Treasury shares 2

Treasury shares have become a familiar feature of the business at listed and AIM company annual general meetings. Their introduction necessitated a great many consequential changes, but the concept is straightforward: that companies should be able to hold bought-in shares until it is advantageous to place them back in the market.

Qualifying shares

To qualify as treasury shares, shares in UK companies must be listed or traded on AIM, or listed or traded on any of the equivalent EEA markets. Shares of private companies, and shares of public companies that are not qualifying shares, are excluded.

When a company buys in its own qualifying shares it can hold them in treasury instead of having to cancel them. If it cancels them, the issued (but not the authorised) share capital is diminished correspondingly, and an amount equal to the aggregate nominal value of the shares is transferred to capital redemption reserve. If it places them instead in treasury, it can hold the shares for later cash sale or in order that they may be transferred for the purposes of or pursuant to an employees’ share scheme, or it can cancel them at any time. The purchase and sale of treasury shares is treated for tax purposes as a normal buyback and fresh issue (but see below as to stamp duty).

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. If the shares cease to be qualifying shares they must be cancelled immediately. This would arise, for example, if the shares were de listed, although not if they were merely suspended. If the 10% limit is exceeded at any time, enough treasury shares to bring the company within the limit must be cancelled or disposed of within 12 months (bearing in mind that cancellation, as opposed to sale or transfer, will use up more shares, as cancellation diminishes the issued share capital by reference to which the limit is set). 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, at present 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 12 of the UKLA Listing Rules and the recommendations of the ABI Investment Committee 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 this regime but must be paid for out of distributable profits. In fact, whenever qualifying shares are bought-in using distributable profits they are treated as potential treasury shares. The directors must determine at that point (if they have not already done so when deciding to make the purchase) whether the shares are to be cancelled immediately or held in treasury (assuming they are not being immediately sold or transferred pursuant to an employees’ share scheme) – in which case they should proceed with registering the shares (see below). The company’s articles of association should be checked to ensure that they do not override this by stipulating the immediate cancellation of all bought-in shares.

The Listing Rules require the relevant circular to include (among other things) a statement as to whether the company intends to cancel any bought-in shares or hold them in treasury. Most companies taking shares into treasury simply say that the directors will in due course cancel or dispose of them in one of the permitted ways according to the circumstances at the time of their decision.

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 have to be changed back to paper form if the company is not itself a CREST member or sponsored by a CREST member.

Details of the shares to be held in treasury (ignoring any shares bought in at the same time that the directors have decided to cancel immediately, which must be notified on Form 169) 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. The form must set out the number and nominal value of the treasury shares and the date they were delivered, and is treated as the instrument of transfer; ad valorem stamp duty at 0.5% of the purchase price is payable on it.

While shares are held in treasury

While in treasury:

• the shares carry no right to attend or vote at meetings or to receive distributions (although if redeemable shares are redeemed while the company holds them it is entitled to the redemption proceeds).
• the company cannot grant a charge over the shares, since the Companies Act prescribes what may be done with treasury shares and does not include granting security over them.
• the shares confer no right to participate pre-emptively in new issues by the company: the other shareholders’ rights are determined by reference to their due proportion of the aggregated share capital excluding the treasury shares.
• if its articles permit, the company can receive fully-paid bonus shares allotted in respect of treasury shares. The shares are treated as if they were treasury shares purchased at the time of allotment. The capitalisation provisions in regulation 110 of the Table A model articles in fact disallow this, as they provide that bonus shares must be allotted only to holders who are entitled to dividends. Companies are likely to have equivalent provisions in their articles and may wish to amend 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% 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. This corresponds with the position on a normal buyback and fresh issue of shares.

Treasury shares have been carved out of the Companies Act 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). Some companies have amended their articles of association where they reiterated provisions in the Act as it was before treasury shares were introduced: 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 Act, which now provides for treasury shares to be excluded from the computation.

The Listing Rules require that, when listed companies seek shareholder authority under section 80 of the Companies Act to allot new shares, the circular containing the resolution must state the number of shares in treasury as at the date of the circular, and the proportion of the total ordinary share capital they represented (calculated exclusive of treasury shares) as at the latest practicable date before publication of the circular. The ABI pre-emption guidelines limit the number of shares over which section 80 authority may be taken to a number equal to the lesser of the authorised but unissued ordinary shares and one-third of the issued ordinary shares. There is no indication that companies must exclude treasury shares from the issued shares when calculating the third.

Selling treasury shares

Treasury shares sold by the company fall within the scope of section 89 of the Companies Act, like newly-issued shares, and therefore have to be offered rateably to the other shareholders unless the sale is covered by a section 95 disapplication resolution. No disapplication is needed, however, for shares transferred under 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 Pre emption Group Statement of Principles on Disapplying Pre-emption Rights (May 2006), to which the ABI and others subscribe, states that any sales of treasury shares counts towards the 5% limit in any year, but not towards the 7.5% limit. The Listing Rules require the company to state the percentage of the issued ordinary share capital (by implication, including treasury shares) that the disapplied amount represents as at the latest date before publication.
• The form of section 95 resolution should expressly refer to the sale of treasury shares as an alternative (wholly or partly) to the allotment of equity securities pursuant to a section 80 authority. There is no requirement that the disapplication should expire in relation to treasury shares at any particular time, but it is normally convenient to make it expire at the same time for sales of treasury shares as for new allotments.
• A sale of treasury shares to a related party taking up its entitlement in a pre-emptive offering is not subject to the related party transactions regime under the Listing Rules.

