Treasury shares: an update

United Kingdom

Before the Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 came into force on 1 December 2003 various modifications were made to the proposals we reported in our Law-Now dated 19 June 2003. The Regulations themselves are to be amended by the Companies (Acquisition of Own Shares) (Treasury Shares) No. 2 Regulations 2003, which were laid before Parliament on 27 November 2003 and will come into effect on 18 December 2003. Below is a revised version of our original article, incorporating relevant changes and developments since it appeared, including prospective changes under the No. 2 Regulations.

Qualifying shares: The Regulations permit certain companies to buy their own shares to hold "in treasury" instead of having to cancel them. It is 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 per cent 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. The Regulations do not apply to companies incorporated in Northern Ireland. 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 per cent 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.

Taking shares into treasury: 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's articles of association should be checked to ensure that they do not stipulate the immediate cancellation of bought-in shares. The UKLA has stated that when listed companies take authority to purchase their own shares the circular containing the relevant resolution should, by way of "clear and adequate explanation", indicate whether the company proposes to cancel any bought-in shares immediately or hold them in treasury.

When shares are taken into treasury the company becomes 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.

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 per cent 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.

While shares are held in treasury: 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 (other than of bonus shares) by the company; under changes to be introduced by the No. 2 Regulations, the other shareholders' rights will be determined by reference to their due proportion of the aggregated share capital excluding the treasury shares. 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.

The definition of "relevant share capital" in section 198 of the Companies Act excludes shares held in treasury, so if, for example, the company takes 3 per cent 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) or transferred to an employees' share scheme. The position corresponds, therefore, with that of a normal buyback and fresh issue of shares.

Provisions in the Finance Act 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. Similarly, numerous minor amendments have been made to the Companies Act in order to carve out treasury shares when calculating qualifying thresholds (for example, the 10 per cent 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). Changes to the Companies Act may give rise to the need to amend articles of association if they reiterate provisions in the Act: for example, articles dealing with consent to the variation of class rights customarily refer to the three-quarters majorities stipulated by section 125 of the Companies Act, which now provides for treasury shares to be excluded from the computation.

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). Changes to the Listing Rules require that, for listed companies, a circular containing a section 80 resolution must state the number of shares in treasury, and the proportion of the total ordinary share capital they represented (calculated exclusive of treasury shares), as at a date not more than a month earlier.

Selling treasury shares: 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 per cent by nominal value of the issued ordinary shares, and to 7.5 per cent 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 per cent limit in any year, although the ABI will at its discretion allow the 7.5 per cent limit to be exceeded to cater for sales of treasury shares. For listed companies, any shares held in treasury must be included in the ordinary share capital when calculating the percentage, which must reflect the position as at a date not more than a month before the date of the circular. The form of section 95 resolution put to shareholders will need to be checked, because if it refers only to the allotment of equity securities pursuant to a section 80 authority it will not cover the sale of treasury shares. There is no requirement that the disapplication should expire in relation to treasury shares at any particular time.

If a sale of treasury shares is (so far as is practical) made available to all the shareholders (or all the holders of the relevant class) on the same terms it will not be subject to the related-party transactions regime under the Listing Rules.

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 to pay cash 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 per cent).

Financial Services and Markets Act 2000: As it is envisaged that companies will use treasury shares to deal in the market-place with greater flexibility and more often, the regulated activities regime under the Financial Services and Markets Act 2000 has been modified to counter the possibility that a company might be deemed to be carrying on regulated activity simply by reason of the frequency of its treasury shares dealings. Financial promotion, however, is potentially a concern: while communications relating to its shares to its own shareholders is covered by an exemption, and should not be problematical when shares are being bought-in, selling treasury shares to buyers who are not already shareholders will require careful use of other exemptions if the expense of using the services of an authorised person is to be avoided.

Takeovers: The Companies Act has been amended so that treasury shares are not counted as shares subject to a takeover offer for the purpose of calculating whether the offeror has achieved the 90 per cent threshold needed to invoke the compulsory purchase provisions of Part XIIIA of the Companies Act. The No. 2 Regulations will amend the definition of "takeover offer" in section 428 so that an offer may qualify even if it is not made in respect of treasury shares. If the offer does cover treasury shares and notice under section 429 is served on the company in respect of them, the company must not sell or transfer them except in accordance with the notice.

The Takeover Code and the Rules Governing Substantial Acquisitions of Shares have been amended with effect from 1 December 2003. The changes are designed to exclude treasury shares in determining various thresholds, such as in the 1 per cent shareholders disclosure of dealings provisions, and the level at which a mandatory bid is triggered.

The Takeover Code also prohibits 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: Numerous changes have been made to the UKLA Listing Rules, also with effect from 1 December 2003. Among the principal changes, the company is prohibited 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. There are certain dispensations corresponding to share scheme-related and "bed and breakfast" exemptions in the Model Code. Other changes require companies to 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. Also, the discount at which treasury shares may be sold by way of placing, open offer or vendor consideration placing is limited to not more than 10 per cent of the middle market price at the time of sale (but the UKLA may waive the requirement if the company is in severe financial difficulties or if there are other exceptional circumstances). The Listing Rules require listed companies' annual reports and accounts to disclose the identity of purchasers of treasury shares sold (or proposed to be sold) off-market or otherwise than on a pre-emptive basis during the period under review.

Consistently with the approach taken in the Companies Act and by the Panel, treasury shares are excluded in the calculation of percentage thresholds (for example, in relation to the class tests for transactions), but they are included when calculating whether an issue will increase an existing listed class of shares by 10 per cent or more (and therefore whether or not listing particulars are required). They are not taken into account when calculating the percentage of shares in public hands for the purposes of the test as to whether at least 25 per cent of a class is held by the public.

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. Paragraph 9.43 of the Listing Rules prescribes the extent of this power, and before 1 December allowed certain additional sanctions if the relevant holding was greater than 0.25 per cent of the relevant class. Since 1 December, treasury shares must be discounted in calculating this threshold, so companies should amend their sanctions articles accordingly.

Employees' share schemes: The Listing Rules already stipulated that an employees' share scheme that did or might involve the issue of new shares required shareholder approval by ordinary resolution before it was adopted. The UKLA has now stated that schemes that do or might involve a transfer of shares out of treasury must also be approved by shareholders, and that, where an existing scheme intends to extend its policy to use treasury shares, shareholder approval for that extension of policy is also required. It is not enough that, as a matter of construction, the existing wording of the scheme appears to accommodate treasury shares without amendment.

One factor weighing against the use of treasury shares for share schemes arises from the ABI's guidelines on share incentive schemes, which impose dilution limits (basically, not more than 10 per cent of the issued ordinary share capital committed to schemes in any 10-year rolling period). The guidelines were extended on 1 December 2003 to provide specifically that the use of treasury shares counts towards the 10 per cent limit.

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 - has necessitated 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 is 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, although the ABI share incentive scheme guidelines will have a bearing on this.

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].