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Share Buybacks – When Are They Void?
A share buyback (a process whereby shares in a company are bought by the company itself and cancelled) is a popular and relatively less-complex way for companies to provide an exit route for, or return surplus cash to, its shareholders. Whilst the law and procedure for carrying out a share buyback is quite clear and straightforward, we have dealt with a number of instances where the validity of a share buyback has been questioned and further action required to be taken in order to ratify the validity of a buyback transaction.
The law setting out the required procedure for a valid buyback is set out in Part 18 of the Companies Act 2006 (the Act). Whilst the requirements are fairly easy to follow, there are a number of provisions which, if not followed correctly, can call the validity of the buyback into question:
- Buybacks not permitted under the company’s articles association – Whilst there is no requirement under the Act for a company to be authorised to carry out share buybacks under its articles, difficulty may arise if a company is specifically prohibited from carrying them out. Prior to carrying out a buyback, it is therefore important to check if the company is restricted from carrying it out and, if so, ensure that a suitable resolution of the shareholders is passed to remove the relevant provision from the company’s articles.
- Purchase price not paid from distributable profits – A company may fund the purchase price for a buyback from its capital reserves. The process for this is fairly complex and lengthy, and involves the company’s directors signing solvency statements to confirm that the buyback will not affect its ability to pay its debts. The most popular way of funding a share buyback is through a company’s distributable profits. We have come across numerous instances where, whilst a buyback was intended to be carried out, the company at the time did not have sufficient reserves (occasionally funding the buyback from its free cash or, more frequently, by way of third party loan) meaning that this requirement was not met and the buyback called into question. It is therefore important that a company’s accountants are called into play early on to confirm that the company does indeed have sufficient reserves (note that the Act does allow small buybacks to be made from cash, rather than reserves, up to £15,000 provided that the company is specifically authorised to do so in its articles of association)
- Buybacks not paid for in full at time of cancellation – One of the most common and serious defects that we find is when a company agrees to pay the purchase price on deferred terms (i.e. some time after the buyback date). Due to the rules on capital maintenance, attempting to carry out a buyback on any terms where the purchase price, or any part of it, is satisfied after-the-event, will automatically invalidate the entire buyback. In such instances, the buyback will not have taken place, and the company is therefore left with an unwanted shareholder. There is no ideal way of rectifying such a transaction, other than to effect the buyback again, on terms which satisfy the Act.
- Approval of shareholders not obtained – Whilst a buyback will normally have been agreed in principle between the company’s shareholders, a formal resolution of the shareholders (either a written resolution or a resolution passed at general meeting) must also be passed to approve the terms of the contract setting out the terms on which the buyback is to take effect. Occasionally, whilst we find that other requirements of the Act have been complied with, a resolution of the shareholders has not been obtained. This, again, will have the potential to void a share buyback, although in some circumstances and depending on all of the parties being willing and able to sign, it may be possible to pass a resolution to approve the buyback and authorise it retrospectively.
- Post-completion formalities not complied with – Once a buyback has completed, there are a number of formalities under the Act which must be adhered to. Stamp duty must be paid on the consideration (0.5%) and forms SH03 and SH06 filed with Companies House, together with a copy of the shareholders resolution authorising the buyback. Whilst failing to comply with these post-completion requirements will not in itself void a share buyback, it will mean that the company and its directors will be committing an offence. Failure to check the historical records at Companies House and the company books/company secretarial documents can lead to serious issues when planning an acquisition or exit event for a client.
If you are taking on a new client, preparing a company for a sale, or looking to buy a company, which in has historically bought back any of its shares, we would be happy to review the relevant documentation to ensure that all of the requirements discussed above have been complied with and, if necessary, carry out any remedial work needed to rectify any defects in them. Rectifying void buybacks can be very challenging, particularly if there remains a hostile “phantom” shareholder, which could prevent or delay a transaction considerably or cause the client to incur significant professional and taxation costs.