REGULATORY REGIME OVER BUY BACK OF SHARES
The concept of buyback of shares was introduced by the Companies (Amendment) Act in the year 1999. Prior to this amendment, the buyback of securities in India was not allowed as per section 77 of the Companies Act, 1956. Section 77 of the 1956 Act imposed restrictions on purchase by a company, of its own shares or holding company’s shares. The 1999 amendment Act inserted sections 77A, 77AA, and 77B which permitted the listed companies to buy their own shares back from the shareholders. However, the buyback was subject to certain conditions provided under Section 77 of the 1956 Act and also in Private Limited Company & Unlisted Public Company (Buyback of Securities) Rules, 1999.
As of now, Sections 68, 69 and 70 of the Companies Act, 2013 (“the Act”) governs the buyback of shares.
Recently, SEBI has also released new regulations regarding the buyback of shares SECURITIES AND EXCHANGE BOARD OF INDIA (BUY-BACK OF SECURITIES) REGULATIONS, 2018, (“the Regulations”) which has already been amended twice in July, 2019 and September, 2019.
MEANING AND OBJECTIVE
Buyback of shares or stock buyback is the situation where the company buys back or repurchases its own shares from its shareholders. Once the shares are bought back they are to be cancelled or destroyed. The buyback can be carried out at two ways –
1. By purchasing the shares from the stock market at the market rate, or
2. By giving the shareholders an open offer (tender offer) to decide a fixed price, which is usually higher than the prevailing market rate of the shares.
A company may opt for buyback of shares under following circumstances –
When there is excessive floating stock in the market
When the stock is fairly priced or over valued
When the stock is undervalued
When the company wants to increase its Earnings Per Share (EPS)
When the company wants to increase the promoters’ holdings
To discourage unwelcomed takeover bids
There are several other objectives also which were considered before making the legislations regarding buy-back of shares.
The legal framework that regulates the buy-back of shares and other specified securities are the following:
Companies Act, 2013
Companies (Shares Capital & Debenture) Rules 2014; and
SEBI (Buy-back of Securities) Regulations, 2018 as well as subsequent amendments thereafter.
Section 67(1) of the Companies Act, 2013 provides that a company limited by shares or a company limited by guarantee having a share capital cannot buy its own shares. The restrictions is applicable to all companies having share capital, whether public or private, except the prohibition to buy-back its own shares shall not apply to a private company:
In whose share capital no other body corporate has invested money;
If the borrowings of such a company from banks or financial institutions or anybody corporate is less than twice its paid up share capital or 50 crore rupees, whichever is lower, and
Such company is not in default in repayment of such borrowings subsisting at the time of making transactions under section 67(1) of the Companies Act, 2013.
However, Section 68 of the Act permits a company to purchase its own shares or other securities subject to certain conditions. The section provides for sources out of which the companies can buy its own shares or other securities. Sourced here depicts the funds available with the company. The company shall only utilize
its free reserves; or
the securities premium account; or
Proceeds of any shares or other specified securities except out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
Conditions for buy-back:
Section 68 of the Companies Act, 2013 provides for certain conditions which the companies have to adhere to while proposing for buy-back:
that the buy-back must be authorized by its Articles
A Special Resolution is passed at the General Meeting of the company authorizing the buy-back of shares. However, this is not required when: a) The buy-back is 10% or less of the total paid-up equity capital and free reserves of the company; and
b) Such buy-back has been authorized by a Board Resolution passed in the Board Meeting of Directors.
The buy-back shall not exceed 25% of the total paid-up capital and free reserves of the company.
the Debt equity ratio should not exceed 2:1
All the shares or other securities for buy-back shall be fully paid-up.
The buy-back of the shares or other specified securities listed on any recognized stock exchange are in accordance with the regulations made by SEBI.
The buyback in respect of shares or other specified securities not listed on any recognized stock exchange are in accordance with Companies (Share Capital and Debentures) Rules, 2014.
No offer of Buyback under this sub section shall be made within a period of one year reckoned from the date of closure of the preceding offer of buy-back, if any.
A Company should extinguish and physically destroy shares bought back within 7 days of completion of the buy-back
Additionally, pursuant to SEBI (Buy Back of Securities) Regulations, 2018, a listed company shall also comply with the following conditions:
No offer of Buyback for 15% or more of paid up capital and free reserves of the company shall be made from open market.
In case of Buyback from open market, company shall ensure that at least 50 % of amount earmarked for buyback as specified in Board Resolution/ Special Resolution is utilized for buying back shares or other specified securities.
A company shall not buy-back its shares or other specified securities from any person through negotiated deals, whether on or off the stock exchange or through spot transactions or through any private arrangement.
No insider shall deal in shares or other specified securities of the company on the basis of unpublished price sensitive information relating to buy-back of shares or other specified securities of the company.
Time limit for completion of buyback:
Pursuant to section 68 (4) of Companies Act, 2013, every buy-back shall be completed within one Year from the date of passing of the Special Resolution or the Board Resolution, as the case may be.
