What is a buyback?
Simply put a buyback is where a company buys its own shares from a shareholder. A buyback usually results in the shares being cancelled and ceasing to exist.
What are they used for?
There are several reasons why a company may do a buyback e.g. to provide an exit route for a shareholder who leaves the business or to return cash to shareholders.
Why can they cause a problem?
The Companies Act 2006 states that unless a buyback is carried out in a prescribed manner it is void i.e. it is treated as if it never took place. There are a number of consequences of a void buyback including:
- the shares purportedly bought back would still technically exist;
- the 'seller' may have a claim to be re-instated in the register of members as the holder of the shares and may have a claim in respect of any dividends that have been paid since the buyback;
- the 'seller' would be obliged to repay the original purchase price;
- the validity or accuracy of corporate actions and filings made since the date of the buyback could be called into question;
- there could be adverse tax consequences; and
- the directors of the company may have breached their directors' duties (potentially leading to personal liability) and committed a criminal offence potentially punishable by a fine and/or imprisonment for up to two years.
Where we see potentially void buybacks causing the biggest problems is on a sale of or investment in a company. A buyer or investor will want certainty regarding the number of shares in the company and who owns them. The risk of someone coming along in the future claiming to be a shareholder will be unpalatable to say the least. Potentially void buybacks can therefore slow down a sale or investment process and create additional work.
How often do they cause a problem?
Frequently! Considering the buyback procedure has been around for years and is well established, we come across a surprising number of void buybacks.
Most common faults
There are a number of different ways in which buybacks can go wrong. However, the most common faults we see which call into question the validity of a buyback are:
- the purchase price being deferred or paid in instalments;
- the company not having sufficient distributable reserves to finance the buyback (note it is the company undertaking the buyback that must have the reserves NOT the wider group in which it may sit);
- no shareholder approval;
- no buyback contract.
Why do so many go wrong?
In most cases the answer is simple: the company did not get legal advice. Companies will often try to do buybacks themselves either using unsuitable documents they have found on the internet or that were produced for a previous buyback. We also frequently see problems where the company has taken advice but from a non-legal adviser.
Can a void buyback be cured?
No. There may be steps we can take to seek to rectify the position or mitigate the risk but there is no perfect solution. Attempting to correct a void buyback is complex and there are many grey areas. In most cases it is not possible to deal with all the potential issues raised or provide a comprehensive, unchallengeable solution. Often the best we can do is to try to improve the position.
There are several options we can look at in the context of an acquisition or investment including:
- getting an indemnity from the sellers to the effect that they will pay the costs of rectifying the buyback if it is ever challenged;
- re-doing the buyback (although this requires the co-operation of the former shareholder);
- cancelling the shares. This can be done as a solvency statement or a court approved reduction of capital. The court approved reduction is expensive and takes time, however, it provides greater certainty as once court approval has been given it cannot be challenged;
- share title insurance; and
- restructuring the transaction as an asset purchase or transferring the business and assets of the company to a new company.
There are pros and cons with each of the above options particularly with regards to cost, time, risk and tax. Legal advice is a must.
Conclusion
Buybacks frequently cause problems on transactions. The amount that companies save themselves in legal fees by attempting to do buybacks themselves or getting non-legal advisers to help is often a fraction of the cost they end up incurring in seeking to correct a buyback which goes wrong. Good legal advice will ensure that a buyback is done correctly and in the most efficient manner and will prevent problems in the future.
If you require any further information, or specific advice, please contact our expert team.
