Purchase of own shares

TheLawStudent

A purchase of own shares takes place when a company purchases shares in itself from an existing shareholder. A company may decide to purchase shares from a shareholder when there is no other buyer available.

It is worth noting that a company can purchase redeemable shares. Where the company purchases redeemable shares, that does not amount to a redemption of those shares where the purchase is not carried out on the terms for redemption set out either in the articles or determined by the directors prior to the allotment of such shares. A public, listed company with listed redeemable shares may choose to purchase them rather than redeem them if they are trading at a discount, as this would be cheaper than redemption.

There are three sources for a company to finance a purchase of its own shares:

  1. out of profits;
  2. out of the proceeds of a fresh issue of shares; and
  3. out of capital either in compliance with Chapter 5 CA 2006 or using the De Minimis provisions set out in s.692(1ZA) without following the requirements of Chapter 5.

Before examining these methods of a company financing a purchase of its own shares, we must consider a further distinction made by CA 2006 between two sources of authority for a company to make a purchase of shares, namely ‘off-market’ and ‘market’.

Authority for making a purchase of own shares:

The two possible ways in which a company can obtain authority to make a purchase of its own shares are by making:

  • an ‘off-market’ purchase; or
  • a ‘market’ purchase.

Off-market purchase of own shares

The definition is set out in s.693(2) CA 2006. This is when a purchase of own shares takes place otherwise than on a ‘recognised investment exchange’ (for example, the London Stock Exchange). (The same term also covers a purchase made on a recognised investment exchange of shares not subject to a ‘marketing arrangement’ on the exchange. Section 693(3) CA 2006 sets out when a company’s shares are subject to a marketing arrangement.

The conditions that need to be fulfilled to make a valid off-market purchase are set out in s.694 CA 2006:

  • a contract to purchase own shares is required (s.694(1) CA 2006); and
  • the terms of the contract need to be approved by ordinary resolution (s.694(2) CA 2006). The contract may be entered into with the purchaser conditional on the ordinary resolution being passed. The shareholder whose shares are being redeemed can vote on the resolution at a general meeting but the resolution will be ineffective if his votes in respect of the shares being redeemed carry the resolution (s.695(3) CA 2006). Therefore that shareholder should be advised to abstain – unless some, but not all, of his shares are to be purchased, in which case he may safely vote on a poll in respect of the shares that he is keeping. If the resolution is passed as a written resolution that shareholder is disenfranchised for that vote (s.695(2) CA 2006).
  • There are separate requirements if the off-market purchase is made pursuant to an employees’ share scheme.

The disclosure requirements for an off-market purchase are as follows:

  • Where an ordinary resolution to approve an own share purchase is proposed at a general meeting, the contract must be available for inspection at the company’s registered office for a period of 15 days before the general meeting and also at the general meeting. Where such a resolution is proposed as a written resolution, a copy of the contract must be sent together with the copy of any written resolution (s.696(2) CA 2006).
  • Within 28 days of the date on which the shares that are bought back are delivered to the company, the company must send a return to Companies House under s.707(1) CA 2006 and a notice of cancellation under s.708(1) CA 2006 together with a statement of capital (s.708(2) CA 2006).

Market purchase of own shares

The definition is set out in s.693(4) CA 2006. This is when the purchase of own shares by a company does take place on a recognised investment exchange (such as the Main Market of the London Stock Exchange).
Section 701(1) CA 2006 specifies that an ordinary resolution of the company is required to approve the market purchase of own shares (although in practice, shareholders of listed companies may ask for a special resolution). A return must be filed with the Registrar of Companies (s.707(1) CA 2006) and a notice of cancellation of the shares (s.708(1) CA 2006) together with a statement of capital (s.708(2) CA 2006) within 28 days of the date on which the shares that are bought back are delivered to the company.

Purchase out of profits or the proceeds of a fresh issue of shares

When a company is purchasing its shares from the selling shareholder, the company must first use any money it has available to it either in the form of distributable profits (unless the De Minimis provisions apply) or it may use money raised from a fresh issue of shares to fund the purchase. In both of these cases the procedural requirements are very straightforward because the capital of the company is not reduced. Where distributable profits are being used wholly or partly to finance the purchase of shares, the amount of distributable profits available should be verified by the company’s accountants.