Post buyback compliances for listed companies:
Along with the aforesaid compliances (if applicable) and pursuant to SEBI (Buy Back of Securities) Regulations, 2018:
The company shall issue a public advertisement in a national daily within two days of expiry of buy-back period, inter-alia, disclosing:
number of securities bought;
price at which the securities were bought;
total amount invested in the buy-back; and
The consequent changes in the capital structure and the shareholding pattern after and before the buy-back.
The merchant banker shall ensure that a final
Circumstances in which buyback is prohibited:
Pursuant to section 70(1) of Companies Act, 2013, no company shall directly or indirectly purchase its own shares or other specified securities:-
Through any subsidiary company including its own subsidiary companies;
Through any investment company or group of investment companies
If a default, is made by the company, in the repayment of deposits or 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.
However, buyback is not prohibited in aforesaid case if default is remedied and a period of three years has lapsed after such default ceased to subsist.
Pursuant to section 70(2) of Companies Act, 2013, no company shall, directly or indirectly, purchase its own shares or other specified securities if company has not complied with the provisions of Section 92 (Annual Return), 123 (Declaration of Dividend), 127 (Punishment for failure to distribute dividend) AND 129 (Financial Statements).
Pursuant to section 68(11) of Companies Act, 2013, if a company makes any default in complying with the provisions of this section or any regulation made by the Securities and Exchange Board, the company shall be punishable with fine which shall not be less than one lakh rupees but which may extend to three lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than one lakh rupees but which may extend to three lakh rupees, or with both.
Withdrawal of Buyback Offers after Announcement:
Prior to the SEBI (Buy Back of Securities) Regulations of 2018, the companies were allowed to announce buyback schemes to generate investor interest and reap the benefit of higher market value of securities while choosing to not implement the same later. The favorable sentiment pursuant to announcement of buyback schemes raises the share prices and attracts more investors. Companies capitalize on this loophole to earn higher profits or stabilize their share prices and subsequently frustrate their buyback scheme. In the case of D-Link (India) Ltd. v. SEBI, SEBI contended that since the company did not implement the buyback scheme pursuant to the shareholders resolution and capitalized on the market sentiment by misleading its investors, it should be penalized. However, the Securities Appellate Tribunal (SAT) held that since there is no mandatory obligation to buy back the shares after passing of a resolution, the company did not engage in any illegal practice.
However, Regulation 24(d) of the SEBI Regulations purported to deal with this issue by mandating that a company shall not withdraw the offer to buy-back after the draft letter of offer is filed with SEBI or public announcement of the offer to buy-back is made. This would ensure that only genuine buyback offers would be made and malpractices like insider trading and market manipulation could be controlled. However, SEBI has not taken a very stringent approach towards the same. It allowed PC Jeweller to withdraw its buyback offer a short while after it made the announcement, citing lack of bank approval for disbursement of the cash as the reason.
Similarly, KPR Mill withdrew its buyback offer after the 2019 Budget proposed to impose an additional tax of 20 percent in case of repurchase of securities by Indian listed companies. Recently, Thomas Cook, a travel company, was also granted to withdraw the buyback offer by the SEBI keeping in mind the COVID-19 situation. This indicates that the withdrawal of buyback offers can be done in situations like policy changes or circumstances that were not envisaged by the company at the time of making the offer. This provides hope for those companies that proposed buyback offers and later wish to withdraw them. It would not fall within the purview of mala fide tactics that aim to mislead investors and earn higher profits.
Regulation for Buyback Price:
While Section 68 of the Act is silent about the pricing of the buyback, Regulations 5(iv) (c) and 5(v) of the SEBI Regulations state that the board resolution authorizing the buyback of securities should specify the maximum price at which the tendered buyback shall be made. However, it still fails to provide any guidelines for setting the price of the tendered buyback. The pricing guidelines are provided only when the buyback is made from the open market through the stock exchange or the book-building process. The Act or the SEBI Regulations do not contain any provisions governing the prices at which the companies can buy back their securities through tendered offers, thereby giving companies unconstrained freedom and power to fix the price.
At first glance, this seems like a lucrative option for companies because they could set the price at any value, based on the market price or the book value. The buyback price does not need to conform to its nominal value, thereby conferring flexibility upon companies to modify the price arbitrarily to either bolster or stabilize its prices in the market. For instance, when faced with negative market situation, companies set a high buyback price, attempting to demonstrate their assessment of the share value in the market. This artificial inflation of their share prices boosts investor confidence and assists the company in coming out of the slump. However, misuse of this freedom can lead to SEBI investigations for insider trading and market manipulation.
In 2005, Abbott India Limited fixed the price at which the buyback was proposed at Rs. 650, as opposed to the book value of Rs. 141.65 per share prevailing in the market, providing an attractive opportunity to the existing shareholders to reduce their shareholdings in the company. However, as this exit price was much lower than the price of the company’s shares subsequent to the buyback, Abbott India Ltd. was accused of securing undue benefit for its promoters. It failed to disclose all the information about its market projections and priced the shares at a very high price, attempting to manipulate gullible shareholders into reducing their shareholdings to their subsequent dis-advantage.
