For private limited companies, the ability to buy back their own shares (whether for cancellation or to be held in ‘treasury’) is an extremely useful way to either structure an exit for a shareholder leaving the business or to return value to one or more shareholders.
However, the statutory requirements which must be followed to validly buy back shares are strict, which can cause significant problems for the unwary.
The Companies Act 2006
Under the Companies Act 2006 (the 2006 Act), some of the key requirements for an off-market buyback of shares are:
- The purchase price must be paid in full at completion (it is not possible to buy back shares and agree to pay any part of the consideration at a later date).
- The purchase price must be paid out of either:
- the company’s ‘distributable profits’ – i.e. monies which could otherwise have lawfully been used by the company to pay a dividend; or
- the proceeds of a fresh issue of shares made for the purposes of financing the buyback.
(There is a separate, more complicated, procedure for buying back shares out of capital, which is rarely used and is outside the scope of this article.)
- The buyback must be documented in a written agreement.
- The terms of the written agreement must be approved by a resolution of the company’s shareholders before it is entered into. This can be passed either at a general meeting, or by written resolution.
Failure to comply with the Companies Act 2006
Failure to comply with many of the 2006 Act requirements will result in:
- the acquisition being void; and
- an offence being committed by the company and every officer in default. (An officer in default is liable to a prison term of up to two years or an unlimited fine, or both.)
This is compounded by the fact that although many of the provisions of the 2006 Act are quite flexible and, where processes aren’t followed to the letter it is often quite straightforward to ratify things, there is no mechanism to ratify a defective share buyback.
An apparently minor failure to follow the 2006 Act requirements to the letter can therefore result in a very messy situation. Shares that everyone had assumed to be cancelled can turn out to still be in existence. As a result, the payment made by the Company for the shares turns out to be a loan which may need to be repaid by the shareholder.
Issues with an Invalid Share Buyback
Where an invalid buyback is not identified for some time, this can also give rise to further issues, including:
- The potential invalidity of shareholder resolutions (where the votes attaching to the shares which everyone assumed had been bought back were required to pass the relevant resolutions).
- Dividend payments not being made to the right people.
- A buyer of the shares in a company not acquiring 100% of the issued share capital (which can in turn give rise to contractual claims by that buyer against the selling shareholders).
- Tax returns being incorrectly completed (which can in turn lead to HMRC claims for penalties and interest on unpaid tax).
It is often the case that problems with buybacks are only picked up as part of a legal due diligence exercise undertaken by a buyer at the point a company is being sold. In this situation, the discovery of a defective buyback clearly has the potential to adversely impact the sale price, the timing of the transaction and possibly even the viability of the sale.
Approaching a Share Buyback
There is a temptation for directors to view a share buyback as a straightforward administrative matter and adopt a ‘D.I.Y.’ approach. However, the potential problems caused by getting it wrong mean that this is, at best, a false economy and, at worst, capable of completely derailing a company and leaving its directors liable for criminal offences. The only sensible approach is for directors to take legal advice at an early stage to make sure that no-one involved needs to spend time looking over their shoulder afterwards.
BHW’s Corporate and Commercial team have extensive experience of all kinds of share buybacks and other returns of value to shareholders. For further information, contact Stephen McElhone on 0116 281 6237 or email email@example.com.
Categorised in: Corporate and Commercial, NewsTags: Commercial Agreements, Commercial Law, Company Law, Share buyback