Drafting of share buyback agreements – Important considerations
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By Martin Kotze and De Wet de Villiers
Topics Commercial & Corporate Law | Contract Law | Tax Law
08 May 2020
In this article, we have a high-level look at some of the important aspects that must be kept in mind when drafting a Share Buyback agreement.
A Share buyback transaction can go hand in hand with another transaction, for example, a Subscription of Share Agreement. The purpose of this note is to discuss Share Buyback transactions in general and not with reference to a specific set of facts.
Compared to the old Act (ss 85 – 87 of the 1973 Act), section 48 of the Companies Act, 2008 (the “Act”) appears to create a “more straight forward process” and in some situations allows a Share Buyback on only a board resolution. There are, however, certain pitfalls.
SECTION 46 OF THE COMPANIES ACT
Whenever considering a Share Buyback transaction, the board of the Company must be sure that the Company will satisfy the solvency and liquidity test immediately after completing the transaction.
If a director fails to vote against the implementation of the Share Buyback transaction knowing that the transaction will not satisfy the requirements contemplated in section 46 of the Act, then the Director may open him/herself up to possible personal liability as contemplated in section 77 (3) (e) (vi) of the Act.
With a Share Buyback transaction, the type of Seller, who the Seller is and who the Seller is related to is of importance and will influence the structuring and timelines relating to the Share Buyback transaction.
Section 48 (8) (a) of the Act, determines if the shares are repurchased from a director or prescribed officer of the Company or a person related to a director or prescribed officer of the Company, then a special resolution of the shareholders of the Company will be required.
Note, “related” has a specific meaning in the Act (have a look at sections 1 and 2 (1) (a) to (c) of the Act).
Furthermore, if the Seller is a Company, you will need to establish if the Seller is disposing of all or the greater part of its assets or undertakings as contemplated in section 112 of the Act.
Section 1 of the Act – “all or the greater part of the assets or undertaking”, when used in respect of a company, means —
(a) in the case of the Company’s assets, more than 50% of its gross assets fairly valued, irrespective of its liabilities; or
(b) in the case of the Company’s undertaking, more than 50% of the value of its entire undertaking, fairly valued;
If the Seller is disposing all or greater part of its assets or undertakings and if an exclusion stipulated in section 112 (1) of the Act does not apply, the shareholders of the Seller will need to approve the transaction by way of a special resolution.
It is also important to consider whether the Seller is a subsidiary of a holding company, and if so, whether the disposal by the Seller (being the subsidiary), constitutes disposal of all or the greater part of the assets or undertakings of the holding Company with regard to the consolidated financial statements of the holding Company.
If the disposal also constitutes disposal of all or the greater part of the assets of the holding Company, then the shareholders of the holding Company will also need to approve the transaction by way of a special resolution.
TAKEOVER REGULATION PANEL
TRP approval is sometimes overlooked because parties are under the incorrect impression that because it is not a high-value transaction, there is no need for TRP approval.
Small and medium companies seldom expressly stipulate in their MOI that Part B, C and the Takeover Regulations must apply to it and its securities. This, however, does not mean that part B, C and the Takeover Regulations will not apply.
If the transaction constitutes disposal of all or the greater part of the Sellers assets as contemplated above, then it is also important to consider whether 10% or more of the issued securities of the Seller have been transferred (other than by transfer between or among related or inter-related persons) within the period of 24 months immediately before the date of a particular transaction or offer (the value of the shares that have been transferred, is irrelevant).
Should the Seller be disposing of all or greater part of its assets or undertakings and should there have been a transfer as contemplated in the aforesaid, then the Seller will be regarded as a “regulated company” that is entering into an “affected transaction”.
The Act stipulates that the Seller (being a “regulated company”) may not dispose or give effect to an agreement to dispose of all or the greater part of its assets or undertakings unless the TRP has issued a compliance certificate or exempted the transaction.
SECTION 114 OF THE COMPANIES ACT
Section 48 (8) (b) of the Act, stipulates that if the Share Buyback (considered alone, or together with other transactions in an integrated series of transactions), involves the acquisition by the Company of more than 5% of the issued shares of any particular class of the Company’s shares, then the requirements of section 114 and 115 of the Act, will apply. This means :
- The Company will need to retain an independent expert who must prepare a report to the board (who must distribute the report the all the holders of securities), which must at a minimum address the items stipulated in section 114 (3) of the Act;
- The Company will not be able to implement the transaction unless the transaction is approved by the shareholders of the Company as contemplated in section 115 of the Act;
- In the case where the Company is a regulated Company, the Panel has issued a compliance certificate in respect of the transaction or exempted the transaction.
