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Is your share buyback a sham?

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Carrying out a share buyback (or a ‘purchase of own shares’) is one way in which a company can return capital to its shareholders. There is a strict statutory procedure which has to be followed and the consequences of not sticking to this are severe: the transaction will be void.

Why buy back shares?

There are various reasons why a company may choose to buyback its own shares from a shareholder: it may be a way of facilitating an exit for a particular shareholder, or the company may want to return surplus cash to all its shareholders. In the case of a listed or quoted company, a share buyback can help improve its ‘earnings per share’ (EPS), a key measure of company performance and valuation. This is calculated by dividing the company’s profits by the number of its issued shares. So reducing the number of shares in issue can increase the overall EPS figure.

Key requirements

The key statutory requirements for carrying out a share buyback are:

  • The company’s articles must not restrict or prohibit the buyback
  • The buyback must be approved by the company’s shareholders
  • The shares being bought back must be fully paid
  • The company must have at least one non-redeemable share in issue after the buyback
  • The consideration for the buyback must generally be paid either from distributable profits or from the proceeds of a fresh issue of shares
  • The shares must be paid for on purchase, in cash

 Loaning back the consideration?

As noted above the statutory requirements require the shares to be paid for when they are bought back. But could the relevant shareholder immediately loan the consideration back to the company, so the money simply moves in a circle? And if so, does the money actually have to physically move or could this simply be recorded by book entries?

This was the scenario in a recent case[1]: a company bought some shares back from its controlling shareholder who immediately agreed to loan the consideration back to the company. The loan was interest free but was intended to be secured by a debenture granted by the company. Crucially, no money ever actually moved from the company to the shareholder (for the buyback) or from the shareholder back to the company (for the loan). Instead, the movements were simply recorded by book entries, effectively moving the relevant amount from shareholder funds to loan account.

The judge held that this did not satisfy the requirement for the shares to be paid for on purchase. He agreed that very similar results could be achieved by structuring the buyback so money was actually paid by the company on completion and an equivalent amount then immediately loaned back to the company. But the judge said that was a substantially different transaction since the company would actually have to find the funds from which to make payment, even if only for a moment before receiving the loan back.

The judge said that provided the buyback and the loan were genuinely separate, and the arrangement was not a ‘sham’, then this would satisfy the statutory requirement for payment on purchase of the shares.

Unfortunately, the judge didn’t elaborate on what would be a ‘sham’ for this purpose. At the least, it would seem sensible to ensure that any loan back is made at a commercial rate of interest otherwise there is a risk that the whole transaction could be void.

[1] Dickinson v NAL Realisations (Staffordshire) Limited & ors [2017] EWHC 28 (Ch)

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