How to buy back and redeem a public company's shares
Even in this time of bull markets, some companies find themselves in a predicament because their shares remain undervalued for long periods of time. While lawyers are not necessarily the people you want to call to fix your public image problem (the sheer number of lawyer jokes in circulation should convince anyone that marketing is not our specialty), we can assist in finding creative ways of making the best of a situation. When it comes to undervalued shares, one idea is for a company to consider redeeming a portion of its shares.
The benefit that a redemption offers is that the remaining shareholders should enjoy an increased share in future dividends and an increase in the book value of their shares. In 1999, this perceived benefit tempted many Polish public companies, including Polifarb Cieszyn-Wroclaw, Polfa Kutno, Wolczanka, Stomil Sanok, Elektrobudowa and Elpo to redeem their shares.
The mechanism for the redemption of shares in a public company actually involves two steps. First, the company must purchase its own shares. This step is referred to as a "buyback." Second, after it has bought the shares back, a company may redeem them. As a general rule, the Polish Commercial Code does not allow a company to acquire its own shares, but an acquisition for the purpose of redemption is one of the exceptions from this restriction.
Statutory law aside, a company may only redeem its shares if a redemption is expressly permitted by the company's charter (articles of association). The charter should state the method and procedure for redemption, neither of which are adequately provided for in the charters of many public companies. As the law regulating redemption is not clear, a company's charter should set forth very specific rules for redemption so as to minimize the inevitable practical problems and misunderstandings that may arise when it comes time to redeem the shares. Thus, a well-planned redemption should start with a good hard look at the company's charter.
The buyback and redemption process starts with the adoption of a resolution at the company's general meeting of shareholders, authorizing the management board to buy back shares. The resolution should set forth the terms and conditions for the buyback, such as the amount of funds available, the maximum price for the buyback and deadlines for both the buyback and the redemption.
As a public company must conduct the buyback of shares on the stock exchange, the next procedural step involves determining whether the company needs to conduct a public tender offer to subscribe for the sale of shares. A tender offer is an offer addressed to all shareholders to purchase shares in the company on the same terms. Without belaboring this point, a desire to acquire within a period of 90 days an amount of shares that would entitle the acquirer to at least 10% of the votes at the company's general meeting of shareholders requires that a tender offer be conducted. It may be argued that the announcement of a tender offer is not obligatory even if the company intends to buy back shares representing 10% or more of the votes in the company because a company may not vote its own shares and the tender offer requirement is set forth in reference to the number of votes represented by the acquired shares. However, a tender offer, as a rule, seems to be the only method to buy back substantial blocks of shares in a way that is fair and equitable to all shareholders and does not expose the management board to price manipulation accusations.
The process of redemption does not end with the company's purchase of its own shares. Upon acquisition, the shares become the company's property (though the company may not vote them or receive dividends). The next main step is usually the adoption of a resolution on the redemption of the purchased shares at the company's general meeting of shareholders. In practice, some interesting legal problems may arise if the general meeting decides not to redeem the shares purchased by the company on the basis of the general meeting's previous resolution to purchase shares for redemption. In this case and under some conditions, though it may sound controversial, the management board is probably required to re-sell the shares as it is unusual for a company to hold its own shares, and this situation should not be continued without an appropriate legal justification.
Shares may be redeemed from net profit or by decreasing the share capital of the company. Without discussing a recent controversial decision of the Supreme Court on the scope of the term "net profit," it may be pointed out that in practice, funds coming from net-profit deductions are sufficient for redemption. The actual "covering" of the redemption from net profit or by decreasing the company's share capital is of an accounting nature, as the price for the shares was paid to shareholders during the buyback. If the redemption is made by decreasing the company's share capital, the company must follow additional procedures applicable to any decrease in share capital. These procedures include making public announcements on the intended decrease, securing creditors who are opposed to the decrease, and registering an amendment to the company's charter.
Despite many other legal problems, the main obstacle for companies and their shareholders in considering buybacks is tax related. The Polish tax authorities interpret a buyback as an event creating "income from sharing in a legal person's profit" for the remaining shareholders. The amount of this income is interpreted to be equal to the total price paid for shares purchased for the purpose of redemption. As such, income generated from a buyback for redemption would be subject to a 20% withholding tax. Experience has shown that even this unclear situation regarding the taxation of buybacks for redemption doesn't prevent shareholders of companies that have remained undervalued for long periods of time from using this handy instrument.
This article was prepared by Lejb Fogelman, the managing partner of Hunton & Williams Poland, with the assistance of Lukasz Pawlak, an associate attorney.
