Qualifying shares: The Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 come into force on 1 December 2003 and will permit certain British companies to buy their own shares to hold "in treasury" instead of having to cancel them. It will be possible to hold treasury shares for later cash sale or for transfer for the purposes of or pursuant to an employees' share scheme, or cancel them at any time. Not more than 10% of the aggregate nominal value of the issued share capital or of any class of share capital may be held in treasury and the shares must be UK-listed or AIM shares or listed or traded on any of the equivalent EEA markets. Shares of private companies, and of public companies that are not "qualifying shares", are excluded. If the shares cease to be qualifying shares they must be cancelled "forthwith". This would arise, for example, if the shares were de-listed, although not if they were merely suspended. Any treasury shares exceeding the 10% limit must be cancelled or disposed of within 12 months. In either case, the company's officers will be liable to fines if the company is in default.
Buying treasury shares: For a normal buyback, a company must have authority in its articles to buy its own shares, the purchase must be authorised by shareholders, the shares must be fully-paid and (for a public company) must be paid for out of distributable profits or the proceeds of a fresh issue. There may be further hurdles: a listed company, for example, must also comply with Chapter 15 of the UKLA Listing Rules and the recommendations of the ABI/NAPF Investment Committees in relation to such matters as shareholder approval by special resolution, price parameters and the timing and maximum amount of the buyback.
Shares intended for treasury will be bought by the company in accordance with the existing regime but must be paid for out of distributable profits. The company will then become registered as a member of itself in respect of the shares. They cannot be held by a nominee on the company's behalf, so shares in CREST will need to be changed back to paper form if the company is not itself a CREST member or sponsored member. The shares will carry no right to attend or vote at meetings or to receive distributions, although redeemable shares will entitle the company to the redemption proceeds if they are redeemed while in treasury. Nor will the shares confer any right to participate pre-emptively in new issues by the company. Any fully-paid bonus shares allotted in respect of the treasury shares will be treated as if they were treasury shares purchased at the time of allotment. Impliedly, the company will not be able to grant a charge over treasury shares since the new provisions prescribe what may be done with treasury shares and do not include granting security over them.
Details of the shares, including their number and nominal value and the date they were delivered, must be filed on Form 169(1B) at Companies House within 28 days of the delivery to the company of shares purchased under the authority and ad valorem stamp duty at 0.5 % of the purchase price will be payable on the form, which will be treated as the instrument of transfer. Form 169A(2) must be filed when the shares are sold, cancelled or transferred. A fixed duty of £5 will be payable on the form (if the shares are cancelled) or the stock transfer form (if the shares are sold or transferred) as the transaction will be treated as a conveyance or transfer otherwise than on sale.
The definition of "relevant share capital" in section 198 of the Companies Act is to be amended so as to exclude shares held in treasury, so if, for example, the company takes 3% of a class of voting shares into treasury it will not have to notify that interest to itself under the section. Other holders of the same class of share may, however, have to notify the company of their interests because by taking the shares into treasury the company will reduce the aggregate nominal value of relevant share capital and therefore increase the others' percentages. A percentage decrease (also potentially notifiable) will occur if treasury shares are sold (see below). This corresponds with the position on a normal buyback and fresh issue of shares.
Numerous minor amendments will be made to the Companies Act in order to carve out treasury shares when calculating qualifying thresholds (for example, the 10 % threshold for members wishing to requisition an extraordinary general meeting, and the tests as to whether a director controls or is associated with a company for the definition of "connected person" in section 346). Similarly, provisions in the Finance Bill 2003 are designed to place the purchase and sale of treasury shares on the same footing for tax purposes as a normal buyback and fresh issue.
Resale: Treasury shares sold by the company will fall within the scope of section 89 of the Companies Act, like newly-issued shares, and will therefore have to be offered rateably to the other shareholders unless the sale is covered by a section 95 disapplication resolution. No disapplication will be needed, however, for shares transferred to an employees' share scheme.
The company will want the disapplication resolution to comply with the ABI pre-emption guidelines, which restrict non-pre-emptive issues in any year to 5% by nominal value of the issued ordinary shares, and to 7.5% in aggregate in any three-year period. The ABI have let it be known that any sales of treasury shares will have to count towards the 5% limit in any year, although the ABI will at its discretion allow the 7.5% limit to be exceeded to cater for sales of treasury shares. The form of section 95 resolution put to shareholders after 1 December will need to be checked, because if it refers to the allotment of equity securities pursuant to a section 80 authority it will not cover the sale of treasury shares. As a separate point, it remains to be seen whether treasury shares will count towards the ABI's limit as to the number of shares over which section 80 authority may be taken (a number equal to one-third of the issued ordinary shares or the authorised but unissued ordinary shares, whichever is the lesser). Under proposed changes to the Listing Rules, the circular would have to state the number of shares in treasury, and the proportion of the total ordinary share capital they represented, as at a date not more than a month earlier.
Sales of treasury shares (but not transfers to an employees' share scheme) must be made for cash. The definition broadly matches the one for "paid up or allotted for cash" in the Companies Act, and covers cheques, undertakings to pay cash and releases of the company's liability for a liquidated sum, but undertakings must be payable within 90 days. If the proceeds exceed what the company paid for the shares, the excess is to be treated as (undistributable) share premium, but otherwise the proceeds will be a realised profit. As the company will have had to use distributable profit to buy the shares, this will do no more than restore profit to that extent, but this is better than the position on a normal buyback and fresh issue. The amount paid by the company is to be calculated using the weighted average price method – in other words, the total cost divided by the total number of shares bought; any bonus treasury shares will be treated as having been acquired for nothing.
