Author: TheLawStudent

Whether the transaction is to be structured as a share sale or an asset sale, similar documents will be required.

At the beginning of every transaction most lawyers prepare a checklist listing the documents that will be required in order to complete the transaction. On a sale by private treaty (a bilateral process) where there is only one buyer and one seller, the parties will agree between them who will be responsible for drafting each document. In practice the buyer’s lawyers often carry out most of the drafting but this can vary depending on the circumstances.

The principal documents on a sale by private treaty are as follows.

Confidentiality agreement

Before negotiations begin and certainly before the prospective buyer is given any sensitive information about the seller or target, the seller will ask the buyer to enter into a confidentiality agreement (also known as a non-disclosure agreement or ‘NDA’) pursuant to which, in consideration for providing the buyer with information regarding target and/or the seller, the buyer agrees to (and agrees to procure that its advisers will) keep such information secret. The obligations in the confidentiality agreement will usually continue indefinitely and will survive even if the transaction subsequently does not complete (although, where a private equity house is involved in a transaction, confidentiality agreements may be seen which are subject to a time limit, for example of two or three years. There are a number of other variations to the acquisition process and documents where private equity houses are involved).

The buyer will usually also ask for mutual confidentiality undertakings from the seller in so far as the seller obtains any confidential information relating to the buyer during the course of the negotiations.

Heads of agreement/Heads of terms

Heads of agreement are often used to set out the parties’ basic understanding of the key commercial terms and structure of the deal. They are merely an expression of the intention of the parties to act as a road map for the full form contract and, generally speaking, are not legally binding.

However, as heads of agreement can take a long time to negotiate (and only carry moral force), it is not uncommon for the parties to proceed straight to a full-form binding contract.

Where heads of agreement are used they often contain clauses relating to confidentiality (if a separate confidentiality agreement has not been entered into) and exclusivity/lock-out. If this is the case, it is crucial that these provisions (and any other provisions that the parties intend to be legally binding) are expressly stated to be legally binding.

Exclusivity relates to undertakings given by the seller pursuant to which it agrees not to solicit offers for target from any other source provided that completion takes place by a certain date. A buyer will usually insist on some form of exclusivity undertaking in order to ensure that it is not in a position where it will be in competition with another buyer and wasting legal/accountancy costs.

Due diligence

A buyer is always going to be subject to the maxim of caveat emptor – buyer beware. This means that it is the buyer’s responsibility to ensure that it obtains detailed information relating to the company or business that it is going to purchase prior to completion.

The buyer obtains the information that it needs by going through a process of due diligence. This will involve sending a due diligence questionnaire covering issues such as details of target’s property, main contracts, tax issues etc to the seller for its responses and/or it will involve the buyer reviewing a data room which will include relevant documentation relating to the target company.

The lawyers will carry out the legal due diligence and the accountants will conduct the financial, accounting and tax due diligence. The focus of the due diligence will depend on the nature of the target company.

On completion of due diligence, the buyer’s lawyers and accountants will produce due diligence reports in which they will highlight areas of concern and advise further action, such as a reduction in the purchase price and/or contractual protection for the buyer such as warranties and/or indemnities which should be included in the acquisition agreement.

The due diligence process is extremely important for the buyer (especially on a share sale due to the acquisition of all the liabilities, including hidden liabilities) and therefore the buyer should conduct a thorough investigation of the target company.

Acquisition agreement

Either during or after completion of the due diligence process the buyer’s lawyers will produce the first draft of the acquisition agreement for negotiation by the parties.

The main provisions in the acquisition agreement (whether structured as an asset sale or a share sale) will relate to the following areas:

1. Consideration – how much is the buyer going to pay for the target company / business? What form is the consideration going to take e.g. cash or shares in buyer, and when is it going to be paid? On a business sale, how is the consideration apportioned between the assets acquired?
2. Warranties – we have already mentioned warranties in relation to the results of due diligence investigations. Warranties are statements of fact which the seller makes in relation to specific aspects of target – the seller warrants that the statements are true and if they are subsequently found to be untrue by the buyer, the buyer will have a contractual claim against the seller for breach of warranty (subject to the usual requirements of loss, mitigation and foreseeability). Common areas on which warranties are given are accounts, employees, intellectual property, real estate, contracts and trading arrangements, disputes and taxation. The emphasis of the warranties will vary depending on the type of company being acquired. The seller’s liability for breach of warranty claims is usually limited by the vendor protection provisions and the contents of the disclosure letter.
3. Indemnities – again, we have mentioned indemnities in relation to the results of due diligence investigations. Indemnities are promises made by the seller to reimburse the buyer for any loss it suffers in connection with contingent liabilities. For example, on a share sale, if there is a customer of the target company who has threatened to bring legal proceedings against it, the buyer may ask that the seller indemnifies the buyer for the costs involved in defending any action brought as well as any resultant damages.
4. Vendor/seller protection provisions – vendor protection provisions are included in the acquisition agreement in order to limit the seller’s liability for breach of warranty claims. The provisions usually contain a time limit as well as an upper limit on any claim for damages that can be brought by the buyer (‘de maximus’) – usually, at most, the consideration paid by the buyer – and a lower level below which claims cannot be brought (‘de minimis’). The vendor protection provisions usually also contain a detailed procedure that must be followed by the buyer in order to bring a claim (including time limits for notification of claims).
5. Arrangements for completion – completion may occur at the same time as exchange of contracts (referred to as simultaneous exchange and completion). However, where a condition precedent needs to be satisfied (for example where consent to the transaction is required from shareholders, regulatory authorities or third party suppliers or customers) then exchange and completion will need to be separated with a time gap in between the two – this is referred to as split exchange and completion.

   The acquisition agreement will detail what issues need to be dealt with at completion, such as completion board meetings of the buyer and seller and the target company (as appropriate) and the agreements that need to be executed – this section can act as a good checklist for lawyers attending completion meetings of what needs to happen.

   Where there is a split exchange and completion, most of the practical steps to effect completion will take place at exchange (board meetings, signing most documents etc) and completion will usually be very quick (often done on the telephone) to confirm that everything that should have happened between exchange and completion has indeed happened and to transfer funds.

The key agreement in a share sale is called a Share Purchase Agreement (SPA). This agreement documents the sale of the shares of the target company to the buyer and confirms the consideration and other key provisions set out above.

Disclosure letter

It has already been stated that the seller’s liability for breach of warranty claims is usually limited by the contents of the disclosure letter. The disclosure letter is a letter written by the seller addressed to the buyer in which the seller sets out the details of any matters which make the statements of fact given in the form of the warranties untrue i.e. the disclosures qualify the warranties and as a result will limit the seller’s liability.

There are effectively two types of disclosure that can be found in a disclosure letter. These are:

1. general disclosures; and
2. specific disclosures.

General disclosures are disclosures which are usually found at the beginning of the disclosure letter (often referred to as the ‘front-end’ of the disclosure letter). General disclosures usually relate to searches of public registers that the buyer should do prior to completion such as searches of the Register of Companies and the Land Registry. The seller will usually seek to ensure that anything that the buyer could have found out by conducting such searches is deemed to have been disclosed. The buyer may seek to resist such general disclosures or may seek to make them as narrow as possible.

Specific disclosures are the disclosures usually found in the latter part of the disclosure letter (usually referred to as the ‘back-end’ of the disclosure letter). The specific disclosures are those that relate to the specific warranties given.

A large proportion of the time spent drafting and negotiating the acquisition agreement will be spent negotiating and drafting the warranties and the disclosure letter.

Other completion documents

There are also various other ancillary documents that may have to be
executed at completion or perhaps exchange (in the case of split exchange
and completion) as follows:

1. service agreements – for the directors/managers of target;
2. tax deed – comprising an indemnity from the seller to the buyer in relation to tax issues (only relevant on a share sale);
3. intellectual property licences/assignments – dealing with the transfer of important intellectual property rights such as trade marks;
4. novation/assignment agreements – for the transfer of third party contracts (only relevant on asset sales when contracts may be transferred from seller to buyer);
5. completion board minutes – for target, buyer and seller (as appropriate);
6. statutory forms (e.g. to notify Companies House of a change to target’s registered office, auditors or directors); and
7. transitional services agreement – if target was being provided with key operational services (e.g. HR/accounting/IT etc) by a parent or sister company prior to completion, the buyer may need those services to continue for a short period after completion. This is to ensure there are no problems with the continuity of trading after completion and to allow target to find an alternative supply of such services.

Who is liable under the warranties where there is more than one warrantor?

The parties giving the warranties are often referred to as the warrantors. You know already that there can be more than one seller which means that there can also be more than one warrantor. The buyer of the target company will usually insist, where there is more than one seller, that all sellers give the warranties on a joint and several basis.