When new shares (i.e. a fresh issue) are issued by a company to a shareholder (new or existing), the subscribing shareholder pays the company for these shares. The proceeds of such fresh issue of shares which is made for the purpose of the purchase or redemption can then be used by the company to fund the purchase of its own shares.

A company may purchase its shares out of distributable profits or the proceeds of a fresh issue of shares for the purpose of the purchase if the following conditions are met:

  • the purchase of own shares by a limited company, whether public or private, is not restricted or prohibited in its articles (s.690(1)(b) CA 2006);
  • the shares being purchased by the company are fully paid up (s.691(1) CA 2006); and
  • following the purchase, the company must continue to have issued shares other than redeemable and treasury shares. This is because if the company purchased shares leaving only redeemable and treasury shares in issue, the company could potentially be left with no issued share capital / no shareholders.

The requirements for an off market purchase of shares apply to a purchase out of distributable profits or a fresh issue of shares. Accordingly, a contract will be needed for such a purchase, and it will need to be approved by ordinary resolution.

Reduced procedure for private companies making de minimis purchases of shares (the ‘De Minimis Procedure’)

The De Minimis Procedure (s.692(1ZA) CA 2006) allows private companies to purchase shares using capital without complying with Chapter 5 CA. The amount of the shares that can be bought back under this procedure is capped at an aggregate amount in a financial year not exceeding the lower of:

  • £15,000, or
  • the value of 5% of its share capital.

This provision effectively allows private companies to make small amounts of share purchases out of capital each year without following the procedures set out in ss.709-723 CA 06. Private companies can therefore purchase their own shares under the De Minimis Procedure without having any distributable profits.

Guidance issued by BIS has clarified that the purchase price of the shares under the De Minimis Procedure can be at more than the nominal value (so at a premium) or less than the nominal value.

Note that a company’s articles must authorise it to follow this procedure so that, where the articles are silent, a special resolution will be required to be able to rely on this provision. In addition, the requirements for an off-market purchase apply to a De Minimis Procedure. Accordingly, a contract will be needed for a De Minimis Procedure, and it will need to be approved by ordinary resolution.

Purchase of own shares out of capital in compliance with Chapter 5 CA 2006

Only private companies are permitted to fund a purchase of their own shares out of capital (s.692(1) CA 2006).

The following conditions must be fulfilled, in addition to those set out in above:

  • check the articles of the company – an own share purchase from capital must not be restricted or prohibited by the articles;
  • see if the company has any distributable profits available to fund the purchase – if it does, those distributable profits (or funds from a fresh issue of shares for the purpose) must first be used to fund the own share purchase before capital can be used (s.710 CA 2006). The company’s capital (the ‘permissible capital payment’) may only be used if that company’s distributable profits are insufficient to fund the total cost of the purchase; and
  • check that the accounts used to determine the distributable profits were prepared to a date no more than three months before the date of the directors’ statement given under s.714 CA 2006 (s.712(7) CA 2006).

Where distributable profits are being used wholly or partly to finance the purchase of shares, the amount of distributable profits available should be verified by the company’s accountants. Likewise, if the directors conclude that a payment should be made out of capital, this view should be verified by the accountants.

Provided that the above conditions have been fulfilled, the further documentation required to effect the payment out of capital is set out in s.713 CA 2006 and is as follows:

  • a contract stating the terms of the purchase, including the price to be paid. An ordinary resolution to approve the contract is required (s.694(2) CA 2006);
  • a written statement of solvency made by the directors of the company. By making this statement, the directors of the company are stating that they believe that the company is able to pay its debts as they fall due from the date immediately after the payment out of capital is made and that it will continue to be able to do so for a period of 12 months (s.714(3) CA 2006);
  • an auditors’ report, which is annexed to the written statement of solvency (s.714(6) CA 2006); and
  • a special resolution to approve payment out of capital, to be passed on (or within a week after) the same day as the directors sign the written statement of solvency (s.716(1),(2) CA 2006).

