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Share buy-backs - Why and How

 

Why might a company buy its own shares?

 

The reasons are many and varied. They include:

• transferring surplus cash to shareholders after an asset sale;
• buying out a dissident shareholder;
• helping the remaining shareholders to retain control of the company if a shareholder wants to sell but the other shareholders do not have the funds to buy his shares;
• controlling the ownership of the shares owned by a director who is leaving the company – it may be simpler for the company to buy the shares than offering them to the other shareholders; and
• acquiring the shares issued to an employee under an employee share scheme when that employee leaves the company.

 

The basics

 

The Companies Act 2006 has simplified the law relating to companies buying their own shares, but it’s still not that simple.  This article reflects company law as it will stand when the final parts of the 2006 Act come into force on 1 October 2009.

 

Under section 658 of that Act, a limited company may not acquire its own shares unless it does so in accordance with the procedures laid down in Part 18 of the Act. If a company does not follow those procedures, the company and every officer of the company who is in default commits an offence and the purported acquisition of the shares will be void.

 

Things to think about

 

A privately owned company, not listed on a recognised investment exchange, buying its own shares will need to address the following issues: 

 

Do the company’s articles of association prohibit the company from buying its own shares?

 

A company may buy its own shares unless its articles specifically prohibit it from doing so.

Will there be at least one shareholder left?

 

A company may not buy its own shares if the result is that there will be no member of the company holding shares (other than redeemable shares or shares held in treasury).

 

Are the shares to be purchased fully paid?

 

If they are not, the company cannot buy them.

 

Will the shares be paid for on purchase?

 

If they are not, the company cannot buy them.

 

Funding the purchase

 

A private limited company may purchase its shares out of:

• the proceeds of a new issue of shares;
• distributable profits; or
• capital (i.e. any payment which is not made out of the proceeds of a new issue of shares or distributable profits).

 

The company may only buy its own shares out of capital after it has exhausted available profits and the proceeds of any new issue of shares made for the purposes of the purchase.

 

A company may not fund the purchase out of capital if its articles prohibit this.

 

The payment out of capital will be unlawful unless:

• the directors, taking account of all of the company’s liabilities make a statement specifying the amount of the permissible capital payment for the shares and that the company is solvent.
• the company’s auditor prepares a report which supports the directors’ statement.
• the payment out of capital is approved by a special resolution of the members;
• the company publishes:  a notice in the London Gazette alerting creditors to the fact that they may apply to the court for an order to prevent the payment; and a similar notice in an national newspaper, or gives written notice to each of its creditors;

• the company delivers a copy of the directors’ statement and auditor’s report to Companies House. 

 

The Companies Act 2006 lays down strict timescales for doing all this.

 

Have the shareholders authorised the contract for the purchase of the shares?

 

The terms of the contract must be authorised by a special resolution of the members.

 

Do the company’s articles or a shareholders’ agreement restrict the transfer of shares?

 

If there are restrictions in the articles or any in any shareholders’ agreement, these will need to be waived.

 

Application to court to cancel the resolution

 

A member of the company who has not consented to or voted in favour of the resolution, and any creditor of the company, may apply to the court for the cancellation of the resolution.

 

Potential liabilities of directors

 

If the company is wound up within a year after it purchased of the shares, the seller and any director who made the directors’ statement are liable to pay the liquidator of the company the amount paid by the company for the shares if:

• it was a payment out of capital; and
• it is necessary to discharge the company's liabilities and the costs of winding up.

 

A director may also be liable to compensate the company if:

• it suffers loss as a result of the use of its capital to buy the shares; and
• he failed to exercise reasonable care when making the directors’ statement.

 

Tax considerations

 

The purchase price will usually be divided into a capital element and a distribution element.

 

The company may be treated as having paid a cash dividend and the shareholder who sells his shares to the company may have to pay Capital Gains Tax.

 

Tax advice should be taken by both the company and the seller.

 

Contact Details

 

If you would like further advice about any of the issues considered above please contact

 Christine Reid on 01865 864195 or email her at christine.reid@northwoodreid.com.

 

Terms of Use

 

This article is not intended to be, and should not be taken as being, legal advice. The law often changes and it varies from jurisdiction to jurisdiction; the information in this article is generic in nature and specific legal advice should be taken before acting on any of it.

 

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