Selective buy-backs and selective capital reductions: buying out a departing shareholder

When a shareholder exits and the remaining holders do not want to fund the purchase personally, the company can acquire the shares itself. Two mechanisms in Part 2J.1 of the Corporations Act 2001 (Cth) allow it: a selective buy-back and a selective reduction of capital. They are not interchangeable, the approval thresholds differ, and the sequence of ASIC lodgements controls the timetable. Getting the order wrong is the most common way these transactions slip.

Which instrument

A selective buy-back is an agreement under which the company buys shares from one holder, or from some holders and not others, and cancels them. It sits in Division 2 of Part 2J.1 and has a defined procedure with defined ASIC forms.

A selective reduction of capital under sections 256B and 256C is a reduction that does not apply equally to all holders of ordinary shares. It requires the reduction to be fair and reasonable to shareholders as a whole, to not materially prejudice the company’s ability to pay its creditors, and to be approved by shareholders. Where the reduction involves cancelling shares, a separate special resolution of the affected class is also required.

For a negotiated exit at an agreed price, the buy-back is almost always the right instrument. The procedure is prescriptive but predictable. A selective reduction suits a different problem: eliminating a class, returning surplus capital unevenly, or restructuring where no purchase price is being paid. If you find yourself arguing that a payment to a departing shareholder is a reduction rather than a purchase, revisit the analysis.

The gateway: section 257A

A company may buy back its own shares if the buy-back does not materially prejudice its ability to pay its creditors, and it follows the Division 2 procedure. There is no solvency declaration to sign, which leads boards to treat the creditors test as a formality. It is not. Where the buy-back is funded by new borrowings, the borrowings are part of the question: the board is assessing the company’s position after the cash has gone out and the debt has come in, not before. Minute the analysis, with the cash flow forecast, the facility terms and the covenant headroom behind it.

Approval: section 257D

A selective buy-back always needs shareholder approval, by one of two routes:

• A special resolution at a general meeting, with no votes cast in favour by the holder whose shares are being bought back or their associates.
• A resolution agreed to by all ordinary shareholders, which does not require a meeting.

The second route is what makes a circular resolution possible on a small register, and it is the reason a circular resolution signed by every shareholder including the seller works. It cannot be the special resolution route, because the seller signing in favour is a vote in favour. Identify which limb you are relying on before the document is drafted.

Section 257D(2) requires the notice of meeting to include a statement setting out all information known to the company that is material to the decision how to vote, other than information already disclosed to shareholders. Section 257D(3) requires the company to lodge a copy of the notice and any accompanying documents with ASIC before they are sent to shareholders. Both apply to a circular resolution.

What goes in the disclosure

RG 110.17 to RG 110.25 of Regulatory Guide 110 Share buy-backs set out the minimum information ASIC expects shareholders to receive. Even on a two shareholder register with a unanimous circular resolution, prepare it properly:

• the identity of the selling shareholder, and the number and class of shares;
• the price, how it was determined, and the source of the funds;
• the effect on the share register, on voting control and on the company’s financial position;
• the directors’ assessment of the effect on creditors and the basis for it;
• any interest a director has in the buy-back, and any recommendation; and
• the terms of any related transaction, including the finance and any security granted for it.

The 14 days, and the forms

Section 257F prevents the company entering into a buy-back agreement until 14 days after it lodges the documents Division 2 requires. The critical detail is what the 14 days runs to. Where the buy-back agreement is conditional on the resolution being passed, the relevant date is the date the resolution is passed. Where it is not conditional, the relevant date is the date the agreement is entered into. A conditional agreement can therefore be signed early, which is why conditions precedent covering financier approval and shareholder approval are standard rather than optional.

• Form 280 notifies ASIC of the buy-back details. It must be lodged, with the notice of meeting or circular resolution and its accompanying documents attached, before those documents go to shareholders.
• Form 281 is the notice of intention. It is the short notice form: lodge it where the Form 280 will go in less than 14 days before the relevant date. It keeps the clock running while the disclosure pack is being finalised. Only the Form 281 requires a date for the proposed buy-back to be specified.

ASIC now accepts both forms as signed PDFs by email to its shares lodgements address, as well as by post. There is no lodgement fee. Confirm ASIC has received and processed the forms before the resolution is signed, and build a buffer in. The timetable depends on ASIC’s processing, not on your lodgement date.

Completion and afterwards

• Execute the share transfer and pay the consideration at completion. Under section 257H(3) the shares are cancelled immediately after the transfer to the company is registered. Cancellation is automatic rather than a separate board decision, so the register entry records something that has already happened.
• Section 254Y requires ASIC to be notified of the cancellation within one month. Form 484 is the vehicle for an unlisted company. A listed entity notifies ASX under Listing Rule 3.8A instead.
• Deal with the resignation of any director nominated by the exiting shareholder as a completion obligation, not as a post-completion courtesy.

Financial assistance

Section 260A restricts a company financially assisting a person to acquire shares in it. A buy-back conducted in accordance with Division 2 is exempted, so a company that borrows in its own name to fund the buy-back of its own shares does not require a whitewash under section 260B. The exemption is narrower than it first appears. If a subsidiary, or an entity associated with the continuing shareholder, grants security or a guarantee to support the facility, section 260A needs to be looked at again on its own facts. Ask for the finance documents and the guarantee and indemnity before forming a view. The structure of the security, not the label on the transaction, decides the answer.

The commercial points

• Restraints belong in the buy-back agreement. Most shareholders’ agreements terminate automatically when the register falls to one member, so a restraint sitting in the shareholders’ agreement disappears at the moment you need it. Move it, or repeat it, in the buy-back agreement, and check the restraint is drafted to survive the buy-back rather than the shareholding.
• Resist a payment plan. Consideration should be paid at completion. If a staged payment is unavoidable, hold the pre-completion instalments in the seller’s solicitor’s trust account so they are returnable if completion fails. Since the seller has no access to the money before completion under that arrangement, there is rarely a reason for the buyer to concede anything further.
• Check the constitution. Some constitutions impose their own buy-back or transfer procedure, or pre-emptive rights that need to be waived before the transfer can be registered.
• Test the value. The price is a related party dealing in substance even where Chapter 2E does not apply. Where the register is not unanimous, a defensible valuation is what answers the complaint later.

How Luma Legal can help

We structure and document selective buy-backs and capital reductions for private companies, including the ASIC lodgement sequence, the shareholder disclosure pack, the financial assistance analysis and the restraint and exit terms. The timetable is driven by ASIC processing rather than by drafting, so the earlier the forms are settled the shorter the transaction takes.