Who does the buyer sue?

All the buyer is concerned about is that it will recover damages from somewhere. This is why the buyer will usually insist on joint and several liability so that it can sue (and recover against) any or all of the sellers and leave them to sort out the apportionment between themselves. A seller’s liability can take the form of any of the following:

1. Joint and several – Here, each seller assumes the obligation collectively (on behalf of all those bound) and individually (for himself). The buyer may then sue any one or more of the sellers for the whole or part of the loss.
2. Several – This is where each seller is liable for an agreed specified proportion of the potential damages. Here, the buyer must bring proceedings against individual sellers for their share.
3. Joint – The position is, in many respects, the same as if the parties were liable jointly and severally. However, the death of a party who is jointly liable will release his estate from liability. This has obvious disadvantages, both for the surviving sellers and for the buyer.

Joint liability also carries another disadvantage for the buyer – in order to bring proceedings against joint parties, the buyer must (subject to certain exceptions) issue proceedings against all of them.

‘Splitting the bill’

Civil Liability (Contribution) Act 1978

The Civil Liability (Contribution) Act 1978 entitles a joint warrantor who is found liable to pay damages for a breach of warranty, to seek a contribution from the others liable for the same damage. The court will evaluate the amount each of the parties should pay to the sued seller based on what the court considers just and equitable having regard to each party’s responsibility for the damage in question.

Express ‘Contribution Agreement’

Often the sellers will not want to leave it to the courts to decide the amount they should each contribute if the buyer is successful in a damages claim. So it is reasonably common for the sellers to agree between them a ‘Contribution Agreement’ to which they may refer should a successful warranty claim be made. They may agree, for example, that a minority shareholder, who does not have much involvement in the running of the company, will have a low cap set on any contribution (s)he may have to pay. Note that the existence of a Contribution Agreement does not affect the buyer’s right to choose who to pursue for a claim.

Again, much will depend on the specific circumstances of the deal in question (such as the bargaining strength of the parties and what the seller is willing to sell) but, just as with a share sale, there are advantages and disadvantages to structuring the transaction as an asset sale both from the perspective of the buyer and the seller. As a general rule buyers prefer asset sales.

Advantages for the buyer

When the buyer purchases shares in a share sale it also indirectly acquires all of the assets and more importantly the liabilities of the company. The effect of a share sale is that the buyer takes the company as it is – the target company retains all of its existing assets and liabilities – which could be a concern for the buyer if they are aware of certain significant liabilities of the target company.

On an asset sale, however, the buyer can decide what assets (and/or liabilities) it would like to purchase and what assets (and/or liabilities) it would like to leave with the seller. This can lead to a certain amount of ‘cherry picking’ by the buyer. There may also be certain tax advantages for the buyer depending on the nature of the assets the buyer is acquiring.

Advantages/disadvantages for the seller

An asset sale can be of great benefit to a seller if the company has a loss making or non-core division that it would like to sell whilst retaining more profitable parts of the business or more generally if the seller only wants to sell part of its business. Conversely, the main disadvantage for a seller is that on an asset sale it will be unable to transfer assets and/or liabilities that it no longer wants to the buyer unless the buyer wishes to purchase them.

In many circumstances, the answer to this question will simply turn on what the seller is willing to sell, but there are advantages and disadvantages to structuring the transaction as a share sale both from the perspective of the buyer and the seller. As a general rule sellers prefer share sales.

Advantages for the seller

For the seller, a share sale will be the best way to achieve a clean break from the business. This is usually particularly important in situations where the current owners of a company are individuals who are planning to retire. Following a share sale, subject to any negotiated future obligations (for example in relation to warranties and indemnities), the seller is able to walk away from the company (and the business within it) having sold all of its actual and potential liabilities. If you go on to study the Private Acquisitions elective module you will also see that there are potentially significant tax exemptions for a corporate seller on a share sale.

Advantages for the buyer

It can be an advantage for the buyer that the entire company will be purchased including all of the assets and liabilities that it has at completion of the transaction. This will mean that the buyer will not have to spend as much time and therefore cost on ensuring that it acquires all of the assets that are required in order to run the business that it wishes to acquire. A great deal of time is spent during the negotiation of an asset sale on agreeing exactly what assets (and liabilities) are to be purchased, as well as dealing with obtaining all third party consents to transfer such assets. Where there is a change of ownership of the assets the consent of customers, suppliers, landlords and others may be required to the assignment or novation of existing contracts. On a share sale there may be certain change of control provisions (e.g. in financing documents) but otherwise there is no need for the third party consents that are needed on an asset sale.

