Buy back of Shares – Need of Listed and Unlisted Companies

Buy back of Shares:

Need of Listed and Unlisted Companies

Ishwar Ahuja & Isha Gandhi*

Outline:

“When Companies with outstanding businesses and comfortable financial positions find their shares selling far below the intrinsic value in the marketplace, no alternative action can benefit shareholders as surely repurchases.”

- Warren Buffett

The term Buy back has two meanings, first, When a business or person sells something, especially shares, and then buys them again according to a fixed agreement; the buying back by a company of its shares from an investor, who put venture capital up for the formation of the company. Secondly, buying by a corporation of its own stock in the open market in order to reduce the number of outstanding shares; the buying by a corporation of its own stock.

The buying back corporation of its own stock in the open market in order to reduce the number of outstanding shares[1] .

The phrase buying back of shares means the buying back of its shares or other securities by a company from the holders thereof, which is necessary or has become a necessity for both the unlisted and listed companies for the following reasons:

Facilitating the company to reorganize their capital structure;

Improving return on capital, net profitability and earning per share (EPS);

Attracting equity investments in small businesses;

Eliminating fractional shareholding and odd lots;

A viable preposition to investors to sell back the shares to the company instead of going through the secondary market mechanism.

Genesis

Prior to 1998 buybacks were not allowed in India. In the 1970’s period, if MNC’s wanted to continue doing their business in India, they could do so only by diluting their shareholding and getting listed on the exchange. They were thus forced to go public. The buyback ordinance was introduced by the Government of India (GOI) on October 31, 1998. There was Insertion of new sections 77A, 77AA and 77B in the Companies Act, 1956 which allowed buyback. The major objective of the buyback ordinance was to revive the capital markets and protect companies from hostile takeover bids. The buyback of shares is governed by the Securities and Exchange Board of India‘s (SEBI) Buy Back of Securities Regulation, 1998, and Securities and Exchange Board of India’s (SEBI) Substantial Acquisition of Shares and Takeover Regulations, 1997, and the amended Companies Act 1956 and now by the companies act 2013.  The ordinance was issued along with a set of conditions intended to prevent its misuse by companies and protect the interests of investors.

Buy back: Whys and wherefores

There is an erroneous belief that the sole reason for buyback is to block hostile takeovers. In this connection it is pertinent to list the five reasons by the Bank of England favor the making of law to allow companies to repurchase their shares, of which blocking takeovers was only one; -

To return surplus cash to shareholders;

To increase the underlying share values;

To support share price during the periods of temporary weakness;

To achieve and maintain a target capital structure;

To prevent or inhibit unwelcome take-over bids.

Almost all OECD countries allow companies to buy back shares subject to certain regulations.[2]

The share capital bought back has the effect of reduction of share capital to the extent of the face value of the shares bought back and there is cash outflow from the companies to the extent of the price of the shares paid to the shareholders. Buy back of shares results into the shareholders, whose shares are bought, ceasing to be the member of the company. Their names are omitted from the Registers of the Members.

The issue is especially pertinent since repurchases are often portrayed as being good for the company. However, the authors argue that repurchases for the purpose of managing diluted EPS should have no real effect on firm value. We find that managers increase the level of their firm’s stock repurchases to offset the effects of securities such as employee stock options, which can decrease diluted EPS. Various articles in the financial press have suggested that managers repurchase shares to offset EPS dilution in response to employee stock option plans, and executives acknowledge that their decisions to issue and repurchase shares are influenced by potential earnings per share effects.

We also find that managers increase their firm’s stock repurchases when earnings fall short of the level required to maintain the past growth rate of diluted EPS. This finding suggests that some EPS growth cannot be attributed to improved firm performance, but rather repurchase activity.

The study controls for several other motives often cited for repurchases including distributing excess cash flow, signaling to offset perceived undervaluation, and re -leveraging the firm. Controlling for a number of alternate explanations, the results indicate that managers’ repurchase decisions are driven partially by financial reporting incentives.

Basic Statutory Provisions governing buy back:

Section 68 vis-a-vis other provisions: Section 68 allows companies to buy their own shares or other securities. It is also an exception to section 66. A buy back of securities in accordance with this section over writes section 68 and 66 or any other provision of the act. This is clear from the non obstante clause, “Not withstanding anything contains in this act” in sub section 1, which means that notwithstanding the provisions of section 68, the company can buy back its shares subject to compliance with the condition mention in that section without approaching the court under Section 66 of the Companies Act, 2013. The conditions applicable to Section 66, Companies Act, 2013 cannot be imported into or made applicable to a buy back under Section 68. Similarly, the conditions for a buy back under Section 68 cannot be applied to a scheme under Section 100 to 104 and Section 391(Old Companies Act, 1956). The two operate in independent fields[3].

