There are many reasons why a company may wish to carry out a share buy back but the key is to ensure that the buy back is carried out in accordance with the Companies Act 2006 (or historically pursuant to the Companies Act 1985).
What is the procedure for a buy back?
In summary, and assuming the buy back is being carried out by a private limited company which has distributable profits, the procedure involves a board meeting, an ordinary resolution of the shareholders, a buy back agreement, Companies House form SH03 (return of purchase of shares) and possibly a form SH06 (notice of cancellation of shares). A private company can also carry out a buy back if it does not have distributable profits but the procedure is more complex and the timing is crucial.
Are there other issues to watch out for?
The reason why buy backs can be problematic is due to the fact that there are some very specific rules and procedures for carrying out a buy back, which must be followed. For example:
1. the shares being bought back must be fully paid;
2. stamp duty must be paid on the consideration paid for the buy back and form SH03 must be sent to HMRC to be stamped and then to Companies House for filing; and
3. subject to some exceptions, shares must be paid for in full at the time they are purchased. This means that it is not possible for the payment to be deferred or paid in instalments. This is the most common area that is undertaken incorrectly.
What if we get the procedure wrong?
Often the first time an issue with a buy back is identified is when a potential sale of the company is being considered and the proposed buyer asks its lawyers to carry out due diligence in respect of the company. At this stage the lawyers will carefully consider all buy backs which have been carried out in order to assess whether the company complied with the relevant Companies Act at the time the buy back was carried out. Therefore it is key that all documentation is retained, the relevant Companies House filings are made and the buy backs are carried out correctly.
If a buy back was carried out in breach of the relevant law, the buy back is likely to be invalid which will result in the shares still technically being in issue. This means the accounts and annual returns since the date of the buy back will also technically be incorrect. This is often of great concern to a potential buyer as it means that there are additional shares which need to be purchased and possibly additional shareholders to contract with. This can cause major issues as the sellers and the company will assume the buy back has been carried out appropriately, as in their mind the departed shareholder is no longer a shareholder and has been paid fully for his shares. Therefore they would not expect the departed shareholder to be involved in a sale process nor to receive further consideration for his shares. A buy back issue can therefore come as a shock!
There are a number of ways in which an invalid buy-back can be dealt with. The option which is selected largely depends on the position of the buyer and how much risk they are willing to accept. What is certain though is that the majority of the options take time, money and effort to deal with, which is an additional burden during a sale process. At its most extreme, the buyer could require the company to locate the departed shareholder and carry out the buy back process again validly, which will largely depend upon whether the departed shareholder can be located and is willing to assist (and the company or the sellers may have to pay the departed shareholder for their co-operation).
Therefore buy backs should be carried out validly at the time of execution or, if the time has passed for this, you should consider rectifying invalid buy backs before embarking on a sale process.
For further information or assistance in relation to buy backs, please contact the Corporate Team at Trethowans who will be happy to assist.
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