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Can a company buy its own shares?

Company Law Solutions provides expert advice and a full documentation service for a company buying its own shares.

A company buying its own shares used to be completely prohibited. Now buy-backs are permitted subject to quite restrictive and detailed rules.
The problem with companies buying their own shares is that, if completely unrestricted, there is a danger that creditors (and potential creditors) may be misled as to the size of the company's capital. This is part of the wider area of maintenance of capital. Under the Companies Act 2006 a new procedure for the reduction of capital without a court order was introduced, which will sometimes be used rather than a buy back..

This is a very technical area. The rules are set out in some detail below, but a summary of them is:

1. At common law companies were prohibited from buying their own shares: Trevor v. Whitworth (1887) 12 App Cas 409.
2. Successive Companies Acts have made it possible for companies to buy their own shares in a number of ways. The current legislation is in Part 18 of the Companies Act 2006.
3. One way is for the company to create redeemable shares and then redeem them. This has long been permitted and redeemable preference shares are quite common. Redemption is subject to the rules on finance mentioned below.
4. A company listed on the Stock Exchange can make a 'market purchase' of its shares through the Exchange, if authorised to do so by an ordinary resolution in general meeting. This, too, is subject to the rules on finance mentioned below.
5. Any company may make an 'off-market purchase' of its shares by contract with one or more particular shareholders. The contract must be approved by a special resolution in general meeting. The shares must be cancelled when purchased and this, too, is subject to the rules on finance mentioned next.
6. Redemption, market purchases and off-market purchases are all subject to restrictions as to financing the redemption or purchase. This may come from either distributable profits (i.e. profits which could be paid out by way of dividend) or from the proceeds of issuing new shares. In either case the company's capital is maintained.
   Further, a private company (only) may make a 'permissible capital payment' to finance a redemption or off-market purchase. Any available profits must be used first and the payment must be approved by a special resolution and advertised to creditors. Creditors and dissenting shareholders may object to the court against such payment.
7. Shares may be bought back as part of a reduction of capital.

In practice, redeemable shares and off-market purchases by private companies are reasonably commonplace. The off-market purchase is useful where a director/shareholder of a successful private company is retiring and selling out his interest, or as a means of buying out a dissenting shareholder. Purchase by the company is an alternative to purchase by the other shareholders in the company. The off-market purchase is also used as part of some management buyouts.

Care must be taken with regard to the taxation of the purchase price. HMRC may treat any premium as if a distribution, and so liable to income tax, rather than as a capital gain, unless certain requirements are met. Discussion of these tax rules is beyond the scope of this database.

Proposed changes to the statutory rules on companies buying their own shares
To make it easier for companies adopting the employee-owner scheme to be able to buy back their shares when such an employee leaves the company, the government proposes to make changes to the statutory provisions for the buy back of shares. A draft statutory instrument has been published, expected to come into effect on 6th April 2013.

Regulation 3 removes the requirement on private limited companies to pay in full the purchase price of shares in cases where the buy back is for an employees’ share scheme; this will allow a private company to pay for its shares by installments.

Regulation 4 reduces the requirements for shareholder authorisations concerning contracts for share buyback to be passed by special resolution to an ordinary resolution.

Regulation 5 allows a private limited company to hold its shares in treasury and to deal with such shares as treasury shares.

The following is a more detailed account of the statutory rules on redemption and buy back.

Redemption of redeemable shares
By CA 2006, sec684 - sec689 a company can issue shares of any class which are to be redeemed, at the option of the company or the shareholder subject to the following conditions:

(1) redeemable shares can be issued only if the company has other shares which are not redeemable;
(2) redeemable shares may not be redeemed unless they are fully paid.
There are restrictions on the financing of the redemption. These restrictions apply also to a company purchasing its own shares and are dealt with in detail below.
Shares redeemed must be cancelled on redemption and the amount of the company's issued capital (but not its authorised capital) is diminished by the nominal value of the shares.

Purchase by a company of its shares
A company may purchase any of its shares (whether or not they are expressed to be redeemable) under CA 2006, sec690 - sec708. The purchase can be by means of a market purchase (PLCs only) or an off-market purchase.

