B P Collins’ corporate and commercial team explores pitfalls when carrying out share buybacks, how to steer clear of them, and the impact if the key requirements are not followed.
What is a share buyback and why do companies sometimes purchase their own shares?
A share buyback is when a company buy its own shares back from one or more of its shareholders. There are several reasons for why a company may decide to carry out a share buyback including:
- Returning surplus cash to shareholders (for example after the sale of a significant asset);
- Increasing key metrics such as earnings per share and net assets per share; and
- Providing an exit route for shareholders.
Share buybacks must be handled carefully, as mistakes in the process can render the buyback void. The requirements for carrying out a valid share buyback are set out in the Companies Act 2006 and it is important that they are followed correctly.
Key requirements under Companies Act 2006
- The Articles of Association must not prohibit / restrict share buybacks.
- Shareholder approval is normally required.
- The shares being repurchased must be fully paid (i.e. nominal value and any premium must be paid).
- The share buyback consideration must be fully paid in cash at the time of purchase.
- The buyback must be financed out of distributable profits (most common), the proceeds of a fresh issue of shares or out of the company’s capital.
- Once the shares have been repurchased, they must be cancelled or, if they were financed out of distributable profits, can be held in treasury.
How can share buybacks go wrong?
If any of the requirements mentioned above are not followed, then the buyback may be void. Common mistakes include:
- Not financed by the permitted sources
For example, if the company chooses to pursue the distributable profits route (most common), and there are insufficient distributable profits, the buyback would be void. This would amount to an unlawful distribution – the shareholder could be liable to repay the buyback consideration and the directors could be personally liable to repay the company. - Not paying the consideration correctly
If the consideration is not fully paid upfront in cash, at the time of the purchase of the shares, the buyback will be void. This includes situations where the parties have tried to use deferred consideration or payment in instalments. - Failure to obtain shareholder approval and/or restrictions in the Articles of Association
A company’s Articles of Association may prohibit buybacks and so an attempted share buyback made in breach of such a provision would be void. In addition, shareholder approval is usually required for a private company buyback, so the buyback will be void if the necessary approval is not obtained. - Defective buyback documentation
In an off-market buyback, one of the required documents is a written buyback agreement that is approved either before the contract is entered into or after the contract is entered into but before the buyback takes place. If there are errors in the paperwork, or the necessary documents have not been entered into, this could render the buyback void.
What is the impact of a defective share buyback?
Failure to comply with the requirements of a share buyback can result in the buyback being void and also potentially criminal offences may have been committed by the company and officers in default (including a prison term up to two years or a fine).
Getting a share buyback wrong can create issues that affect the company’s share capital and potential uncertainty over later share transactions. As a result, when acting on a corporate transaction, solicitors often scrutinise historic share buybacks carefully, as a void buyback can cause significant problems and significant costs may need to be incurred to rectify the position.
Common solutions can include carrying out a share buyback again or cancelling the purportedly purchased shares. However, the exact solution depends on the circumstances of the particular case and legal advice should be sought in the event of a defective buyback.
Share buybacks and company restructurings can involve complex legal requirements. Our team can help you navigate the process and ensure that all statutory requirements are properly complied with. If you discover a defective share buyback, we can review the facts and advise on how you should proceed in the circumstances.
For further advice on share buybacks, including what to do if you discover the share buyback process has not been followed, please contact Alex Zachary or B P Collins’ corporate and commercial team at enquiries@bpcollins.co.uk or call 01753 889995.
