Although there is a general prohibition against a company buying back its own shares, there are exceptions to this rule. Rachel Eng explores these exceptions, including the types of buyback schemes provided for under the Companies (Amendment) Act 1998 and the benefits of allowing share buybacks.
Introduction
General principle against share buybacks
Generally, a company cannot return any assets to its members while it is a going concern (except in the form of dividends if there are available profits). In the case of a company limited by shares, the obligation of a member is limited to the amount unpaid on the shares of such a member. As these members enjoy limited liability, the law ensures that the share capital of the company is not reduced to the prejudice of its creditors as the capital of the company is meant to be used to pay creditors in the event of winding up. Thus, a company cannot buy back its own shares as this would reduce the assets available for distribution to creditors upon its winding up. This prohibition is expressly found in section 76(1)(b) of the Companies Act (Cap 50).
Exceptions
There are certain exceptions to the general rule against the return of capital.
First, company law permits a company to issue preference shares on terms that they may be redeemed. In the redemption of preference shares, creditors' interests are safeguarded as they can only be redeemed out of distributable profits or out of the proceeds of a fresh issue of shares. Section 70(5) of the Companies Act further provides that in the case of a redemption out of distributable profits, a sum equal to the nominal value of the redeemed shares must be transferred to a capital redemption reserve . Thus, the company's capital is not reduced but the issued preference share capital is simply replaced by the capital redemption reserve.
Secondly, a company may undertake to cancel unissued or forfeited shares without any court sanction so long as it is approved by shareholders.
Thirdly, a company may cancel its shares by way of a court sanction if, for instance, such share capital is lost or unrepresented by assets or to pay off any paid up capital which is in excess of the needs of the company. The interests of all parties, particularly the creditors, would be taken into account by the court before it grants the order.
Objections against share buybacks
As seen above, the law has in place provisions to ensure that creditors' interest are safeguarded and not prejudiced when there is return of share capital. However, protection of creditors' interest is not the only concern. Other considerations include the risk of abuse by company directors who can enhance their control of the company by having the company buy back its shares, or indeed, arrange for their own shares to be bought back at inflated prices. Share buybacks also increase the chances of insider trading, since share prices usually rise before the commencement of a share buyback. Where the share buyback option is made available, companies may also lose the incentive to seek investment options for their excess cash or may even use share buyback as a means to prop up their share price.
The Companies (Amendment) Act 1998
The economic crises in Asia indicated that a number of companies were cash rich but were not able to identify good investments. The government studied models adopted by various countries such as the United States, the United Kingdom, Hong Kong, Australia and New Zealand and developed a fairly limited share buyback scheme. The Companies (Amendment) Act 1998 introduced new provisions (sections 76B to 76G) to allow listed and unlisted companies, public and private companies in Singapore to purchase or acquire their own shares out of distributable profits, after obtaining the necessary mandates from shareholders.
It is interesting to note that the new share buyback provisions constitute an 'exception' to an old prohibition contained in section 76(1)(b)(i). The remaining prohibitions contained in section 76(1) relating to the giving of financial assistance for the purchase of a company's own shares and the lending of money on the security of a company's own shares continue to apply. Therefore, it follows that any purported share buybacks scheme that is in breach of the rules and procedure laid down in the new sections of the Companies Act may run foul of the general statutory prohibition against the giving of financial assistance in the acquisition of a company's own shares.
Share Buyback Scheme
General provisions
Provisions in Articles of Association
Companies may only buy back their own shares if their Articles of Association allow for it (section 76B(1)). Thus, the Articles of Association of existing companies will have to be amended to allow for share buybacks.
Limit on types of shares purchased
When the Companies (Amendment) Act was passed in 1998, companies could only buy back ordinary shares (section 76B(1) and (2)). The Companies (Amendment) Act 2000, which was recently passed in parliament, sought to amend the share buyback provisions by extending the categories of securities which may be repurchased to 'ordinary shares, stocks and preference shares'. This amendment makes it clear that companies which are denominated in stock units may undertake a share buyback. Companies which have issued preference shares could also buy back 10% of their issued non-redeemable preference share capital. There is, however, no limit on the number of redeemable preference shares that may be purchased.