Sales of treasury shares (but not transfers under an employees’ share scheme) must be made for cash. The definition broadly matches the definition of “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 treated as (undistributable) share premium, but otherwise the proceeds are realised profit. As the company will have had to use distributable profit to buy the shares, this does 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 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 are treated as having been acquired for nothing.

Form 169A(2) must be filed when the shares are sold, cancelled or transferred. A fixed duty of £5 is payable on the form (if the shares are cancelled) or the stock transfer form (if the shares are in certificated form and are sold or transferred), as the transaction is treated as a conveyance or transfer otherwise than on sale. If the transfer is to a person whose business is issuing depositary receipts or providing a clearance service duty is charged ad valorem at 1.5%.

Financial Services and Markets Act 2000

As it was envisaged that companies would 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 was 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 are 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 requires careful use of other exemptions if the expense of using an authorised person is to be avoided.

Takeovers

The Takeover Code excludes 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.

Unless an offer is made for them, treasury shares are not 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 13A of the Companies Act or (where the Takeover Directive applies to the offer) Schedule 2 to the Takeovers Directive (Interim Implementation) Regulations 2006, and an offer will qualify as a takeover offer for this purpose even if it is not made in respect of treasury shares. Following the announcement of a firm intention to make an offer the company must on request provide the offeror with details of any shares held in treasury and of any arrangements to sell or transfer them. The offeror can extend the offer to shares that cease to be treasury shares before a date determined in accordance with the terms of the offer, but offering for the shares as treasury shares may be problematic, since they must be sold for cash and may be subject to pre-emption rights.

The Takeover Code also prohibits the company:

• from accepting an offer in respect of treasury shares until the offer is unconditional as to acceptances (which prevents the company from using the shares to treat an offeror preferentially where there are competing bids); and
• 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 possible with the Panel’s consent).

UKLA Listing Rules

Under the Listing Rules:

• the company is prohibited from selling or transferring treasury shares (other than non equity securities whose price or value is unlikely to be significantly affected by publication of the information) during a close period or when it has inside information. There are certain dispensations corresponding to share scheme-related exemptions in the Model Code.
• the company must disclose sales and transfers into and out of treasury, any bonus shares held in treasury, and any cancellations of treasury shares or shares allotted as bonus shares by virtue of treasury shares – each time stating the proportion of treasury shares to other shares of the class.
• 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% of the middle market price at the time of announcement of the offer or agreement of the placing, but this does not apply if the offer or placing has been specifically approved by the shareholders or is made under a pre-existing disapplication of pre-emption rights.
• the company’s annual report and accounts must disclose the identity of purchasers of treasury shares sold (or proposed to be sold) off-market in connection with an employees’ share scheme or otherwise than on a pre-emptive basis during the period under review.

In the Listing Rules treasury shares are usually excluded in the calculation of percentage thresholds (for example, in relation to the class tests for transactions). 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% 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. The Listing Rule prescribe the extent of this power, and allow certain additional sanctions if the relevant holding is greater than 0.25% of the relevant class, after discounting treasury shares. Companies whose articles pre-date the introduction of treasury shares may need to update the relevant article.

Employees’ share schemes

The Listing Rules require a scheme that involves or may involve the issue of new shares or the transfer of treasury shares to be approved by shareholders before the scheme is adopted. Using treasury shares for a scheme already approved and adopted before treasury shares were introduced is potentially a fundamental change to the terms of the scheme. The change would require shareholder approval. The UKLA has said that re approval would not be required where the scheme already allowed the use of both new and existing shares, and has told us that it would be the same if the scheme required only existing shares to be used. If, however, the scheme stipulated the use of new shares only, using treasury shares would require shareholder approval (perhaps by means of a simple resolution covering more than one scheme, accompanied by a brief explanation).

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% of the issued ordinary share capital may be committed to schemes in any 10-year rolling period). The guidelines provide specifically that the use of treasury shares counts towards the 10% limit.

Two cheers for treasury shares?

There were high hopes of treasury shares, built on the fact that they were already a familiar feature in other jurisdictions and were often used by multi-nationals. But the restrictive framework of the UK regime – particularly in relation to the requirement to sell treasury shares on a pre-emptive basis – was a disappointment, and some commentators felt that using treasury shares was hardly less cumbersome than a conventional buyback and fresh issue.

Nevertheless, even though 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 is treated as realised profit. Despite the ABI share incentive scheme guidelines, they are being used in relation to employees’ share schemes.

This article first appeared in our clearly corporate bulletin July 2006. To view this publication, please click here to open a new window.