This article is written by Suresh Gupta, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Introduction

Buyback of shares is the repurchasing of own shares by the Company from existing shareholders at a premium that prices over and above market price. Buyback of shares is a method for reduction of share capital A working group on companies Act, 1956 constituted under the chairmanship of Dr K.R. Chandratre in 1997 and group recommended for introduction of law relating to buyback of shares in India vide Companies (Amendment) Act, 1999. 

Indian Companies like Reliance Industries, Ashok Leyland and Bajaj started to buy back their shares. It was a strong belief that repurchase of shares will be financially beneficial in many ways like if a company distributes excess cash and it helps to improve operational efficiency and earning per share will increase. The share prices will also increase due to an increase in P/E Ratio is expected after the buyback. 

A lower debt-equity ratio company may reduce equity capital through a buyback mechanism to achieve an optimal debt-equity mix to improve the cost of capital of the company. It is an alternative mode to reduce equity shares without the approval of the National Company Law Tribunal (NCLT) and prevent a hostile takeover bid, provide an additional exit route to shareholders specially unlisted company shares.

The important key aspect about buyback of shares

There are several conditions, restrictions and prohibitions for the buyback of shares:

• The company will not borrow money to fund the buyback.
• The company shall ensure that the buyback offer one announced can’t be withdrawn.
• A company repurchasing its own shares will not issue fresh capital except the issue of bonus shares, for the next 12 months.
• Only fully paid-up shares are eligible for the purpose of the buyback.
• No company shall buyback its own shares;

1. Through any of its subsidiary company, investment company or group of investment companies;
2. If the default in the repayment of deposits and interest payable thereon, the redemption of debentures and payable interest or preference shares or payment of dividend or repayment of any loan or interest payable thereon to any financial institution. However, the buy-back can be made, if a period of three years lapsed from the date of such default ceased to subsist; and 
3. In case of noncompliance of provisions Sections 92 (non-filing of annual return), 123(failure to pay a dividend), 127 (punished for the non-payment of dividend) and Section 129 (failure to prepare financial statement) of the companies Act, 2013.

Legal framework for buyback process 

For private companies and unlisted public companies

The Private Company and unlisted public company having a share capital shall be governed by the provision of Sections 68, 69 and 70 of Companies Act, 2013 and Rule 17 of Companies (Share Capital and Debentures) Rules, 2014 (“Rule”).

For listed companies 

A company listed on a recognized stock exchange shall have a compiled provision applicable on unlisted public companies and Securities Exchange Board of India (Buyback of Securities) Regulation, 2018 as well.

Source of funding of buyback 

A company may fund buyback from:

1. Its free reserve (distributable profit i.e., the amount available for distribution dividend is a free reserve);
2. The securities premium account; or
3. The proceeds of the issue of shares or other specified securities. However, the Company shall not utilize the proceeds of an earlier issue of the same kind of shares for the buyback.

Authorization for buyback 

The company must be authorised by Article of Association(‘AOA’) of Company unless otherwise made amendment of Article of Association by the due procedure provided under the provision of Companies Act, 2013.

Quantum of buyback 

Approval of Board of Directors by way of board resolution

Buyback of shares up to 10% of total paid-up equity share capital and distributable profit of the company.

Consent of shareholders by way of special resolution 

Buyback of shares up to 25% of total paid-up equity share capital and distributable profit of the company. In the case of a listed company, a special resolution shall be passed by the shareholder only through postal ballot.

Every buyback of shares shall be accomplished within 12 months from the date of approval of buyback obtained through special resolution or resolution passed by the board, as the case may be.

In recent case D–Link India Limited vs. the Securities Exchange Board of India

In this case, D-Link India Ltd failed to initiate any buyback within a 12 months period, due to which its shareholder resolution lapsed. SEBI initiated action against the company on the ground that the company never had any intention of buying back its shares and passed a resolution for the purpose of misleading the investors. SEBI passed an order stating that the company violated regulation 5(1)(a) of SEBI(Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) regulation, 1995. The company was directed not to buy, sell or deal in securities in any manner directly or indirectly for a period of one month. The company has filed an appeal to the SAT against the SEBI order. SAT overturned SEBI’s order.

Filing of letter of offer 

The company authorized by a special resolution shall, before issuing of a letter of existing shareholders, be dated and signed by two directors, one of whom must be managing director, if any. Letter of the offer shall be filed with the Registrar of Companies in Form SH-8 along with an applicable fee.

Filing of declaration of solvency with Registrar of Companies (ROC)

A declaration of solvency in form SH-9 shall be filed to Registrar of Companies and Securities and Exchange Board of India (in case of a listed company) along with a letter of offer and applicable fee and signed by the two directors of the company, one of whom shall be the managing director, if any, and verified by an affidavit as specified in the said Form.

Dispatch of letter of offer

The letter of offer shall be forwarded to the existing shareholders immediately after filing with the Registrar of Companies but not later than twenty days from its filing.

