Companies Act Capital reductions and share buybacks. April 2008

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1 Companies Act 2006 Capital reductions and share buybacks April 2008

2 Introduction Under the Companies Act 2006, private companies will from 1 October 2008 be able to make a reduction of capital without needing court approval. A company wishing to return funds to its shareholders may in future, depending upon the commercial objectives, decide to choose this mechanism instead of the mechanisms which are currently available, including by way of a share buyback. This briefing note examines the new law, and the factors that will influence the company s choice of which route to use. Mechanisms for returning funds There are a variety of mechanisms for a private company to return capital or distributable profits to some or all of its shareholders: a share buyback, a reduction of capital with court approval, issuing redeemable shares and subsequently redeeming these, payment of a special dividend out of distributable profits, or a takeover by a new holding company under a scheme of arrangement which again requires court approval. Reasons for returns of capital Reductions of capital Three specific types of capital reduction are outlined in the Companies Act 2006 (the relevant provision comes into force from 1 October 2008 but is similar to the existing law), which states that a company may: (a) extinguish or reduce the liability on any of its shares in respect of share capital not paid up, or (b) either with or without extinguishing or reducing liability on any of its shares (i) cancel any paid-up share capital that is lost or unrepresented by available assets, or (ii) repay any paid-up share capital in excess of the company s wants. However, these are merely examples, and it is provided that a company may, subject to compliance with statutory requirements, reduce its capital in any way. Share buybacks As the name suggests, in this case the company enters into an agreement to purchase all or some of the shares of a particular shareholder on specified terms. The purchase price will be received by that shareholder and not by the shareholders as a whole. Shares may generally only be bought back out of distributable profits or the proceeds of a fresh issue of shares. However, private companies can, subject to compliance with statutory requirements to protect creditors, make a buyback out of capital. For an outline of the procedures and timetable for a share buyback out of capital, see our separate briefing note Share buybacks in the UK. A return of capital may form part of a general restructuring of the company s share capital, or simply be designed to provide surplus cash to investors, perhaps following a disposal. It is more likely for a listed public company to want to increase its earnings per share or net assets per share ratios, but this might also apply to certain private companies. The main features of reductions of capital and share buybacks are set out below.

3 Comparison of existing routes This is not a purely procedural choice - a reduction of capital and a share buyback are not simply separate methods of reaching an identical result. A share buyback changes the composition of the shareholdings, but a capital reduction may change the shareholders liabilities (for example, where cancelling the liability to pay the balance due on partly-paid shares). There are circumstances in which it may be necessary or desirable for the company to buy back the shares of a specific shareholder. Having the company as a potential buyer can enhance marketability for private company shares, and assist the operation of forced transfer mechanisms in an investment or joint venture context. It can also provide a means of removing untraceable shareholders from the register. Other factors may also point strongly in favour of one route over the other. However, where all else is equal, a capital reduction may currently be less attractive than a share buyback for the following reasons: (a) the court has a discretion as to whether to grant the order requested and, if so, whether to impose any terms and conditions (b) Although a share buyback out of capital also involves a fairly significant volume of paperwork, preparing the claim form and related witness statements for the court hearing is likely to be more onerous Simplified capital reductions under the 2006 Act Procedure The new capital reduction procedure (Sections 642 to 644 of the 2006 Act) is due to be available from 1 October 2008, and requires only the following steps: (a) the members of the company pass a special resolution to approve the reduction (b) the directors of the company sign a solvency statement (see below) (c) within 15 days from the date of the special resolution, the company files with the Registrar of Companies the special resolution, the solvency statement, a statement of capital setting out prescribed details of the company s share capital (as reduced), and confirmation that the solvency statement was made not more than 15 days before the passing of the special resolution (failure to comply with the filing deadline does not however invalidate the resolution) The special resolution takes effect when the solvency statement and statement of capital are registered, preventing the resolution specifying an effective date a long way in the future. The company s articles of association will not need to contain an express authorisation for a capital reduction, but can impose restrictions - this will also be the case for share buybacks under the 2006 Act (and details of transitional arrangements are awaited for existing companies).

