The share buy-back has long been an effective manner to consolidate ownership within a company. A share buy-back in many instances is also attractive from a tax perspective because it is considered a dividend and thus does not give rise to a capital gains event. Share buy-backs are governed by Section 48 of the Companies Act 71 of 2008 (“the Act”), which allows the Board of Directors (the “Board”) of a company to determine that the company will acquire its own shares, subject to a solvency and liquidity test.
The Board’s rights to implement a buy-back are however limited by S48(8)(b) of the Act which places a 5% threshold on share buy-backs, in that the Board only has the authority to re-acquire 5% of the issued share capital in any one share class. Once this 5% threshold is exceeded the Act seems to consider the transaction a scheme of arrangements, and subject to the requirements of S114 and S115 of the Act. In terms of the Act, the implementation of a scheme of arrangement requires that the Board appoint an independent expert to compile a report to inform the shareholders of the effects of the proposed buy-back. The shareholders are then required to approve the transaction by way of a special resolution.
Now while a 5% threshold may seem reasonable in the context of listed companies or private companies with shareholders who are otherwise uninvolved in the management of the business, the inverse is true in the case of an owner managed business. The requirements of S114 of the Act, specifically the independent report, can be seen as onerous and costly in the context of a “friendly share buy-back”, this being a buy-back in which both shareholders and management determine that a buy-back would constitute a good exit or consolidation strategy.
So the question that one must then ask is, does a share buy-back which exceeds the 5% threshold under S48(8) automatically become a scheme of arrangements? This seems to be a rather contentious question with some learned individuals arguing that a company re-acquiring its shares by means of a scheme of arrangement as envisioned by S114 is irreconcilable with a share buy-back in terms of S48(8). In that S48 is there to deal with casual, or once-off, decisions to re-acquire shares in a manner which does not amount to a restructuring of the company’s capital structure. It is therefore argued that S114 is envisaged to administer the implementation of fundamental changes to a company’s capital structure.
It is however also important to consider the intention of S114 & S115 of the Act, being the protection of shareholders and the limitation of Board power. A prudent Board would therefore have to be mindful of the effect of the proposed buy-back, not only on the company and its capital structure but also to the shareholders before making a determination as to whether or not the move to re-acquire shares would constitute a scheme of arrangements. The Board should thus consider if any one or more of the shareholders would be prejudiced by a failure to comply with S114, if the answer would be in the affirmative then the transaction would surely not be considered “friendly” and as such S114 should be applied strictly.
In light of the perceived conflict between S48 and S114 it may be practical in instances of a “friendly share buy-back” to favour a wider interpretation of S48(8), one which excludes the operation of S114 of the Act. In adopting a wider interpretation of S48(8) share buy-backs may be implemented in a more cost effective and expedient manner, which is of great importance to business in the current financial climate.