TAKEOVER REGULATION PANEL
If the transaction involves the acquisition by the Company of more than 5% of the issued shares of any particular class, then it is also important to consider whether 10% or more of the issued securities of the Company have been transferred (other than by transfer between or among related or inter-related persons) within the period of 24 months immediately before the date of a particular transaction or offer.
Should section 48 (8) (b) apply and should there have been a transfer as contemplated in the aforesaid, then the Company will be regarded as a “regulated company” that is entering into an “affected transaction”.
In the circumstances contemplated in the aforementioned, the Act stipulates that the Company may not give effect to the Share Buyback transaction unless the TRP has issued a compliance certificate or exempted the transaction.
It is further important to determine whether the Company in which the shares are held is also a “regulated company” as contemplated in Part B – Authority of Panel and Takeover Regulations of the Act.
If the Company’s MOI does not expressly determine that the Company and its securities are subject to Part B, Part C and the Takeover regulations, then you will need to determine whether 10% or more of the issued securities of the Company have been transferred (other than by transfer between or among related or inter-related persons) within the period of 24 months immediately before the date of a particular transaction or offer.
If there was a transfer or transfers as contemplated in the aforementioned, then you will need to determine the following:
- Was there a person (or a person and a related or inter-related person or a person and another person acting in concert) that was able to exercise less than 35% of all the voting rights attached to securities of the Company immediately before the date of a particular transaction?
- If yes, will this person, as contemplated in the aforementioned, be able to exercise at least 35% of all the voting rights attached to securities of the Company after implementation of the Share Buyback transaction?
If the Company is a regulated company and if both the above questions are answered yes, then the contemplated person will be required to make a mandatory offer to the remaining shareholders of the Company in terms of section 123 of the Act.
As will be discussed below, Share Buyback and Subscription arrangements are sometimes used by corporate shareholders as a more “tax effective” way to divest their holdings in companies. Even low-value transactions can trigger various unintended consequences, for example a mandatory offer as contemplated in the aforementioned. Structuring of these transactions must be carefully planned and usually require input from the legal and finance teams.
Share buyback transactions can be structured to either trigger capital gains tax (“CGT”) or to be treated as a dividend.
Should the buyback be structured as a dividend, the following considerations are relevant: Dividends are generally exempt from income tax in terms of section 10(1)(k)(i) of the Income Tax Act, 58 of 1962 (the “ITA”) and dividends paid to South African resident companies are exempt from dividends tax in terms of section 64F(1)(a) of the ITA.
Structuring a transaction in such a way that the proceeds from the divestiture be regarded as dividends holds various advantages, especially for South African resident companies. SARS has, however, started to tighten the rope on these types of transactions.
On 16 March 2015, SARS issued Government Notice No 38569, in terms of which the following arrangement has been identified as a ‘reportable arrangement’ for purposes of sections 35 and 36 of the Tax Administration Act, 28 of 2011 (the “TAA”):
Any arrangement in terms of which-
(a) a company buys back shares on or after the date of publication of this notice from one or more shareholders for an aggregate amount exceeding R10 million; and
(b) that Company issued or is required to issue any shares within 12 months of entering into that arrangement or of the date of any buy back in terms of that arrangement.
Furthermore, paragraph 43A of the Eighth Schedule to the ITA (the so-called “anti-dividend stripping rules”) can treat exempt dividends received that arise from share buybacks, that meet certain criteria, as proceeds for CGT purposes.
With the introduction of Paragraph 43A(4) of the Eight Schedule to the ITA, care should also be taken when share subscription transactions are entered into as those transactions now also fall within the ambit of the anti-dividend stripping rules.
Furthermore, should the Seller in the transaction realise a capital loss Paragraph 19 of the Eight Schedule to the ITA should also be considered as it could have the effect of clogging the capital loss realised.
Knowing your client and related parties is crucial when drafting Share Buyback Agreements. Even low-value transactions between SMMEs can trigger, for example, a mandatory offer or may require shareholder approval in some way.
By using the contracts.tech contract creation tool you will be able to create your first drafts of the transaction documents in minutes and you will be guided through relevant questions ensuring that you cover important considerations. Give it a try today.
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Martin Kotze holds a BCom LLB degree from the University of Pretoria and is an admitted Legal Practitioner, Conveyancer and Notary Public. He is the managing director of MJ Kotze... Read more about Martin Kotze
De Wet de Villiers holds the BAcc.LLB degree from Stellenbosch University. De Wet joined PwC’s corporate and international tax team in Cape Town as a Tax Consultant in 2011. During... Read more about De Wet de Villiers