Another advantage for the buyer is continuity – because the business carries on as it did prior to completion there will be less disruption to the business as a result of the change in ownership (e.g. ownership of properties remains the same/employees’ employer remains the same). As far as the outside world is concerned it will look as if there has been no change to the business at all.

A share sale is generally considered to be more straightforward than an asset sale as the only thing being transferred is the shares. However, because the buyer is acquiring the target company (together with its liabilities) on a share sale, more time/costs will be spent on due diligence.

To an asset sale

The parties to an asset sale are as follows:

Buyer/Purchaser: the purchasing company/partnership/sole trader.

Seller/Vendor: the selling company/partnership/sole trader.

The consideration on an asset sale will therefore be paid to the selling company/partnership/sole trader. In the case of a company this will mean that for the consideration to reach the shareholders the selling company will need to declare a dividend or be wound up by its shareholders.

To a share sale

The parties to a share sale are as follows:

Buyer/Purchaser: the purchasing company/partnership/individual(s).

Seller/Vendor: the selling shareholder(s) (which could be individual(s), company(/ies) or partnership(s)).

The consideration on a share sale will therefore be provided straight into the hands of the selling shareholder(s).

Introduction

There are three main types of business media:

1. limited companies;
2. partnerships; and
3. sole traders.

All of these businesses can be acquired, although the structure of the acquisition may differ depending on the type of business.

Terminology

The business or company being purchased is often referred to in practice as ‘target>/b>’, a term which I will use throughout my posts on the topic.

Note that the purchase of a listed company is a special case, and is referred to as a takeover, rather than an acquisition.

Valuing a company

One of the biggest single investments a company can make is to buy another company. It is an investment decision and the cost of the investment needs careful consideration. Therefore, it is necessary to estimate the value of the company before the costs and benefits can be assessed.

If the company is a listed company for example, the share price will be quoted on a stock exchange and therefore it is possible to place a market value on the company. However, suppose that the company is not doing very well and the share price is depressed, the market value may not represent what someone else is prepared to pay for it. Other companies may feel that if the company was better managed they would be able to make more profit and then increase the return and hence value of the company. In addition, we have to answer the same question concerning value even if the company is not quoted and therefore there is no quoted share price available.

So how much would the potential buyer be prepared to pay for the company?

Book value

One value that can be placed on the company is the balance sheet value of the assets. However, as this is a book value it may not be the true value of the assets. Another version of this method is to value all the assets at the break-up value, i.e. how much would be left if all the assets were sold and the liabilities paid.

‘Going Concern’

The book value or break-up value often doesn’t reflect the true value of the company as it will probably be worth more as a going concern (i.e. as a money generating business) than it would if it were broken up and sold. This depends, of course, on how well the company is performing and the future prospects for the company’s products and services.

Future cash flows

If an investor buys a company, they are in effect making an investment that is expected to provide a return. In fact, if the company makes a profit, it could provide a return for a number of years into the future. A common way of viewing this is to say that the purchaser of the company is actually buying a future stream of income that is generated by the profits of the company, or future cash flows.

Viewed in this way, a common way to value a company is to take a number of years’ multiple of the future profits. If we made a bold assumption that the profits are equivalent to cash flows we can calculate the present value of a number of years’ future cash flows. This can be equated to the return that the investor will receive from the investment over a period of time, leaving aside any increase in the value of the company when it is sold.

In reality, there is no best way to accurately value a company, as there is always an element of subjective judgment, e.g. how many years are taken into account and what return is expected.

How do you acquire the business of a company limited by shares?

Such companies are owned by their shareholders who each own shares in the company. As you have learned, these shares are capable of being transferred from one person to another. As a result of this, there are three ways in which you can purchase the business of a company limited by shares:

1. by acquiring all of the shares in the company (a share sale);
2. by acquiring the business of the company as a going concern or by acquiring a particular part of the business of the company as a going concern (e.g. a trading division) (commonly referred to as an asset sale or business sale); or
3. by purchasing the particular assets that you require (a sale of assets).

Note: the sale of target may be conducted via an auction process, whereby a number of potential buyers are invited to submit bids for target.

