In our article Buying Back Shares - The Importance of Getting it Right, we highlighted the steps required for a company’s buyback of shares out of distributable reserves and the importance in ensuring that the correct procedure is employed to make sure that the transaction is valid.
Over the past couple of years our Corporate & Commercial Department has encountered a number of instances where critical steps have not been carried out correctly, resulting in the buyback transaction being void. This article outlines two similar examples of how the ineffective buyback affected the disposals of those companies, with contrasting outcomes.
Example 1 – G Ltd
On this occasion, the shareholders of the company (G Ltd) entered into the sale process with a potential buyer, and the buyer commenced its due diligence. As part of that process, it was noted that a buyback of shares had been concluded over 10 years previously.
The departing shareholder, Mr J had agreed to dispose of his shares for a cash payment, and the buyback process was undertaken with the assistance of G Ltd’s accountants. On the face of it the correct type of paperwork had been prepared, signed and filed where necessary at Companies House. Critically, the buyback agreement provided for G Ltd to pay for the shares in monthly instalments over four years. G Ltd had paid the instalments to Mr J when due, and stamp duty had been paid on the purchase price. Mr J was removed from G Ltd’s register of members following his disposal of shares and annual returns were filed to reflect this in the years subsequent.
However, as the purchase price was payable in instalments against the single completion of the buyback of shares, the entire transaction was void and Mr J should not have been removed from G Ltd’s register of members. The further consequence is that Mr J was still entitled to vote on shareholder resolutions of G Ltd, to receive any dividends paid on the shares, and to participate in a sale of shares of G Ltd So in effect many of G Ltd’s administrative steps in that period would be void.
In the event of a sale of shares, the buyer would need to be satisfied that it was acquiring the entire issued share capital of G Ltd, and that could not be assured in this case without the involvement of Mr J.
Ultimately G Ltd’s shareholders decided not to proceed with the transaction, and the situation remains unresolved, with the risk that Mr J could discover that the buyback of his shares was void. As such he would technically still be a shareholder, he would be entitled to payment of dividends paid in the meantime and he would still have had a stake in a successful business. Having decided not to proceed, G Ltd’s shareholders lost this opportunity to realise the value of their investment. As a result they would be able to sue their accountants for negligence for their role in the void buyback, and there is no doubt that the potential liability for their loss of opportunity would be substantial.
Example 2 – F Ltd
In the second example, the circumstances were remarkably similar in that the shareholders of the company (F Ltd) entered into a sale process with a potential buyer, and in the course of the buyer’s due diligence it was noted that a buyback of shares had been concluded some time previously.
Similarly, the departing shareholder, Mr P, had agreed for his shares to be bought back for a cash sum, with F Ltd’s accountants dealing with the transaction and preparing the paperwork. Again, the transaction paperwork was signed, payments were made as required and stamp duty was paid. Mr P was removed from the register of members.
The buyback agreement however provided for the shares to be bought back in one transaction with instalments of the purchase price to be paid over ten years. Payments remained payable while negotiations continued with the proposed buyer, but as the buyback agreement provided for payments to be made in instalments, the buyback itself was void, with the same potential consequences existing as in Example 1.
In this case, the shareholders of F Ltd decided to proceed with the sale of shares to the buyer, and in order to do so they first had to address the question of the void buyback. This involved some delicate handling but ultimately Mr P agreed for his shares to be bought back by F Ltd afresh. The buyer agreed with the approach taken subject to the shareholders giving indemnities to the buyer against any issues that might arise after the event. This enabled the shareholders to sell their shares successfully, and any claim against F Ltd’s accountants for negligence resulting in the loss of that opportunity was avoided.