Publication

Company in Itself: Company’s Buyback of Its Own Shares

23/02/2022

Solomiia Petryk

Associate

Anticorruption Issues,
Corporate and M&A

A share repurchase or the so-called ‘buyback’ is a common practice in stock markets. Companies announcing buybacks repurchase shares from their shareholders and effectively remove them from the stock market. In particular, this is how publicly traded companies react to the undervaluation of their shares in the marketplace, thereby reducing the risk of hostile takeovers.

Private companies, including limited liability companies, may also take advantage of the share buyback. The Law on Limited Liability and Additional Liability Companies (the “LLC Law” or the “Law”) allows companies to acquire their own shares and establishes the basic requirements for such procedure. This article further describes the specifics of the buyback of a share in an LLC.

What are the different types of the buyback?

The company may acquire its shareholder’s share with or without reducing its registered capital.

In the first case, the share acquired by the company is actually canceled and disappears as an asset. In this case, the state registrar reduces the company’s registered capital by the share acquired by the company when registering changes in the list of shareholders in the Unified State Register.

The company may retain its current registered capital after the buyback if the company creates a reserve capital amounting to the purchase price of the repurchased share. As a general rule, the company is required to sell the repurchased share within one year after its acquisition. However, the recent amendments to the LLC Law allowed the company’s shareholders to postpone such sale and provide for any different term in the company’s articles of association.

What may the company do with the repurchased share?

Should the share be acquired without reducing the company’s registered capital, the company becomes the owner of the repurchased share. In the jurisprudence, such share is referred to as a treasury share. We will use this definition below.

The treasury share is not taken into account when counting votes at the shareholders’ meeting, distributing the company’s profits or distributing the company’s property in the event of its liquidation.

The treasury share is only (temporarily) recorded on the company’s balance sheet until the company sells it.

The law does not expressly provide for the consequences of the company’s violation of the requirement to sell its treasury share within the time limits provided by the law or the articles of association. The case law suggests that, after the prescribed term, the treasury share loses the signs of property and legally disappears. Therefore, a company that failed to sell the repurchased share on time is required to reduce its registered capital by the amount of such share. Thus, courts do not recognize the third-party ownership of the treasury shares that were purchased after the expiration of the time period for disposing of the same.

Why does an LLC need a treasury share?

1. Attracting investment in business

The company may use the treasury share to attract investment. Such investment is often referred to as a cash-in because it is attracted into business. In this case, the investor will be able to repurchase the treasury share, become a shareholder of the company and thereby invest in the business without changing the structure and value of contributions made by the other shareholders of the company.

As a result of acquiring the treasury share, the company will receive funds to its account without increasing its registered capital. Instead, where an investor purchases the share not from the company but from its shareholder, the funds will be received by the selling shareholder, not the company, which makes it impossible for the company to use this investment without further transacting. Such share sale by a shareholder to an investor is sometimes referred to as a cash-out as the shareholder exits the business receiving for this share price from the investor, who becomes a new shareholder.

2. Securing the company's obligations

The treasury share may also be pledged as security for the company’s obligations to its creditors. For this to be done, the company and the creditor must enter into an agreement containing a condition providing for the transfer of the share to the creditor as a result of enforcement.

The 2021 amendments to the LLC Law set out the requirements for an agreement under which the emergence, change or termination of rights and obligations to dispose of a share in a company are conditioned by circumstances. From now on, Article 21 of the Law expressly allows the company to be a party to such agreement if the company holds a share in itself. Such share will be the subject of the agreement.

The pledge of a treasury share can be an effective tool to protect the interests of the company’s creditor, especially if combined with a corporate agreement, which will determine the status of the creditor as a future shareholder of the company.

3. Simplified reduction in the registered capital

As part of the “classic” procedure to reduce the registered capital, a company is required to give (30-day) prior notice to all creditors with unsecured (by pledge, surety, etc.) demands and wait yet another 30 days until they make their claims (for example, to terminate the agreement with the creditor or grant a pledge by way of its security) and ultimately do what each of the creditors will ask it to do or spend time to agree upon another acceptable option with such creditor.

Having repurchased its own share, a company will be able to reduce the registered capital by avoiding an agreement with creditors. In contrast to a capital reduction, if a company repurchases a share in its own registered capital [unless the company forms a reserve capital] it reduces its registered capital automatically without the company itself making any decision to reduce such capital. Accordingly, there is no reason to notify creditors of the share so repurchased. The authors have already tested this approach in practice.

However, before buying back a share, a company should review its current contractual obligations to find out if there is any obligation to notify the creditor of any buyback or other changes in the corporate structure. When entering into agreements, sufficient attention is not often paid to such provisions because the relevant actions were not intended at the time when the agreement was made.

4. An alternative to the shareholder`s withdrawal

As a matter of the Law, if a shareholder withdraws from the company this gives rise to the following consequences:

-    the registered capital is reduced by the share held by the withdrawing shareholder; and
-    the company is required to pay the former shareholder the value of the share held by it.

If, instead of withdrawing, the company and the shareholder agree upon the buyback of the share, both consequences can be “taken under control”. Thus, the parties will be able to enter into an agreement to determine the value of the share and procedure for its payment. A reduction in the registered capital can be avoided or postponed by forming a reserve capital.

The buyback of a share as an alternative to the withdrawal can be used if, in particular, it is about dismissing an employee who held a share in the registered capital. Moreover, a practical need may be another example when it is essential for the company to keep the registered capital at the current level to participate in the tender or to avoid the consequences of capital reductions provided for, for example, in loan agreements.

What can prevent an LLC from buying back a share?

1. The other shareholders` preemptive right to the share. The articles of association or corporate agreement may provide that other shareholders have preemptive right to buy the share one of the shareholders intends to sell to a third party. If so, the shareholders may “snatch away” the share and prevent the company from buying it back. Thus, there is a practical issue sometimes: may such a shareholder (rather than the company) repurchase the entire share or only a part of it in proportion to its share in the company? It is often the case that this issue is not clearly regulated leaving thus a space for different interpretations.

2. The shareholders will not agree upon the buyback. According to the Law, a company may not purchase a share from a shareholder unless the general meeting ratifies the terms of such sale. If so, all of the company shareholders must attend the general meeting and vote in favor of the buyback. This is one of the few issues for which the Law requires active consensus voting by all of the shareholders. Accordingly, if any of the shareholders fails to attend the general meeting or there is at least one “contra” or “abstained” vote, the buyback will be blocked.

3. Restrictions on companies owning agricultural land. Starting from 1 July 2021, the Land Code (Article 130) prohibits legal entities from buying a share in the registered capital of legal entities who own agricultural land. In its spirit, this rule focuses on something else, i.e., preventing from circumventing the limitations on the agricultural land market of the new design. So, technically speaking, a company that owns (any) agricultural land would violate the prohibition prescribed by the Land Code by repurchasing a share in its registered capital.

***

Every year the Ukrainian corporate laws improves regulation of companies and transactions involving shares. Thanks to the recent amendments to the LLC Law related to the buyback of shares, this mechanism has become even more convenient for companies. A company may avail itself of the buyback when it plans to attract investments and reduce the registered capital without time-consuming negotiations with creditors or keeping the registered capital at the then current level whenever a shareholder withdraws.

Author: Solimiia Petryk, Associate

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