Market purchase
A market purchase is a purchase of shares on the Stock Exchange and must be authorised by ordinary resolution which may give a general authority to purchase the company's own shares or be limited to shares of a particular class or description. The authority may be unconditional or conditional. The authority cannot last for more than 18 months. It is standard practice in many PLCs to have such a resolution passed at each AGM.

Off-market purchase
This is any purchase of shares other than through the Stock Exchange. It can include shares in a PLC bought other than through the market, or any buy-back by a private company. The statutory provisions are to be found in CA 2006, sec690 - 708.

An off-market purchase may be made only if the terms of the contract of purchase are authorised before the company enters into the contract by a special resolution. In most cases this will be under a contract drawn up for the purposes of the buyback, but it may also be done under the terms of a previously authorised 'contingent purchase contract': a contract under which a company may, subject to any conditions, become entitled or obliged to purchase its own shares.

The member whose shares are the subject of such a special resolution to approve the purchase of them cannot exercise the votes attached to those shares. The member may, however, exercise any votes on any other shares if the resolution is passed at a meeting on a vote by poll.

The special resolution will not be effective unless a copy of the proposed contract of purchase, or a written memorandum of its terms if it is not in writing, is available for inspection by members of the company, both at the registered office for at least 15 days before the date of the meeting at which the resolution is passed, and at the meeting itself.

Where a company has purchased its own shares it must, within 28 days, deliver to the Registrar a return (form SH03) stating the number and nominal value of those shares and the date they were purchased. Stamp duty must be paid on this form if the consideration paid by the company for the shares is £1,000 or more.

In a private company the shares must be cancelled on buy-back. The company must then register another form, SH06, which includes a statement of capital.

The company must keep a copy of any contract to purchase its own shares, or a memorandum of its terms if it was not in writing, at its registered office for 10 years. It must be made available for inspection by members and, if a public company, by any other person.

Financing redemption or purchase of own shares
Subject to the provisions which enable private companies to make payments out of capital in certain circumstances (see below) shares may be redeemed or bought back by a company only out of the distributable profits of the company or the proceeds of a fresh issue of shares made for the purpose: CA 1985, sec162, applying sec160.

Permissible capital payments
Where a private company redeems shares or enters into an off-market purchase for its own shares it will usually finance the transaction out of distributable profits or the proceeds of a fresh issue of shares, but it is possible for a private company to make all or some of the payment for these purposes out of capital if it complies with CA 1985, sec171 - sec177. The payment is called a 'permissible capital payment' and it may be made only after profits available for distribution have been used. In some cazses the same effect may be achieved by a reduction of capital without a court order.

The procedure for a payment out of capital is as follows:

(1) The directors must make a statutory declaration of solvency that, having made full inquiry into the affairs and prospects of the company, the directors have formed the opinion that, having made the payment, there will be no ground on which the company could be found to be unable to pay its debts, and for the year following that date the company will be able to carry on business as a going concern and be able to pay its debts as they fall due.

(2) Annexed to the statutory declaration must be a report by the auditors that they have inquired into the company's state of affairs and they are not aware of anything to indicate that the opinion of the directors in the declaration is unreasonable.

(3) The proposed payment out of capital must be approved by a special resolution passed within a week after the date of the statutory declaration. The statutory declaration and auditors' report must be available for inspection at the meeting. The voting rights attached to the shares which are the subject of the special resolution cannot be exercised in respect of the resolution.

(4) Within one week of the special resolution, the company must advertise the payment in the London Gazette and either in a national newspaper or by writing to each of the company's creditors.

(6) The actual payment out of capital can be made only between five and seven weeks after the date of the special resolution.

Within five weeks of the special resolution, any member of the company (other than one who consented to or voted in favour of the resolution) and any creditor may apply to the court for the cancellation of the resolution. On hearing an application the court has wide powers to confirm or cancel the resolution on such terms and conditions as it thinks fit.

If the company is wound up within one year of a payment for shares out of capital and the assets are insufficient to meet the company's liabilities the vendor of the shares and the directors who made the statutory declaration of solvency will be liable to contribute up to the amount of the capital payment. A director can escape liability by showing reasonable grounds for the opinion expressed in the statutory declaration.

Company Law Solutions provides expert advice and a full documentation service for a company buying its own shares.

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