Share Sales

Share sales occur as a result of a buyer purchasing the issued share capital of a company.

It is possible for a buyer to purchase only some of the issued shares. In such a case, following the purchase, the company will not be wholly-owned (i.e. owned by a sole shareholder) and particular issues may arise in the running of the company as a result of the existence of a minority shareholding. It is more common however for all of the issued shares to be purchased, so that the target company will be wholly-owned following the purchase.

When a share sale completes, the target company itself does not change. It continues to trade as it did prior to completion but with a new owner. The shares will be transferred by stock transfer form.

Asset Sales

Asset sales occur as a result of a buyer purchasing either the whole of the business of a company as a going concern, or when a company has separate and distinct trading divisions within it and the buyer purchases one or more of those trading divisions as a going concern. By ‘a going concern’ we mean that the whole of a business is purchased (or a large proportion of the assets including the goodwill), so that the business can trade after completion of the purchase just as it did prior to completion of the purchase. A key feature of an asset sale is that each asset needs to be transferred separately and have part of the purchase price apportioned to it. For example, a TR1 will be required to transfer any property to the buyer, IP will need to be assigned or licensed to the buyer and contracts will need to be assigned or novated. Employees who work for the business being transferred will transfer to the buyer automatically under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (known as ‘TUPE’).

When an asset sale completes, ownership of the company selling its assets (i.e. the shares in that company) does not change but the business that is being sold does change hands. Following the sale, the selling company continues to exist. If it has sold the whole of its business, it will now be a ‘cash shell’, a company with no assets except the cash proceeds of the asset sale.

How do you ‘acquire’ a partnership or sole trader?

Partnerships and sole traders operate unincorporated businesses where there are no shares owned, in comparison to limited companies which are owned by the shareholders.

This means that in relation to partnerships and sole traders the only option open to a potential purchaser is an asset sale (i.e. to buy the business as a going concern) or to buy the individual assets that it requires.

This has been a very important area in practice because it has frequently arisen in corporate transactions. Previously the rules prohibiting financial assistance applied to assistance given by all companies.

Since 1 October 2008, the prohibition on private companies from giving financial assistance for the purpose of the acquisition of their shares, or the shares of their private holding company, has been removed. A process commonly known as the ‘whitewash’ procedure was also abolished on that date.

Public companies giving financial assistance for the acquisition of their shares or their parent company’s shares or private companies giving financial assistance for the acquisition of the shares of their public holding company continue to be caught by the financial assistance restrictions in ss.677-683 CA 2006.

Financial assistance has been given a wide interpretation by the courts and can cover any help of a financial nature given by a company for the share acquisition. For example, when an individual wishes to purchase shares in a company, but is having trouble raising finance, the company may consider giving a guarantee to a bank so that it lends the money to that individual to enable the individual to proceed with the share purchase. However, the directors need to be aware that the proposed guarantee may constitute financial assistance in accordance with the CA 2006 and thus be illegal.

The protections in relation to financial assistance in the CA 2006 are another good example of the doctrine of maintenance of share capital. In essence, the money invested by shareholders should boost the net assets of a company and therefore swell the shareholders’ funds and further protect creditors due to the restrictions on releasing those sums during the life of the company. If, however, a company uses its own resources to help a shareholder to buy shares in it, then it is offending the principle of maintenance of share capital.

Hence, the legislation is designed to protect the company’s assets representing share capital. It is therefore vital to be able to identify financial assistance before it occurs and to be able to determine whether or not it is possible to make it lawful (and how to do so). For instance, where financial assistance is proposed to be given by a public company for the acquisition of its own shares, if that company is re-registered as a private company, it will then fall outside the prohibition on the giving of that assistance.

A scheme of arrangement is a statutory procedure under ss.895-900 CA 2006 ‘where a compromise or arrangement is proposed between a company and its creditors, or any class of them, or between the company and its members, or any class of them’ (s.895(1) CA 2006).

A scheme can be a compromise or arrangement about anything which the company and its creditors or members can agree between themselves. Schemes are used for many purposes, including returns of capital, reductions of capital, company reorganisations and insolvencies.

The key stages of a scheme of arrangement are as follows:

Stage One

The company, creditors or the members apply to the court.

Stage Two

The Registrar will make an order on the claim form convening meetings of the relevant classes of members or creditors. Currently, it is usual for 21 clear days’ notice to be given to members and/or creditors. Depending on what the scheme is being used for, a general meeting may also be required, but this is entirely separate from any court meetings. Notice of the court-convened meetings must be accompanied by an explanatory statement explaining the effect of the scheme.