The procedure and timing for use of capital to fund an own share purchase is:

  • A board meeting of the company purchasing its own shares must be held to call a general meeting on at least 14 clear days; notice (unless either the short notice or written resolution procedure is used). The contract to purchase must be made available for inspection by shareholders both (i) at the company’s registered office for at least 15 days ending with the date of the general meeting and (ii) at the general meeting (s.696(2)(b) CA 2006). This means that the general meeting cannot be held on notice which is shorter than 15 days. Where a written resolution is used, the 15-day requirement does not apply. Instead, a copy of the contract must be sent to each member at the same time as, or before, the written resolution is sent (s.696(2)(a) CA 2006).
  • The directors’ statement and auditors’ report must be finalised on the day of (or within 7 days prior to) the general meeting (s.716(2) CA 2006).
  • A general meeting must be held (unless the resolutions are to be passed as written resolutions), at which two resolutions are passed: one ordinary resolution to approve the contract and one special resolution to approve the use of capital. The selling shareholder can vote on the resolutions at a general meeting but if his votes in respect of the shares
    being sold carries either of the resolutions, it will be ineffective (ss. 695(3), 717(3) CA 2006). Therefore that shareholder should be advised to abstain – unless some, but not all, of his shares are to be purchased, in which case he may safely vote on a poll in respect of the shares that he is keeping. If the resolutions are passed as written resolutions that shareholder is disenfranchised for that vote (ss. 695(2), 717(2) CA 2006).
  • Under s.719 CA 2006, the company must publish a notice in the Gazette within the week immediately following the date of the special resolution approving the payment out of capital. The notice must state:
    • that the company has approved a payment out of capital for the purpose of purchasing its own shares;
    • where the directors’ statement and auditors’ report are available for inspection; and
    • that any creditor of the company may, at any time within the five weeks immediately following the date of the resolution, apply to the court under s.721 CA 2006 for an order preventing the payment.

    Within the week immediately following the date of the special resolution, the company must also publish a notice in the same form as the Gazette notice in an appropriate national newspaper, or give notice in writing to that effect to each of its creditors (s.719(2) CA 2006).

    The company must (i) deliver a copy of the directors’ statement and auditor’s report to Companies House on or before the day its first notice is published and (ii) make those documents available to any shareholder or creditor of the company for inspection, without charge, from the day its first notice is published until five weeks have passed since the special resolution approving the payment out of capital (ss.719 and 720 CA 2006).

  • The share purchase can take place no earlier than five weeks, and no later than seven weeks, after the date of the special resolution (s.723 CA 2006). This period cannot be reduced even if the special resolution is passed unanimously – the five week delay is designed to enable shareholders and/or creditors of the company to object to the payment out of capital by lodging an application at court for cancellation of the resolution (s.721 CA 2006). Shareholders who vote in favour of the resolution cannot object and so if the resolution is passed unanimously there can be no objection by the shareholders (although creditors can still object). The seven week longstop period is intended to ensure that the view formed by the directors in their statutory declaration as to the solvency of the company is still likely to be accurate at the time the share purchase is made.
  • Within 28 days of the date on which the shares that are bought back are delivered to the company, the company must send a return to Companies House under s.707(1) CA 2006 and a notice of cancellation under s.708(1) CA 2006, together with a statement of capital (s.708(2) CA 2006).

NB: the requirements of s.714, s.716 and s.719 CA 2006 do not apply where a company wishes to finance an own share purchase for the purposes of or pursuant to an employees’ share scheme out of capital, as it can do so by special resolution together with a written statement of solvency made by the directors (s.713(2) and s.720A CA 2006). In other words, no auditors’ report is required and the special resolution must be passed within 15 days of the written statement of solvency.

No deferred payment after purchase of own shares

When the shares are purchased by the company, there is no ability to defer the payment of consideration on an own share purchase (s.691(2) CA 2006) (except where the purchase is for the purpose of or pursuant to an employees’ share scheme (s.691(3) CA 2006)). This is different to the position when redeemable shares are being redeemed.