Last week, in part one, we discussed the meaning of share premium, the various ways a company may use share premium and its importance when determining the assessable capital of a company.

Today, we will discuss contributed surplus, another frequently misunderstood concept which is distinct from and is not to be confused with share premium.

Contributed surplus is defined under section 54(2) of the Companies Act 1981, as amended, as including “proceeds arising from donated shares, credits resulting from redemption or conversion of shares at less than the amount set up as nominal capital and donations of cash and other assets of the company”.

On the balance sheet of a company, contributed surplus appears as a separate line entry on the equity side of the balance sheet and is a quasi-equity account.

Contributed surplus differs from share premium in a number of material ways, including that (i) it is gratuitous in nature; (ii) it does not count towards the determination of a company’s assessable capital; and (iii) a company can make distributions out of its contributed surplus account that do not offend the capital maintenance rules.

Contributed surplus is a gift to the company that could be in the form of cash or other assets. The distinguishing feature is that the company does not issue shares in exchange for the contribution. Remarkably, the Companies Act is permissive; a person who is not a shareholder can make a contribution to any company.

Further, contributed surplus does not count in the determination of a company’s assessable capital, which is used to calculate the annual government fee that a company is required to pay to the Bermuda Registrar of Companies.

Finally, the contributed surplus account may be used to make a distribution, provided the company can satisfy the “solvency test” and “net asset test” as set out in section 54 of the Companies Act.

Therefore, unlike with a statutory reduction of share premium that requires, amongst other things, a legal notice to be published and shareholder consent, a company does not need to be concerned that it will be in breach of certain capital maintenance rules when utilising assets recorded in the company’s contributed surplus account.

In addition to making a distribution from its contributed surplus account to its shareholders, it is common for companies to use a contributed surplus account to off-set debt owing to its shareholders or to grant loans to its subsidiaries.

It must be underscored that a shareholder does not have a right to claim the money that has been credited to the contributed surplus account, notwithstanding that he or she may have donated any portion or all of the assets in the account.

To ensure the contributed surplus account is accurate, companies should pass a resolution approving distributions from its contributed surplus account as well as acknowledging receipt of the funds constituting contributed surplus.

While there is no statutory requirement to do so, in practice, as a matter of good corporate governance it is prudent to ensure amounts constituting contributed surplus are properly recorded and to expressly distinguish that the contribution is not for a subscription of shares.

Companies have a legal responsibility to ensure the contributed surplus account is accurate or they could face financial penalties.

Therefore, if in any doubt, please obtain legal advice on the proper characterisation and any steps required to record, reduce or distribute monies from the contributed surplus account of the company.

Associate Ashley Bento is a member of Appleby’s Corporate department. A copy of this column can be obtained on the Appleby website at www.applebyglobal.com.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.