Stage Three

The resolution to approve the scheme will then be proposed at the class meeting(s) convened by the court. To be effective, the scheme must be approved by a majority in number representing 75% in value of either creditors or members (or any class of creditors or members) who vote at the meeting and be approved by the court (s.899(1) CA 2006).

There may be more than one court meeting. The court must summon meetings for each of the relevant classes of member. These meetings operate in much the same way as a standard general meeting save that they are convened by the court.

Following the court-convened meeting(s) the chairman will report to the court with the result.

Stage Four

The court will then hear the petition to sanction the scheme. The court has discretion in its decision. In deciding whether or not to sanction the scheme the court must be satisfied that:

• approving the scheme is reasonable;
• each class has been fairly represented by those attending the meeting; and
• the statutory provisions have been complied with – for example, correct notice having been given of the court convened meeting, sending out the explanatory statement, or passing the resolution to approve the scheme correctly.

Stage Five

Once the scheme has been sanctioned by the court, an office copy of the s. 899 CA 2006 order must be filed at Companies House. The order is not effective until this has been done. Once the court has sanctioned the scheme and the court order has been registered at Companies House, the scheme becomes binding on all the members and creditors (s.899(3) CA 2006).

The major advantage of schemes of arrangement is that they can be organised in many different ways, without, for example, the constraints imposed by the specific statutory provisions for a buy-back or an insolvency arrangement.

General

This is another exception to the doctrine of maintenance of share capital.

A limited company having a share capital may reduce its share capital:
(a) in the case of a private company limited by shares, by special resolution supported by a solvency statement (see ss.642 to 644 CA 2006);
(b) in any case, by special resolution confirmed by the court (see ss. 645 to 651 CA 2006).

There are a variety of reasons why a company might wish to reduce its share capital:

• it may wish to create distributable reserves, which increases its ability to pay dividends;
• it may have surplus capital which it wishes to return to its shareholders;
• there may have been a substantial reduction in the value of the assets of the company with the result that the share capital of the company is no longer representative of the true value of the assets of the company;
• so the company can carry out a redemption of its redeemable shares or purchase of its own shares where it does not have sufficient distributable reserves to redeem or buy back the shares; or
• it may form part of a ‘scheme of arrangement’ which is a method of structuring mergers and acquisitions.

In such cases, the company can agree to reduce its capital by special resolution, but, unless the company is a private company, the resolution is not effective unless confirmed by the court, on petition by the company.

Section 654 CA 2006 states that any reserve arising from the reduction of capital is not distributable without the consent of the Secretary of State. The Companies (Reduction of Share Capital) Order 2008 provides that (subject to anything to the contrary in the shareholder resolution relating to the reduction or anything in the company’s articles) if a private company reduces its share capital supported by a solvency statement but does not apply for a court order confirming the reduction, then the reserve will be treated for the purposes of Part 23 CA 2006 (which deals with distributions) as a realised profit. The position is slightly different if a private company reduces its share capital and the reduction is confirmed by the court – in such a scenario the reserve will be treated as realised profit for the purposes of Part 23 CA 2006 unless the court orders otherwise.

The key stages of a reduction of capital using the court procedure are as follows:

Preliminary Stage

Check the articles of the company – a reduction of capital must not be restricted or prohibited by the articles (s.641(6) CA 2006).

Stage One

A timetable for the reduction needs to be agreed by the court. Three key dates need to be agreed:

• the date by which the petition must be presented to court;
• the date of the directions hearing; and
• the date of the petition hearing.

Stage Two

A special resolution must be passed approving the reduction of capital.

Stage Three

Once the special resolution has been passed, the company can present the petition to the court. The company will also issue an application notice setting out directions to be sought from the court at the directions hearing.

Stage Four

The petition must be supported by either a witness statement or an affidavit of the chairman of the general meeting when the special resolution was passed.

Stage Five

The directions hearing will take place at which the court will consider the position of the creditors. The court will not confirm a proposed reduction of capital unless it is satisfied that the interests of all the company’s creditors who are entitled to object to the proposed reduction are not adversely affected by the proposal. The court will also want to check that the appropriate approvals and consents have been obtained. Normally the court will provide for the advertisement of the petition in a broadsheet newspaper. The advertisement will be placed in a broadsheet seven days before the date that has been fixed for the hearing of the petition.