Limit on percentage of shares purchased
The total number of ordinary shares purchased or acquired by a company during the relevant period may not exceed 10% of the issued ordinary capital of the company (section 76B(3)), ascertained either as at the date of the last annual general meeting of the company held before the resolution was passed to authorise the company to buy back its shares, or as at the date of such resolution, whichever is higher. A difference in the number of shares between these two dates may arise if the company has issued new shares since the date of the last annual general meeting or warrants have been exercised or convertible bonds have been converted, thus increasing the total number of shares.
No treasury stocks allowed
Shares purchased or acquired are deemed cancelled and the rights and privileges attached to those cancelled shares expire (section 76B(5) & (6)). In this respect, the Singapore position is similar to the position in Australia and the United Kingdom. In some jurisdictions like New Zealand, companies may hold their own shares after repurchase. Such shares are commonly referred to as treasury stocks. The companies holding treasury stocks may later sell these shares on the market to realise a profit or issue such shares to employees in accordance with employee share option schemes.
The main concern about treasury stocks is that directors of a company may use the shares owned by the company to entrench themselves. This concern may be addressed if the law provides that the rights attached to the shares are suspended for so long as they are legally or beneficially owned by the company. For private companies, allowing for treasury shares which may be resold may erode the protection afforded to members under the Companies Act and the Articles of Association relating to the authorisation of share issues and pre-emption rights.
Repurchase to be out of distributable profits
Section 76F(1) makes it very clear that a company may only repurchase its shares out of its distributable profits. As such, a share repurchase will not lead to a diminution in the company's capital. Distributable profits are defined in the new section 76F(4)(a) as profits available for the payment of dividends, but exclude any amount in the share premium account or capital redemption reserve. If payments are not made out of distributable profits, the purchase will be regarded as unlawful.
In some jurisdictions which permit share buybacks, the repurchase by the company of its shares may be paid out of existing capital provided the company remains solvent after the acquisition.
A director or manager of a company (which presumably includes a company secretary) who wilfully makes or authorises the making of a payment referred to in section 76F(1) out of what he knows are not distributable profits shall, without prejudice to any other liability, be guilty of an offence.
Solvency requirement
Every director and manager who approves or authorises the purchase or acquisition of a company's own shares with the knowledge that the company is insolvent or will become insolvent as a result of the purchase or acquisition is, without prejudice to any other liability, guilty of an offence.
A company is deemed insolvent if either the company is unable to pay its debts as they become due in the normal course of business, or the value of the company's assets is less than the value of its liabilities, including contingent liabilities.
The penalty against a director or a manager who authorises payment when he knows such funds are not from distributable profits or if the company is insolvent is a fine not exceeding $5,000 or imprisonment for a term not exceeding 12 months. In addition to that, the director or manager shall be personally liable to the creditors of the company for the amount of debts due by the company to them to the extent by which the amount paid as consideration has exceeded distributable profits, and such amounts may be recovered by the creditors or the liquidator suing on behalf of the creditors. With such a solvency requirement, it may be unnecessary to limit share buybacks to distributable profits.
Capital maintenance
Like the redemption of preference shares, the Companies (Amendment) Act provides for the safeguard that a capital redemption reserve must be established. The shares purchased are cancelled and the amount by which the company's issued capital is diminished shall be transferred to this capital redemption reserve. Under the Companies Act, the capital redemption reserve is to be treated as if it is the paid-up share capital of the company, except that the reserve may be applied by the company in paying up its unissued shares to be allotted to members of the company as fully paid bonus shares.
Types of share buyback schemes
The Companies (Amendment) Act 1998 provides for three types of share buybacks. These are:
Apart from the general rules discussed above, there are specific provisions relating to each of the three methods of share buybacks.
Off-market acquisitions on equal access scheme - section 76C
An off-market acquisitions on an equal access scheme may be undertaken by both listed and unlisted companies.