But Section 68 does not over write any provision of any other law. Therefore, a Company buying back its shares or other securities must comply with any other law if applicable. A Company can under Section 68 buy its own shares (Equity or preference) or any other securities. Section 68 does not define “Securities”, nor is it elsewhere in the Act. But it stipulates that a Company can buy only those securities which are securities as defined in clause (h) of Section 2 of Securities Contract (Regulations) Act, 1956.

“Securities” include—

shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; derivative; Units or any other instrument issued by any collective investment scheme to the investors in such schemes; Security receipt as defined in section 2 of the SARFAESI Act; Units or any other such instrument issued to the investors under any mutual fund scheme; Government security; such other instruments as may be declared by the  Central Government to be securities; and rights or interest in securities; Companies eligible to buy back securities: Under Section 68, any company limited by shares or company limited by guarantee and having a share capital can repurchase its securities, whether it is a private company or public company, listed company or unlisted company.

In case of listed companies, a buy back of the shares or other specified securities listed on any recognized stock exchange shall be in accordance with the regulations. The buyback of Equity shares by listed companies is governed by SEBI (Buy back of securities) regulations.[4]

A buy back of securities by unlisted companies must be in accordance with the private ltd. Company and unlisted public ltd companies ( buy back of securities) rules, 1998 issued by the department of ministry of company affairs, Govt. of India.

Which securities can be bought back:

A company can buy its securities under-

from the existing security holders on a proportionate basis; or from the open market; or from odd lots, that is to say, where the lot of securities of a public company whose shares are listed on a recognized stock exchange, is smaller, than such marketable lot, as may be specified by the stock exchange; or by purchasing the securities issued to employees of the company pursuant to a scheme of stock option.

Process:

A buyback of securities needs approval of the company at general meeting by SPECIAL RESOLUTION. The special resolution and the explanatory statement annexed to the notice of the general meeting must disclose certain specific information. A special resolution authorizing a buyback of securities may be passed at an Annual General Meeting or at an Extra Ordinary General Meeting. Special resolution may be passed authorizing board of directors to buy the securities either by tender offer or by book building. Route at the discretion at the appropriate time [5] the sanction of a general meeting would not be required where buyback is less than 10%of the total paid up equity capital and free reserves of the company according to section 68(2). Securities to be bought back must be fully paid at the time of buyback. If any of the securities which are proposed to be bought back are partly paid, steps must be taken to make them fully paid before a buyback of such securities. The securities, on which the call money remains in arrears, cannot be bought back.

Offer: 

The company should file draft letter of offer with Registrar before the buy back in specified form given under the specified rules. The draft letter should be accompanied by a declaration of solvency in the prescribed form 4 A with ROC. The offer remains open for a period of not less than 15 days but not exceeding 30 days.

Payment To Shareholders:

The company immediately after the date of closure of offer opens a special account and deposit therein, such sum, as would make up the entire sum due and payable as consideration for the buy back in terms of these rules.

Permitted Modes Of Buy Back By Listed Companies:

1.    Tender Offer: 

Tender offer means an offer by a company to buy back its securities through a letter of offer from the holders of the security of the company. Tender means an offer made in writing by one party to another to execute certain work or supply certain commodities, etc., at a given cost; a bid. In this specified securities are bought back by the company at a certain price within a stated time limit, often in an effort to win control of the company.

For instance if a company has offered to buy back 10,000 equity shares but it has received offers for 15,000 shares, it should buy 1 share for every 1.5 shares. Therefore a shareholder who has offered 1,500 shares, the company will buy from him 1,000 shares.

Regulation 8, 9, 10, 11 and 12 of the buyback regulation govern the buyback of shares or other specified securities by tender offer.

2. Buyback of Odd lot shares:

The term “Odd lot” denotes those shares or other specified securities of a listed company which are not in market lot fixed by the stock exchange.

For example, if a market lot is 50 shares or other specified securities in numbers less or more than 50 will be treated as odd lot. The provision pertaining to buy back through tender offer shall be applicable mutadis mutandis to odd lot shares or other specified securities[6].

3.    Buy back from Open Market:

The company intending to buy back its securities in accordance with the provision of section 68 may buy back from the open market in compliance of buy back regulations. The buyback of shares or other specified securities from the open market may be in any one of the following methods:

a.    Through stock exchange:

Intimation to the stock exchanges where the company’s securities are listed, seven days before the date of the board meeting, at which the matter of buyback of securities is to be considered by the board.

Board meeting to consider the matter of buy back and appointment of merchant banker.

Special resolution at general meeting, in accordance with regulation 5(1).

File resolution with ROC, SEBI, and Stock exchanges.

Board meeting to approve public announcement (to contain disclosure on brokers and stock exchanges), in accordance with regulation 15(d).

File Public Announcement with SEBI in accordance with regulation 15(e) within 3 days.

File Solvency Declaration with SEBI and ROC according to 16(1) within three days.

Commence purchases from day eight.

Inform Stock Exchanges detail of purchases made on daily basis according to regulation 15(i).

Verify securities and remit consideration according to Regulation 16(2).