Stage Six

The Companies Court Registrar will hear the petition to reduce the capital in open court.

Stage Seven

The reduction will become effective once the court order and a statement of capital have been registered at Companies House. The registration of the order will then be advertised in a broadsheet newspaper. It is important to be aware that in certain situations creditors may have the right to object to the reduction and if the reduction affects separate classes of shareholders differently, there may be issues with class rights under s.630 CA 2006.

Reduction of capital by private companies under the solvency statement procedure

Under the CA 2006 there is also a non-court procedure for private companies only to reduce their capital. The availability of the procedure is subject to any restriction or prohibition in the company’s articles. The company cannot use the procedure if, following the reduction of capital, only redeemable shares will be in issue or the issued share capital will be reduced to zero (s.641(2) CA 2006). In addition, the company should ensure that one person will not end up holding all of the shares (unless the conditions in s.641(2B) CA 2006 are met.

The procedure is set out in ss.642-644 CA 2006. The company’s shareholders are required to pass a special resolution to reduce capital and the directors have to sign a statement of solvency. The special resolution must be passed within 15 days of the date that the directors’ solvency statement is made.

Within 15 days of the resolution being passed, the company must file the special resolution, the solvency statement and a statement of capital at Companies House. The resolution cannot take effect until these documents are registered. Note that there is no requirement for the directors’ statement to be supported by an auditors’ report, unlike a redemption/purchase out of capital.

An advantage of seeking the court’s approval of a reduction of capital is that, once confirmed by the court, the procedure cannot be challenged. In addition, as each director needs to make the solvency statement, if any director refuses to do so, the court procedure will need to be followed (unless the director resigns). However the court procedure will take longer and be more expensive.

Where a company redeems or purchases its own shares, tax will usually become payable by the shareholder.

In most cases, any payment to a shareholder exceeding the amount paid on allotment of the relevant shares is treated as a distribution (dividend) to that shareholder (see your Tax Workbook for tax treatment of distributions) unless repayment is on a winding up of the company. Therefore, as a general rule, the proceeds of a share buy-back will be treated as an income receipt in the hands of the shareholder.

However, ss.1033-1045 CTA 2010 allows the money received on the buyback to be treated as a capital receipt if the following conditions are satisfied:

1. the shares must be in an unquoted trading company;
2. the seller must be resident in the UK in the tax year in which the sale occurs;
3. the shares must have been owned for at least 5 years;
4. there must be a ‘substantial reduction’ in the seller’s shareholding (at least a 25% reduction in the percentage of the seller’s shareholding is required);
5. for 12 months after the purchase, the seller must not hold more than 30% of the company’s:
   1. issued ordinary share capital; or
   2. share and loan capital; or
   3. voting power.

   N.B. The shares bought back by a company are cancelled so the number of shares in issue are reduced; and

6. the buy-back must benefit the trade and must not be part of a scheme to avoid tax or enable the shareholder to participate in the company’s profits without receiving a dividend.

These are quite stringent rules but where they can be met the shareholder will treat the receipt as capital in nature. This could mean that various CGT reliefs and exemptions can be utilised to reduce any gains made (e.g. the annual exemption), resulting in less tax being paid than would be the case if the money received was taxed as an income receipt. Importantly, the capital treatment is not optional: if the conditions are met, this treatment will apply.

Unless the purchase price for shares bought back is below £1,000, the company will usually have to pay stamp duty on the purchase unless one of a few limited exceptions applies.

Shares which have been redeemed or purchased by a company are normally cancelled. However, in practice you will find that companies can, if they wish, purchase their shares out of distributable profits and hold them ‘in treasury’ instead of having to cancel them. Shares purchased out of a fresh issue of shares or out of capital cannot be held as treasury shares (and this includes shares purchased by using the De Minimis Procedure). Treasury shares can be held in treasury indefinitely, sold for cash, cancelled at any time, or transferred for the purposes of an employees’ share scheme.

Prior to 30 April 2013, only companies whose shares were quoted on the Main Market of the London Stock Exchange, AIM and other investment exchanges could hold treasury shares. This restriction has now been removed and all companies are now able to hold shares in treasury. No s.551 CA 2006 authority is required to sell shares held in treasury, but s.561 CA 2006 preemption rights apply to treasury shares as if the sale of treasury shares were an allotment of ‘equity securities’.