Learning Outcomes
After reading this article, you will be able to explain the legal requirements for share buybacks under the Companies Act 2006, including the procedures for private and public companies, funding restrictions, and the role of directors’ duties. You will be able to identify when shareholder approval is needed, understand the impact of capital maintenance rules, and apply these principles to SQE1-style scenarios.
SQE1 Syllabus
For SQE1, you are required to understand the legal and practical aspects of share buybacks as part of business finance. In your revision, focus on:
- The statutory framework for share buybacks under the Companies Act 2006
- The capital maintenance principle and funding restrictions for buybacks
- The procedural requirements for private and public companies
- Directors’ duties when authorising buybacks
- Shareholder approval and disclosure obligations
- The consequences of non-compliance and the impact on creditors and shareholders
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What are the main funding sources a private company can use for a share buyback?
- Which shareholder(s) are excluded from voting on an ordinary resolution to approve an off-market buyback?
- What is the purpose of the solvency statement procedure when a private company funds a buyback out of capital?
- What are the consequences if a company fails to comply with the statutory procedure for a buyback?
- How do directors’ duties under the Companies Act 2006 affect decisions to buy back shares?
Introduction
A share buyback occurs when a company purchases its own shares from shareholders. This reduces the number of shares in issue and can have significant effects on the company’s capital structure, shareholder value, and creditor protection. The Companies Act 2006 sets out strict rules to ensure that buybacks are carried out lawfully and do not undermine the interests of creditors or other stakeholders.
Statutory Framework for Share Buybacks
The Companies Act 2006 (CA 2006) governs share buybacks in Part 18. A company may only buy back its own shares if permitted by its articles of association and if it follows the statutory procedures.
Key Term: share buyback
A transaction where a company purchases its own issued shares from shareholders, reducing the number of shares in circulation.Key Term: capital maintenance
The legal principle that a company’s share capital must be preserved as a fund for creditors and cannot be returned to shareholders except as permitted by law.
Types of Buyback
There are two main types of buyback:
- On-market buybacks: For public companies, purchases made on a recognised investment exchange.
- Off-market buybacks: Purchases made by private or public companies otherwise than on a recognised investment exchange, usually by private agreement.
Funding Restrictions
A company may only fund a buyback using certain sources:
- Distributable profits: Most common for both private and public companies.
- Proceeds of a fresh issue of shares: The company issues new shares and uses the proceeds to fund the buyback.
- Capital: Private companies may, in limited circumstances, use capital for a buyback if they follow the solvency statement procedure.
Key Term: distributable profits
Profits available for distribution to shareholders, calculated as accumulated realised profits less accumulated realised losses.Key Term: solvency statement
A formal statement by the directors confirming that the company can pay its debts as they fall due and will remain solvent for at least 12 months after the buyback.
Procedural Requirements
The procedure for a buyback depends on whether the company is private or public, and whether the buyback is on-market or off-market.
Private Companies
- The articles must not prohibit buybacks.
- The company must enter into a buyback contract, which must be approved in advance by an ordinary resolution of the shareholders (CA 2006, s. 694).
- The shareholder whose shares are being bought back cannot vote on the resolution.
- The buyback contract (or a summary) must be available for inspection by shareholders at least 15 days before the meeting.
- Payment must be made only for fully paid shares.
- If funding from capital, the directors must make a solvency statement, supported by an auditor’s report, and a special resolution must be passed (CA 2006, ss. 709–723).
Public Companies
- Buybacks must be made either on a recognised investment exchange or by an offer to all shareholders on the same terms (CA 2006, s. 701).
- The company must have sufficient distributable profits or use the proceeds of a new share issue.
- Additional disclosure and reporting requirements apply.
Key Term: off-market buyback
A purchase by a company of its own shares otherwise than on a recognised investment exchange, typically by private agreement.
Directors’ Duties and Share Buybacks
Directors must comply with their statutory duties when authorising a buyback, in particular:
- Duty to act within powers (s. 171): Directors must act in accordance with the company’s constitution and only exercise powers for proper purposes.
- Duty to further the success of the company (s. 172): Directors must act in good faith for the benefit of the company as a whole, considering the long-term consequences, employees, creditors, and fairness between members.
- Duty to exercise reasonable care, skill, and diligence (s. 174): Directors must properly assess the financial impact of the buyback and seek advice if needed.
- Duty to avoid conflicts of interest (s. 175): Directors must not allow personal interests to influence their decision.
Key Term: directors’ duties
The statutory and common law obligations imposed on company directors, including acting in good faith, with care, and for proper purposes.
Shareholder Approval and Disclosure
For off-market buybacks, an ordinary resolution is required, and the buyback contract must be made available for inspection. Public companies must also comply with disclosure requirements, including notifying the market and filing returns at Companies House.
Capital Maintenance and Creditor Protection
The capital maintenance principle restricts the sources of funds for a buyback to protect creditors. Private companies may use capital only if they follow the solvency statement procedure, which requires directors to confirm that the company will remain solvent after the buyback.
Tax and Regulatory Considerations
Buybacks may have tax implications for both the company and the selling shareholders. For public companies, buybacks must also comply with market abuse regulations and, in some cases, the Takeover Code.
Worked Example 1.1
A private company wishes to buy back 10% of its issued shares from a retiring shareholder. The company has sufficient distributable profits. What steps must the company take to lawfully complete the buyback?
Answer: The company must check its articles allow buybacks, enter into a buyback contract, and obtain shareholder approval by ordinary resolution (excluding the retiring shareholder from voting). The contract must be available for inspection 15 days before the meeting. Payment must be made for fully paid shares. The company must file a return of the buyback at Companies House and cancel the shares.
Worked Example 1.2
A private company wants to fund a buyback out of capital. What additional requirements apply?
Answer: The directors must make a solvency statement, supported by an auditor’s report, confirming the company can pay its debts and will remain solvent for 12 months. A special resolution must be passed to approve the payment out of capital. Notices must be published in the Gazette and to creditors. The buyback cannot proceed for at least five weeks after the special resolution, allowing time for objections.
Worked Example 1.3
A public company proposes to buy back shares on the stock exchange. What are the key legal requirements?
Answer: The buyback must be authorised by the articles and by an ordinary resolution. The purchase must be made on a recognised investment exchange or by an offer to all shareholders equally. The company must use distributable profits or the proceeds of a new share issue. The company must comply with disclosure and reporting requirements.
Exam Warning
Directors must ensure that the company remains solvent after a buyback. If a buyback is funded out of capital without following the solvency statement procedure, the transaction is void and directors may be personally liable for losses.
Revision Tip
Always check the company’s articles for restrictions on buybacks and ensure all statutory procedures are followed. Failure to comply can result in the buyback being void and directors being required to indemnify the company for any loss.
Key Point Checklist
This article has covered the following key knowledge points:
- A company may only buy back its own shares if permitted by its articles and if it follows the Companies Act 2006 procedures.
- Buybacks must be funded from distributable profits, proceeds of a new share issue, or (for private companies) capital using the solvency statement procedure.
- Off-market buybacks require an ordinary resolution, with the selling shareholder excluded from voting.
- Directors must comply with their statutory duties, including acting in good faith and considering creditor protection.
- Capital maintenance rules protect creditors by restricting the sources of funds for buybacks.
- Failure to comply with the statutory procedure can render the buyback void and expose directors to liability.
Key Terms and Concepts
- share buyback
- capital maintenance
- distributable profits
- solvency statement
- off-market buyback
- directors’ duties