A stock transfer form will be needed for the sale of shares in paper form. A fixed duty of £5 will be payable unless the transfer is to a person whose business is issuing depositary receipts or providing a clearance service (in which case the duty will be charged ad valorem at 1.5%).
Takeovers: The Companies Act will be amended so that treasury shares will not be counted as shares subject to a takeover offer for the purpose of calculating whether the offeror has achieved the 90% threshold needed to invoke the compulsory purchase provisions of Part XIIIA of the Act. If those provisions do come into play and notice under section 429 is served on the company in respect of the treasury shares, the company must not sell or transfer them except in accordance with the notice.
The Panel on Takeovers and Mergers is currently consulting on treasury share-related changes to the Takeover Code and the Rules Governing Substantial Acquisitions of Shares, to take effect on 1 December. The changes are designed to exclude treasury shares in determining various thresholds, such as in the 1% shareholders disclosure of dealings provisions, and the level at which a mandatory bid is triggered. Amongst the amendments proposed, offerors and offerees would have to announce details of their relevant securities in issue at the commencement of an offer period; the announcement would not include treasury shares, so the basis for calculating thresholds will be clear from the outset.
It is also proposed to prohibit the company from transferring shares out of treasury during the course of an offer, or if it has reason to believe that a bona fide offer might be imminent, without the approval of shareholders in general meeting, although transfers of treasury shares to satisfy options exercised under an employees' share scheme established before the offer will normally be permitted.
Listing Rules: the UKLA is currently consulting on treasury share-related changes to the Listing Rules, also to take effect on 1 December. The principal proposed changes are to prevent the company from selling or transferring treasury shares (other than non-equity securities whose price or value is unlikely to be substantially affected) during a close period or when it has unpublished price-sensitive information; to make companies disclose sales and transfers into and out of treasury, any bonus shares held in treasury, and any cancellations of treasury shares – each time stating the proportion of treasury shares to other shares of the class; and to limit the discount at which treasury shares may be sold non-pre-emptively to not more than 10% of the middle market price at the time of sale. This limit will not apply if the sale is covered by a section 95 disapplication resolution, or if the sale is to a small number of named persons specifically approved by the shareholders in general meeting, and in addition the UKLA may waive the requirement if the company is in severe financial difficulties or if there are other exceptional circumstances.
Consistently with the approach taken in the Companies Act and proposed by the Panel, it is proposed to exclude treasury shares in the calculation of percentage thresholds (for example, in relation to the class tests for transactions), but they would be included when calculating whether an issue will increase an existing listed class of shares by 10% or more (and therefore whether or not listing particulars are required). They would also count as shares not in public hands for the purposes of the test as to whether at least 25% of a class is held by the public.
Under paragraph 13.13 of the Listing Rules, an employees' share scheme that does or might involve the issue of new shares already requires shareholder approval by ordinary resolution before it is adopted. It is proposed that schemes that do or might involve a transfer of shares out of treasury be treated in the same way.
The articles of association of many listed companies include power to impose sanctions on shareholders who fail to comply with a notice served under section 212 of the Companies Act. As permitted by paragraph 9.43 of the Listing Rules, the sanctions differ according to whether the relevant holding is greater or less than 0.25% of the relevant class. It is now proposed to change paragraph 9.43 so that treasury shares will be discounted in calculating this threshold – which means that, unless the terms of the paragraph are modified, companies that have not amended their sanctions article by 1 December will technically be in breach of the Listing Rules.
Accounting treatment: The Companies Act will require the company's annual accounts to show the number and aggregate nominal value of any shares in treasury.
The Urgent Issues Task Force of the Accounting Standards Board has published a draft abstract proposing that treasury shares should be accounted for as a deduction from shareholders' funds, on the basis that, conceptually, the shares will represent a reduction in the company's ownership interest, not an asset. The purchase, sale or cancellation of the shares will not give rise to gains or losses in its profit and loss account or statement of total recognised gains and losses, but will be presented as changes in shareholders' funds. Further draft abstracts address treasury shares in the context of employees' share schemes and ESOP trusts.
What difference will treasury shares make? A seemingly straightforward concept – that companies should be able to hold bought-in shares until it is advantageous to place them back in the market – will necessitate a great many consequential amendments spanning company law, market regulation and accounting practice.
Initial reactions to the DTI's 2001 consultation showed disappointment, particularly in relation to the requirement to sell treasury shares on a pre-emptive basis. The DTI hopes that using treasury shares will be a less cumbersome - and therefore less expensive – process than a conventional buyback and fresh issue, although some commentators feel that the cost advantage has been overstated. Nevertheless, despite the fact that the number of treasury shares that can be sold on a non-pre-emptive basis will be restricted by the ABI guidelines, treasury shares do have attractions: for example, in enabling companies to take advantage of capital growth in their own shares by selling small numbers of treasury shares opportunistically, and in the fact that at least part (if not the whole) of the proceeds of sale of treasury shares will be treated as realised profit. They may also come increasingly to be used in relation to employees' share schemes.
For more information, please contact Gary Green (Corporate partner) on +44 020 7367 2111 or at [email protected], or Simon Howley (Corporate professional support lawyer) on +44 0207 367 3566 or at [email protected] or, in relation particularly to the implications for employees' share schemes, please contact Kate Kelleher (share schemes partner) on +44 020 7367 2860 or at [email protected].