UK: Treasury Shares

Last Updated: 31 March 2004
Article by Sarah Owen

When companies used to buy back their own shares under the Companies Act 1985, such shares had to be cancelled immediately and the share capital consequentially reduced. The introduction of the Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 [SI 2003/1116] (the "Regulations") on 1 December 2003 has enabled certain companies to hold such shares in treasury for resale without cancelling them.

Introduction

It is hoped that treasury shares will give these companies greater flexibility in managing their share capital and should help them reduce the cost of raising new capital by enabling them to sell shares from treasury via a broker and, therefore, avoiding the costs of a new issue of shares.

Why Buy Back Shares?

Listed companies often use the buy back process as a means of increasing earnings per share which should, in turn, lead to an increase in share price. Buybacks can also stimulate an inactive market for the shares, enhancing share liquidity and can also be a method of returning cash to shareholders.

The Regulations

The Regulations amend section 162 of the Companies Act 1985 and insert new sections 162A-G and provide that:

  • Not every share may be held in treasury. Only shares admitted to the Official List and traded on the London Stock Exchange’s main market or the Alternative Investment Market or their equivalents in other EEA states may be held in treasury ("qualifying shares"). If such shares cease to be qualifying shares whilst held in treasury, they must be cancelled forthwith.
  • The aggregate nominal value of the shares held in treasury may not at any time exceed 10% of the nominal value of the issued share capital (or where the capital is divided into classes of shares, 10% of each class). Where the treasury shares exceed this limit, such excess must be disposed of or cancelled within twelve months.
  • Treasury shares must be held by the company and not by a nominee. Therefore, if the shares are held in CREST and the company is not a CREST member or sponsored member then the shares will have to be rematerialised into paper form.
  • Purchases of shares to be held in treasury may only be financed from distributable profits. Shares purchased but then cancelled can still be financed out of the proceeds of a fresh issue of shares.
  • No dividend or other distribution of assets can be paid or made on such treasury shares. No voting or other rights may be exercised in relation to such shares whilst they are held in treasury.
  • Treasury shares may only be sold for cash, cancelled or transferred for the purposes of, or pursuant to, an employee share scheme.

Pre-Emption Rights On Sale Of Treasury Shares

The pre-emption rights contained in section 89 of the Companies Act 1985 which apply to the allotment of new shares for cash will also apply to the sale of treasury shares bringing with them the costs and inconvenience of marketing the shares to existing shareholders. Such rights can be disapplied with the sanction of a special resolution passed by the shareholders.

The guidelines set by the Pre-emption Group for listed companies (which includes the Association of British Insurers ("ABI")) on the disapplication of pre-emption rights restrict non-pre-emptive issues on an annual basis to 5% of nominal value of the issued shares of a company, and to 7.5% in aggregate in any three year rolling period. The group is considering whether treasury shares should be counted in such limits. It is, however, the ABI’s view that treasury shares should be counted towards such 5% limit but that there may be a better case for flexibility for the 7.5% limit.

Consequential Changes To The Listing Rules And The City Code

The Listing Rules

As a result of the introduction of treasury shares, the Financial Services Authority ("FSA") has made the following modifications to the Listing Rules effective from 1 December 2003:

  • Due to concerns that companies may abuse the flexibility of treasury shares to create a false market or to manipulate the share price a new Rule 5.19 has been inserted to prohibit sales of treasury shares for cash during close periods or price-sensitive times when a director would be prohibited from selling under the Model Code. However, it was thought that such restrictions were too onerous on treasury share transfers to share schemes and therefore, the exceptions to the Model Code contained in paragraphs 20(g) – 20(m) will also apply to dealings in treasury shares so that the operation of all-employee schemes can continue without regard to close periods.
  • Disclosure of sales and transfer shares held in treasury. Where shares are purchased and held in treasury, a statement of the total number and class of such shares purchased and the remaining number of shares in issue must be made as soon as possible to a Regulatory Information Service.
  • A limit on the discount to market price at which treasury shares can be sold for cash non-pre-emptively. New Rules 15.23 and 15.24 state a company must not sell treasury shares for cash at a discount of more than 10% to the middle market price of those shares at the time of the sale unless such shares are offered on a pre-emptive basis. Rule 15.24 provides an exception where the UK Listing Authority is satisfied that the issuer is in severe financial trouble or there are other extenuating circumstances or where the sale is to a small number of persons approved by shareholders or is pursuant to a general section 89 disapplication.

Minor amendments are also expected to be made to the AIM rules to account for treasury shares.

The City Code

On 30 April 2003, the Code Committee of the Panel on Takeovers and Mergers released for consultation the changes it proposes to make to take account of the introduction of Treasury Shares.

The proposed changes are:

  • only shares held and in issue outside Treasury are relevant for the purposes of the Code;
  • a transfer of shares out of treasury will normally be treated in the same way as a new issue of shares;
  • it will normally be possible to obtain a Rule 9 whitewash of a transfer of shares out of treasury where such transfer would trigger a Rule 9 mandatory offer;
  • shareholders’ consent in general meeting will be required to transfer or sell treasury shares during the course of an offer or when the board believes that an offer is imminent; and
  • details of treasury share transactions must be disclosed in any offeree board circular.

Additional Considerations

Before a company embarks on the treasury share route, it should ensure that its articles of association do not insist on the cancellation of shares bought back by the Company. However, most companies will not need to change their articles to participate in the treasury share regime. In addition, unless companies are happy to offer treasury shares for sale on a pre-emptive basis, they should ensure that any special resolution disapplying such pre-emption rights is wide enough to permit sales of treasury shares.

Conclusion

Treasury shares have been introduced with the aim of providing certain companies with greater flexibility in managing their share capital. Treasury shares will facilitate the management and optimisation of gearing through the use of buy backs rather than the more traditional route of increasing or reducing debt. As the company no longer has to cancel the shares, it can hold them in treasury and resell in batches to raise capital as and when required without the need for a costly and time consuming placing or rights issue.

Treasury shares will be particularly useful in relation to employee share option schemes. Such shares held in treasury will be able to be used to satisfy the exercise of options. Treasury shares have an advantage over the employee benefit trust in that the company will save trustees fees and the stamp duty that would otherwise be payable on a transfer from a trust to an employee. Treasury shares will also give the company the option of buying shares at the date of grant of the option and holding them in treasury until exercise. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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