Legal perspective - Establishing a statutory reserve for companies

All public joint stock companies are legally required to deduct 10 per cent of the net profits of the company to create a statutory reserve. This process should be followed each year.
However, the law gives the company the right to go for a higher ceiling provided this is provided for in the articles of association (AoA) of the company, Normally this takes place when the company is in need of more provisions to meet certain liabilities.

The general assembly could stop such deductions if the statutory reserves reach one-half of the paid-up capital of the company. According to the law, in case the statutory reserve reaches one-half, the company may not put additional money therein.

However, this particular money which should have been added to the statutory reserve should be identified in the company records so as to be distributed to shareholders in the years when the company does not achieve sufficient net profits to reach the rate specified in the AoA.

In certain companies, the AoA may provide for establishing a special "additional reserve" to be allocated for certain reasons and special purposes. Such reserves shall not be used or utilised for any reason whatsoever without a clear resolution from the ordinary general assembly.

The AoA of each company should specify the percentage of net profits to be distributed as dividends to all shareholders. However, dividends should not be distributed before deduction of the statutory reserves and the additional reserves.

Some companies are not allowed to distribute dividends before obtaining prior approval of certain competent authorities, because they should allocate certain provisions to meet certain obligations.

Each limited liability company shall allocate 10 per cent of its net profit each year to the statutory reserve. This process shall continue until such reserves reach half of the capital and, thereafter, the general assembly shall decide to give all accrued net profits to all partners.

A question could arise here, as to the reasons for establishing statutory reserves in companies, and not allowing shareholders/partners to rejoice by earning all the profits? One of main reasons for making the companies maintain reserves is to have money available at hand, in case the company decides to increase its capital.

The availability of the reserves plays a great role in taking any decision regarding increase in capital. Other reasons could be to have accessible money to meet contingent liabilities that could arise unexpectedly at any time during the life-span of the company.

A. Warsama Ghalib is legal advisor to the Central Bank. The views expressed above are his own.