ISSUE V : Buy-back by listed companies: Regulatory insight

INTRODUCTION

Buy-back is a corporate financial strategy whereby a company purchases its own securities with the object of corporate restructuring through stake consolidation, preventing unwelcome takeover bids, achieving optimum capital structure, improving its earning per share etc. It can be financed out of a company’s free reserves, security premium account, and/or proceeds of an earlier issue other than the fresh issue.¹ Listed companies must conform with the provisions of the Companies Act, 1956 and SEBI (Buy- Back of Securities) Regulations, 1998 (“Regulations”) to effect a valid buy-back. This bulletin highlights the requisite conditions, different modes and the procedure for buy-back by listed companies.

1. Requisite conditions for buy-back²

The general conditions necessary for a valid buy-back are as follows:

1. The buy-back must not exceed 25% of the total paid-up capital plus the free reserves and should not be made out of the proceeds of an earlier issue of the same kind of securities.
2. Only fully paid-up securities qualify for buy-back.
3. It must be completed within 12 months of the date of passing of the shareholders resolution where the buy-back exceeds 10% of the paid-up capital and free reserves or a Board resolution where the buy-back is less than 10%.
4. Transfer of a sum equal to the nominal value of the shares must be made to the Capital Redemption Reserve³ (“CRR”) where buy-back is made out of free reserves.
5. The company must not have defaulted on the re-payment of deposits, term loans, redemption of debentures and/or preference shares. In addition, promoters or persons acting in concert must not deal in securities of the company while the buy-back offer is open.
6. Post buy-back, the ratio of debt to equity must not exceed 2:1. Further, it must be in accordance with SEBI Regulations.⁴
7. Modes of buy-back

In a tender offer the security holders may exercise their option to submit their securities either in part or full within a certain time period which shall generally be at a price higher than the current market value. Subsequently, a letter of offer may be made by these holders to the company and securities may then be eventually allotted on a proportionate basis. In an open market offer buy-back can be made either through the book-building process⁵ or stock-exchange. In the former supply of securities proposed to be bought back is elicited and built up and their price is assessed for determining the quantum to be bought back while in the latter securities can directly be purchased through brokers. The third mode is buy-back of

securities from odd-lot holders. This term generally denotes those shares of a listed company which are not in the market lot fixed by the stock-exchange.

However, no buy-back must be made through negotiated deals, spot transactions⁶ or any private arrangements.

1. Pre-requisites

The procedure necessary for buy-back is described in Regulations 5, 5A and 19 and is as follows:

1. The Articles of Association must authorize the buy-back and where they do not contain such a provision, they should be amended appropriately.
2. The shareholders by way of a special resolution⁷ must authorize buy-back up to 25% of the total paid-up capital and free reserves. Such an approval must be by way of a postal ballot. The notice containing the special resolution must be accompanied by an explanatory statement stating all material facts, necessity for buy-back, class of security intended to be purchased etc. However, where the buy-back is or less than 10%, it may be authorized by way of a Board resolution. A copy of the resolution must be filed with SEBI and the stock-exchange(s) where the company’s securities are listed.⁸
3. The company must nominate a compliance officer⁹ for ensuring compliance of the Regulations, listing agreement and to redress the grievances of the investor. There must be at least one investor service center. In addition, a merchant banker must be appointed who shall besides other obligations, ensure that the company is able to implement the offer, that firm arrangements for payment are made, that the contents of the public announcement are true, fair and correct etc.
4. Additional procedural requirements under the respective modes¹⁰
5. Tender offer/Odd lots

1. The explanatory statement annexed to the notice or the public notice mentioned in point (2) below of this section must contain the following additional disclosures:-

• The maximum price at which the buy-back shall be made;
• Whether the Board is authorized at the general meeting to determine subsequently the specific price at which the buy-back may be made at the appropriate time;
• In case the promoters intend to offer their securities:¹¹ (a) the quantum of securities proposed to be tendered by promoters; (b) the details of their holdings for the last 6 months prior to the passing of the special resolution including information on number of securities acquired, the price and the date of acquisition.

2. Where a Board resolution is passed, the company must prior to a public announcement give public notice¹² which shall incorporate all those details similar to those of an explanatory statement as specified in Schedule I of the Regulations.

3. A public announcement¹³ must be made in the manner similar to that of a public notice and contain material information such as details of the offer, specified date, process and methodology to be adopted etc. as specified in Schedule II of the Regulations.

4. A draft letter of offer containing disclosures¹⁴ such as the necessity of buy-back, the process to be adopted, minimum and maximum number of securities proposed to be purchased, etc. must be filed with SEBI along with requisite fees within 7 working days of the date of public announcement. In addition, a copy of public announcement and declaration of solvency must also be filed with SEBI and registrar to the issue. Such declaration must be annexed with a report addressed to the Directors by the company’s auditors which must state, among other things that they have inquired into the company’s affairs and that the amount of permissible capital payment for the securities in question is properly determined.

5. The company must deposit in an escrow account by way of security for performance of its obligations on or before the offer opens a sum as specified in the Regulations. SEBI may exercise its power to forfeit the escrow account either in full or in part where the requisite formalities are not fulfilled and, consequently, such amount may be distributed pro rata amongst the security holders who accepted the offer.

