Can a Company cancel its own shares?
Following incorporation, private companies might find that as the business has grown and developed, they have a complex capitalisation structure in place involving various classes of shares, both equity and deferred, and employee incentives and loan instruments. A simple solution may be for the company to reorganise the share capital as an investment or as part of a restructuring. Private companies may wish to strike out the original shares, however, the shares cannot simply disappear. More will need to be done to cancel these shares and a few options are considered below.
Re-classify the shares under a different class
The company could re-classify the shares as a different class, for example B shares, which may then have the following rights and restrictions:
- No voting rights
- No dividend rights
- Reduced value
The company will need to comply with legislation to successfully re-classify the shares and complete:
- A special resolution to vary the class rights;
- Form SH02, confirming the variation of share rights, and file this at Companies House; and
- Form SH08, confirming the re-designation of the shares, and file this at Companies House.
Gift shares to the company
Another option is for the shareholders to gift their shares back to the company without any payment or consideration being made. As these shares will constitute a gift, the company will not need to comply with any formalities required to purchase its own shares. The only requirements will be to complete a stock transfer form so that the legal title can be transferred. As no consideration is being made, there will be no need to pay stamp duty.
As the Companies Act 2006 is silent on the matter, it appears that gifted shares will continue to exist with the register of members confirming that the company will now be listed as the holder of those shares. The provisions relating to treasury shares under Section724 will not apply to these gifted shares.
Should the company wish to cancel these gifted shares, the following steps will need to be carried out to reduce its share capital:
- Since the enactment of the Companies Act 2006, the articles of association must expressly prevent the company from reducing the capital; therefore, check there is no such provision which prohibits the company from cancelling these shares;
- The directors need to sign a solvency agreement; and
- The shareholders will need to provide approval by special resolution.
If the company does reduce its capital, a Form SH19 will need to be filed at Companies House.
Although Section 659(1) confirms that a limited company can acquire its own shares than otherwise for a valuable consideration, there is no authority to clarify what happens to those shares (as opposed to a buy-back situation which is covered below). As a gift to a company of its own shares does not result in a decrease in share capital, it is not contrary to the general maintenance of capital principles. Therefore, what the directors do to these, such as cancelling, holding (and exercising voting rights) or re-selling will be governed by the general principles of capital maintenance, accounting standards, protection of minorities and the director’s duties.
Company Buy Back
A company buy back procedure is only successful if the company has sufficient distributable profits.
- Sufficient distributable profits:
- As above, the articles of association must expressly limit or prohibit buy backs so you will need to check there is no such provision included in the articles;
- The shareholders will need to provide approval by an ordinary resolution for the contract; and
- The company can then make an off-market purchase of its own shares.
- Insufficient distributable profits:
Issuing new shares can often finance a buy-back in which case the company can use up to £15,000 or 5% of the share capital, whichever is lower. If so:
- The directors will need to provide a director’s statement in the prescribed form; and
- A Notice will be published in the Gazette, which will circulate news of the proposed buy-back, including any interested parties.
Company buy backs are subject to The Companies Act 2006 (Amendments of Part 18) Regulations 2013 which allows a company buy back of its own shares even where the company does not have sufficient distributable reserves. This procedure is particularly useful for buying-back employee shares.
Again, the articles will need to be reviewed to confirm there is no provision which expressly prohibits the company buy backs. Unless the restriction is entrenched, which means it can only be appealed or amended if certain conditions are met, the articles can be amended by passing a special resolution of 75% of the shareholder’s votes.
In addition, the company’s shareholder agreements should be checked for any pre-emption rights. The inclusion of such rights means that the company will need to first offer shares to the current shareholders before shares can be transferred to any party, including the company itself.
In this case, the company would probably only be able to purchase the shares at their nominal value. Where a private limited company buys back any of its own shares as part of an off-market purchase:
- These shares must be cancelled where they are purchased using the proceeds of a new issue of shares from capital as authorised by:
- Chapter 5 of the Companies Act 2006; or,
- The de minimis exemption under section 706(b) of the Act (shares bought prior to 6 April 2015, however, can be held in the treasury).
- The shares may be cancelled or held in treasury, where they are purchased out of distributable profits as per section 724 Companies Act 2006.
What happens to the shares if a shareholder becomes bankrupt or loses mental capacity?
The bankrupt shareholder’s shares will form part of their bankruptcy estate and vest in the Trustee in Bankruptcy on appointment.
The company’s articles should confirm the rights of a trustee in bankruptcy as being a ‘Transmittee’ of the shares of the bankrupt. Usually, the Transmittee will have a right to be registered as a member but until then, will not have any entitlement to attend and/or vote at any meeting of the company.
A Trustee in Bankruptcy’s objective will be to realise as much value as possible from the bankrupt’s shares. However, the market for shares in a private limited company is likely to be restricted especially if the articles (or any relevant shareholder’s agreement) sets out what happens in the event of a bankruptcy.
As part of their role, the Trustee in Bankruptcy must ensure a fair and proper value is achieved for the shares on a sale or transfer and the relevant provisions in the articles (and any shareholder’s agreement) will be reviewed to check that they are valid. During this process, the following issues are likely to be considered:
- Transfer restrictions – these are usually included and relate to a restriction on the transfer of shares or the application resulting from the shareholder’s bankruptcy;
- Pre-emption rights – as above, the articles may provide a right of first refusal to existing shareholders. However, private companies may exclude the application of the statutory pre-emption right, either generally or in relation to particular allotments, by making this provision in their articles. If the Trustee in Bankruptcy concludes that the shares have little or value, of if there would be substantial costs associated with a sale, they may consider disclaiming the shares or simply accepting a nominal payment from a third party (e.g. from another shareholder); and
- Refusal to register – the articles may give the company’s directors express powers to refuse to register a transfer of shares, however, they must exercise this power in good faith and in the best interests of the company.
In a situation where a shareholder loses mental capacity, the key issue will be to consider who has the authority to deal with the shares in the absence of the shareholder’s ability to do so. The test for mental capacity is specific to the decision being made so it would be possible for the shareholder to have the capacity to make some decisions but not others.
The shareholder may have provided someone with the authority to act under an Enduring Power of Attorney (EPA) or a Lasting Power of Attorney (LPA) in respect of their property and financial affairs. If no such power exists, then it becomes necessary to apply to the Court of Protection to either appoint a Deputy to make decisions on the shareholder’s behalf or to make specific orders about decisions that need to be made.
The authority, either in the form of an EPA, LPA or Deputyship Order, will determine what powers the Attorney will have, including whether the Attorney can sell the shares or vote in respect of them (this will be subject to any relevant provisions in the company’s articles which should also be reviewed). If the Attorney does not have the power to act, they can apply to the Court of Protection for authority or directions.
A company’s articles may also provide that a member in respect of whom an order has been made relating to mental disorder, may vote by their Receiver, Curator Bonis or other person authorised in that capacity as appointed by the Court. Such provisions are included in Table A but there is no such equivalent in the model articles.
It is worth noting that if transpires that a bankruptcy order was made against an individual with mental health issues then there may be ground for annulling the bankruptcy in certain circumstances.