Extinguish share certificates according to Regulation 16(1) on 30th day.

Reporting to SEBI and Stock Exchanges regarding extinguishment (verification of securities, remitting consideration and formalities to take place on revolving basis till the last purchase is made) according to regulation 16(1) on or before thirty days of completion.

Advertising national daily within two days of completion and file report with ROC within thirty days of completion.

b.    Book Building:

A company may buy back its shares or other specified securities through the book building process in the manner stated in the Regulation 17 of Buyback Regulations.

Intimation to Stock Exchange where the company’s securities are listed, seven days before the date of the board meeting, at which the matter of buyback of securities is to be considered by the board.

Board meeting to consider the matter of buy back and appointment of merchant banker.

Special resolution at general meeting, in accordance with regulation 5(1).

File resolution with ROC, SEBI, and Stock exchange within 2 days as per regulation 5A as inserted via amendment 2012.

Board meeting to approve public announcement (to contain disclosure on brokers and stock exchanges).

Open Escrow Account with reference to regulation 17(1) (d).

Make a public announcement, at least seven days prior to the opening, with reference to regulation 17(1) (c).

Public announcement with SEBI along with fees on day four, with reference to 17(1) (e).

File Solvency Declaration with SEBI and ROC with reference to Regulation 16(1) on day four.

Offer opens on day nine.

Offer closes on day twenty four with reference to Regulation 17(1) (i).

Open special bank account with reference to Regulation 11(1) on day twenty five.

Transfer money out of Escrow Account to Special Account within twenty five days.

Verify securities and finalize list of applicants with reference to regulation 11(2).

Permitted Modes Of Buyback For Unlisted Companies:

In case of Buy back of shares by Private limited Company and Unlisted Public Company “Private Limited Company and Unlisted Public Company (Buy back of Securities) Rules, 1999 are required to be complied with provisions of Companies Act,2013. Such Company many buy back in following ways:

1. From existing shareholders on a proportionate basis through private offers.

2. By purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

A company is required to pay tax in case of buyback of its own shares which are not listed any recognized stock exchange of India. The tax is payable at 20% on distributable income-  the consideration paid by the company for buying back its own shares as reduced by the amount received by the company for issue of such shares. The buyback receipts which are taxed in the hands of the company is not subject to tax at the shareholder level.

Prohibition And Limitations:

According to regulation 4 of SEBI (Buyback of Securities) Regulations, 1998, a company is prohibited from buying back its shares under following cases:

1. Negotiated deals: A company shall not buy its specified securities from any person through negotiated deals, whether on or off the stock exchange or through spot transactions or through any private arrangements.

2. Insider Trading: Any person or an insider shall not deal in securities on the basis of unpublished information relating to Buy Back of specified securities of the company.

Limitations:

According to section 70 of Companies Act, 2013, No company shall directly or indirectly purchase its own shares or other specified securities:

a) through any subsidiary company including its own subsidiary company;

b) through any investment company or group of investment companies, or;

c) if a default, is made by the company, in the repayment of the deposit accepted either before or after the commencement of this Act, interest payment thereon, redemption of debentures or preference shares or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company:

Provided that the buyback is not prohibited, if the default is remedied and a period of three years has lapsed after such default ceased to subsist. 

Conclusion

Buybacks aren’t without value. It is crucial, however, for managers and directors to understand their real effects when deciding to return cash to shareholders or to pursue other investment options. A buyback’s impact on share price comes from changes in a company’s capital structure and, more critically, from the signals a buyback sends. Investors are generally relieved to learn that companies don’t intend to do something wasteful such as make an unwise acquisition or a poor capital expenditure with the excess cash. Share buybacks are all the rage. In 2004 companies announced plans to repurchase $230 billion in stock more than double the volume of the previous year. During the first three months of this year, buyback announcements exceeded $50 billion. And with large global corporations holding $1.6 trillion in cash, all signs indicate that buybacks and other forms of payouts will accelerate.

In general, markets have applauded such moves, making buybacks an alluring substitute if improvements in operational performance are elusive. Yet while the increases in earnings per share that many buybacks deliver help managers hit EPS-based compensation targets, boosting EPS in this way doesn’t signify an increase in underlying performance or value. Moreover, a company’s fixation on buybacks might come at the cost of investments in its long-term health.

For example, Dell’s announcement earlier this year that it would increase its buyback program by an additional $10 billion didn’t slow the decline of its share price, which had begun to slide because of worries about operating results.

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[1] Webster’s new world dictionary and thesaurus on cd; oxford business and law electronic dictionary

[2] Corporate Government Environment in OECD Countries’, mimeo, OECD, Paris, February 1995.

[3]  SEBI v Sterlite Industries(India ltd.) 2003, 113 Comp Cas

[4] Buyback regulations; regulation 3

[5] SEBI press release no.PR74/79 dated 19th march,1999

[6] Buy Back regulations, Regulation 13.