally be sufficient distributable profits to make the redemption. (This is calculated by net realisable profits less net realisable losses – usually found in the retained profit line in the balance sheet); (b) there must be at least one share in issue which is not redeemable to ensure the entire capital is not redeemed leaving no shareholders. In theory, a payment out of capital would also be possible under section 709 and 713 of the Companies Act 2006, however in practice the need to have a directors’ statement of solvency, obtain an auditor’s report, and pass a resolution of the members and advertise the proposal would make this a complicated and expensive process.
Once redeemed the shares are cancelled and cease to exist. Article 33 of the Model Articles for a CIC limited by shares (with power to pay dividends) states:
“Purchase of Own Shares: Subject to the articles, the Company may purchase its own shares (including any redeemable shares) and may make a payment in respect of the redemption or purchase of its own shares otherwise than out of the distributable profits of the Company or the proceeds of a fresh issue of shares. Any share so purchased shall be purchased at its nominal value.”
So CICs are able to issue redeemable shares, provided that the amount of redemption does not exceed the amount paid for them at the outset (Regulation 24 of the CIC Regulations 2005). This is to stop capital and profits being siphoned off in contravention of the statutory asset lock provisions.
How does this compare with the position for cooperatives and community benefit societies? Coops and community benefit societies do not have the same formal statutory restriction on repaying shareholders only from distributable profits, however in practice the same constraint is likely to apply, since a prudent board could only sanction repayment if there was sufficient accumulated reserves and working capital to make the payment. A second difference is that cooperatives and community benefit societies are allowed to pay interest on share capital at whatever rate which is reasonable to attract investment (which is a more subjective judgment), whereas CICs have an absolute cap of 35% of distributable profits.
Thirdly, cooperatives and societies can treat interest paid on their share capital as a deductible expense against any corporation tax liability, whereas dividends paid by a CIC will have to come out of post corporation tax surpluses.
A further wrinkle – the requirement for a prospectus?
Section 85 of the Financial Services and Markets Act 2000 states:
“It is unlawful for transferable securities to which this subsection applies to be offered to the public in the United Kingdom unless an approved prospectus has been made available to the public before the offer is made.”
Contravention is punishable by a prison sentence or fine and can give rise to claims for damages by persons who suffer loss. If the Articles of the CIC or the Rules of a CIC permit the shares to be transferred from one person to another (which may not actually be necessary), this prohibition could apply. Most withdrawable shares in societies are expressed in their rules to be non-transferable so the problem does not arise. However, Section 85 (5) goes on to say that the prohibition does not apply to securities listed in Schedule 11A. In Schedule 11A we find exemptions for a charity, registered housing association, a community benefit society (but not a cooperative) registered under the 2014 Act, a pre-existing old style industrial and provident society and “(e) a non-profit making association or body recognised by an EEA State with objectives similar to those of a body falling within [any of the other categories]”. Perhaps unhelpfully, there is no specific reference to a community interest company, but it would be reasonable to describe a community interest company as a non-profit making body falling within (e) since its core purpose is not to maximise profit, but to serve a community purpose. Alternatively, Section 86 (1)(b) may help: it states that the prohibition does not apply if the offer is made to or directed at fewer than 150 persons or is for an amount less than 100,000 euros (currently £70,688).
A possible route for CICs to issue community shares?
Some commentators have suggested extreme measures, such as winding up the CIC and transferring assets into a community benefit society, or setting up a community benefit society alongside the CIC as a subsidiary or holding company in order to facilitate a community share offer using a CIC. All these artificial routes entail additional costs and complexity which most community groups could do without, frankly.
Taking into account all of the above, I would like to suggest a scenario which could be used for a CIC to issue community shares (though this comes with a health warning that it is untested and unproven). A group intending to raise funds from the community using a CIC format could proceed as follows:
– Set up an unlimited company – this is a body corporate, but does not benefit from limited liability status. It could be used to assemble and organise a body of supporters who will later become investors.
– Recruit supporter members to this unlimited company
– Once the membership drive is complete, re-register the unlimited company as a private company limited by shares and community interest company
– Proceed to offer and issue shares to the existing membership who are then within the common interest exemption, being careful to comply with the requirements about the communications with investors and making suitable background documents available to enable investors to reach an informed view.
Creating legal certainty
Looking to the longer term, it would be immensely helpful if the Cabinet Office and legislators introduced specific exemptions to create legal certainty in this area: (a) An ‘offer of shares to the public’ in section 755 of the Companies Act could specifically exclude share offers by any community interest company for community benefit; (b) the Financial Promotions Order 2005, Schedule 1 paragraph 14(3) could include an additional exemption for ‘Offer of securities by a community interest company for community benefit’; and (c) the Financial Services and Market Act Schedule 11A, paragraph 7 could usefully include an explicit exemption for prospectuses for a ‘community interest company’.
I am happy to be shot down in flames on these proposals, but I offer them up to advance debate in this area!
Mark Johnson is an experienced solicitor and company secretary helping social enterprises, charities and SMEs to flourish. His company Elderflower Legal advises on the development of successful community and social enterprises. This article is intended for general guidance and to stimulate debate on the topic. We are not responsible for action taken in reliance on this post unless you have a professional retainer with us.