Corporate law solutionsprovides expert advice and a full documentation service for a company purchasing its own stock. In some cases a similar effect can be achieved by areduction of capitalwithout a court order.
It used to be completely forbidden for a company to buy its own shares. Now buybacks are allowed under quite restrictive and detailed rules.
The problem with companies buying their own stock is that if fully restricted, there is a risk that creditors (and potential creditors) will be misled as to the size of the company's capital. This is part of the broader realm of capital preservation. Under the Companies Act 2006 a new procedure for theCapital reduction without a court orderintroduced, which is sometimes used rather than a buyback.
This is a very technical area. The rules are set out in detail below, but a summary of them is:
- Common law companies were forbidden to buy their own shares: Trevor v. Whitworth (1887) 12 App Cas 409.
- Successive Companies Acts have allowed corporations to purchase their own stock in a variety of ways. The current legislation is in Part 18 of theCompanies Act 2006. These provisions have been modified byThe Companies Act 2006 (Amendment to Part 18) Regulations 2013 SI 999("the 2013 Regulations"). For purchases under one, the rules will be relaxed a bitemployee participation program.
- One possibility is that the company createsRedeemable Sharesand then redeem them. This has long been allowed, and redeemable preferred stock is common. The following financing rules apply to the return.
- A publicly traded company may buy its shares through the stock market if authorized to do so by an ordinary resolution of the general meeting. The following financing rules also apply here.
- Any company can have a 'Off-market purchase' Its shares by contract with one or more specified shareholders. The contract must be approved by an ordinary resolution of the general meeting. A special order was required under the original legislation, but this was amended by the 2013 regulations. The shares must be canceled upon purchase or, again under the 2013 Regulations, may be held as treasury shares. The following financing rules also apply to off-exchange purchases.
- Redemptions, market purchases and over-the-counter purchases are all subjectFunding Restrictionsredemption or purchase. These may come from either distributable profits (i.e. profits that could be distributed as dividends) or from the proceeds from the issuance of new shares. In both cases, the company's capital is retained. These were relaxed slightly by the 2013 regulations. Seeunder.
In addition, (only) a private company canpermitted capital payment' to finance a redemption or an over-the-counter purchase. All available winnings must be used first. The directors must issue a solvency statement which must be endorsed by the auditors and the payment must be authorized by special resolution and announced to creditors. Creditors and dissenting shareholders can object to this payment in court. The 2013 regulations relaxed the rules a bit when the payment is being made to fund an employee stock option buyback, as explainedunder. - Shares can be bought back under areduction of capital.
- Special rules may apply to an over-the-counter purchaseemployee participation program.
In practice, redeemable shares and over-the-counter purchases by private companies are fairly commonplace. The OTC purchase is useful when a director/stockholder of a successful private company retires and sells its shares, or as a means of buying out a dissenting stockholder. The purchase by the company is an alternative to the purchase by the other shareholders of the company. Over-the-counter buying is also used as part of some management buyouts and employee stock plans.
Caution is required when taxing the purchase price. HMRC may treat awards as a distribution and therefore subject to income tax and not as a capital gain unless certain requirements are met. Discussing these tax rules is beyond the scope of this database.
The legal regulations on return and buyback are explained in more detail below.
Redemption of Redeemable Shares
By CA 2006, sec684 - sec689 a company may issue shares of any class to be redeemed, at the company's or the shareholder's option, subject to the following conditions:
(1) Redeemable Shares may only be issued where the Company has other Shares which are not redeemable;
(2) Redeemable Shares cannot be redeemed until fully paid.
There are restrictions on how the redemption can be funded. These restrictions also apply to a company buying its own stock and are discussed in detail below.
Shares redeemed must be canceled upon redemption and the amount of the Company's issued capital (but not its authorized capital) will be reduced by the par value of the Shares.
Purchase of shares by a company
A company can buy all of its shares (regardless of whether they are marked as redeemable or not) according to CA 2006, sec690 - sec708. The purchase can be made via a market purchase (PLCs only) or an off-market purchase.
purchase at the market
A market purchase is a purchase of shares on the stock exchange and must be authorized by Ordinary Resolution, which may give general authority to purchase the Company's own shares or may be limited to shares of a particular class or description. The power of attorney can be unconditional or conditional. The power of attorney may not last longer than 18 months. It is common practice in many PLCs to have such a resolution passed at each general meeting.
Off-market purchase
This is any non-stock exchange purchase of Shares. This may include shares in an SPS purchased by means other than the market, or a buyback by a private company. The statutory provisions can be found in CA 2006, sec690 - 708.
Except where the purchase is in connection with an employee share purchase scheme under the Regulations 2013, an over the counter purchase may only be made if the terms of the purchase agreement are approved before the Company enters into the agreement by ordinary resolution. In most cases, this is done under a repurchase agreement, but it can also be done under a pre-approved “conditional purchase agreement”: an agreement that gives a company the right or obligation to acquire its own stock, subject to any conditions.
The member whose Shares are the subject of such a resolution approving the purchase may not exercise the votes attached to those Shares. However, the member may exercise all votes on all other shares if the resolution is passed at a meeting to vote by vote.