This is similar to insider trading strategies adopted by unscrupulous companies, wherein they buy their securities at a lower price before the buyback scheme is announced and sell the same at the higher price prevailing in the market post the buyback. Even though Regulation 4(3) of SEBI (Insider Trading) Regulations, 1992 strictly prohibits insiders from trading in securities based on unpublished buyback information, there is a need to address the root of the problem by merely implementing pricing guidelines.
Hence, to avoid any unnecessary litigation, it would be wise for all companies adopting the tendered-offer buyback option to use the pricing guidelines established for open market buybacks until further clarity is provided by SEBI in this regard.
Certain Grey areas under Sections 68 and 70:
The Act suffers from certain regulatory gaps and ambiguities which companies should be aware of, to ensure that the interests of their shareholders and creditors are not adversely affected. By ensuring to avoid these uncertainties before announcing a buyback, they can save the added cost and burden of future litigation.
Firstly, the Act prohibits companies from implementing buyback schemes if they fail to comply with provisions of Sections 92, 123, 127 and 129 of the Act, which require the companies to file their annual return, pay their dividend within 42 days of declaration, and prepare their balance sheet and profit and loss account to disclose the financial position of the company respectively.
However, there is ambiguity regarding the temporal limit applicable on such compliance. The Act does not clearly specify whether these requirements need to be complied with only in the year when buyback scheme is announced or in previous years as well. Furthermore, the repercussions of a few impediments in compliance with these requirements on the buyback plans of the company are indeterminate and need clarity. The Act needs to clarify whether minor nonconformities in filing of returns or accounting standards have the effect of depriving the company from implementing buyback schemes or attract some minor penalty. To avoid any problem in this regard, companies should strive to comply with all accounting standards required by SEBI.
Secondly, sub-section 7 of Section 68 requires companies to extinguish and physically destroy the securities bought back within seven days of the ‘last date of completion of buyback’. However, there is ambiguity regarding what counts as ‘completion of buyback’. If completion refers to completion of all buyback transactions, which may go on for an entire year, then it creates grey areas for application of laws. For shareholders whose shares were bought back when the scheme was introduced but the scheme continued to exist for the year, the last date of completion would mean shares bought back at the end of the year.
Therefore, the voting rights for the shares given up and dividend payment, if any, accruing from such shares, remain indeterminate for the period between the two transactions, creating difficulties for the company. However, if ‘completion of buyback’ refers to the particular buyback offer made to the shareholders that is open for a period of 10 days, then much of these ambiguities will disappear.
Thirdly, Section 68(1) of the Act does not specify the temporal limit for using the proceeds from previous issue of different kind of securities. It could mean using the proceeds from issues immediately prior to conducting buyback transactions or those raised 10 years ago as well. Therefore, the limit on the use of proceeds needs to be specified.
Fourthly, while Section 68(8) prohibits issue of same type of securities for 6 months after completion of buyback, it allows companies to raise funds through other kinds of securities even immediately after implementing such schemes. However, Regulation 24(f) of the SEBI Regulations prohibits companies from raising further capital for a period of one year from expiry of buyback period, thereby generating conflict with the six-month embargo provided under the Act.
Impact of Buyback on Growth and Expansion Policies:
While buyback seems like a lucrative option to ensure that companies can stay afloat in this pandemic, its adverse impact on the company’s long-term growth should not be lost sight of. The utilization of funds on buying back securities from existing shareholders results in increased earnings per share and short-term profitability without hampering the operational productivity of the company. However, it significantly reduces the existing capital base by decreasing the reserves or the share capital proceeds used for funding buyback.
Therefore, the existing non-selling shareholders bear the brunt of such a reduction in the form of reduced dividends and fewer expansion opportunities. The long-term growth of the company suffers a setback when companies divest a large sum of money in buying back securities to secure higher immediate returns.
Companies set aside these funds for buyback at a later date instead of using them for growth and expansion projects, thus diverting funds from prudent investments to such schemes.They fail to capitalize on long-term gains generated by such investment opportunities, focusing instead on the short-term gains resulting from the temporary market favorability created by buyback schemes. Moreover, companies become more risk-averse in their outlook as buyback is the less precarious option in comparison to other investment opportunities. This myopic vision stems from being ill-informed about buyback and its repercussions, the transient gains of buyback schemes clouding their judgments instead.
Companies should ensure that they consider all relevant factors before announcing a buyback –the impact of a buyback on its long-term growth, withdrawal of their buyback offer, pricing guidelines governing the offer and the possible minor non-compliances and their repercussions. This will ensure that the process is conducted smoothly, without any unwelcome SEBI interferences, while also boosting investor confidence and keeping the company afloat. The investors must also keep a close eye on the market for better investment strategies and avoid getting manipulated. Moreover, these regulatory loopholes require urgent legislative intervention to ensure that there is no scope for abuse of the buyback mechanism by companies while also creating a more conducive business environment.
BY RAGESHWARI CHUNDAWAT, AMITY LAW SCHOOL, NOIDA