Share Buybacks: how to get them right and avoid complications on a future sale

Selling shares in a company is a complex legal process which can be further complicated if errors in a company’s share ownership history are identified by a buyer in its due diligence process. One issue which may (and often does) arise is a faulty buyback of shares where the company has previously attempted to purchase some of its shares from a shareholder but has failed to meet the strict statutory requirements of the repurchase process. This article will explore the impact a void buyback may have on a company sale and highlight the key components of a buyback to get right in order to avoid any of the issues flagged.

This note specifically relates to off-market share buybacks carried out by private limited companies.

What could go wrong?

A buyer of the entire issued share capital of a company will want absolute certainty that this is what they are buying and will carry out due diligence into the share history of the company to verify the sellers’ title to the sale shares.  

Where a void buyback is discovered, the shareholder whose shares were purportedly bought back will still actually own these shares. This therefore adds another shareholder into the mix, in addition to the sellers, which is not what the buyer would have anticipated.

In such circumstances, a buyer will typically request that the buyback be carried out again properly to eliminate these shares. This could cause sell-side problems as follows:

• the sellers will have to incur the costs of drawing up new documentation and amending the statutory registers of the company to re-enter the original shareholder;
• if the purported buyback was carried out a long time ago, the sellers may not be able to locate the original selling shareholder;
• if the original selling shareholder is available, they may refuse to re-do the buyback and prefer to become a party to the sale in order to achieve a better price for their shares; and/or
• if the original selling shareholder declared the money they received from the purported buyback as a capital receipt for the sale of shares on their tax return, this is incorrect and they will be liable to pay HMRC any additional tax due plus any interest and possibly also penalties.

Alternatively, the buyer may request that the shares which were not bought back be cancelled by way of a capital reduction or they may wish to switch to a business and asset sale to bypass the issues with the corporate entity. Both of these options will complicate the sale process and cause both sides to incur further time and expense.

How can I ensure that the buyback is valid?

To avoid the issues highlighted above on a sale, it is essential to ensure that any buyback is properly carried out in the first place. Below are some of the key considerations when carrying out a buyback of shares:

1. Articles of association: check the articles of the association of the company to ensure that there are no restrictions placed on a company buying back its shares. If a company is purchasing its shares out of capital under the de minimis rule in s692(1ZA) Companies Act 2006 (a simplified process under statute which allows for small buybacks of shares) then the articles should expressly permit this.  
2. Shares must be fully paid up: A company cannot purchase its own shares unless they are fully paid for. Any buyback of unpaid shares will be void.
3. Having a buyback contract: Generally, a formal contract governing the sale of the shares from the shareholder to the company must be entered into. A copy of the agreement must be made available for inspection by the shareholders of the Company prior to their approval of it (see below).
4. Obtain shareholder approval: The share buyback contract must be approved by the company’s shareholders. Approval can either be obtained prior to the buyback contract being entered into or the contract can be conditional on approval being obtained before completing the buyback. Generally, an ordinary resolution (requiring approval from more than 50% of the shareholders entitled to vote) will be required unless the company’s articles set a higher threshold. Note that the shareholder whose shares are being bought is not eligible to vote. Failure to obtain shareholder approval will render the buyback void.
5. Ensure the shares are paid for at the right time: The shares must be paid for in full (instalments are not permitted) on completion of the buyback (unless the buyback is pursuant to an employee share scheme). Failure to do this results in the share buyback being void. A transfer of cash must be made on completion – it cannot be a promise to pay in the future. There is case law to suggest that assets can be transferred in lieu of cash or part of the consideration may be used to settle a debt owed by the shareholder but it is best practice to fully transfer the cash amount to the shareholder who then uses this to discharge their debt.
6. Requirements based on funding :A buyback can be funded in different ways (i.e. out of distributable reserves, capital or the proceeds of a fresh issue of shares). Note that these each have different requirements that will need to be met in order to ensure that the buyback is valid. Additionally, different rules apply to buybacks which are made pursuant to an employee share scheme. Care should be taken to ensure all specific requirements based on the circumstances of the buyback are met.  
7. Pre-emption rights: Check the articles of association for any pre-emption rights on a transfer of shares. These require shares to be offered first to the existing shareholders of the company before they can be transferred to the company. Such rights can be either waived or disapplied prior to the buyback.   

Conclusion

There are many hurdles to ensuring a buyback is carried out correctly. By taking appropriate legal advice, a company can ensure that these hurdles are met and avoid the issues a failed buyback creates on a future sale of the company.

If you or your business has any corporate matters you would like advice on, including the matters raised in this article, please contact our Corporate team by email on [email protected]