The resolution will not take effect until a copy of the proposed contract of sale or a written memorandum of its terms, if not in writing, is available for inspection by the members of the Company at the registered office for at least 15 days before the date of the meeting at which the decision is made, and in the assembly itself.
If a company has purchased its own shares, it must send a declaration (Form SH03) to the Registrar within 28 days stating the number and par value of those shares and the date they were purchased. Stamp duty is payable on this form where the consideration paid by the Company for the shares is £1,000 or more.
In the case of a partnership, the shares must be redeemed upon repurchase or held as treasury shares. In the event of a cancellation, the company must register another form, SH06, which contains a statement of capital. If held as treasury shares, the voting and dividend rights attached to the shares cannot be exercised (if at all) until the shares are sold.
The Company must keep a copy of any agreement to purchase its own shares, or a memorandum of its terms if not in writing, at its registered office for a period of 10 years. It must be made available for inspection by the members and, if it is a corporation, by any other person.
Financing the redemption or purchase of own shares
Subject to provisions allowing private companies to make payments out of capital in certain circumstances (see below), shares may only be redeemed or repurchased by a company out of the company's distributable profits or the proceeds of a reissue of shares for the purpose : CA 2006 sec692. The2013 regulationshas relaxed these rules slightly by allowing a capital payment not to exceed the lower of £15,000 or 5% of the company's share capital.
Allowable Capital Payments
When a private company repurchases stock or makes an over-the-counter purchase for its own stock, it typically funds the transaction out of distributable profits or the proceeds of a new share issue, but it is possible for a private company to use all or part of the payment for these purposes from the Capital if it conforms to CA 2006, sec709 - sec723. The payment is referred to as the "permitted principal payment" and may only be made after the profits available for distribution have been used. In some cases, the same effect can be achieved by aCapital reduction without a court order.
The capital payment process is as follows:
(1) The directors shall make a declaration of solvency that the directors, having fully considered the affairs and prospects of the company, have come to the opinion that, having made the payment, there is no reason which the company could insist on being unable to pay its pay debts and for the year after that date the Company will be able to continue in business and pay its debts as they come due.
(2) The affidavit must be accompanied by a report from the auditors stating that they have inquired about the circumstances of the company and that they are not aware of any indications that the statements made by the managing directors in the statement are inappropriate. This is not required if the purchase is part of a post-employee stock option plan2013 regulations.
(3) The proposed capital payment must be approved by special resolution within one week of the date of the affidavit. The affidavit and the auditor's report must be available for inspection at the meeting. The voting rights of the shares that are the subject of the special resolution cannot be exercised on the resolution.
(4) Within one week of the special resolution, the Company must announce payment in the London Gazette and either in a national newspaper or in writing to all creditors of the Company. This is not required if the purchase is part of an employee share scheme under the2013 regulations.
(6) The actual payment of the capital can only take place between five and seven weeks after the day of the special resolution.
Within five weeks of the special resolution, any member of the company (other than one who has consented or voted in favor of the resolution) and any creditor may petition the court to set aside the resolution. When hearing an application, the court has broad powers to confirm or set aside the order on such terms as it deems appropriate.
If the company is wound up within one year of a payment for shares from the capital and the assets are insufficient to pay the company's liabilities, the seller of the shares and the directors who have made the statutory declaration of solvency are bound until to the amount of the capital payment. A director may avoid liability by showing reasonable grounds for the opinion expressed in the affidavit.
Off-market purchase as part of an employee share scheme
To make it easier for companies thatEmployee Ownership SystemIn order to be able to buy back their shares if such an employee leaves the company, the government has relaxed the rules on share buybacks.The Companies Act 2006 (Amendment to Part 18) Regulations 2013 SI 999entered into force on April 30, 2013.
Changes only apply to employee share plans
1. Installment
CA 2006 sec691(2) provides that if a company purchases its own stock, the stock must be paid for at the time of purchase, thereby preventing an installment payment on a buyback. This provision has been amended so that it does not apply to a repurchase for the purpose of an employee stock option plan.
2. Authorizing a company to buy its own shares
The long-established rule for a company buying its own stock over the counter is that the terms of the repurchase must be approved by resolution (formerly special, now ordinary). Repurchases for the purposes of an employee share purchase plan continue to require such approval, but the resolution need not approve a specific transaction. It may be general or limited to a particular class or description of Shares and may (but need not) impose conditions. The resolution must set the maximum number of shares that may be purchased and the minimum and maximum prices to be paid (although these may be determined by reference to a formula and are not fixed amounts). The resolution must set a deadline that may not exceed five years. The resolution may be modified, revoked or renewed by a similar resolution.
3. Simplified capital payment procedure
The general rules are modified only slightly to fund an over-the-counter purchase of equity for the purposes of an employee stock option plan. Any distributable profit must first be used, the directors must submit a credit statement and the capital payment must be approved by special resolution. However, the rules are being relaxed in the sense that no supporting statement is required from the company's auditors and the proposed payment does not have to be announced in the Official Gazette and in a national newspaper or in writing to all creditors.
Corporate law solutionsprovides expert advice and a full documentation service to a company buying its own shares and to areduction of capitalwithout a court order.