Payback rules: Navigating share buybacks

In times when companies are successful and profitable, the normal course is to retain some earnings for future investment in business growth. Many companies will also return funds to shareholders by way of dividend payments.

There are times, typically when there is surplus cash, when companies may choose to return funds to shareholders through share buybacks. This may be done by on or off-market purchases and by a general buyback programme or a tender offer.

Governing provisions

The relevant rules and regulations can be found in Part 18 (sections 658–737) of the Companies Act 2006; chapters 9, 12 and 13 of the Listing Rules for Main Market companies; Article 5 of the EU Market Abuse Regulation; and the EU Buyback and Stabilisation Regulation.

The Investment Association has also issued Share Capital Management Guidelines, which listed companies should refer to.

Section 658 of the Companies Act 2006 generally bars a limited company from buying back its own shares, unless the process is carried out in accordance with the provisions of the act. Although rare, it is worth noting that unlimited companies are not restricted from buying back their shares.

Section 659 contains exemptions that allow a company to buy back its shares, including as part of a capital reduction process and as part of the forfeiture of (partly paid) shares for failure to pay any sum due on those shares.

“The general rule for a public company is that any shares it holds beneficially in its own share capital must be cancelled”

There follows the general rule for a public company that any shares it holds beneficially in its own share capital must be cancelled, reducing the amount of its nominal share capital. If this falls below the statutory minimum for a public limited company, then the company must re-register as a private company.

The company has three years to cancel the shares following their acquisition. If it wished to retain the shares then it could hold them in treasury (see page 44).

Some of the provisions for share buybacks for employee share schemes are subject to different requirements.

Financial assistance

Chapter 2 (ss677–683) of Part 18 sets out the rules on financial assistance for public companies. These are not considered in detail here, but broadly a public company is not allowed to financially assist anyone in order for them to acquire shares in the company.

This is one of the issues in the case against Barclays and some of its former executives. It is alleged the company gave financial assistance to investors who bought its shares at the time of the financial crisis. This investment prevented it failing and having to be bailed out by the government, ensuring it did not come under government control.

Critically in cases like this, financial assistance is allowed if:

• The company’s main reason for giving the financial assistance is not for the purpose of any such share acquisition, but for another reason
• Giving the assistance for a share acquisition is only an incidental part of some larger purpose of the company.

There are other circumstances when financial assistance is allowed. For private companies, the restrictions on financial assistance were removed in October 2008 and the ‘whitewash’ procedure used under previous legislation was repealed.

Buybacks

Chapter 4 (ss690–708) of Part 18 allows a company to buy back its (fully paid) shares under the provisions of the Companies Act 2006 (and subject to any restrictions in its articles) unless the buyback would result in the company no longer having an issued share capital, or only having an issued share capital made up of redeemable or treasury shares.

Generally speaking, if a company buys back its own shares it must do so out of distributable profits or the proceeds of a fresh share issue made to finance the purchase (s692). This section also allows a private limited company to buy back its shares out of capital, as set out in Chapter 5 of Part 18.

Alternately, if not under Chapter 5 and allowed by its articles, it may buy back up to a total of the lower of £15,000 and the nominal value of 5% of its fully paid share capital, as at the beginning of the financial year.

“If a company buys back its own shares it must do so out of distributable profits or the proceeds of a fresh share issue made to finance the purchase”

Off-market purchases

There are detailed procedures in the legislation (ss694–700) for off market purchases. Purchases made on the London Stock Exchange (LSE) Main Market or its smaller Alternative Investment Market (AIM) would not be treated as off market.

Authorities required

It is not necessary for share buybacks to be permitted in a company’s articles, but they are subject to any restrictions or prohibitions in the articles. Sections 693 to 701 deal with the authority needed for off-market purchases and section 701 sets out the authority required for market purchases.

A shareholder resolution will be required and the key points include:

• The act does not require the shareholder resolution to be a special resolution, however this is the preference of investors – as stated in the Investment Association guidelines.
• There must be a time limit specified in the resolution which cannot be more than five years from the date of the resolution’s passing. However, investor guidelines require listed companies to seek annual authority.
• The maximum and minimum prices in the resolution may be specific amounts or refer to a formula used to calculate the price. The minimum price is usually the nominal value of a share. The maximum is usually 105% of the average of the middle-market prices of the shares for the five business days immediately before the purchase, as published on the Official List.
• The resolution authorising market purchases must be filed at Companies House, whether it is an ordinary or special resolution.

If a company enters a contract to buy back its shares it must keep a copy of that contract for 10 years. This must be available for inspection at the registered office (or Single Alternative Inspection Location (SAIL) address).

A form must be filed at Companies House if it is to be kept at the SAIL address. If there is no contract, the company must keep a memorandum of the terms of the buyback.

Listing rules

LR12 deals with share buybacks and sets out the rules regarding announcements
and other matters. LR13 sets out requirements for any shareholder circular about share buybacks and LR9 covers what should be included in the annual report about share buybacks.

Investor guidelines

The Investment Association has issued share capital management guidelines which include recommended best practice in relation to share buybacks.

“Investor guidelines do not favour a company holding more than 10% of its shares in treasury”

Buybacks from capital

Chapter 5 of Part 18 of the Companies Act 2006 (ss709–723) allows a private limited company to buy back its shares by a payment out of capital, subject to any restrictions in its articles. The procedure is set out in the legislation.

Treasury shares

Chapter 6 (ss724–732) deals with treasury shares. Treasury shares arise when a company buys back its own shares out of distributable profits, but continues to hold them in its own name in the register of members. Treasury shares:

• May be held; sold for cash, broadly defined; transferred, for instance in relation to an employees’ share scheme; or cancelled
• Do not have voting rights and do not receive dividend payments
• Are shown separately when disclosing figures in relation to a company’s share capital, as the total voting rights figure (used for the purposes of disclosures under DTR5, for example) will be the total share capital, less the number of treasury shares in existence
• Should be excluded when calculating the percentage of the issued share capital in relation to a shareholder allotment authority
• Should be included when calculating the percentage of the issued share capital in relation to a shareholder resolution to disapply pre-emption rights, as this authority will also cover non pre-emptive cash sales of treasury shares.

Treasury shares are restricted, in that shares purchased using the proceeds of a fresh share issue may not be held in treasury, while the sale of treasury shares is subject to pre-emption rights and these may be disapplied by special resolution.

Investor guidelines indicate that they do not favour a company holding more than 10% of its shares in treasury, although this is not a restriction under the act.

Stamp duty

Stamp duty is payable by the company on the purchase of its own shares (or stamp duty reserve tax if the purchase is through the CREST securities depository). However, if the company’s shares are traded on the AIM market and it has completed the necessary declaration, no stamp duty is payable on dealings in its shares.

Lorraine Young is company secretarial director of Shakespeare Martineau