6. Any modification specified by SEBI must be carried out by the company. Unless SEBI indicates otherwise, letter of offer¹⁵ should be dispatched to the security holders which must reach them before the offer opens. The offer should remain open for a period ranging from 15-30 days. Further, the date on which the offer opens should not be earlier than 7 days nor later than 30 days from the specified date. This date determines the name of the security holders to whom the letter of offer shall be sent and it shall be within 30 days from the date of a public announcement.

The company must complete the verification of the received offers within 15 days of offer closure. Further, lodged securities shall be deemed to be accepted unless a communication of rejection is made during that time. Where the number of securities offered by the holders is more than the total number to be bought, the acceptance would be made on a proportionate basis i.e. acceptances tendered should be divided by total acceptances received and multiplied by total number of securities to be bought back.

7. A special account must be opened with a banker to the issue immediately after the date of closure of the offer. The amount contained in this account together with the amount lying in the escrow account must make up the entire sum due and payable as consideration and should be deposited in such account at the time of opening of the account. Further, payment must be made within 7 days from the date of completion of verification of offers.

8. The security certificates bought back must be extinguished and physically destroyed in the presence of a registrar to an issue or the merchant banker or the statutory auditor within 15 days of completion of buy-back. Further, all the securities bought back must be extinguished within 7 days of the last date of completion of buy-back. The company must submit a certificate certifying such compliance to SEBI on a monthly basis.

9. Within 2 days of completion of buy-back, a post public advertisement must be issued in a national daily containing particulars such as the number and the price at which the securities were bought back, total amount invested, details of the security holders from whom securities exceeding 1% of total securities were bought back and the consequent changes in the capital structure and the shareholding pattern before and after buy-back.

10. The company must within 30 days of completion of buy-back file with the Registrar and SEBI, a return¹⁶ containing the particulars relating to buy-back.

Stock-exchange

As in case of a tender offer, the resolution must specify the maximum price at which the buy-back would be made. It is necessary that the stock-exchange should have nationwide trading terminals. The company and the merchant banker should give the information to the stock-exchange on a daily basis regarding the securities purchased for buy-back which must be published in a national daily. The identity of the company as a purchaser must appear on the electronic screen when the order is placed.

Book-building

The resolution must specify the maximum price at which the buy-back would be made. The provisions pertaining to appointment of a merchant banker, making of a public announcement, verification and extinguishment of certificates apply mutatis mutandis to book-building as well as stock-exchange as in the case of a tender offer. The provisions relating to escrow account are subject to the condition that deposit must be made before the date of public announcement and the amount must be determined with reference to the maximum price as specified in the public announcement. It must contain a detailed methodology of the process involved, the manner and format of acceptance, to be sent by the security holders and the details of the bidding centres.

The book-building process must be made through an electronically linked transparent facility. The company and the merchant banker must determine the buy-back price on the basis of received acceptances. The final buy-back price, which should be the highest price accepted should be paid to all holders whose securities have been accepted.

CONCLUSION

Buy-back is purely a commercial decision which may be resorted to for various reasons based upon a company’s needs. Where the company decides to implement a buy-back the aforementioned conditions, and procedure shall assume significance. The failure to comply with these may necessitate action by SEBI including criminal prosecution and an investigation with full powers to the officer to conduct the investigation similar to a trial. Therefore, it is imperative that the compliance officers and corporate legal departments ensure strict compliance with all these points.

1 Section 77A(1) of the Companies Act, 1956.

2 Section 77A of the Companies Act details the sources of buy-back, its pre and post requirements and penalties for non-compliance, 77AA deals with transfer of certain sums to CRR and 77B prohibits buy-back through any subsidiary company, investment company or where a default is made in repayment/redemption of loan, deposit etc.

3 A reserve fund into which profits are allocated for the purpose of redeeming or buying back shares in the company.

4 For the sake of brevity, each individual Regulation has not been cited and may be referenced in the SEBI Regulations.

5 A process by which supply of securities proposed to be bought back is elicited and built up and their price is assessed for determining the quantum to be bought back.

6 A foreign exchange transaction in which each party promises to pay a certain amount of currency to the other on the same day or within one or two days.

7 It must be passed by at least 75% of those voting in a general meeting, the intention to pass it as a special resolution must be specified in the notice calling it, a proper notice of 21 days along with the explanatory statement must be given.

8 In case of special resolution within 7 days and in case of Board resolution within 2 days of passing of a resolution.

9 A Board resolution must be passed for the appointment of a compliance officer and Form 1AA of the Companies (Central Government’s) General Rules and Forms, 1956 must be filed by the designated compliance officer with the Registrar.

10 Regulations 7-17.

11 Where promoters intend to offer their securities it is essential that a special resolution be passed at a shareholders meeting.

12 It must be given within 2 days of passing of the resolution in at least one English national daily, one Hindi national daily and a regional language daily, having wide circulation at the place where the registered office of the company is situated.

13 A public announcement must be made at least 7 days prior to buy-back in case of open market method.

14 Schedule III of Regulation 8(4) lists the disclosures to be made in the Letter of offer.

15 It must be dispatched only after 21 days have elapsed from the date it was submitted to SEBI.

16 Rule 5C and Form No. 4C of General Rules and Forms.