Share Buyback Theory

BACKGROUND AND DEFINITION OF TERMS
Company being a going concern means that the company can foreseeably function without liquidation for a period of at least twelve months.
A creditor is one to whom money or its equivalence is owed by a company.
Insolvency is a situation where a company is unable to pay back all the money it owes; in this situation, the liabilities of a firm supersede the assets leading to the inability to pay debts.
MAINTENANCE OF CAPITAL RULE
The concept was outlined in Trevor v Whitworth where the concept of share buyback by companies was held to be ultra vires, in support of the maintenance rule. In this case Lord Herschell stated that “the capital may, no doubt, be diminished by expenditure upon and reasonably incidental

An example is in the case of Ridge Securities Ltd v IRC wherein a subsidiary company undertook to grant a debenture to the parent company. Among the terms of the debenture was that the parent company would receive all large sums of money in the form of interests. This was held to be ultra vires. Similarly, in the Re: Halt Garage case it was held that there were certain payments made to shareholders and directors as gifts or bonuses and as such could not be considered genuine payments and were therefore ultra vires the

In Kenya, creditors are protected by restrictive laws against payment of capital by shareholders in the following ways;
• The rule in Flitcroft’s case where dividends are only paid out of profits.
• The rule in Trevor v Whitworth where a company cannot buy back its own shares
• The fact that in general, court orders are required in order for capital to be reduced and also statute in pursuant to reduction of capital that provides that it can only be done through a special resolution.
• Prohibition of financial assistance by a company in acquisition of its own shares as was seen in Ridge Securities Ltd v IRC.
On the formation of a company, firms usually have the aim to take in investor’s capital, commit it into specific assets and then use the special knowledge and ability of the staff to convert these assets into goods and services that are likely to yield larger cash flows in future. By the very nature of a limited liability company, it declares in its memorandum that the companies’ capital should be applied for solely the purpose of the business and as such should not be watered