In order to qualify as an equal access scheme, the offers under the scheme are to be made to every member to purchase the same percentage of their shares and the terms of all the offers are the same. The scheme must be authorised in advance by the company in a general meeting and the notice of the meeting must:
The authority for an off-market purchase under an equal access scheme may be varied or revoked by the company in the general meeting.
Authority for selective off-market acquisitions - section 76D
Selective market acquisitions may only be made if the company is not listed on a stock exchange and the purchase or acquisition is made in accordance with an agreement authorised in advance. The terms of any agreement for a selective off-market purchase must be authorised by a special resolution of the company with no votes being cast by a person whose shares stand to be acquired or purchased by the company or by his associated persons.
'Associated person' is defined under section 76D(14) and in relation to a person it means:
A person (or his associated persons) is regarded as exercising the voting rights carried by his shares regardless of whether he votes in respect of his shares on a poll or not.
A notice specifying the intention to propose the special resolution to authorise an agreement for a selective off-market purchase must specify the date on which the authority is to expire (which cannot be a date later than the next annual general meeting is or is required by law to be held, whichever is the earlier) and specify the sources of funds to be used for the purchase or acquisition, including the amount of financing and its impact on the company's financial position.
The special resolution is not effective unless a copy of the agreement or a written memorandum of its terms are available for inspection by members of the company both at the meeting for the passing of the special resolution itself and at the registered office of the company for not less than 15 days prior to the date of the meeting.
One safety measure to note is that any variation of the agreement must also be approved by the company by way of special resolution, with the same interested parties precluded from voting (section 76D(9)). Such variation must also be available for inspection in accordance with section 76D(7).
Other safety measures include:
It is understandable that selective off-market acquisitions are subject to more stringent requirements such as a special resolution, as it affects only certain members and may be used as a means to give preferential treatment to such members. For the same reason, these members are not allowed to vote on the resolution.
Authority for market acquisition
The third and final method of conducting a share buy-back is via an acquisition of a company's own shares listed on the stock exchange. To do this a company needs to be duly authorised in advance by its shareholders at a general meeting. The notice and procedure to specify the intention to propose the resolution to authorise a market purchase is virtually the same as the equal access scheme. The authority for any market purchase may be unconditional but can be subject to conditions. The notice specifying the intention to propose the resolution is to contain the same matters which are specific for resolutions authorising an equal access off-market acquisition.
Listing Manual Requirements
In addition to the above, listed companies have to comply with the new clause 948 of the Listing Manual. The following are the requirements of the Listing Manual which complement the safeguards found in the Companies Act:
The Singapore Code on Takeovers and Mergers
The Securities Industry Council issued a new practice code, Practice Code 13, shortly after the share buyback provisions were introduced into the Companies Act. Pursuant to Rule 33 of the Singapore Code on Takeovers and Mergers ('the Code'), a mandatory takeover is triggered if the voting rights of a shareholder and his concert parties increase to 25% or more, or if they together already hold 25% to 50% and their voting rights creep up by more than 3% in a 12 month period. Practice Code 13 deals with the situation where either of the trigger points is reached in the course of share buybacks.
If a share buyback results in the breach by a shareholder of the trigger point under Rule 33 of the Code, he does not have to make a general offer if he is not acting in concert with the company's directors. In the case of directors and their concert parties, a waiver from the Securities Industry Council will be valid only if the circular to shareholders on the share buyback resolution contains advice that by voting for the buyback, they will waive their right to a general offer from directors and their concert parties. The directors and their concert parties must abstain from voting and refrain from making any recommendation to shareholders to vote in favour of the share buyback. Nor should they buy shares if they are aware that a share buyback is imminent.
A general offer has to be made if one of the main purposes of the share buyback is to help any shareholder obtain or consolidate control of the company. If a shareholder acquires shares that raise his voting rights to 25% or more between the date of notice of resolution to authorise the share buyback and the next general meeting, the shareholder would be required to make a general offer. If a general offer is required, it has to be made in cash or in cash alternative at the highest price paid by the directors or his concert parties in the preceding 12 months or the highest price paid by the company during the buyback.
Benefits of Share Buybacks
The following are some of the benefits of share buybacks.
Rachel Eng
Wong Partnership