Buyback offer period 

The offer for buy-back shall be open for a period of a minimum of fifteen days and not more than thirty days from the date of communication of the letter of offer.

However, shareholders may agree to a buyback period less than fifteen days from the date of communication of the letter offer.

Methods of buyback

1. Tender offer

The company repurchases its shares from existing shareholders at a fixed price within a stipulated time frame. The promoters and shareholders of the company are allowed to offer their shares for the buyback. Company shall issue a letter of the offer along with tender form to all existing Shareholders as on buyback record date. Eligible shareholders participate through Demat accounts.

2. Open market

Under the open market method, a company can do so either through a book building process or stock exchange.

Buyback of shares through the book building process 

Under this method, the buyback of shares shall be processed through an electronically linked bidding system. The company shall appoint a merchant banker to handle the buyback procedure and determine the buyback price. The company fixes the price band and shares to be purchased from the market during a given time period and the company has the option to lower the price and number of shares as per the prevailing market conditions. Promoters are not allowed to take part under this method.

Buyback of shares through stock exchange 

Under this method, companies fix the price at which buyback offers shall be made to the shareholders and shares purchased through stock exchanges having nationwide trading terminals via an order matching mechanism. All existing shareholders are allowed to participate in this offer except promoters. 

Buyback of shares through odd-lot holders 

An odd lot holder is a shareholder with shares less than a marketable lot as specified by the stock exchange. The company shall buyback shares directly from odd-lot holders. 

There was buyback of equity shares done by listed companies during the following financial year;

Source: SEBI Annual Report 

Acceptance and verification of buyback application 

In case of oversubscription of the buyback offer, the acceptance of buyback offer shall be on a proportionate basis.

The company shall verify all buyback offers within fifteen days from the date of closure of the offer. The company fails to verify that the within stipulated time frame shall be deemed to be accepted. In case of rejection of buyback offer within 15, communication of rejection shall be made within twenty-one days from the closure of the offer.

Now all companies shall have an International Securities Identification Number (ISIN) and shareholders shall convert their physical shares into Demat account to participate in the buyback process and private limited company shareholders are free to participate through physical shares.

Opening of separate account and payment to shareholders 

The company shall open a separate bank account after the date of closure of the offer and deposit such sum, as would make up the entire sum due and payable as consideration for the buy-back of shares.

The company shall make payment of consideration to those shareholders whose securities have been accepted within seven days from the date of verification of Buyback offer or return the share certificates to the shareholders whose securities have not been accepted at all or return of share certificate of balance securities, in case of partial acceptance. However, whereof shares in Demat account (electronic form) return of share of the certificate shall not be applicable.

Post buyback compliance 

1. It shall extinguish and physically destroy the shares so buyback within seven days from the completion of buy-back;
2. The company shall maintain a register of shares buyback in Form SH-10 and shall be kept in custody and authentication of entries shall be made by the company secretary or any person authorised by the board. The register of buyback shall be kept at the registered office of the company;
3. The company shall file a return containing the particulars of buyback in Form SH-11 with the Registrar of Companies and the Securities and Exchange Board of India (in case of listed companies) along with the prescribed fee within thirty days of such completion and annexed a certificate in Form No. SH-15 signed by two directors of the company and one of them shall be managing director, if any, certifying that the buy-back of securities has been made as per conformity with the provisions of the companies Act, 2013 and rules made thereunder;
4. When funding the buyback from free reserves or securities premium account, a sum equal to the nominal value of the shares so purchased shall be transferred to the capital redemption reserve account and such transfer to capital redemption reserve shall be disclosed in the balance sheet. The capital redemption reserve account may be used by the company, to issue fully paid bonus shares to shareholders of the company;
5. The ratio of the aggregate debts owed by the company after buy-back shall not be more than twice the paid-up capital and its free reserves i.e. the ratio shall not exceed 2:1. However, the Central Government notified debt to equity ratio shall be 6:1 for the Non-Banking Financing Institution (NBFC) and Housing Finance Companies.

FEMA Compliance

In case of buyback of shares from person resident outside India Foreign Exchange Management Act, 1999 shall applicable and Reserve Bank of India (RBI) has now put the buyback of shares under automatic route subject following condition:

1. The company must be eligible for automatic investment route under the FDI policy and must not be restricted;
2. The pricing of shares as per RBI guideline;
3. Form FC-TRS along with other annexures and information is filled with an authorised dealer.

Conclusion

It is an internal corporate restructuring mechanism used by Indian companies to increase earnings per share (EPS), provide exit routes to shareholders when IPO or individual deals fail and support the undervaluation of their stocks in capital markets. As per a news report published on Moneycontrol.com, Online brokerage firm Zerodha is planning to buyback shares issued to employees under the employee stock option scheme (ESOP) valued at $25 million (RS 150-200 crore). It offers an opportunity for the company to use its liquidity position to bring back its own shares today and issue them in future. The shareholder gets a premium price (in excess of the current market price) by selling their shares to the company during the buyback.

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