The ability of a private limited company to purchase its own shares is an extremely useful tool. It can provide an exit route for shareholders looking to realise their investment or a way of returning surplus cash, often in advance of a sale process.
The process was made even simpler last year with the relaxation of certain statutory requirements and a new ability to carry out small buybacks using the 'cash de minimis' exemption.
What is often not fully appreciated are the implications for individual directors, the company itself and its shareholders if the prescriptive steps set out in Part 18 of the Companies Act 2006 (Act) are not correctly followed.
Failure to follow the correct procedure when carrying out a share buyback can result in:
- the acquisition of those shares being void
- an offence being committed by the company and each of its officers
In the context of a company going through a share sale process, the effect of a void buyback can prove costly to the company and its shareholders, both in terms of time and money - that is if it does not put a prospective buyer off the acquisition completely.
If the buyback is void, the shares remain in issue and the selling shareholder remains the holder of those shares.
The 'phantom' shareholder will therefore have been entitled to participate in all the rights and privileges attached to those shares from the date they were purportedly bought back, right up to the current day. This could include rights to attend and vote at meetings and participation in dividend payments and, significantly, an entitlement to share in the proceeds of sale of the company. The phantom shareholder would therefore benefit from any uplift in the company's value between the time of the purported buyback and the time of the company's sale.
Any actions of the company requiring shareholder consent taken after the purported buyback may be tainted and need ratifying. Companies House records may also be incorrect and the company will need to consider whether any filings, such as accounts and annual returns, should be amended and re-filed.
Whether or not a sale of the company is in progress or is imminent, it is important to 'cure' the defect. The longer it is left, the more difficult this will become, particularly if the phantom shareholder is untraceable or has died.
Depending on the defect, it may be necessary to carry out the whole buyback process again. This will require co-operation of the phantom shareholder and, if the value of the shares has increased in the intervening period, the company may be vulnerable to ransom.
The directors will need to be transparent about the current value of the shares and any impending sale of the company when discussing the buyback with the phantom shareholder in order to avoid any potential claims for misrepresentation as well as criminal liability that may arise in relation to misleading statements or practices relating to the acquisition of shares.
Due to the potentially significant consequences, it is imperative that any share buyback undertaken is carefully considered and executed fully in accordance with the procedures set out in the Act.
Whilst not intended to be an exhaustive list, it is important to remember that:
- the ability to buy back shares must not be prohibited in the company's articles of association
- small buybacks out of cash (using the cash de minimis exemption) will require specific authority in the company's articles
- unless the buyback is pursuant to, or for the purposes of, an employees' share scheme, the shares must be paid for at the time of purchase, not by instalments deferred over subsequent months or years
- the company must be clear as to the source of payment for the shares and the accounting treatment of that payment. A buyback is usually funded from the company's distributable profits but can also be funded from the proceeds of a fresh issue of shares, out of capital or, under the cash de minimis exemption, using cash up to the value in any financial year of the lower of £15,000 or 5% of the nominal value of its share capital
- the procedures which must be followed vary according to the source of funds used and whether or not the buyback relates to an employees' share scheme
- the buyback must be approved by the shareholders, either by written resolution or at a general meeting, and the shareholder whose shares are being bought back is not eligible to vote on the resolution
- the buyback contract must be made available to the members either, if a written resolution is used, by circulating it with the resolution or, if the resolution is to be passed at a general meeting, by making it available for inspection at the company's registered office for a period of 15 days ending on the date of the meeting, and at the meeting itself.
Following completion of the buyback it is important to attend to the loose ends including payment of any stamp duty, companies house filing requirements and updating the statutory books. If all the statutory requirements are fully and properly adhered to, this should allow the company and its directors to draw a line under the transaction and avoid both criminal liability and the time and expense involved in unravelling a void buyback.
If you are in any doubt as to the requirements for effecting a buyback, then please get in touch.