4 Directors solvency statement The solvency statement is a statement that each of the directors: has formed the opinion, as regards the company s situation at the date of the statement, that there is no ground on which the company could then be found to be unable to pay its debts has also formed the opinion that the company will be able to pay its debts as they fall due during the year immediately following that date (this is varied where it is intended to commence winding up the company within that year) In forming their opinions, the directors are obliged to take into account all of the company s liabilities, including contingent liabilities such as amounts required to redeem shares during the following year. If the directors deliver a solvency statement without having reasonable grounds for the opinions in it, every director in default commits an offence. The onus is therefore on the directors to ensure that the solvency statement is valid. Unlike with share buybacks, there is no statutory obligation to obtain any auditor s report, and the solvency statement does not include a statement that full inquiry has been made into the affairs and prospects of the company, but the directors may decide it is prudent to take steps to obtain documentary evidence to justify their opinions. Continued use of court procedure The new simplified procedure is inserted alongside the continuing route of obtaining court approval. Public companies are required to obtain court approval, but private companies may also choose do so, in particular where: not all of the directors are willing to sign the solvency statement (but the dissenting directors do not resign) the company s share capital is to be reduced to zero, for example as part of a scheme of arrangement on a takeover validation is required for a previous return of capital (perhaps when it is intended to sell the company), or where one group of shareholders is to be treated differently the company wishes to make a distribution of the reserves arising where this would otherwise not be permissible (depending upon the outcome of the review of this area see above) The company s directors may generally prefer to obtain a court order where there is a possibility of challenge by a creditor since it would be more difficult for the creditor to establish that material facts were withheld from the court than to assert that there were no reasonable grounds for the opinions given in a solvency statement. There is also no requirement for the company to obtain creditors consent, or to discharge or provide security for creditors claims, and existing creditor protections are due to be diluted in any event from 6 April Treatment of reserves arising from reduction The 2006 Act sets out a default principle that a reserve arising from a capital reduction is not distributable, but empowers the Secretary of State to make regulations to relax this rule. Since around 50% of capital reductions in 2007 were carried out with the aim (at least partially) of creating distributable profits, the approach taken in this regard could be very important for the utility of the new mechanism. Draft regulations were issued some time ago but it is understood that these are being reconsidered and further details are currently awaited.

5 Share buybacks under the 2006 Act The provisions of the 2006 Act relating to share buybacks or redemptions out of capital (Sections 709 to 723) are due to come into force from 1 October There are a few changes, but these are not as significant as for capital reductions. The main difference from the 1985 Companies Act is that the directors will make a prescribed form of statement regarding the company s ability to meet its debts, rather than a statutory declaration. The liabilities to be taken into account in giving this statement are wider than under the 1985 Act, and aligned with those relevant to reductions of capital under the 2006 Act. A statement of capital will need to be filed with the Registrar of Companies along with the directors statement and the auditor s report. Future strategies Initially, the government intended to delay introduction of the new capital reduction procedure until 1 October 2009, along with the other provisions of the 2006 Act relating to share capital. It reported that it was persuaded not to do so by the strength of business representations which indicates that companies intending to undertake returns of capital are looking ahead and waiting for the reforms to take effect. A capital reduction will not be appropriate in every case, but from 1 October 2008 it is likely to become the preferred route in a significant proportion of cases as a result of the changes made under the 2006 Act. Another development is that the purchase contract can be entered into on the basis that completion of the share buyback is conditional upon members approval by special resolution. Signature of the contract will not need to be delayed, and if for any reason the buyback is never completed the company does not have to seek the approval.

6

7 Contacts Andrew Blankfield t. +44 (0) e. Nigel Taylor t. +44 (0) e.

8 Field Fisher Waterhouse LLP 35 Vine Street London EC3N 2AA t. +44 (0) f. +44 (0) This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed. Copyright Field Fisher Waterhouse LLP All rights reserved. Field Fisher Waterhouse LLP is a limited liability partnership registered in England and Wales with registered number OC318472, which is regulated by the Solicitors Regulation Authority. A list of members and their professional qualifications is available for inspection at its registered office, 35 Vine Street London EC3N 2AA. We use the word partner to refer to a member of Field Fisher Waterhouse LLP, or an employee or consultant with equivalent standing and qualifications.

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